market-perspectives-oct-2017 by Finlight

Market Perspectives October 2017

Oct. 20th, 2017 www.finlightresearch.com

They're telling you to buy at any priceâ&#x20AC;Ś

â&#x20AC;&#x153;If the underlying exposure is poorly liquid, ETF may offer superior liquidity, benefiting from the liquidity of the order book and the liquidity of market makers. The liquidity benefit of ETF requires the ETF secondary market (on-exchange + off-exchange) to be balanced, e.g. ETF sellers meeting ETF buyers. In case of a one-way market or a selloff, ETF secondary market liquidity might disappear. ETF liquidity could then become equivalent to that of the underlying assets and could be potentially low if these are poorly liquid, which might induce unexpected liquidity costs for investors

â&#x20AC;?

- SocGen note

2 FinLight Research | www.finlightresearch.com



It’s worth noting the last time the Economist came out with a similar bullish cover… 



Investors that, 6 months ago, were doomsayers are now speaking of a blow-off top.



Is that CAPITULATION of bears ?

Source: http://www.themacrotourist.com/

3 FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation 



   

We witness a revival of the reflation trade theme on the back of positive macro, the hawkish Fed repricing. and renewed optimism surrounding the release of the Trump’s tax reform plan Markets are roaring in optimistic mode with equities making new highs, cyclicals and financials outperforming, bond yields moving up, volatility and credit spreads shrinking, and industrial metals outperforming the commodity complex. We also see overbought signals and optimistic valuations High-yield credit spreads and volatility remain at complacent levels. Even some of the most passionate bears seem to be throwing in the towel, talking about a "final" melt-up. Massive short positions are put in VIX / VIX futures, making any short covering a nightmare… Markets seem to be priced for perfection. A lot of things need to continue to be right for the current levels in equity valuation /vol / credit spreads to continue to be justified.

20/10/2017 View

We remain worried about the eventual unwind of QE holdings and reduced liquidity in global markets. We summarize our views as follows 

20/07/2017 View

19/06/2017 View

12/05/2017 View

Oct'17

Aug & Sep'17

Jul'17

Jun'17

May'17

Equity

S&P 500

Euro Stoxx 50

Fixed Income

T-Note 10Y

Bund 10Y

US TIPS

Euro HICP

Credit

Inv. Grade

US High Grade

EUR High Grade

High Yield

US High Yield

EUR High Yield

EM Sovereigns

Forex

N/A

EUR-USD

USD-JPY

NIKKEI 225 MSCI Emerging Markets

Commodity

Base Metals

Precious Metals

Agri

Alternatives

Return Enhancers

Risk Diversifiers

Energy

We see more signs of capitulation of bears. Is that the signal for a maturing cycle?

01/09/2017 View

4 FinLight Research | www.finlightresearch.com

MACRO VIEW



The Good Manufacturing data point to underlying strength in the U.S. economy. The ISM Manufacturing Index surged above 60 for the first time in 13 years. ISM services also registered a huge move. In the Eurozone, September business surveys were strong. Flash Eurozone composite PMI new orders rebounded to a 6-year high of 56.3 in September, a level that is consistent with a GDP growth of 3%



The Bad US Employment news was mixed, probably a result of Hurricanes Harvey and Irma : Total nonfarm payrolls decreased by 33K in September. Numbers for July and August were also revised downward by 38K. Productivity growth remains sluggish (stuck near its lows) New Residential Housing Starts was down again, in September



The Ugly : Besides geopolitical risks… Main systemic risk resides in China because of high leverage, risk from the shadow banking bubble and potential resurgence in yuan devaluation fears. Property (which remains a key variable for the growth/risk outlook in China) may be the (unexpected) catalyst Brexit risk is still not resolved. Negotiations over Britain’s exit from the European Union may weigh on markets in an unexpected way. ETF liquidity: We remain convinced that their current success lies at their vulnerability to any significant shock (specially in the Fixed Income sphere) . 5 FinLight Research | www.finlightresearch.com

Macro is Getting Better

 

The Citi economic surprise index tends to show that recent macro date releases exceeded expectations. This improved macro environment coincides with the revival of the global reflation traded  Hawkish Fed repricing.

