First Quarter 2010 GTAA Equities

8/14/2019 First Quarter 2010 GTAA Equities

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GTAAEquities

January 9th , 2010

Damien Cleusix

Clue6 First Quarter 2010

am en c ue .com



1Executive Summary

Stocks

Valuations are now above levels where erformance oin forward will not lease the bu & hold crowd, even if we o

back to the good old days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200

on the S&P 500 will be priced more expensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of

the 1929 move... This does not imply that the market will fall in the short or even the medium term but that a further rise

will only have speculative and no investment merit if bought. Our base assumption remains that we will fall to significantly

undervalued levels before a new secular bull market can start (in the developed world as you know we believe that we are in a

secular bull market in emerging markets). This currently implies a sub-530 level on the S&P 500 going up by 5-6% a year.

Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in

. ,

trend (higher highs and higher lows). This does not imply that the market can not continue to rise in the medium-term but morethat it should at least consolidate in the short-term. Small investors optimism has finally started to rise and is now deep in

overconfident territory…

Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...

On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging marketequity fund. This has historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks

but they remain very low while IPO’s and Secondaries have been plentiful with bubble reminiscent level in Hong Kong and

China…Monetary aggregate momentum is turning down and this could prove to offer some headwind to risk assets…

Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of


.



2Executive Summary

Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month

in January, especially after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near

future…

Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative

good performance of defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good.e are more worr e a ou e me um- erm momen um o on s an commo es w c s n a con gura on w ere equ y

market productivity has been poor historically…Sovereign CDS will continue to need your attention…

The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of

the channel ex ected before a otential resum tion of the u move but the rest of the anal sis oints out to somethin

potentially bigger than the correction we had since March…




3Equities: Valuations – A Repeata ua ons are no use u or s or - erm mar e pro ec ons u are essen a n orecas ng

long-term returns. They become informative in the shorter term when they reach extremes .When they are very high one should not allow the other indicators in one’s arsenal to deteriorate

too much before pushing the exit button, the reverse is true when they reach very low levels.

US Earnings VolatilityChart 1

.

look at normalized price to earning ratios (normalized using an trailing reported earnings moving

average, average margins or peak earnings) and price to book value. We like to look at a historical

dataset as long as possible. It is also important to consider the quality of the data. One often

hears that valuations should be higher because the markets are less risky.

We disagree.

Main Street has clearly been less volatile in the past 30 years (well up to now), as has

inflation. The consequence is that companies have increased their leverage dramatically (cf.

’ “ ” ’ “ ”. . .

process earnings volatility has increased rapidly in the past 10 years (Chart 1). From the mid50’s to the mid 80’s, real annual earnings were rising or falling by 3.8% for every percent change

in annual real GDP growth. In the past 10 years if was 22%...

Source: R. Shiller, Clue

Table 1 Tangible Book Value

1. intangibles have become legion in some countries (Table 1) (ask a bondholder of a bankrupt

high intangibles company what intangibles are worth...),. Goldman Sachs has calculated that

the S&P 500 constituents asset/equity ex-goodwill has risen from 2.5 in the 80s to 4.4 today.

Source: Bloomberg, Clue6

. .

3. Assets' mark to market which increase their pro-cyclicality.

In brief, as often repeated in the past, we think market should be valued at lower levels, not

higher levels than historically.


This is thus not surprising that AAA and AA bonds represented almost 60% of the BarclaysCapital Investment Grade Index at the end of the 70s while they only represent 25% today.



4Equities: Valuations – A Repeat

Investors attach a lots of importance to what happen to earnings on the very short term

while they have a very negligible influence on the intrinsic value of the markets . Indeed even

if earnings were to be 0 in the next 2 years, this would not affect by more than a few percentage

S&P 500 and Middle to Young

CohortChart 2

points the intrinsic market value derived by a dividends or cash flows discount model.

Remember that markets are a claim on a very long-term stream of cash flows.

What moves market valuation around fair value in the short-term is investors’ risk appetite.This is what we analyze extensively in the Sentiment, Breadth, Liquidity, Seasonality and Cycle

section of our presentations.

In the long-term, we believe that the main driver of long-term generational fluctuation in

valuation ratios from very undervalued to very overvalued, is the reallocation of the stock of

wealth (as demonstrated by J. Tobin more than 40 years ago). One can see this phenomenon in

action loo ing at t e Saver/Spen er ratio or Mi le to Young co ort (C art 2).

This is the ratio of the population aged 40-49 years to 20-29 years (we will show graphs for other

markets later). For the US we think the time for the next structural bull market to start will be the

low made between 2014-2016 (with a preference for 2014).

Source: Census Bureau, Clue6

As we have said in the past 10 years, this does not mean that there won’t be cyclical bull markets

in between.

