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Market Perspectives Sep. ‘19

Sep. 6th, 2019 www.finlightresearch.com

Are you familiar with the sword of Damocles?


“

What is necessary to break the pattern

of escalation and retreat is a brutal market shock that prompts detente between Washington and Beijing and removes the uncertainty facing business investment and global trade. In that respect, a significant drop in US equities stands a better chance of convincing US president Donald Trump that his current course of action is not a winning hand.� - Michael MacKenzie

2 FinLight Research | www.finlightresearch.com


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

Central Banks policy was the key driver of risk appetite YTD, as it boosted the search for yield , once again. Market participants remain riveted on the trade tensions and the yield curve. Without a trade deal, risks remain to the downside. Exchange rates could be the next battleground Government bond yields have moved toward cyclical lows in many market (and all-time lows were reached in many other) reflecting depressed inflation expectations and slowdown/recession fears Some fundamental indicators like the labor market and housing market are already sending warning signals about global growth. But, we continue to think recession fears are likely overdone. The small-cap equity continuous underperformance (vs large caps) is another warning signal. The persistent uncertainty calls for a cautious stance, and puts the volatility on the rise.

We summarize our views as follows 

3 FinLight Research | www.finlightresearch.com


MACRO VIEW

The Good  US Retail Sales have recovered and have resumed their upward trajectory.  US core CPI inflation was firmer than expected in July, increasing 0.3% MoM (2.2% YoY)  The NFIB Small Business Optimism Index rose 1.4 points to 104.7, with seven of 10 components advancing. The Bad  While global growth news remains mixed, Chinese data has surprised consistently to the downside in past weeks : imports are down 5.6% from a year ago, industrial production at its slowest growth rate in 17 years…  In Aug, the Consumer Sentiment Index decreased by -8.6%, the largest monthly decline since Dec. 12  In the US, industrial production is sluggish and housing data points to a substantial slowdown in the residential real estate sector  The EU data is becoming more concerning with EU Industrial Production, ZEW German sentiment and German industrial output down The Ugly: Ugly yesterday, ugly today!  Trade tensions (US-China, US-Europe) remain a key risk to our outlook. Our warry is that the trade conflict escalates out of control  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  Main systemic risk resides in China because of high leverage, growing indebtedness, and current unsustainable housing bubble. 4 FinLight Research | www.finlightresearch.com


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 remain especially interesting to watch, from here

5 FinLight Research | www.finlightresearch.com


Hunting Recession – US Overtime Hours

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The current decline in the average weekly overtime hours can be seen as a warning signal. The average weekly overtime hours have been declining for several months in a row, a behavior usually seen before and during a recession

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US Initial Claims

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Unemployment rate and initial claims are stagnating at low levels without further improvement (but not increasing either)

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Hunting Recession – US Manufacturing PMI

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Amid the US/China intensifying trade tensions, the US Manufacturing PMI dropped to 49.1 in August, the lowest such level recorded since 2016.

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Hunting Recession – Search Interest

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Fears of economic recession have spiked to levels last seen around the GFC

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Eurozone Industrial Production

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Eurozone industrial production dropped 1.6% in June versus 1.5% estimated. The trend is still negative, driven by manufacturing.

Source: Beskope

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Market Risk Appetite

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An interesting analysis from GS (based on the split of their Risk Appetite Index into its principal components) tends to show that monetary policy was the main driver of risk appetite YTD The recent actions in monetary policy have clearly boosted the search for yield again. But the effect seems exhausted. On the opposite side, the global growth component has constituted a negative drag force on risk appetite (similar to May ‘19)

11 FinLight Research | www.finlightresearch.com


Hunting Recession – Chinese Trade

Historically, the G10 Citi Economic Surprise index has been leading Chinese imports and exports data in the past 15 years This time again, the deterioration in the G10 economic data seems to be pushing Chinese exports and imports (like business sentiment) down. Source: Eikon Reuters

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Hunting Recession – Chinese Industrial Production

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Chinese industrial production grew by only 4.8%, the slowest rate since 2002.

