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Market Perspectives Oct 2013

October 2nd, 2013


The Good  The Chinese flash PMI rose to 51.2, a six-month high.  Personal income and spending edged higher than expectations.  Households' financial health shows a continuous and significant improvement  Durable goods new orders and ISM appear to be recovering The Bad  Inflation remains too low. With inflation continuing to undershoot the Fed's inflation target, and millions remaining unemployed, policy action is needed more then ever  Clear weakening in pending home sales: The housing recovery has slowed, but it is still ongoing  Consumer confidence continues to disappoint on both the Conference Board and Michigan measures. The September reading of the Michigan Consumer Sentiment is at its lowest level since April. The confidence gap is higher then ever.  ISM-NY current business conditions index fell to 53.6 last month from 60.5 the previous month  September’s U.S. ADP jobs data (ex-agriculture and government) missed expectations (+166k vs. +170k) and August’s gains were revised lower (to +159k from +176k)  This month, the government of Poland confiscated all bond holdings of the private pension funds in the country to transfer them to the state pension vehicle (ZUS). In this scheme, new confiscated assets net out sovereign debt liability, lowering the debt/GDP ratio. The Ugly  US budget crisis: The two themes, the shutdown and the debt ceiling, have become linked. A shutdown might cut GDP by as much as 1.4%. Consumers, foreigners, and markets may lose confidence if the debt ceiling deadline is approached  Syria, although the reduced chance of military action against it, at this stage 2 FinLight Research

Households’ Financial Health

Household net worth now stands at $74.8 trillion, up some $4.5 trillion from the previous (March '13) estimate, and up $18.4 trillion from the recession low. Virtually every metric (Debt, real estate, financial assets) of households' financial health has shown significant improvement over the past several years.

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Consumer Confidence

The University of Michigan Consumer Sentiment final number for September came in at 76.5. This is a 4.6 decline from the August final reading of 82.1.

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Consumer Confidence


Although more volatile, the broad pattern and general trends of the Conference Board Index are remarkably similar to those of the Michigan Index. The NFIB Business Optimism Index shows that small business owners are in a similar mood

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Confidence Gap

The following chart from Bespoke tracks an interesting breakdown in consumer confidence -- those with incomes of $35K versus $50K+. It clearly shows that the confidence gap is higher then ever.

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There was a dip in the Consumer Confidence Index in September. However, the percentage of respondents to this survey who agreed that “jobs are hard to get� dropped to 32.7%, the lowest reading since September 2008 Improving jobs-hard-to-get survey sees jobless rate under 7% soon

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Good news: the average unemployment duration is going down.

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Disposable Personal Income (DPI)


The August nominal 0.38% month-over-month and 2.03% year-over-year numbers put us approximately back to the trend we saw near the end of last year prior to the forward pull of income and subsequent plunge to manage expected tax increases. However, when we adjust for inflation, the real MoM change is trimmed to 0.25%, and the real YoY is a discouraging 0.87%  An economy without real disposable income growth is heading for trouble.

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Personal Consumption Expenditures & DPI

DPI and PCE are still in line. Their growth rates look however sluggish.

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Big Four Indicators

The overall picture of the US economy remains one of a ploddingly slow recovery from the Great Recession

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Big Four Indicators

A zoom on the average of the big four indicators confirms that the economic improvement is still here but slowing‌

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Capital Spending

YoY percentage changes in orders for capital goods (ex-defense and aircraft) shows that capital spending appears to be recovering, which should feed through to better earnings for the industrial and technology sectors

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the ISM manufacturing index rose from 55.7 in August to 56.2 in September while the Markit manufacturing PMI’s headline declined from 53.1 to 52.8

The ISM nonmanufacturing index’s headline fell from 58.6 in August to 54.4 in September, which was the largest monthly decline since November 2008

The drop-off in September brought the ISM down to a level which is more or less consistent with 2.0% real GDP growth in 3Q.

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Economic Surprises

Citigroup Economic Surprises Index appear to have reached a high and turning lower.

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The September Final GLI places the global industrial cycle on the border of the ‘Slowdown’ phase, characterized by positive but falling Momentum.

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The short-term setup for stocks is difficult to read.


UW US stocks, OW VIX

We prefer to keep a long volatility bias into October, given policy uncertainties…

The bulls still hold a slight but discernible advantage over the bears. For how long ? This is the question… There are increasing signals of a material top building In term of secular trend, the current level of Tobin’s Q-Ratio is close to the vicinity of market tops, with Tech Bubble peak as an extreme outlier.