6 FinLight Research | www.finlightresearch.com

US GDP vs PMIs



The ISM manufacturing PMI is impressive.



BUT, a stark divergence has emerged between the it and Markit manufacturing PMI.



If it is indeed the ISM PMI that is "right“, then the outlook for US GDP growth would be turned upside down. A GDP growth around 5% (instead of 2%) should be expected, then…



This is not really our main scenario!

7 FinLight Research | www.finlightresearch.com

The Big Four Economic Indicators

 

The current picture is characterized by relatively strong Employment and Income, an Industrial Production (weakest link since the GFC ) in recovery mode and Real Retail Sales showing signs of improvement After having been trending lower since Nov. ‘14, the average of these indicators has started getting better mid-2016. The average is now receding from its previous highs.

8 FinLight Research | www.finlightresearch.com

Inflation Expectations

ď&#x201A;§

YoY changes in crude oil prices have been, historically, a good proxy for Developed Markets inflation surprises (actual to expected inflation difference)

ď&#x201A;§

Given our views on crude (rangy for a while), we expect DM inflation to be flat, and even biased to the downside

Source: Citi

9 FinLight Research | www.finlightresearch.com

Red Flag 1: Productivity Remains an Issue…



US Productivity remains stuck near its historical lows.



At current productivity growth of around 0.5% (annualized), the only way to maintain GDP growth near 2% is to insure an employment growth of 1.5% indefinitely!

Source: Deutsche Bank

10 FinLight Research | www.finlightresearch.com

Red Flag 2: Household Net Worth vs Disposal Income

ď&#x201A;§

The ratio of US households' net worth to disposable income has hit 670%, pulverizing its previous records (620% during the tech bubble and 660% just preGFC)

ď&#x201A;§

An important part of this spectacular move in household net worth is due to the euphoric move in FANG stocks (and their amazing 130 P/E)

11 FinLight Research | www.finlightresearch.com

Red Flag 3: Construction Spending

ď&#x201A;§

Since the beginning of 2015, the total (residential and nonresidential) construction spending has decelerated substantially.

ď&#x201A;§

YoY Construction spending growth is now heading towards zero.

12 FinLight Research | www.finlightresearch.com

Red Flag 4: China Private Debt

 

China’s private sector debt service ratio is now well above the level seen in the US before the GFC In the same time NPL ratio is around the highs seen since 2009

Source: Deutsche Bank

13 FinLight Research | www.finlightresearch.com

EQUITY



Global equity markets had continued to make new highs, helped by more fiscal easing optimism in the US and strong economic data releases.



On most measures US equities look expensive. But, for now, The earnings picture is still looking solid and financial conditions remain supportive for equities. This is enough to keep valuation behind the scene.



Momentum in equities is still intact. But we still see an increasing risk of a correction, as sentiment indicators seem too stretched to the upside.



Bottom line : According to our positioning rules, we’ve turned again tactically OW on equities as the S&P500 broke above 2495. Our positioning rules on the S&P 500 are adjusted as follows:  We will turn Neutral again below 2490  We will turn UW after a clean break below the uptrend through the lows since Feb.’16  We’ll be Neutral between 2490 and the trend across the lows since Feb. ‘16 We stay medium-term OW equities vs bonds on a view that a recession is still some time away We move back from UW to Neutral on Japan vs. US stocks as the Yen seems to have reached a ceil against the US dollar. We keep our UW Europe as we remain cautious on the outlook for European relative to US equities. We expect fading Euro area PMI momentum and rising real yields to weigh on European 14 FinLight Research | www.finlightresearch.com

EQUITY



Bottom line :



equity momentum over the coming months. Furthermore, the « tax reform theme » should favor US equities.



In September, the revival of Trump’s reflation trade has benefited small caps vs large caps, reversing the prevailing trend (large caps outperforming small caps) in 2017. We move to Neutral US small vs large caps. We continue to avoid financials (despite the fact that they remain the key beneficiaries of rising yields and inflation).

 

We remain Neutral value vs growth stocks. We maintain our OW defensives vs cyclicals, for at least 2 reasons:



Cyclicals are trading on a 13% Shiller P/E premium relative to defensives, the highest level in more than 10 years.