Source: Beskope

13 FinLight Research | www.finlightresearch.com


EQUITY

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The stock market is in a precarious position. Until growth turns up equity drawdown risk remains elevated. Political risks (like US/China trade tensions or Brexit ) make equities even more vulnerable. The Q2 earnings season was better than expected and seems consistent with a modest upward move in stocks (to the 3000-3100 area by year-end) On the other hand, the S&P 500's technical picture appears to be shaky. Moreover, the important underperformance in the Russell 2000 index and investors rotation out of cyclicals (into defensives like utilities and real estate), both seem to point to troubles ahead. Despite the correction, S&P 500 valuation remains stretched relative to history, when growth is expected to slow. The long-term risk-reward doesn't favor bulls. The rallying bond market remains a very concerning sign for growth and equities. Exchange rate war could also be catastrophic: We’ve had a proof that China could sink the equity market with a sufficiently low yuan fix Nevertheless, equities remain a better bet than credit over the coming months, given tight credit spreads, lower rates and the return of risk appetite

Bottom line :

Our main scenario over the medium-term remains the same: Another capitulation decline in the weeks/months ahead (with VIX spiking to 25-30 panic levels), providing a new buying opportunity and igniting an ultimate leg up (target = 3300 – 3500 on the S&P500). 14 FinLight Research | www.finlightresearch.com


EQUITY

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Since our previous report (Jun. 14th), and according to our positioning rules, we’ve moved from Neutral to OW as the S&P500 broke above 2915 (June 18th), then back to Neutral on (Aug. 2nd), and again to OW (Sep. 4th) Our positioning rules are adjusted as follows:  Remain OW above 2935 and target 3020  Move to Neutral between 2840 and 2935  The setup weakens again below 2840. Go UW and target 2680 - 2700

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)

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.

15 FinLight Research | www.finlightresearch.com


Global Equities – Towards a Profit Recession?

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The risk of a profit recession is getting more concrete After 18 months of slowdown in global growth, the MSCI World 12-month forward EPS YoY growth seems to be turning negative.

16 FinLight Research | www.finlightresearch.com


Equities – Investor Sentiment

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The percentage of S&P500 stocks trading at a one-month high (currently above 40%) shows a decent improvement in the market breadth

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Equities – Investor Sentiment

According to MS-PB data, hedge Fund net leverage is now at multi-year lows. A similar move was observed in the Eurozone. Historically, similar extreme levels have preceded powerful rallies, in the US, like in Europe

18 FinLight Research | www.finlightresearch.com


Equities – Investor Sentiment

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According to 2iQ Research, European insiders have used the pullback to buy shares. The buy-to-sell ratio of corporate executives in Europe (similar behavior is seen in the US) reached its highest level (3,3 in August) since December, probably giving a buy-signal for equities This goes against the massive outflows we’ve seen in global equities since Dec. ‘18 Ratio of European insider stock purchases vs sales, euro value

Source: 2iQ Research

19 FinLight Research | www.finlightresearch.com


Equities – Investor Sentiment

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Since Dec ‘18, global equities outflows have reached 3% of assets under management This is about half the outflows sustained during last recession On the other hand, this aggressive de-risking provides some cushion to equities.

Source: Barclays

20 FinLight Research | www.finlightresearch.com


S&P500 – A Short-Term Tech. Perspective

Since our previous report (Jun. 14th), and according to our positioning rules, we’ve moved from Neutral to OW as the S&P500 broke above 2915 (June 18th), then back to Neutral on (Aug. 2nd), and again to OW (Sep. 4th) S&P 500 has broken the ceiling of the falling trend in the short term, and went up through the resistance at 2924. A clean break above 2976 would open the way to 3020. Our positioning rules are adjusted as follows:  Remain OW above 2935.  Move to Neutral between 2840 and 2935  The setup weakens again below 2840. Go UW. FinLight Research | www.finlightresearch.com

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S&P500 – Can We Go Really Higher?

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The (positive) technical picture for the S&P500 remains intact…

But a topping process has probably begun. This is, a least, what is pointed out by the yield curve. We need to see the 2y-10y curve inversion reaching a top and reverting before we can say the top in equities is in!

