Finlight Research - Market Perspectives - Feb 2016

Market Perspectives

February 2016

Feb. 8th, 2016

www.finlightresearch.com

Valuations don't matter...until they do.

“These markets are all rigged, and I don’t say

that critically. I just say that factually”– Ed Yardeni

“The situation is worse than it was in 2007.

Our macroeconomic ammunition to fight

downturns is essentially all used up”

– William White

(former chief economist of BIS)

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� The risk-off trade continued to weigh on the major asset classes in

January. The year started with an unprecedented selloff, mainly

explained by oil weakness, global recession fears, Fed premature hawkish

stance and China’s ongoing economic woes.

� BoJ’s announcement of its negative interest rate policy gave a reason to

markets around the world to rebound sharply. But the relief was brief.

� The global picture remains precarious: The global manufacturing

recession continues, slowdown concerns are mounting in DMs, a hard

landing in China cannot be fully discarded at this stage, and leveraged

EMs seem more vulnerable than ever to Fed hikes and a China slowdown;

� We remain cautious on risky assets and expect lower asset returns and

higher volatility to make the essence of the new year. More risk-off

episodes and downwaves (similar to the one we’re experiencing right now)

should be expected in the course of the year..

� 2016 could be the year commodities finally make a sustainable long-term

bottom and the US dollar reaches a turning point.

� We reiterate our view that we are sailing a cyclical bull within a

secular bear. The current cyclical bull may go higher for longer. But,

rising volatility and stalling earnings growth may indicate we are in the

late stage of the cycle.

� The perfect storm is building…

� We summarize our views as follows �


View View View

Feb '16 Jan '16 Dec '15

Equity N UW N

S&P 500 N N N

Euro Stoxx 50 N N N

NIKKEI 225 N N N

MSCI Emerging Markets UW UW UW

Fixed Income UW UW UW

T-Note 10Y UW UW UW

Bund 10Y OW OW OW

US TIPS OW OW OW

Inv. Grade UW UW UW

US High Grade OW OW OW

EUR High Grade UW UW UW

High Yield UW UW UW

US High Yield N N N

EUR High Yield N N N

EM Sovereigns N N N

Forex N/A N/A N/A

EUR-USD OW N N

USD-JPY N N N

Commodity UW UW UW

Energy OW UW N

Base Metals N N N

Precious Metals OW N N

Agri N N N

Alternatives OW OW OW

Return Enhancers UW UW UW

Risk Diversifiers OW OW OW

MACRO VIEW

� The Good� US labor market is still expanding at a healthy pace� Consumer confidence looks strong � Chicago PMI surprised with a sharp rebound from the low levels of the past few months (55.6

from previous reading of 42.9)

� The Bad� The latest US GDP report showed an anemic .7% Q/Q growth rate� Equipment spending is sluggish. Durable goods orders plunged 4.3% in December� ISM manufacturing remains in recessionary territories for the fourth consecutive month� US Equity earnings reports have disappointed. Even growth ex-energy is barely positive

� The Ugly � Main systemic risk resides in China: The credit bubble is unsustainable. The Chinese debt

burden is extremely high (debt to GDP ratio is around 300%) and the credit cycle is probably starting to turn. We are probably in the early stages of a bursting credit bubble.

� We feel concerned about the credit market liquidity as turnover ratios are well below pre-crisis levels and the bid-ask spreads are much wider.



The Big Four Economic Indicators

� The current picture is characterized by relatively strong Employment and Income, a weak Industrial Production (down in 9 of the last 12 months) and uncertain to weak Real Sales.

� The average of these indicators suggests that the economy is still trending sideways. Industrial Production and Retail Sales are pulling the trend lower. But setting a new high still seems possible over the short term.


GS – Global Leading Indicator (GLI)

� The Jan. Final GLI came inat 1.2%yoy. Its MoMmomentum came at 0.05%(down from 0.06% lastmonth)

� GLI remains inSlowdown phase.

� Only three of the tenunderlying components ofthe GLI improved inJanuary.

� We continue to think thatthe acceleration we’vebeen witnessing sinceJan. ‘15 is quite modestfor a typical expansionphase


US PMI – Manufacturing vs Services Divergence

� While Services PMI remainsresilient, Manufacturing PMI isplunging towards recessionaryterritories.