Cyclicals are expected to underperform as PMI momentum fades



Over the past 6 months, EM equities have outperformed global and US equities thanks to a combination of falling bond yields, a weaker USD and rising industrial metal prices. Furthermore, EM EPS are actually outperforming expectations



We remain UW EMs vs DMs. Over the short-term, sentiment seems stretched to the upside, and vulnerable to commodity prices and to a strengthening in USD. We see little support for EM relative performance from falling yields from here. EM valuations are also near the upper end of the historical range.. 15

FinLight Research | www.finlightresearch.com

Relative Value – Small Caps vs Large Caps



In September, the revival of Trump’s reflation trade has benefited small caps vs large caps, reversing the prevailing trend (large caps outperforming small caps) in 2017.



Investors rotation into small caps was probably driven by the news about the coming tax reform, from which (more domestically-focused) small caps have more to gain.



We move to Neutral US small vs large caps.

16 FinLight Research | www.finlightresearch.com

Relative Value – European vs US Equities



According to DB analysis, the Euro area PMI momentum explains around 70% of the variance in Stoxx 600 momentum



Euro area PMI momentum stands now at 0+. But we expect it to turn down over the next 3 months, driving the price momentum for European equities in negative territories.



Our negative view is due to the current level reached by the Euro area flash composite PMI new orders (>56, the highest since 2011) which is consistent with a 3%+ annualized GDP growth (too much for us!).



We keep our UW Europe vs US stocks

17 FinLight Research | www.finlightresearch.com

Relative Value – EM vs DM Equities



Over the last 12 months, EM equities have been flat versus DM equities;



This seems consistent with 1%-2% further move in relative GDP growth.

Source: Deutsche Bank, Bloomberg

18 FinLight Research | www.finlightresearch.com

Market Sentiment – Investors are Bullish…



The TD IMX Index is based on buying / selling data derived from TD Ameritrade's brokerage business to provide an insight into retail investors positioning.



The TD IMX moved down from extreme levels reached in September. But it’s still very high.



19 FinLight Research | www.finlightresearch.com

Market Sentiment – In European Equities too…



European equity investors positioning (and, thus, sentiment) is approximated here by the 3month beta of a set of Europeanfocused equity funds vs the Stoxx600.



This proxy has recently reached its 3-yearhighs before moderating a little bit.



Looked at through its (more stable) 3-month MA, the positioning proxy is still close to its historical highs.

Source: JP Morgan, Bloomberg

20 FinLight Research | www.finlightresearch.com

Market Sentiment â&#x20AC;&#x201C; Greed is the King

ď&#x201A;§

The CNN Money Fear and Greed Index has moved to the highest level over the past 2 years.

Source: CNN Money

21 FinLight Research | www.finlightresearch.com

Market Sentiment – And Euphoria the Queen…



The Topdowncharts.com “Euphoriameter” quantifies investors sentiment through a mixture of 3 signals : the VIX level, the forward PE ratio and the bull/bera surveys (AAII and II surveys)



Current level seems to point to an extremely euphoric sentiment  We are probably in the later stages of a bull market

22 FinLight Research | www.finlightresearch.com

Market Sentiment – Consumers Exuberance is Back



Stock market expectations have never been higher



This chart from Dana Lyons shows the University of Michigan Survey of Consumers "Probability of Increase in Stock Market in Next Year"



Currently, more than 62% of respondents expect stocks to be higher over the next 12 months. More than 10% of respondents think that this scenario has a 100% chance to occur!

 

This level of optimism was last encountered around the 2007 peak and the 2015 local top.

23 FinLight Research | www.finlightresearch.com

Implied Correlation & Skew: Caution Should Be The Rule

ď&#x201A;§

Implied Correlation Index has returned to levels last seen around the 2007 market top. Statistically, implied correlation troughs tend to be close to market tops (at least local ones)

ď&#x201A;§

At the same time, the uptrend in the Skew seems to signal that tail risk hedges are getting more expensive as demand for hedge increases.

24 FinLight Research | www.finlightresearch.com

S&P500 – A Long-Term Perspective



The cyclically adjusted price to earnings ratio (CAPE, here, adjusted by Hussman Strategic Advisors for equity margin evolution) has reached levels last seen during the tech bubble and near 1929 highs.



These levels are consistent with very poor investment returns over the coming 12 years.