In the past we have showed that during structural bull markets the market rises around 85%

o t e t me w e n structura ear mar et t r ses approx mate y o t e t me…

So where do we stand now…




5Equities: Valuations

For longer-term return projections (7 years), we use a methodology similar to Grantham, Mayo,

Van Otterlo & Co so let’s use their graphs (Chart 3 and 4). What is the performance of thevarious categories if in 7 years they trade at the average valuation normalized to average margin.

Another indicator we look at is the Value Line Median Appreciation Potential (VLMAP) which

Chart 3ears

Return Forecast

August 2009

P.Bernstein used in his valuation estimation of the market. It is the median price appreciation

potential estimated by Value Line of the all of the 1700 stocks they cover for the following 3 to 5

years. It fell below 60% which is at the bottom end of its history… One should start

accumulating stocks when it rises above 100%...

High quality stocks expected return has declined by more than 2% to 9.6%. This is where

we still would be greatly overweight (and as an aside valuation our macro scenario favor

"bunker-like" balance sheets).

As we will show in the next few pages, we think there is a non-negligible risk (it is a risk

Source: Grantham, Mayo, Van Otterlo & Co

identified and not a prediction…) that the market will make “THE” bottom at levels up to

50% below where the markets are now.

In 2000 we said that the S&P 500 would fall below 500 before the next structural bull market

starts, we still believe that this is a potential outcome (but we would add 5-6% a year to this

Chart 4 November 2009

objective going forward (would be a combination of extension and time for the correction I.E the

longer it takes the lower the required decline…)

But we also know that timing the exact bottom is impossible so we will automatically increaseour recommended allocation on declines once we fall below 700-750 on the S&P 500 and we

see breadth extremes without regard to the trend. The allocation will be increase along

price declines exactly as we did in March this year.

One need a plan to stick to in such environment and this is ours . We will also limit the extent

to which we take net short positions the closer we are to what we consider rock bottom


va uat ons.




US PBChart 5We have shown that the concept of book value haschanged in the last 15 years (Table 1 earlier).

This is especially true for the US and Europe.

Chart 6 Europe PB

In 2007, in our effort to convince clients of the

overvaluation of the market, we presented data

demonstrating that balance sheets had

experienced a radical mutation in the past 25

years. Not only i we see a ecline of t e

importance of the tangible assets, those were now

dominated by financial assets whose pro-

cyclicality was masking the potential problems

and over-leveraging.

We understand that in a service economy tangibleassets are not as important as when manufacturing

dominated (see the proportion of tangible assets in

emerging economies on table 3), but once more,

Japan PBChart 7 Chart 8 Japan Small Caps PB

Source: Bloomberg, ClueSource: Bloomberg, Clue

as yourse w a n ang es are wor n a

bankruptcy…

On the various charts the semi-transparent

area represent time when the market was

c eaper an o ay on a oo va ue per s a re

basis.

A cursory look at the graphs confirm that

valuations are not as attractive as they were just 6


… ,,




Asia ex Japan PBChart 9

The picture is less flattening if one looks at price to

normalized earnings or price to replacement value

Chart 10 Latin America PB

All in all we would estimate the US and European

markets to be overvalued by 30-40% with a fair

value between 750-800 (and do not forget that we.

feel comfortable (and in good company…J.

Grantham, A. Smithers, J. Hussman,…)

Japan remains undervalued and as said, the low

Eastern Europe PBChart 11

Source: Bloomberg, ClueSource: Bloomberg, Clue

mean revert to other countries standard now that Japan is slowly, but surely, becoming more

shareholder friendly.

...

excess liquidity pumped by central banks around the world and from the cheap USD but... The USD

won't fall forever and once you reach a certain level of valuation you are only counting on finding a

bigger fool. Trend change should definitely be acted upon from here on...

background... Buy aggressively on a return to 0.5-0.6 PB.


,



Equities: Valuation 8

Chart 13USA and Europe Return on EquityChart 12e ng, enera an

Administrative Expenses YoY

Return on Equity is probably near a bottom in the US and there is still some work to be done in Europe which tends to lag by 12-18 months, as doearnings (Chart 12). Return on equity analysts projection which we qualified as overoptimistic earlier might come to pass for 2010 (well the one

Source: Goldman SachsSource: Morgan Stanley

they add a couple of months ago not the current ones.

At least US companies have been firing a lot of workers. The decline in nonfarm payrolls at more than 5% surpasses the decline in GDP... In

Europe we have only seen 1% decline...


The consequence has been that the annualized Q2/Q3 growth of the business sector GDP has been 1% while profit have increased by 46% (thanks

to financials which represents again more than 35% of total profits…)



Equities: Valuation 9

US Private Compensation/GDPChart 15US Profit/GDPChart 14

The reliance of margins in the US has been in good part due to the foreign profits margin (Chart 14) (more on this later) … Note also that the

Source: BEA, Clue6Source: Bloomberg, Clue6

…

Longer-term we are expecting to see a mean-reversion in the Private compensation to GDP (Chart 15) which will weight on margins which might

stay lower for longer and not reach the 2007 and even 2000 high for quite some time. This should be associated by a reduction in inequalities,...