� Similar disconnects were seen inprevious mid-cycle stages, but thecurrent divergence hardly fits inthat.

� This divergence should bewatched closely.


Any Signs of Recession? – US Productivity

� Productivity is the additional outputthat each unit of labor produces

� Productivity has been flat over thelast 2 years, and weak for severalyears now.

� Without a sharp increase inproductivity, there is no way tocatch up the pre-crisis GDP growthtrend

� From a historical point of view,current readings could beassociated with recession.

� The US economy is unquestionablyfacing some headwinds, but noneof the indicators we usually lookat indicates that recession isalready here.


Any Signs of Recession? – US Employment

� The “Number of CiviliansUnemployed for 15 weeks andOver” FRED metric used to troughmonths ahead of all previousrecessions

� For now, we see no indicationthat this metric has startedforming a bottom…


Any Signs of Recession? – Industrial Production

� The Industrial Production Indexis down 0.6% over the last 6months.

� But we are still well above the -3% threshold needed to call forrecession.

Source: FRED 6-month change in natural log of IP index. Blue line at -3 threshold


Any Signs of Recession? – Manufacturing PMI

� ISM Manufacturing PMI iscurrently at 48.2

� But according to Travis Bergeand Oscar Jorda studies, weneed to reach the 44.5threshold before calling forrecession.

Source: FRED ISM Manufacturing PMI. Blue line at 44.5 threshold


US Inflation – No Signs of Acceleration

� "Inflation is expected to remainlow in the near term, in partbecause of the further declines inenergy prices, but to rise to 2%over the medium term as thetransitory effects of declines inenergy and import prices dissipateand the labor market strengthensfurther.“ (Selected quotes from theJan. 27 FOMC statement)

� A probable source for futureinflation lies in employment costs.

� But so far, inflation data show nosigns of acceleration…


EQUITY

� We keep our positioning unchanged. We think that the equity bull market is aging, that market valuation is elevated, volatility is heading up, and earnings and margins are declining.

� Several signs may be interpreted as a reminiscence of what happened in the late-stage of previous economic expansions:� Large amounts involved in M&A activity and buybacks� Elevated levels reached on Debt/EBITDA for non-financial companies

� Stocks appear rich to corporate profits, when corporate profits themselves appear to be at extreme levels as a share of GDP.

� S&P 500 earnings have now declined for four straight quarters while revenues have declined for three consecutive quarters. No earnings/revenue growth is projected before Q3-2016

� This peaking in profit margins puts a cap on any upside in equities

� Stock market breadth doesn’t look healthy as most of the index performance is driven by very few companies and masks broader weakness across the market. The S&P 500 Index is held afloat by the relatively strong performance of some of its very large caps. It is only a matter of time before these stocks finally capitulate to the bearish pressure

� Other ugly medium-term signal for stocks are provided by:� The break of the 2011 bull trend in the Russell 2000� Shanghai Composite index sinking below its Aug. ‘15 low of 2 850� Credit market entering its late-cycle stage


EQUITY

� Our main scenario from here (80% chance) : A massive top forming around 2135 – 2170 :� US profit margins are showing increasing evidence of peaking. On Price/Sales metric, equities

are trading at the top of the historical range. � A resumption of earnings growth going into 2016 will be necessary for equities to move higher.� Recent data shows more evidence of lower productivity, lower potential GDP growth and (later)

higher inflation risk. � This is a bad scenario for stocks

� Our alternative scenario (20% chance) : The S&P500 breaks the 2135-2140 resistance, opening the way to 2225.

� Stocks seem more vulnerable than ever to any external choc (Central Banks action, China, Crude oil…)

� Tactically: The current sell-off represents a correction in an exhausted bull market, rather than the beginning of the next major global bear market. We still wait for a final leg up with a massive top forming around 2135 – 2170 on the S&P500


EQUITY

� Bottom line :

� De-risking should continue. A higher allocation to cash is sensible in this late-stage stock bull.

� We’re currently Neutral on the S&P500 and will stay so as far as the spot remains above 1850 (major support) and below 1903.� Between 1850 and 1790 and above 1903, we will move to OW to play the rebound.