OW EM stocks and European stocks vs US stocks The rebound in global manufacturing is confirmed by September’s global PMI, implying a OW position on Cyclical vs. Defensive sectors.

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Secular Trends: Q-Ratio

The Q Ratio (developed by J. Tobin) is the equity market value divided by the replacement cost of all its companies. The calculation is done with the Federal Reserve Z.1 Financial Accounts of the United States

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Secular Trends: Q-Ratio

The current level is close to the vicinity of market tops, with Tech Bubble peak as an extreme outlier.

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Secular Trends: Crestmont P/E


Crestmont P/E is similar to the Cyclical P/E10 ratio Its current level of 23.5 is 70% above its average of 13.8. It puts the current valuation at the 96th percentile of these 140 years.

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Equity : Value vs Growth

The market is playing the divergence between a maturing cycle in the U.S., and Europe where we are leaving the double dip

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Equity: Quality-Index Ratio

The S&P 500 High Quality Rankings Index comprises those constituents in the S&P 500 with a Quality Ranking of A- and above.

The S&P 500 Low Quality Rankings Index comprises those constituents in the S&P 500 with a Quality Ranking of B and below, excluding companies with scores of D or in liquidation.

The S&P500 seems in line with the Highto-Low Quality Rankings ratio, but approaching a top

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US Stocks

The bulls still hold a slight but discernible advantage over the bears

The 50-day MA has acted as technical support, which the index has not breached yet

The behavior of the higher beta small cap Russell 2000 Index confirms the bullish trend. The Russell 2000 has achieved double breakouts and remains in an uptrend

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US Stocks

But the momentum of the S&P500 uptrend remains poor. There a real risk of another retrace towards the uptrend from the Nov. ‘12 low at 1,665. Going below that point seems unjustified, at this stage.

If a break below 1665 coincided with a break of the June peak on the VIX (21.9), it could be a bearish signal.

Bulls would feel more comfortable if S&P500 close back above the recent highs (1710)

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US Stocks


Our trading model became massively short as soon as we breached 1722. Under 1700, it became long, targeting 1722 again. However, 2 systems are still short with a target at 1638 and 1622. There is a little bias to be long, at this stage, as far as the 1655 level is preserved.

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EU Stocks

We see a steady increase in demand for equities from European investors. Driven by improvements in the data. The flows we are seeing are consistent with the pick-up in the survey data

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EU Stocks

The CAC is still testing the 4170-4360 pivot area. There is, however, no reason to be aggressively bullish ‌

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US Stocks

Since its high of May 22nd, the risk appetite index (RAI) has been drifting lower, driving down the 6mmomentum in US stocks. The RAI stands in neutral territories.

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US Stocks


VIX is now oscillating between the low and medium regimes. It has been doing so since the beginning of 2013 (similar to 2004 but with more uncertainty in macro data). Since Aug 15th, VIX is back in Medium Regime. The probability of being in Low Regime is going down. Source : Bloomberg & FinLight Research calculation


VIX Index


Probability in Low Regime

Most Probable Regime

75.0% 75






0.0% 35



5 01/01/1990 27/09/1992 24/06/1995 20/03/1998 14/12/2000 10/09/2003 06/06/2006 02/03/2009 27/11/2011 23/08/2014 19/05/2017

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US Stocks

Factory orders (a good proxy for the physical side of the economy) seems to validate the performance of the equity market. It is less the case for Durable Goods Orders

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On the short term, overall risks seem skewed towards lower rates in the US. Some signals point to increased chances of a material retrace of the recent up move in UST yields We stay biased towards higher yields over the medium-term, but wait for better levels to put on our shorts.

The curves appear to be set to flatten over time. The UST curve has started to flatten quite significantly. We should keep the US 10yr-2yr spread on the radar.

On the medium term, the downside risk looks predominant in HY

Bottom line : OW Govies and wait for better levels to enter shorts, set curve flatteners, OW European High Yield vs High Grade because of continued good economic news in Europe, OW EM sovereigns

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Some signals point to increased chances of a material retrace of the recent up move in UST yields : The 10y UST yield broke the uptrend from May 3rd, and failed in preserving the 2.70 support. A clean weekly close back below 2.65 (old primary downtrend from 2700) could start a more significant retrace Next big pivot / support to watch ~ 2.53, then the 2.42-2.35 area

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Current CFTC net speculative positions are highly skewed to the short side, suggesting limited appetite to enter new shorts‌ That points to an imminent upward movement in treasuries. Shortcovering could accelerate the move.