But more on this very important and under discussed problematic later in 2010…




Equities: Valuation – US Earnings 10

S&P 500 as Reported Earings and Margin Direction ModelChart 17US NIPA and S&P 500 Operating ProfitsChart 16

We have used the Chart 16 a couple of times in the past (2000, 2002 and 2007) to forecast a turn in the S&P 500 operating earning cycle. NIPAProfit leads by 2 to more quarters. This bodes well for at least the coming 2 quarters (at the top of the cycle accountants tries to mask the earning

Source: Clue6Source: Clue6

deterioration while at bottoms they do the reverse…)

A few remarks… First the big increase in the last quarters NIPA profit was mainly due to financials. Profits in the sector rebounded strongly

because of a decline in both charge offs… One has also to see that the current ratio of as reported (according to GAAP) to operating earning at 14%

is the lowest in history (last low was 60% during the 2000-2002 bear market). Accountant are working hard… Finally our basic margin model is


has recently turned negative… If earnings grow beyond Q2 2010 it will have to be supported by top line growth.



Equities: Valuation – Style 11

Speculative vs. DefensiveTable 2Valuation Factor DispersionChart 18

There are many analysis one can use to time styles. One we use and have advised to use for many years, is factors dispersion. There are many ways

to calculate it… On Chart 18 you can see the calculation for both Europe and the US of the value factor dispersion… When dispersion is spiking

Source: ZeelotesSource: Morgan Stanley

g er, uy un stoc s we ave emonstrate n t e past t at t e est stoc s to uy a ter a ottom an t can a so e an nterme ate ottom n an

on-going bull markets) were the stocks appearing in short screens) when it is low, buy quality…

The messages are… the outperformance of simply buying low PB stocks vs. high PB stocks is likely to be much below average going forward

(until dispersion increase again but dispersion could decrease further before we would short them), speculative factors are likely to underperform


un we ge e nex ou o ncreas ng spers on, w s a e grow , roc so a ance s ee , s ea y ncreas ng

dividends and book value per share and a moat…



Equities: Valuation – US Future GDP Growth 12

Source: CBO,Clue6 Idea: J.Hussman

As said in the past, in the long run, earnings tend to grow slightly less than GDP. The above concept to estimate forward growth was first proposed

by J.Hussman. For the US real GDP to reach the CBO potential real GDP forecast in 10 years, the growth should be 2.7% which is one of the

lowest in history.

If one add that there is a non-negligible risk of deleveraging and overcapacity related deflation (if Central Banks and Government do not go all-in


where inflation might become a problem) this does not bode well for nominal growth which is what people and companies use for they investment

and consumption decisions…



13Equities: Sentiment – Surveys

NAAIM Survey and S&P 500Chart 20Investor Intelligence Bull/Bear RatioChart 19

For the first time in a while, almost all of the Surveys we follow are indicating a very high level of confidence that the market will continue to rise…

Source: NAAIM, Clue6Source: Investor Intelligence, Clue6

On Chart 19 one can see the the Investor Intelligence Bull ratio which has recently reached its highest level in many, many years (with the Bearish

percentage at its lowest level since 1987, and thus 3 weeks in a row now…) The same configuration is starting to emerge when looking at the

American Association of Individual Investors survey with the bearish percentage at 23% (but it went below 10 a couple of times in the past)…


e at ona Assoc at on o Act ve nvestment anagers a ocat on survey art s a so not are away rom past g s ur ng t e past

weeks… Markets have tended to struggle after such a long stretch of bullishness…




TSP Survey and S&P 500Chart 22Greenwich Macro Managers Bearish%Chart 21

On Chart 21 one can see that the Macro Managers bearishness has abated but remains relatively highs (and we would not use it as a contrarian signal

Source: TSP, Clue6Source: Greenwich Alternative Investments, Clue6

at this juncture)

Finally the TSP Bull/Bear Survey (Chart 22) has recently moved sharply higher and has given a sell signal according to the methodology they use…





ML Fund Managers Survey Percentage Net

Overweight Emerging marketsChart 24ML Fund Managers Survey Percentage

Net Overweight JapanChart 23

Source: Merrill LynchSource: Merrill Lynch

On a Country/Region basis there are 2 stand outs…

Everybody hates Japanese stocks (Chart 23) while the sky seems to be the limit for Emerging markets (Chart 24)…

2 potential surprises for 2010? Probably but the timing will have to be right with probably 3-4 phases during the year but with the Topix beating EM

by the end of the year….