� Any break below 1760-1790 would make us move massively to UW

� We remain Neutral on Europe and Japan vs. US despite the policy divergence between the Fed and the ECB/BoJ:� The Topix earnings momentum has shown some signs of stalling over the last quarter� Europe is trading at 15 year highs, relative to the US. � Weak demand from China is expected to continue to weigh on Japan's production and

exporters in Eurozone.

� We remain UW in US small caps vs large caps.� We remain UW EMs vs DMs, given the Fed hawkish stance and USD strengthening. Negative

spillovers from China will also likely have a strong impact on other EMs.


US Earnings

� The S&P500 stands within an earnings recession with -0.4% YoY in Q2 and -1.3% YoY in Q3

� FactSet's data shows a current forecast of a -3.8% decline YoY for Q4-2015 earnings (+2.2% increase ex-Energy) and a -3.4% decline in revenues.

� If this earnings decline becomes effective, it will mark the first time the index has seen 3 consecutive quarters of year-over-year declines since Q1/Q3-2009.

� No earnings/revenue growth is projected before Q3-2016

� For Q1 2016, 57 companies have issued negative EPS guidance and 14 companies have issued positive EPS guidance


US Earnings

� On top of that the S&P500 is still over priced relative to the currently falling forward 12 month PE

� The 12-month forward P/E ratio for the S&P 500 now stands at 15.4, well above historical averages: 5-year (14.4), 10-year (14.2)


Equity Earnings Growth

� Q4-2015 EPS growth has been revised down steadily both in US and Europe

S&P500 blended Q4 '15 EPS growth Stoxx600 blended Q4 '15 EPS growth


US Equity – The Leverage Issue

� Debt/EBITDA for non-financial companies is reaching record levels in the US (~1.6x) and globally (3x) � Globally, companies have taken on $29 trillion in debt over the last few years, according to

Bloomberg. � In 2015, debt reached 3x the earnings (EBITDA), a 12-year record.� More than 30% of these companies are unable to generate enough returns on investment to

cover the cost of credit.


US Equity – The Buyback Effect

� M&A activity and stock buybacks are now close to 2007 levels

� But the stock buybacks engine seems exhausted.

� US buyback stocks have stopped beating the US market

� The S&P 500 buyback index has been underperforming the S&P 500 since Q3 2015


S&P500 – Market Breadth

� As said in our previous reports, the only thing that is holding the S&P 500 Index afloat is the relatively strong performance of some of the very large caps.

� The portion of stocks trading above their 200-dma within the S&P500 is clearly in a downtrend: This is indicative of a weaker market that is more and more reliant on very few of its components.


US Equity – A Long-Term Perspective

� The "Dow Megaphone Pattern" is one of the most apocalyptic we have at hand

� According to this pattern, the new highs we’ve seen in 2015 would ultimately drive us down to lower lows.

Source: Yahoo Finance


S&P500 – A Medium-Term Perspective

� We see potential for some near-term weakness from here.

� But, the underlying bull structure hasn’t suffered any material damage yet, as both the 200-wma (~1788) and the trendline from 2009 lows (~1758) have been preserved.

� We’ve been UW most of the time since Dec. ‘15 (as the S&P500 broke below the 2020 support).

� We moved to Neutral when the spot entered the 1885-1903 zone, and to UW again as it moved above.

� We’re currently Neutral and will stay so as far as the spot remains above 1850 (major support).

� Between 1850 and 1790, we will move to OW to play the rebound.

� Any break below 1760-1790 would make us move massively to UW


Equity Volatility – Switching to a Higher Regime

� As said in our research paper of Feb ’15* (“Volatilité – Un avant-goût de fête”), equity volatility has started to switch to a higher regime.

� Current situation is very similar to what we’ve seen end of 2007.

� Such a switch is hardly compatible with a continuation of the bull market.

� It induces 2 things :

� We’re are sailing cyclical bull within a secular bear.

� We are in the late stage of the cycle.

L

H

M

E

Volatility regimes: Low (L ~12.4) – Medium (M ~17.3) – High (H ~25.1) – Extremely High (E ~41.1)

(*) http://www.finlightresearch.com/volatilite-un-avant-gout-de-fete/


Equity Volatility – Switching to a Higher Regime

� This regime switching is clearly confirmed by the downtrend in the probability of being in the lowest regime…

� Again, we are at levels similar to end of 2007.