22 FinLight Research | www.finlightresearch.com


S&P500 – A Long-Term View

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The equity valuation long-term picture remains unchanged. Currently, the S&P500 to GDP ration is extremely high. The stock market valuation can diverge from the economy for periods of time, but always end up reconverging.. Morover, the ratio has historically predicted the stock market’s 10 year future return. Here we are!

R²=85%

Source: R. Shiller’s database. Data from Jan. 1960 to Aug. 2019 J. Huddleston calculation

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S&P500 – A Long-Term View

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Thus, the projected S&P500 future return is less than 2.5% per annum (dividend included) over the next 10 years. This is hardly 100 bps above the 10y UST yields and less than the 10y yield offered by AAA-AA corporate bonds

Source: R. Shiller’s database. Data from Jan. 1960 to Aug. 2019 J. Huddleston calculation Prediction model: ( 1 + 5.2% GDP Growth Rate) * ( Median S&P % GDP / Contemporary S&P % GDP ) ^ ( 1 / 10 ) - 1 + Contemporary Dividend Yield

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FIXED INCOME & CREDIT GOVIES

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In our positioning rules of June 14th, we said “Go OW below 2,0. Downside risks heighten materially through this level”. As expected, the move below 2,0 in US 10y yields was impressive. We’re already at 1,5! Last weeks decline in US 10-year yields was one of the largest since the GFC. The 2s-10s flattened below 10bps. Furthermore, the market seems to expect 4 cuts this year, which hasn’t happened outside of a recession over the last 30 years. CB actions continue to be driven by a desperate search for higher inflation expectations The narrative behind this collapse in LT bond yields combines global growth concerns with US/China trade conflict escalation and rising deflationary forces Despite the bond rally, traders are still at some of the most extreme net short positioning in history. This, combined with the backdrop for monetary policy, leaves room for lower rates from here. But, given low existing yields and rising fiscal debts and deficits, locking money in LT Treasuries seems hardly sensible, except from a tactical perspective. For now, 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). 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) 25 FinLight Research | www.finlightresearch.com


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 2,0 (please see our previous report, in which we said “Go OW below 2,0. Downside risks heighten materially through this level”) The 10y yield is currently breaking above 1,55. Confirming this break would set a bottom in an open the way to 1,62 an 1,79. Thus, we decide to switch to Neutral. Our positioning rules are adjusted as follows:  Remain Neutral 10-year USTs between 1,55 an 1,62  Move to UW above 1,62  Move to OW again below 1,55 What about the curve? In our June’s report, we said “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 expect the US yield curve to trade with a flattening bias. But it could resume steepening if the Fed shifts to a more accommodative stance (with a clear tolerance for temporary inflation overshoots) and US growth remains acceptable. We remain Neutral on the 2-10 curve and will get into steepeners either when the slope reaches 10bps or breaks through +30bps 26 FinLight Research | www.finlightresearch.com


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 tariffs are also weighing on global growth and risk appetite and, thus, pulling inflation expectations down.

In summary, we see further downside to US breakeven inflation over the near-term.

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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Fear of missing out continues to drive spreads tighter, to levels hardly sustainable. Fed’s reversal explains a lot of it. Furthermore, the sharp rise in negative-yielding global debt makes credit (and specially HY) an attractive asset class for investors

But, we believe markets are still too optimistic on the outlook for the US economy As such, we are cautious on credit at current prices and expect the spread widening to resume (both in IG and HY) in Q4-2019 because of the uncertainty around economic growth and the shift we are expecting to a 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. On a relative basis, we also UW credit vs equities: Over the past 6 months, IG credit has outperformed equity. We expect the move to revere from here.

28 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT CORPORATE CREDIT

Within the credit asset class, 

The “low rate for longer” ECB policy (+ the high odds of a reactivation of corporate bond purchases) 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.

We reiterate our up in quality stance, across sectors and ratings. Trade related growth risks should weigh more on HY than IG. We reiterate our preference for IG over HY, especially in EUR credit. 