25 FinLight Research | www.finlightresearch.com

S&P500 – A MT to LT Tech. View



Technically, the market seems approaching an inflection point. 2620 is the next level to watch.



However, the S&P500 still has room to extend its move towards 2720-2750.



According to our positioning rules, we’ve turned again tactically OW on equities as the S&P500 broke above 2495.



We will turn Neutral again below 2490



We will turn UW after a clean break below the uptrend through the lows since Feb.’16



We’ll be Neutral between 2490 and the trend across the lows since Feb. ‘16 26 FinLight Research | www.finlightresearch.com

S&P500 – A Short-Term Perspective



The S&P 500 RSI is flashing an overbought signal



We should expect, at best, a period of consolidation, from here A sell-off is also possible.

 ..

27 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT GOVIES



Market optimism about the US/global. economy and the Trump’s tax reform plans pushed treasuries lower (yields higher).

 

The revival of the reflation theme also drove the 2-10 Treasury yield spread higher (curve steepening).



The continued improvement in the global growth and continued tightening in labor markets keeps us bearish on duration via shorts in 2y USTs, especially as the market is still priced for little more than 2 hikes by end-2019



We maintain our initial target of 2.45-2.500 on 10y UST. Only a sustained firming of inflation and/or an effective progress on tax plans could push long-term yields substantially higher



Tactically, we remain Neutral on the 10-year sector, and short duration at the front end (through 2-year notes).



From bull flattening, we still expect the yield curve to move soon to bear steepening. We remain long 5-10 steepeners on the US yield curve

We think the BLS unemployment (lower unemployment and higher participation rate) report keeps the Fed on track for a 25 bp hike in December.

28 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT GOVIES



We remain Neutral on USTs vs Bunds. Nevertheless, we see more upside on the US-German 10y spread, for at least 2 reasons:

 

The Euro area PMI is expected to turn negative, which typically drive Bund yields lower. The improved inflation / growth outlook in Europe will make it harder for the ECB to justify the QE at its current level.



According to our positioning rules, we remain Neutral on USTs as the 10y yield stays between 2.0 and 2.5.



Our positioning rules are unchanged:  Remain Neutral between 2.00 and 2.50  Move to UW above 2.50, targeting 2.70 and even 3.00.  OW below 2.00-2.05 targeting 1.85 and reversing the reflation trade.  Move to Neutral again around 1.25

29 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT INFLATION-LINKED



Peter Oppenheimer, chief global strategist at Goldman Sachs, writes in the FT that “Inflation holds the key to what’s next for asset prices. If prices in the real economy finally start to rise, interest rates would no longer be sustainable at current levels, causing a cascade effect…rising prices in the real economy could push down prices across financial markets.” We agree on it.



Since the announcement of the Trump administration tax reform proposals, US inflationary expectations have jumped up. The reflation trade is back!



The global macro backdrop (US labor market tightening, rising commodity / labor costs, trends in PMI…) remains positive for breakevens.

 

Inflows into TIPS ETFs seem also picking up.

 

A shift towards more expansionary fiscal policy in the US would accelerate the process of inflation normalization.

We keep our OW US breakevens view, with an initial target at 2.00-2.10 on 10y-breakevens. We also maintain our OW HICP Inflation as a medium-term strategic play.

30 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT CORPORATE CREDIT



Corporate credit continues to benefit from a pro-reflationary rise in stocks, stable and benign credit metrics, better growth perspectives, greatly improved fundamental backdrop for issuers and optimism surrounding the release of new US tax plans.



Credit spreads settle into the pre-crisis range (despite the little bump seen in August). The market seems to be pricing in a prolonged period of above-trend growth, low default and low volatility.



Spreads are historically tight, but could remain sideways for a while. They look compatible with the extremely suppressed level of equity volatility.



Credit valuations appear too tight for us, especially for HY. Adjusted for expected losses, the premium embedded in spreads also ranks at the low end of its historical range, implying very low compensation for taking on credit risk.



We feel convinced that we are already at the end of the benign cycle (or nearing it) for corporate credit. But, the inflexion point is not visible yet.

31 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT CORPORATE CREDIT

 

In credit overall, we remain neutral.