� This increase in environment risk is reflected also in volatility skew levels.

� Skew levels across equity indices underwent a significant shift after the Yuan devaluation


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has switched to substantially long on Jan. 8th S&P500 close (@1922.03). Since then, the model has been putting more longs near 1880 and alleviating (to flat) near 1940.

� The model targets 1903 – 1952 and reduces its positions below 1850.� Given the dispersion within the system probabilities, the model conviction seems limited.

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FIXED INCOME & CREDIT

� Bonds rallied strongly this month on dovish FOMC and a surprising move by the BoJ to negative interest rates.

� We maintain, however, our bearish directional view on duration, expect higher nominal rates and realized rates volatility to remain elevated given the uncertainties surrounding the pace of Fed’s hikes and the trend in inflation.

� The real test for bond markets would be the moment when:� Other Central Banks start getting away from QE-easing, putting all the rates on a upside track� The Fed decides (sooner or later) to replace the use of its "temporary" tools (reverse repo among

others) with the an outright reduction in its securities portfolio to reduce reserve balances.

� We moved tactically from Neutral to UW on USTs as the 10-year yield broke below 2.00. We will keep our positioning as long as the critical support of 1.78 is preserved. Below, we’ll move to Neutralagain

� We think that the risk is still biased to the upside on yields. Our ultimate target on 10y yields stands at 2.60 by H1-2016 and 2.75 by H2-2016

� On German Bund, we also moved from Neutral to UW as the 10-year yield dived below the 0.40 –0.45 area.

� We maintain our relative view of US Treasuries underperforming Bunds and JGBs

FinLight Research | www.finlightresearch.com

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� Inflation data continue to show no signs of acceleration. We expect an increase in the marketpricing of long-term inflation in the US. Inflationary signs should be watched closely as they willforeshadow a steepening decline in Govies.

� We remain Neutral HICP Inflation as we expect breakevens to trade sideways in the Eurozone � We remain OW on 10y-TIPS breakevens given their historically-low levels. While we see no

immediate catalyst for a move higher in breakevens, we view US 10y breakevens as structurally cheap, having limited downside and may benefit from a stabilization of energy prices.


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� We remain UW on corporate credit, due to valuation, to rising volatility, to position within the credit cycle and given the weak total return forecast. We believe that the potential for a further sell-off is elevated, given risks around commodities prices and equity earnings

� We expect volatility to stay elevated and think that an additional liquidity premium is needed to make HY attractive

� We still prefer IG over HY on a risk-adjusted basis as we expect volatility on spreads to remain elevated and we believe IG corporates better positioned to absorb the impact of rising rates and bad news from China.

� More signs tend to show that the US credit market is already in the late-cycle stage. Credit quality is deteriorating, but at a measured pace. Financing gap has turned strongly negative, making corporates more and more dependent on external sources of liquidity.

� But low cost of funding and continued investor demand have kept the asset class afloat…� Nevertheless, the current HY spreads are implying default rates consistent with a recessionary

environment

� We expect the focus on liquidity to remain. As said in a previous report, we feel concerned about the credit market liquidity as the rate of turnover in corporate bonds has steadily declined since 2009, despite the huge inflows. � We do not think investors are getting paid enough to own less-liquid credits� We feel cautious about the significantly negative CDS-Cash basis, especially on HY, induced by

supply fears and the increasing use of CDS indices to get (through protection selling) exposed to the credit market with a reasonable liquidity.


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� US High Yield is the only segment where we see some potential for spreads tightening. But we expect this tightening to be more then offset by the rise in UST yields

� European credit looks to be in a Goldilocks scenario. European growth is picking up but is not too hot yet and default rates are expected to remain low (around 2% - 3% versus 5% in the US) over next year.

� Nevertheless, we feel cautious about EUR HY despite the prospects of further easing by the ECB.� Next QE may drive a rally in European credit over the near term, but long positioning is getting

crowded, liquidity scarce and volatility higher.� Over that, Euro HY seems to be held hostage to oil and US HY � According to our fair pricing model, current spreads are compatible with default rates around 3%

and VSTOXX in the mid-to-high twenties.� �We see Euro HY trending wider over 2016.