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

We maintain our preference for liquidity. Illiquidity premia have increased but are still not enough to make illiquid bonds attractive given the lingering policy uncertainty and weak growth sentiment

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). 29 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT CORPORATE CREDIT

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Leveraged loan funds have experienced substantial outflows since the end of 2018, offsetting all the inflows since 2017. The move was mainly driven by the shift in the Fed policy that weighed on investor demand for floating-rate assets Nevertheless, from an asset allocation perspective, we continue to 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

30 FinLight Research | www.finlightresearch.com


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.

31 FinLight Research | www.finlightresearch.com


US Govies – Is the Curve Signaling Recession?

Historically, inversion in the yield curve has generally reflected concerns about future economic growth, and preceded all recessions over the past decades However, inversion cannot be used to time recessions: the lead time between inversions and was quite variable (with an average around 20 months) It’s worth noting that the NY Fed currently has a probability of a US recession in the next 12m standing above 31%, a similar level to August 2007. 32 FinLight Research | www.finlightresearch.com


US Govies – A Tech. View

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According to our positioning rules, we’ve moved from Neutral to OW Treasuries as the 10-year yield broke below 2,0 (please see our previous report, in which we said “Go OW below 2,0. Downside risks heighten materially through this level”) The 10y yield is currently breaking above 1,55. Confirming this break would set a bottom in an open the way to 1,62 an 1,79. Thus, we decide to move to Neutral. Our positioning rules are adjusted as follows:  Remain Neutral 10-year USTs between 1,55 an 1,62  Move to UW above 1,62  Move to OW again below 1,55

33 FinLight Research | www.finlightresearch.com


US TIPS – Breakeven Inflation

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Given the Fed’s dovish stance and increasing growth concerns, the decline in breakevens since May was comprehensible We can expect further downside from here, probably targeting the 2016 lows We remain neutral US breakevens.

In summary of both effects, we see further downside to US breakeven inflation over the near-term. A decline back to the 2016 lows is not out of the question

34 FinLight Research | www.finlightresearch.com


US Credit – Dispersion is UP!

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A way to measure the credit dispersion is to take the difference between the 90th and 10th percentiles of monthly excess returns (normalized by their sum) across the components of the iBoxx IG and HY indices Until a few weeks ago, dispersion was near post-crisis lows but it has spiked recently This is probably indicating a that the idiosyncratic risk is rising, a trend we expect to continue

35 FinLight Research | www.finlightresearch.com


US Credit – IG vs HY

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We expect the downside risk to global and Eurozone growth should weigh more on HY vs IG. Given growth risk, we continue to prefer leveraged exposures to IG versus HY.

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US Credit – HY vs Leveraged Loans

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Leveraged loan funds have experienced substantial outflows since the end of 2018, offsetting all the inflows since 2017 The move was mainly driven by the shift in the Fed policy that weighed on investor demand for floatingrate assets Nevertheless, from an asset allocation perspective, we continue to 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 37

FinLight Research | www.finlightresearch.com


EXCHANGE RATES

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Our thesis: There are many factors that could push the dollar lower in the short term, but the longterm trend is in favor of the dollar. We expect US-China trade war escalation to be 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. Actually, US dollar is driven by the real growth differential between the US and other major DM economies Global demand for U.S. dollars has been on the rise and will likely continue to rise, providing another supporting force for the currency. Interest-rate differentials remain one of the major driving forces of the US dollar in the short run, especially against the euro and the yen. On the other hand, the forward path for the US dollar remains clouded by the Fed's dovish stance, future rate cuts and rising US deficit 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. The primary risk factors we see with our long-dollar positioning: an inflation surprise or positive economic news. 38 FinLight Research | www.finlightresearch.com