Macro and micro fundamentals are getting better in the Euro area. Nevertheless, we stay underweight in EUR HY vs US HY (because the re-leveraging cycle looks more mature in the US)



The IG/HY decompression theme has resurfaced (both in cash and synthetics) over the past few weeks. We reiterate our preference for IG over HY.

We expect the US corporate tax reform to be very supportive for HG bond spreads, especially in the US. We move to OW on US vs EUR IG credit.

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



In high yield, we keep our bias towards higher quality as we don’t think this is the point in the cycle to reach for yield. Any unpriced rate hike (and/or dollar strengthening) would weigh on low quality bonds (High Yield and EM debt). We also prefer HY loans to HY bonds.

32 FinLight Research | www.finlightresearch.com

FIXED INCOME & CREDIT

EM DEBT



EM corporate spreads remain within a narrow range, supported by a stable economic environment and improving fundamentals

 

EM (ex China) sovereign spreads are around post-crisis lows, in local currencies.



We prefer to underweight EM external debt and remain Neutral on EM local debt.



Bottom line : Our views were mildly adjusted: Tactically Neutral Govies, Neutral US vs Eurozone Govies, long steepeners on the US yield curve, remain short duration in 2y USTs, UW credit mainly through HY and Neutral on IG (duration hedged), UW Eurozone vs US in IG/HY credit, OW 10y-TIPS breakevens and EUR HICP Inflation, UW High Yield vs High Grade, UW on EM sovereigns (external debt).



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.

In hard currency, absolute EM corporate spread levels stand at post-crisis tights. They also appear extremely compressed when compared to EM sovereigns as well as US credit. JP Morgan CEMBI Broad HY has also been trading well below US HY for the past year.

33 FinLight Research | www.finlightresearch.com

US Govies – 10y UST Tech. View



According to our positioning rules, we remained Neutral as the 10y UST yield stayed between 2.0 and 2.5.



Our positioning rules are unchanged:  Remain Neutral between 2.00 and 2.50  Move to UW above 2.50, targeting 2.70 and even 3.00  OW below 2.00-2.05 targeting 1.85 and reversing the reflation trade.  Move to Neutral again around 1.25



Breaking above 2.45-2.50% would bring back the reflation theme, opening the way to the 2.7% level  higher probability for the S&P500 to breakout to new highs and for the US dollar to move up. Under this scenario, precious metals should suffer. 34 FinLight Research | www.finlightresearch.com

US Govies – 10y UST Yield



The DM composite manufacturing PMI has clearly diverged from the US 10-year government bond yield since the end of 2016.



The current level of Composite PMI is pointing to a 10y UST yield around 3%

35 FinLight Research | www.finlightresearch.com

US Govies – 10y-2y UST Slope



The yield curve offers a more sober view of the economy than the stock market, or even the yield levels.



The US yield curve (10y – 2y) remains stuck near the narrowest of the cycle



It’s now only around 5bps above its mid-2016 trough. We are still in a bear flattening phase.



The Fed’s Dec hike is already priced in. But we expect that additional hikes will imply a bear steepening from here.

36 FinLight Research | www.finlightresearch.com

US Govies – Yield Curve Positioning



According to CFTC data, speculators are long flatteners (long 10yr and 30yr, and short 2y and 5y)



Current positioning is the most loaded in flatteners in years.



A certain steepening seems plausible from here.

37 FinLight Research | www.finlightresearch.com

US Govies – TIPS



The 10-year TIPS yield remains stuck in the center of the range that has prevailed since 2013

38 FinLight Research | www.finlightresearch.com

US Govies – 10y UST Tech. View



10y TIPS Breakevens continue to look low when compared to ISM prices. This has been the case since 2015

  

Core CPI should move to just over 2% by year-end, given the recovery in the manufacturing ISM Inflows into TIPS ETFs appear to have been picking up again, recently. For these reasons, we stay long 10y breakevens.

39 FinLight Research | www.finlightresearch.com

EM Credit – Local Currency



Since the beginning of 2017, EM local rates have continued their downward move and seem to be hardly impacted by UST yield movements



Nevertheless, we expect this divergence to close again over the medium-term.



We think EM bond yields are vulnerable to additional Fed hikes and further increases in US real yields.