� Within the credit pocket, we remain Neutral on USD vs. EUR HY spreads, but we prefer USD on a total return basis, despite its higher beta to energy sector. We position our credit portfolios into higher quality names across sectors

� Within the HY pocket, we see a more favorable risk/reward tradeoff in the BB and B rating buckets

� We still prefer US IG over Eurozone.IG, as we think that more attractive spread valuations and higher carry should fuel a stronger bid for US credit.


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� Bottom line : UW Govies, UW US vs Eurozone Govies, remain long flatteners on the US yield curve and short duration in 2y USTs, UW credit, Neutral Eurozone vs US HY credit, UW Eurozone vs US IG credit, OW 10y-TIPS and Neutral HICP Inflation, UW High Yield vs High Grade, Neutral on EM sovereigns


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US Govies – 10y USTs

� Tactically, we’ve remainedNeutral on 10-year USTs, waitingfor a clean break either above 2.35or below 2.00 to change ourpositioning.

� Unexpectedly, the 10y UST yieldbroke to the downside and wemoved to UW below 2.00.

� We keep our positioning as long as the critical support of 1.78 ispreserved.

� Below, we’ll move to Neutral again.


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US Credit - Downgrade Risk

� Downgrade risk has become a growing source of concern in both IG and HY segments

� Last 12-month upgrade-to-downgrade ratio is now headingsouth


34

USD vs Euro Credit

� Compared to the USD market, the EUR credit depicts a fairly benign picture

� Downgrade risk is clearly more visible in the former. � Within the USD market, the bulk of the risk appears to be concentrated in commodity (Oil & Gas and

Mining) sectors with the remaining sectors looking relatively insulated (specially in IG credit)


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USD vs Euro Credit

� When commodity credits are excluded, Euro spreads appear to be wider than USD spreads across most ratings (except BB- and CCC)

� Most of the remaining difference may be explained by FX hedge costs.


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EXCHANGE RATES

� The dollar rally is not over. We reiterate our bullish view on USD over the medium-term and expect a revival of the appreciation cycle of the '90s

� Historically, USD cycles have been persistent, lasting 5-6 years in the appreciation phase. We thus see further medium term USD gains against the major crosses (especially EUR and JPY) and expect a cyclical low in EUR/USD somewhere in H2-2016 (before the ECB tapering)

� Besides the Fed being in hiking mode, we expect the US dollar to be supported by the fears of a global recession. The risks to our view reside in delayed Fed action and disappointing ECB action. But we think that most of that is already priced in.

� To be more comfortable with our primary scenario, we need to see the DXY index above 98.3 again.Ultimate target ~ 102

� The continued monetary divergence between the Fed and ECB, and the shallow growth outlook for China, should lead to further downside in EURUSD throughout at least the first half of 2016. Ultimate target ~ parity.

� Our positioning on EUR-USD remains driven by (almost) the same trading rules:� We’ve moved from Neutral to OW as the spot broke above the 1.1088 resistance� We’ll move to Neutral again if the pair reintegrate the 1.08 - 1.1060.range� We’ll move to UW again after a clean break below 1.08. Targets = 1.0440 and then 1.02-1.03� We will als0 move to Neutral near 1.1584, and UW near 1.1760.


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EXCHANGE RATES

� On USD-JPY, we remain Neutral for the moment, as the spot failed to hold a break above 124-125 resistance.

� We think the pair has already reached a peak in 2015 and is likely to see a downward trend in 2016 (target ~114). Main reason for that: increasing current account surplus and expected unwinds of foreign assets by Japanese investors.

� We remain neutral as far as USD-JPY stays in the consolidation range (114-125). Above, we’ll switch to OW. We’ll also move to OW near the low of the range, and to UW on a clean break below the 113.50-114 area.

� We remain UW EM and Commodity FX, given the Fed’s hiking stance and bad news coming from China.