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Given the technical setup in place, the curve should flatten quite materially over time.

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Italian 10-yr yields seem to be forming a reverse head & shoulders. There is a bias towards higher yields on Italian bonds. The opposite with regard to Eurozone sentiment.

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HY looks a bit expensive to IG now. This situation should persist for a while as we expect the highyield default rate to remain well below its 4.0% long-term average over the next year (unless exceptional tail risk crisis).

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Given the rolling default rate of barely 1%, there seems to be good medium-term value in US high yield spreads.

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However, High Yield has never been so expensive compared to equities.

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An upgrade-to-downgrade ratio degradation should give the signal for an upturn in default rates (like end 2007). On the medium term, the downside risk looks predominant in HY

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Last week, we saw commodity linked currencies losing their luster. This week, EM currencies were the key movers, all shifting back towards strength EURUSD remains around 1.35, which is quite a high level relative to Treasury-bund spreads. Keep an eye on the 2y spread between Germany and US. It would give a strong signal on the EURUSD spot Neutral EUR vs USD between 1.33 and 1.37. Given the configuration of DXY, the 1.3711 resistance should hold.

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Two things are acting against the UD dollar:  The US budget crisis, government shutdown and debt ceiling  Fed's decision to delay tapering

The Commitment of Traders speculative positioning in the CME currency futures shows that:  The net long euro (vs US$) position is the largest since May 2011.  The euro has the largest gross long speculative position of almost 130k contracts.

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Net non-commercial futures positions is more compatible with a level of 1.40-1.50 on the EUR-USD

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Compared to the sovereign spread between Germany and US, EUR-USD stays too expensive.

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When the 2-year spread does eventually make a clean break from its multi-year consolidation (0bps and 35bps) it will probably give a very strong signal on the EURUSD spot

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Based on its historical behavior since 2010, a weekly close of EUR spot back below the 200-wma (1.335) would indicate a reversal to the downside.

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On precious metals (gold and silver), the market seems increasingly at risk of resuming its prior trend lower  UW gold & Silver. Wait for a trend to develop before entering the market

The rebound in PMIs justifies our OW in commodities as a whole, but also in energy and base metals (copper in particular).  Take profit from the high roll premium of over 1% per month in BRENT futures (half in WTI futures)

OW grains as supply expectations continue to be revised down sharply

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Corn, wheat and soybeans cost 28% less today than they did a year earlier, as supply expectations continually surprised to the upside. Agriculture prices have stabilized somewhat over the last couple of months  The downside trend seems to be coming to an end.

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Precious Metals


Last week we saw one huge withdrawal out of COMEX eligible gold stocks that led to a new cyclical low for total COMEX gold inventories, and brought them down to a level not seen since 2005. This large withdrawal, done in one day from the HSBC warehouse, represents more than 5 tonnes of gold, 3% of total COMEX gold inventories, and 5% of all gold held at the HSBC warehouse. This move is curious enough to be worth noting‌ Is it the beginning of a new hemorrhage?


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Precious Metals


After the corrective move from the Jun. 28 low to the Aug. 28 high, the market seems increasingly at risk of resuming its prior trend lower. 1275 is the important pivot to watch. If the downturn is confirmed, 1180 would be the short term target.


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Precious Metals


 Our theoretical price (using US$, sovereign CDS and Real Rates) stands at 1260, versus a market price 5% higher.

1950 GOLDS Index

1750 GOLD Fair Value (USTW$+CDS+Real Rates adjusted)




1150 950







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


US 10y-TIPS (r.h.s, inv.)

1600 18/11/2010


Source : Bloomberg data, FinLight Research calculations 350 28/05/2005 10/10/2006 22/02/2008 06/07/2009

-1.5 Gold















3 Source: & FLR calculation












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10y - US Real Rates


Bottom Line: Global Asset Allocation


OW EM stocks and European stocks vs US stocks

Overweight commodities, base metals, energy and grains. Underweight precious metals

OW position on Cyclical vs. Defensive sectors. Keep a long volatility position OW Govies and wait for better levels to enter shorts, set curve flatteners, OW European High Yield vs High Grade because of continued good economic news in Europe, OW EM sovereigns

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