40 FinLight Research | www.finlightresearch.com

US Credit – Is High Yield Too Rich?



Not really, when compared to prevailing macro conditions…



The economics/cyclical picture justify current spread levels



Using BAML’s Current Activity Indicator (CAI), we see that, since the financial crisis and despite CBs massive interventions, the HY spreads (here, measured by its 12m MA to get main trends) have behaved in accordance with historical norms.

41 FinLight Research | www.finlightresearch.com

US Credit – Is High Yield Too Rich?



HY spreads appear in line with speculative default rates. At around 400bps, HY market seems to be priced for default rates 1% lower (close to historical floor levels).



But, in contrast to previous credit cycles, we see a substantial divergence between defaults (receding from their 2015 tops) and corporate debt to GDP ratio (which is close to an all-time high)

Source: Deutsche Bank, Bloomberg

Source: JP Morgan

42 FinLight Research | www.finlightresearch.com

US Credit – Is High Yield Too Rich?



The question is relevant for the VIX, also… Both HY spreads and the VIX are trading around the lows.



As said previously, the macro picture seems to justify current spread/vol levels.



Nevertheless, we thinks that both volatility and credit spreads are priced for perfection.



Little cushion is left to deal with uncertainties (CB policy, geo-political risks…)



Call it complacency or (over) confidence. The ultimate result would be the same…

43 FinLight Research | www.finlightresearch.com

Credit RV – HY vs IG



In both the cash and synthetic markets, we’ve seen a revival of the IG/HY decompression trade, during September.



IG has notably outperformed HY on a risk-adjusted basis.



Furthermore, at current spread levels, we continue to think the extra-cushion embedded in HY (after taking into account expected losses) is extremely thin



We maintain our preference for IG over HY.

44 FinLight Research | www.finlightresearch.com

Credit RV – USD vs EUR



As expected, and despite a friendly growth/inflation mix in the Euro, USD spreads have outperformed their EUR counterparts in both cash and synthetic, reversing the negative relative trend started after the French election.



The move was justified by optimism about the US tax reform and uncertainties raised by the political crisis in Spain.

45 FinLight Research | www.finlightresearch.com

EXCHANGE RATES



The dollar has finally seen a bounce in September as prospects for a December rate hike increase and the US/global economy outlook got better.



From here, the dollar may find additional support in speculative futures positioning (which is stretched towards shorts), extremely oversold breadth metrics, and positive seasonality.



On the EUR-USD: 5 months ago, we moved to OW on the EUR-USD as the downtrend from May ‘16 was finally broken to the upside.



the recent hawkish turn in Fed expectations has put upward pressure on the US 2yr note yield, the 2yr US-German yield spread, and thus USD vs EUR



The EUR-USD has broken below its uptrend from April. But, according to our positioning rules, we’ve maintained our OW stance, as the 1.169 level was preserved.



From here, we adjust our positioning rules as follows: Remain OW above 1.1670. Our confidence will strengthen above 1.1940. Move to Neutral between 1.1670 and 1.1420 Move UW on a break below 1.1420

46 FinLight Research | www.finlightresearch.com

EXCHANGE RATES

 

On the USD-JPY: We remain Neutral as the spot stays in the multi-month range of 108 – 114.5 We keep our positioning rules unchanged: Remain Neutral as long as we stay in the multi-month range of 108 – 114.5 Move to OW above this range Only a clean break below the 107.5-108 range with a bearish momentum, would make us move to UW (targeting 104-105)

47 FinLight Research | www.finlightresearch.com

US Dollar Index



During Sep/Oct., we’ve seen positive developments for the DXY index.



After an impulsive rebound, the DXY has broken not only above its 50-DMA (a level it didn't trade above all summer), but also above its downtrend from April.



The next level to watch stands at 94.40. Breaking this level would open the way to 96.00



This scenario will be favored as far as the spot doesn’t go back below its Apr. downtrend (currently at 92.30)

48 FinLight Research | www.finlightresearch.com

EUR-USD



As for the DXY index, the EUR-USD has broken below its uptrend from April. But, according to our positioning rules, we’ve maintained our OW stance, as the 1.169 level was preserved.