EXCHANGE RATES

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EUR-USD: We view the upside for EUR-USD in the short term as very limited. Markets are likely to remain skeptical about a growth recovery in the Eurozone. ECB dovish tone is supposed to weaken the EUR further. Technically, the MT picture remains bearish. Only a clean break above the 200-dma may undermine this view.. But considering the struggle that EUR-USD has demonstrated since end of 2018 to break above this MA, the bias here for the market would appear to remain to the downside. Since our June Report, and according to our positioning rules, we’ve remained Neutral as the EURUSD stayed between the trend across the lows since Nov ‘18 and the 200-dma. We switched to UW on Sep 2nd and went back Neutral a few days later, as the break below the former turned out to be a wrong one. From here, we adjust our positioning rules as follows:  Remain Neutral as the pair remains in the channel across the highs/lows since end of June (currently at 1,09 – 1,111)  Move to UW below to target 1,08 and even 1,07, and (tactically) to OW above to target 1,13

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EXCHANGE RATES

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USD-JPY: The USD/JPY pair has dropped precipitously recently, the JPY acting as a safe-haven asset According to our positioning rules, we’ve been UW the USD-JPY since it 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 decide to move to Neutral from here and adjust our positioning rules as follows:  Remain Neutral as far as we stay within the descending channel drawn across the highs/lows since Mar. ’19 (currently 104-108)  Go OW above and UW below USD-CNY: In our Feb. 19 report, we said : “Following the China PMI miss, USD-CNY reached its 10 year highs. Reasonable target from here: USD-CNY in the 7.0-7.3 range. An advisor to the PBOC has been quoted saying the level of 7.0 may break by year-end (especially if tensions with the US continue to deteriorate)” Here we are. Our target has finally been reached. We still look for CNY underperformance vs USD and major EM currencies. With the Chinese economy slowing and trade tensions escalating, we think Chinese policy-makers have little choice, but letting the yuan fall. PBOC won’t jump in to support the CNY without a sharp worsening in capital outflows

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US Dollar – A Risk-Off Trade?

We have recently seen a substantial increase in the correlation between the dollar and longterm USTs. Despite growth fears in the US and dovish Fed, the dollar seems to behave as a risk-off trade similar to Gold and JPY.

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US Dollar Index

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According to Citi FX positioning indicator, traders are extremely short USD relative to the 2012-2019 positioning range. This could drive the DXY higher.

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EUR-USD

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Since our June Report, and according to our positioning rules, we’ve remained Neutral as the EUR-USD stayed between the trend across the lows since Nov ‘18 and the 200-dma. We switched to UW on Sep 2nd and went back Neutral a few days later, as the break below the former turned out to be a wrong one. From here, we adjust our positioning rules as follows:  Remain Neutral as the pair remains in the channel across the highs/lows since end of June (currently at 1,09 – 1,111)  Move to UW below to target 1,08 and even 1,07, and (tactically) to OW above to target 1,13

https://www.tradingview.com/chart/EURUSD/q205MAns-EURUSD-H4-Trending-Idea-6-Sept/

FinLight Research | www.finlightresearch.com

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USD – JPY

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Over the last 3 months, the USD-JPY has followed the US - Japan 2y interest rate differentials Given the Fed’s dovish stance, there is still downside there.

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USD-JPY

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According to our positioning rules, we’ve been UW the USD-JPY since it broke below 110. In our June’s Report, we said: “ We expect the USD/JPY to suffer much more downside from here. First target = 104.60.” On Aug. 25 the pair bounced exactly on our target. We decide to move to Neutral from here We adjust our positioning rules as follows:  Remain Neutral as far as we stay within the descending channel drawn across the highs/lows since Mar. ’19 (currently 104-108)  Go OW above and UW below

45 FinLight Research | www.finlightresearch.com


USD-CNY

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Our target of 7,00-7,20 on the USD-CNY has finally been reached. Our view was based on the fact that China was obliged to keep the yuan artificially strong to calm the Trump administration. Even after the recent depreciation, and contrary to Trump’s allegation, the yuan is not artificially weak: An IMF recent report shows that the yuan is inline with economic fundamentals. From a tech. perspective, there are no obvious levels to watch above 7! All depends on the amount tariffs China would try to offset…

46 FinLight Research | www.finlightresearch.com


COMMODITY

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Commodities struggled under the weight of escalating trade tensions and growing evidence of a slowdown in global economy. The S&P GSCI was down 5.6% for the month but remained up 6.7% Ytd. Gold continued its strong YTD performance, taking advantage from its safe-haven status

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.