38

US Dollar

� Based on previous cycles, we think that the US dollar has already achieved 80% of its up cycle.� From here, US dollar may show some slowing in the pace of its appreciation


39

EUR-USD

� In our previous report, we said:“The key level which the EUR-USD must stay under is 1.1088.A close above would likely leadto much more EUR upside witheven a squeeze towards 1.17”

� With last week close at 1.1160,our primary scenario wasinvalidated (for the moment).

� According to our positioning rule,we’ve moved from Neutral toOW as the spot broke above the1.1088 resistance

� The next level to watch forconfirmation stands at 1.1250. Abreak higher would open the wayto 1.16-1.18

� We will move to Neutral againnear 1.1584 (or below 1.1060),and UW near 1.1760.


40

USD-JPY

� As expected, the weakness inUSD-JPY continued with a breakbelow 118.

� We still expect the downtrend toexpand toward 114.

� We remain neutral as far as thespot stays in the consolidationrange (114-125).

� Above, we’ll switch to OW.� We’ll also move to OW near the

low of the range, and to UW on aclean break below the 113.50-114 area.


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COMMODITY

� Prospects for commodities are still looking shaky:� China’s investment slowdown poses a clear downside risk for commodity prices� US dollar strengthening is expected to persist over the coming 6 months, weighing on commos� The tightening cycle has started in the US. Higher rates are usually bearish for commos as they

put a higher cost on carrying them in inventories� Excess supply hasn’t been solved yet

� The downtrend in commodities looks about to bottom out. But the prospects for a rapid recovery arevery slim. In previous cycles, oil and copper have spent a much longer time trading at depressedlevels

� We don’t see any sustainable recovery without a pick-up in global growth or a substantialshrinkage in supply. It is likely that supply destruction will be the main catalyst for the next recoveryin prices.

� Over 6 to 12 months, return forecasts are negative for commodities as a whole. We remainunderweight commodities overall .

� From a longer-term perspective, owning commodities makes sense in an asset allocation because oftheir structural low correlations to other assets and strong inflation hedging abilities,


42

COMMODITY

� Bottom Line :

Energy:� Fundamentals still indicate downward pressure on crude prices. High levels of global inventories

and a continuation of output from OPEC, Russia and the United States continues to weigh on price� The world oil market is estimated to be oversupplied by 1.5M B/d, yet Saudi Arabia and OPEC

keep pumping…� Prices have approached levels that may to force production temporarily offline, bringing the market

near a bottom.

� Last month, we moved UW as the spot breached the August low (~38), targeting 35 and 28-30. Ourtargets have been reached and we moved to OW within the bottoming zone of 29-25

� We still expect a bottoming formation somewhere between 25 and 29. Only a close above thetrend across the highs since Nov. ‘15 (~33.12) may signal that the bottom is already in place

� We’ve adjusted our tactical rules accordingly:� Stay OW within the bottoming zone of 29-25� Move back to Neutral if the spot breaks above 38 or below 25� Move to OW above 42 and trade the 42-52 range� Go Neutral again if the WTI goes above 56.5� Go OW if the it breaks above 63


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COMMODITY

Precious Metals:

� Outlook for precious metals continues to be dominated by the potential timing and pace of Fed’s rate hikes and the subsequent impacts on US dollar, real yields and commodity prices.

� The main factors suppressing gold / silver prices in the near term are: higher US real yields, stronger USD, outflows from gold ETPs and weaker gold flows to Asia.

� We believe prices will likely trough in mid-2016 as these factors begin to fade.� In the meanwhile, gold / silver are still due for a final leg down. Our ultimate target remains at 980-

1000 on gold and 12.5 on silver.

� We’ve moved from Neutral to OW as the spot broke above the 1070-1120 range. Our conviction would be enforced if the spot breaks above the 1200 threshold. Such a break would significantly increase the chances that a material low is already in place

� Our positioning rules remain unchanged:� Neutral between 1120 and 1070.� OW below and above.� We will wait for 1050 to progressively start accumulating Gold.


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COMMODITY

Base Metals:� The main reasons (growth disappointments in China and broader EM) behind the bear trend we’ve seen

since 2011 are still alive… The developments surrounding Chinese economy will continue to dictateprices in 2016

� From here, lower prices are still needed to oblige producers to cut production and to rebalanceoversupplied markets.