From here, we adjust our positioning rules as follows: Remain OW above 1.1670. Our confidence will strengthen above 1.1940. Move to Neutral between 1.1670 and 1.1420 Move UW on a break below 1.1420

49 FinLight Research | www.finlightresearch.com

USD-CNY



The RMB continues to trade in line with 2-year rate differentials.



We expect the US-China yield spread to widen over time, with the Fed continuing its hikes and the PBoC unlikely to be able to match the move given the high public/private indebtedness



Thus, we keep our bullish bias on the USD-CNY (but moved our targets lower: 7.00-7.30)

Source: Deutsche Bank, Bloomberg

50 FinLight Research | www.finlightresearch.com

COMMODITY



At an aggregate level, we stay neutral over the short-term, given the mixed signals we see.



Over the medium to long 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.



Backwardation (implying positive roll returns) and low correlations to other assets make commodities more attractive from an asset-allocation perspective.



This year, base metals have performed strongly with energy prices rallying since mid-year

51 FinLight Research | www.finlightresearch.com

COMMODITY



Bottom Line :

Energy:



Energy markets have been bid, with crude oil prices making +20% since mid-year, mainly driven by investors optimism around OPEC cuts and inventories builds.



But even so, the bigger picture still looks range-bound, with overall supply/demand roughly balanced now, and absent a tail risk shock.



As supply is capped by shell production and floored by OPEC interventions, crude is likely to remain rangy within $40-60/bbl



Backwardation is also likely to remain in place in coming months because of strong demand and greater apparent cohesion within OPEC.



According to our positioning rules, we’ve switched from UW to Neutral on crude oil at the end of July, as the WTI moved above its 50-dma.

 

In September, We turned OW as the WTI broke above its downtrend from January Our tactical rules are modified as follows : Remain OW as the WTI stays above the Jan. downtrend Move to Neutral below Move to UW below the recent range low at 42 Move again to OW below $35. 52 FinLight Research | www.finlightresearch.com

COMMODITY Base Metals:

 

Base metals look priced for perfection in 2H



The current tightening of credit conditions in China is expected to have negative impacts across commodities, especially on industrial metals.



We prefer to stay Neutral on base metals and to OW Copper within the asset class.

We see reasons to go tactically OW base metals over the short-term, but headwinds should be expected later in the year, driven by slowing in China and stronger supply.

Agriculture:

 

Agris have been flat since end of August (on S&P GSCI Agri TR Index) We maintain our Neutral stance on Agris.

53 FinLight Research | www.finlightresearch.com

COMMODITY Precious Metals:

 

September marked the end of the friendly macro environment for gold



We still expect higher US real rates and ongoing withdrawal of stimulus by the Fed to put more downward pressure on precious metals (especially gold).



Following our positioning rules, we’ve switched from OW to Neutral as Gold returned below 1300 (please see our previous report)



From here, we adjust our positioning rules as follows:

Fed’s hawkish stance has steepened the expected path of the fed funds rates, pushed the dollar and US real rates up, and, thus, weighed on the yellow metal

Turn OW above 1300 Remain Neutral between 1300 and 1200 Go UW below 1200 to target 1120 again and then 1070-1100 Go OW at 1070-1100



We remain bullish precious metals over the long-term , no matter what happens (on US dollar, China, growth…)! But, we are bearish on gold short to medium term prospects. we still think that lower lows can be seen before the next bullish phase takes place. The last leg down we are still waiting for, may bring the Gold below 1070 - 1100.



This last leg down scenario (we’ve been promoting for a while) will be back on the table with a break (on weekly closes) below the primary downtrend from 2011 (currently around 1200-1220) 54 FinLight Research | www.finlightresearch.com

Energy – Crude Oil



According to our positioning rules, we’ve switched from UW to Neutral on crude oil at the end of July, as the WTI moved above its 50-dma.



In September, We turned OW as the WTI broke above its downtrend from January



Our tactical rules are modified as follows : Remain OW as the WTI stays above the Jan. downtrend Move to Neutral below Move to UW below the recent range low at 42 Move again to OW below $35.