47 FinLight Research | www.finlightresearch.com


COMMODITY

Bottom Line : Energy:

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Oil markets continue to see headwinds from the trade war and global growth risks The rise in the level of stockpiles and US production were factors that contributed to price weakness in crude. But the latest figures from the EIA point to a balanced market A weakening outlook for long-term demand, combined with near-term oil supply disruption has lowered spot prices while the structure of the futures market has switched pretty firmly into backwardation Price volatility is likely to remain high until the end-demand proves resilient given the fears about global growth. For now, we remain bearish on the price of oil. 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. From a technical point of view, this is very bearish over the medium term. According to our positioning rules, we’ve remained UW (since the spot broke below 59). Our tactical rules are adjusted as follows:  Remain UW below 59 and continue to target the 45 area  Move to Neutral if the spot fail to break below the uptrend across the lows since beginning 2019 (currently around 52)  Move to OW above 59 48 FinLight Research | www.finlightresearch.com


COMMODITY Base Metals:

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As the trade tensions have escalated once again, the metals complex has weakened substantially. Only Nickel extended its impressive performance, up 24.3% for the month (69%Ytd!) on fears of market deficit (Indonesia decided to ban exports of nickel ore starting on Jan. 1, 2020, 2 years earlier than initially planned) Because of copper's widespread applications in the economy, demand for copper is often viewed as a reliable leading indicator of economic health. But, Copper is trading at a 52 week low which doesn't suggest that robust economic growth lies ahead. We believe that any sharp CNY depreciation could spell further downside to the industrial metals complex As such, we remain cautious (UW) the complex, for now

Agriculture:

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Most agricultural commodities have been in a downturn since end of June. Mid August, the US Department of Agricultural released its August World Agricultural Supply and Demand Estimates report (WASDE) that was received with a bearish reaction. Grains tanked on larger than expected supplies. We expect a lot of volatility in the primary grain markets over the coming months as we go in the growing season and as the US/China trade and currency war evolves We remain OW on Agris as a whole, with a preference for grains 49 FinLight Research | www.finlightresearch.com


COMMODITY Precious Metals:

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Political and economic uncertainty tends to be gold's best friend . The Fed's recent dovish tone adds a positive factor for it (by lowering real rates and capping dollar strengthening). Moreover, and the first time since 2016, the US real rates are about to turn negative, which reduces the opportunity cost of owning gold. However, the long-Gold trade is getting quite crowded. Money managers and large speculators are approaching record levels of long exposure in the precious metal Technical analysis shows early signs of exhaustion, and suggests a nearby top (followed by a correction that lasts a few months) unless prices manage to break sustainably above 1 550-1 590. The trend remains clearly up. We need to go all the way back to critical support at 1267 (or primary uptrend from Aug ’18) before the uptrend is put into question. We remain bullish precious metals (specially Gold) over the long-term, no matter what happens (on US dollar, China, growth…)! We believe Gold will be the best investment for the next decade. However, we see the (medium-term) risk of a still missing one corrective leg down to 1120 and lower..

50 FinLight Research | www.finlightresearch.com


COMMODITY Precious Metals:

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Following our positioning rules, we’ve stayed OW on gold (for reminder, we’ve OW since it broke above 1300). Our initial target of 1490 was reached and exceeded. We chose to move UW from here Our positioning rules are adjusted as follows:  Remain UW below 1507. Our targets down: 1480 and 1425  Move Neutral between 1507 and 1525  Turn OW after a clean break above 1525 to target 1550-60 In our June Report, we said “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)”. We were completely wrong! Silver price spiked from $14,5 to $18 over about 3 months, with surging speculation about a big buyer (probably China) in the market. It’s important to note that Silver is a very tiny market. Gold is a 7 trillion dollar market, whereas Silver is something like 350 Blns. When money goes into silver (to play Precious Metals / Gold move, as it seems cheaper on a relative value basis), prices have a tendency to move up sharply. Although silver market seems in deficit, we prefer to stay on the side and wait for a better entry level.