� We remain Neutral on base metals, but continue to avoid holding Iron ore and Copper (despite the last rebound explained by the fact that Chine posted it largest single month import total for copper metal)

Agriculture: GSCI Agri was down -2.4% in January. Grain prices have stabilized over the month : 0% forSoybeans, +1.9% for Corn, -1.6% for Wheat.

� Hedge funds returned to a net long position in agricultural commodities in the biggest bullish shift inpositioning in 7 months. This swing was particularly evident in corn and mainly driven by short-coveringin grains, news about a surge in South African corn imports and Russia constraining grain exports

� Funds tend to get unnerved when net short, or net long, positions are at historic highs – as they wereearly last month, when the net short in position in grains, including the soy complex, hit a record top.

� We continue to believe in a limited downside to grain prices from here when upside seems veryinteresting (on medium-term).

� At this stage, we choose to remain Neutral because of still evident excess supply.


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Commodity

� Despite a -50% performance over the last five years, we see no sign of a bottom forming yet…


Source: Bloomberg. Bloomberg Commodity (BCOMTR), UBS Bloomberg CMCI (CMCITR),

Reuters/Jefferies CRB (CRYTR)

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Crude – Tech. Perspective

� Our target of 28-29$ wasreached (and exceeded) onJan. 19th. And we moved toOW according to ourpositioning rules.

� Nevertheless, we still viewrecent price bounce as anormal correction within anoverall bearish trend.

� A break below the Januarybase (27.56 ) would signal asqueeze lower towards 25

� We still expect a bottomingformation somewherebetween 25 and 29.

� Only a close above thetrend across the highssince Nov. ‘15 (~33.12) maysignal that the bottom isalready in place.


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Gold – Tech. Perspective

� The next major level to watchclosely stands near 1200 (100-wma and the downtrend sinceMar. ‘14).

� Our positioning rules remainunchanged:� Neutral between 1120

and 1070.� OW below and above.� We will wait for 1050 to

progressively startaccumulating Gold.

� Accordingly, we’re OW gold.

� Our conviction would be enforced if the spot breaks above the 1200 threshold. Such a break could significantly increase the chances that a material low is already in place.


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Iron Ore

� Iron Ore is probably thecommodity that suffered the mostfrom China’s investmentslowdown

� China’s real estate fixed assetinvestment continuous plungestill poses downside risk forIron Ore

� Keep away from Iron Ore! Weexpect a 20% selloff from here…


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Small Cap Miners

� The current down cycle inJunior Resource market isone of the longest and mostsevere we’ve seen over thepast three decades

� But, there is no sign of baseformation yet.

� Such a bottoming seemshardly possible without:� A rebound in physical

commodity prices� A purge of all nonviable

companies


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ALTERNATIVE STRATEGIES

� The HFRI Fund Weighted Composite Index posted a decline of -1.7% in January, concluding the worst start to a year for hedge funds since 2008. Losses were led by Equity Hedge (-3.66% MoM) and Event-Driven (-2.26% MoM)

� The HFRI Macro Index led gains for the month with +1.5% and positive contributions from trend-following short exposure to equity and commodity markets. The HFRI Macro: Systematic Diversified/CTA Index posted a gain of +2.6%

� CTA performance was mainly driven by long exposure to FI in DMs, shorts in European/US stocks (despite the rebound of end of January) and EUR. CTAs were negatively impacted by their shorts in commodities. Their performance was dragged down by the recovery in oil and metals prices.

� Among Equity Hedge sub-strategies, Equity Market-Neutral performed the best (+0.8% MoM)

� We believe that diversifying portfolios with an increased allocation to alternatives is particularly attractive at this stage of the cycle, given the current macroeconomic and interest rate uncertainties

� We stick to our preference for risk diversifiers (pure alpha generation strategies) over return enhancers. Our choice has been rewarding as performance divergence between directional beta and market and quantitative trend-following strategies expanded last month.

� We think that the widening gap between the Fed and ECB monetary policies (and its subsequent impacts on US dollar, commodities and Govies) is supportive for CTAs and Global Macros on which we remain overweight


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ALTERNATIVE STRATEGIES

� We are not changing our recommendations on alternatives which we consider to be suited to current market conditions / dislocations .