55 FinLight Research | www.finlightresearch.com

Precious Metals – Gold



Following our positioning rules, we’ve switched from OW to Neutral as Gold returned below 1300 (please see our previous report)



From here, we adjust positioning rules as follows:

our

Turn OW above 1300 Remain Neutral between 1300 and 1200 Go UW below 1200 to target 1120 again and then 10701100 Go OW at 1070-1100



The last leg down scenario (we’ve been promoting for a while) will be back on the table with a break (on weekly closes) below the primary downtrend from 2011 (currently around 1200-1220) 56 FinLight Research | www.finlightresearch.com

Industrial Metals - Copper



In our June report, we’ve been expecting a rebound in Copper above $6000. In July, we enforced our OW stance, as we saw prices continuing 5% higher on solid demand / slowing supply growth.



On Sep. 1st (around 6 750), we said “From a technical point of view, a 10% upside is still in reach from here […] At this stage, we prefer to stay Neutral on base metals and to OW Copper within the asset class



We keep our view unchanged and target 7150-7180.



We will switch from OW to Neutral on Copper around 7150-7180

57 FinLight Research | www.finlightresearch.com

ALTERNATIVE STRATEGIES



CTAs: The trend following environment remains poor in the fixed income and FX sectors, with frequent trend reversals in both. Conditions are getting better in commodities. In line with equity market movements, CTAs’ net positioning on equities is at historical highs. But, CTAs now rely less heavily on trends in equites. The strategy has rebuilt its allocations to other performance engines (fixed income and commodities)



Global Macro: The strategy has reduced its Ytd losses thanks to equities and commodities. The forex bucket remained mixed, and the fixed income bucket (with shorts in USTs, Bund and Gilt) contributed to losses.



We maintain a positive outlook for both CTAs and global macro strategies. CTAs should finally benefit from an improved trend following environment and lower correlations between assets. Global macro should capitalize on new trading opportunities in central banks actions and benefit from any higher economic/market volatility



We believe U.S. tax reform should support alpha generation for stock pickers >> We maintain a positive outlook for long/short equity investing, regardless of market trends and valuations. L/S Equity Market Neutral is the strategy to favor. The strategy should benefit from lower stock correlations, higher dispersion.

58 FinLight Research | www.finlightresearch.com

ALTERNATIVE STRATEGIES



We think 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 cycle characterized by high valuations and complacency, unpredictable macroeconomic (CB decisions, Brixit negotiations…) and geopolitical events.



Within the hedge fund universe, we continue to prefer strategies with moderate market directionality (“risk diversifiers” type) such as L/S Equity Market Neutral, Volatility RV, Global Macro and CTAs (especially when they are experiencing their drawdowns). We like CTA’s low correlation to traditional asset classes and the potential risk mitigating characteristics in certain market environments. We also like the Fixed Income Arbitrage strategy as it is expected to outperform when bond yields rise.

59 FinLight Research | www.finlightresearch.com

CTAs



We remain convinced it’s an interesting time to be in the strategy because we are just starting (or about to) to turn up of a technical drawdown.

BTOP50 VAMI

Historically, that has been one of the better entry points to CTAs

BTOP50 Drawdown

Source: Bloomberg.Data from January 1987 to August 2017. See www.franklintempletondatasources.com for additional data provider information. VAMI refers to the Value Added Monthly Index, which tracks the performance of a hypothetical $1,000 investment.

60 FinLight Research | www.finlightresearch.com

Bottom Line: Global Asset Allocation 



   

20/10/2017 View

We remain worried about the eventual unwind of QE holdings and reduced liquidity in global markets. We summarize our views as follows 

20/07/2017 View

19/06/2017 View

12/05/2017 View

Oct'17

Aug & Sep'17

Jul'17

Jun'17

May'17

Equity

S&P 500

Euro Stoxx 50

Fixed Income

T-Note 10Y

Bund 10Y

US TIPS

Euro HICP

Credit

Inv. Grade

US High Grade

EUR High Grade

High Yield

US High Yield

EUR High Yield

EM Sovereigns

Forex

N/A

EUR-USD

USD-JPY

NIKKEI 225 MSCI Emerging Markets

Commodity

Base Metals

Precious Metals

Agri

Alternatives

Return Enhancers

Risk Diversifiers

Energy

We see more signs of capitulation of bears. Is that the signal for a maturing cycle?

01/09/2017 View

61 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.

62 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...

63 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

64 FinLight Research | www.finlightresearch.com