51 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

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The negative relationship between gold and the US real rate is still intact. Lower real rates tend to reduces the opportunity cost of owning gold and to increase demand for it

52 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

TIPS have been soaring since November last year (for the first time since 2016, the US real rate is approaching zero!), and so has Gold That said, we doubt that gold may continues its rapid growth from here unless US real rates turn negative and/or the US Dollar moves substantially lower. It is worth noting that the historical highs of 2012-13 in Gold were reached with lower real rates and a much lower dollar index .

53 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

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According to COT data, commercial positioning is extremely bearish by historical standards (-54% of Open Interest). It is close to July 2016 and Oct 2012 peaks at -56% It is a warning signal on Gold but we need to see a break of support before these truly do matter..

54 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

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Following our positioning rules, we’ve stayed OW on gold (for reminder, we’ve OW since it broke above 1300). Our initial target of 1490 was reached and exceeded. We chose to move UW from here Our positioning rules are adjusted as follows:  Remain UW below 1507. Our targets down: 1480 and 1425  Move Neutral between 1507 and 1525  Turn OW after a clean break above 1525 to target 1550-60

55 FinLight Research | www.finlightresearch.com


Precious Metals – Silver

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With the recent spike in silver price from $14,5 to $18 over about 3 months, speculation surged about a big buyer (probably China) in the market Silver ETFs have added over 100 million ounces of silver in the past 3 months! It is worth noting that the silver market was in a deficit last year and is expected to remain very tight this year. The reason behind: a decreasing supply due to the fact that the metal has been trading for months below the average cost of production for most of the silver miners. Is that enough to signal the beginning of a big rally?

. FinLight Research | www.finlightresearch.com

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Metals – Gold vs Copper

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The copper to gold ratio is now at its all-time record low. It is now probably forming another base. Given that this ratio is highly correlation to US bond yields, this could also indicate the end of the bond rally and the beginning of another risk-on period.

57 FinLight Research | www.finlightresearch.com


Energy – Crude Oil

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According to our positioning rules, we’ve remained UW (since the spot broke below 59). The 38,2% Fib level (57,40) was hit and rejected on multiple occasions  bearish Our tactical rules are adjusted as follows:  Remain UW below 59 and continue to target the 45 area  Move to Neutral if the spot fail to break below the uptrend across the lows since beginning 2019 (currently around 52)  Move to OW above 59

58 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

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Hedge Funds posted mixed performance in August. Nonetheless, the alpha generated by hedge funds since the summer remained outright positive, despite the confusing context. The current environment remains favorable for risk diversifiers (low beta strategies). We reiterate our OW stance on L/S Equity Market Neutral, L/S Credit, Volatility RV and Global Macro strategies. We reiterate our OW stance on Fixed Income Arbitrage. 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. Whatever the benchmark we use, CTAs seem on an upward trend since the beginning of the year. But, we prefer to stick to our Neutral stance on the strategy 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

59 FinLight Research | www.finlightresearch.com


CTAs

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CTAs did relatively well for the third month in a row. Whatever the benchmark we use, CTAs are on an upward trend since the beginning of the year. CTAs have provided a good hedge during the last risk-off episode. According to a Lyxor analysis, “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      

Central Banks policy was the key driver of risk appetite YTD, as it boosted the search for yield , once again. Market participants remain riveted on the trade tensions and the yield curve. Without a trade deal, risks remain to the downside. Exchange rates could be the next battleground Government bond yields have moved toward cyclical lows in many market (and all-time lows were reached in many other) reflecting depressed inflation expectations and slowdown/recession fears Some fundamental indicators like the labor market and housing market are already sending warning signals about global growth. But, we continue to think recession fears are likely overdone. The small-cap equity continuous underperformance (vs large caps) is another warning signal. The persistent uncertainty calls for a cautious stance, and puts the volatility on the rise.

We summarize our views as follows 

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

Profile for Finlight

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