� We maintain our OW positioning on:� Equity Market Neutrals both for their “intelligent” beta and their alpha contribution. � CTA’s and Global Macro as a diversifier and tail hedge. These strategies should outperform as

FX and commodity current trends are likely to persist.� Vol. Arb strategy and prefer funds that trade volatility globally (all assets / all regions). This is our

way to take advantage from the higher volatility regime.


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CTAs

� CTAs did remarkably well during the recent market meltdown. One reason for that was their ability to accurately spot inflection points in equity markets


Bottom Line: Global Asset Allocation

� The risk-off trade continued to weigh on the major asset classes in

January. The year started with an unprecedented selloff, mainly

explained by oil weakness, global recession fears, Fed premature hawkish

stance and China’s ongoing economic woes.

� BoJ’s announcement of its negative interest rate policy gave a reason to

markets around the world to rebound sharply. But the relief was brief.

� The global picture remains precarious: The global manufacturing

recession continues, slowdown concerns are mounting in DMs, a hard

landing in China cannot be fully discarded at this stage, and leveraged

EMs seem more vulnerable than ever to Fed hikes and a China slowdown;

� We remain cautious on risky assets and expect lower asset returns and

higher volatility to make the essence of the new year. More risk-off

episodes and downwaves (similar to the one we’re experiencing right now)

should be expected in the course of the year..

� 2016 could be the year commodities finally make a sustainable long-term

bottom and the US dollar reaches a turning point.

� We reiterate our view that we are sailing a cyclical bull within a

secular bear. The current cyclical bull may go higher for longer. But,

rising volatility and stalling earnings growth may indicate we are in the

late stage of the cycle.

� The perfect storm is building…

� We summarize our views as follows �


View View View

Feb '16 Jan '16 Dec '15

Equity N UW N

S&P 500 N N N

Euro Stoxx 50 N N N

NIKKEI 225 N N N

MSCI Emerging Markets UW UW UW

Fixed Income UW UW UW

T-Note 10Y UW UW UW

Bund 10Y OW OW OW

US TIPS OW OW OW

Inv. Grade UW UW UW

US High Grade OW OW OW

EUR High Grade UW UW UW

High Yield UW UW UW

US High Yield N N N

EUR High Yield N N N

EM Sovereigns N N N

Forex N/A N/A N/A

EUR-USD OW N N

USD-JPY N N N

Commodity UW UW UW

Energy OW UW N

Base Metals N N N

Precious Metals OW N N

Agri N N N

Alternatives OW OW OW

Return Enhancers UW UW UW

Risk Diversifiers OW OW OW

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Disclaimer


This writing is for informational purposes only and does not constitute an

offer to sell, a solicitation to buy, or a recommendation regarding any

securities transaction, or as an offer to provide advisory or other services

by FinLight Research in any jurisdiction in which such offer, solicitation,

purchase or sale would be unlawful under the securities laws of such

jurisdiction. The information contained in this writing should not be

construed as financial or investment advice on any subject matter.

FinLight Research expressly disclaims all liability in respect to actions

taken based on any or all of the information on this writing.

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...


Our Standard Offer

Provide tailor-made quantitative analysis of your

portfolios in terms of asset allocation, risk profiling and risk contribution

Provide tailor-made quantitative analysis of your

portfolios in terms of asset allocation, risk profiling and risk contribution

•Risk Profiling

Offer a turnkey 3-step factor-based process in GAA

with factor selection, risk budgeting and

dynamic portfolio protection

Offer a turnkey 3-step factor-based process in GAA

with factor selection, risk budgeting and

dynamic portfolio protection

•Factor-based GAA Process

Provide assistance with alternative

investments (including real

assets) in terms of profiling, and

integration in a GAA

Provide assistance with alternative

investments (including real

assets) in terms of profiling, and

integration in a GAA

•Alternative Investments

Provide assistance with asset

allocation and related risk control

and/or risk budgeting techniques

Provide assistance with asset

allocation and related risk control

and/or risk budgeting techniques

•Global Asset Allocation (GAA)


Finlight Research - Market Perspectives - Feb 2016

Economy & Finance

Transcript of Finlight Research - Market Perspectives - Feb 2016