16Equities: Sentiment – Put Call Ratios

S&P 500 and Equity PC RatioChart 26S&P 500 and OEX PC RatioChart 25

Looking at option activity the picture is similar…


On Chart 25 one can see that the OEX put call ratio rose above 2 4 times in the past few weeks… this is something very worrying.

At the same time the Equity put call ratio is hovering at a low level (Chart 26).


ot were com ne on a s ng e grap , one wou see t e aw attern we ave scusse n t e past…



17Equities: Sentiment – Put Call Ratios

S&P 500 and Small Traders Buy to Open Put/Call RatioChart 28S&P 500 and Small Traders Option ActivityChart 27

Source: OCC, Clue6Source: OCC, Clue6

, ,

16% of their total activity which is near an historic high while their call buy to open activity represents 36% of their transaction… not far from the

40-42% extremes reached in the past (Chart 27 and 28)…




18Equities: Sentiment – Insiders

Footsie and InsidersChart 30S&P 500 and Russell 3000 InsidersChart 29

The number of sell transactions in the US is reaching a high level (especially given the fact that at year end activity usually abate somehow…) while

Source: ML, Clue6Source: Bloomberg, Clue6

buying remains low (Chart 29).

The same is true in the UK where the buy to sell ratio is historically low (Chart 30)…

But remember, insiders activity is especially useful in 2 configurations: lots of relative buying or increased selling when the market decline…





Europe Directors’ Selling (in eur mio.) (transactions

capped at eur 1 mio.)Chart 32Chart 31 Europe Directors’ Buying (in eur mio.) (transactions

capped at eur 1 mio.)

In Europe we have seen a big increase in selling during the past 8 weeks consolidation (Chart 32) while buying has remained low (Chart 31)…

Source: Deutsche Bank ource: eutsc e an





Global Insiders ActivityTable 4Global Insiders ActivityTable 3

Looking at other markets around the world, one can see that insiders have become increasingly bearish in Hong Kong notably (Table 3-4)…

Source: Bloomberg, Clue6Source: Bloomberg, Clue6

Note that the last quarterly ratios where already much higher than the very bullish (lots of insiders buying) that we witnessed at the end of 2008 and

the start of 2009…




21Equities: Sentiment – Smart Money

S&P 500 and Leuthold Core Beta ExposureChart 34S&P 500 and Hussman Strategic Growth Beta ExposureChart 33

J. Hussman strategy here is clear. He buys small on weakness and re-hedge completely on strength. According to our calculation he is currently fully


hedged and he has been out recently saying that a >20% correction is likely (but not certain…) to start in the next 8-12 weeks…

S. Leuthold, who has been bullish and right since early in 2009, has started to sound more cautious, at least for the short-term… His exposure is still

high though (Chart 34)…




22Equities: Sentiment – Smart/Dumb Money

S&P 500 and Strategists Stock AllocationChart 36Nasdaq 100 and Non-Commerical Net Long Future PositionChart 35

Non-Commercial have dramatically diminished their Nasdaq 100 futures net long positions from an all-time high to approximately 2000 contracts


(Chart 35).

Wall Street Strategists have dramatically increased their equity allocation recommendation in the past few weeks (Chart 36) and while it remains

lower than average if one look at the past 12 years history this would probably not be the case if a longer history was available…




23Equities: Sentiment – Dumb Money

Analysts US Stock Recommendations 3 Months ChangeChart 37 Topix and Percentage Analysts Sell Recommendations JapanChart 38

Analysts recommendation momentum is not very informative here with both buy and sell recommendations being lower than 3 months ago (Chart

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

37)

In Japan after a pick up in sell recommendations at the end of 2008 we are seeing continuing decrease in the momentum of buy recommendations

(Chart 38).




24Equities: Sentiment – Dumb Money

Topix and Shares Sold on Margin Profit/Loss RatioChart 40Topix and Shares Bought on Margin Profit/Loss RatioChart 39

In Japan analysts have access to the performance of the margin buyers and sellers.


n art one can see t at w en nvestors are start ng to ma e money on t e stoc s oug t on marg n or even os ng ess t an , t e ra y s

usually very near a reversal…

The same is true on stocks sold short on margin (Chart 40)… when they start to make a profit, a reversal to the upside is not very far… we had a

good example in December…


Margin traders are currently losing both way…



25Equities: Sentiment – Volatility

S&P 500 and CFTC VIX Large Speculator Net PositionChart 42S&P 500 and Vix Time-SpreadChart 41

Our VIX Indicators are giving conflicting signals…


The time-spread is at levels where market volatility has increased and markets have struggle to make sustain advances (Chart 41) while non-

commercials have an important net short position indicating that they believe the VIX will continue to decline in the near-term (Chart 42).

Remember that they are the smart-money here (but note that they were dead wrong with their highest net long position in December so…

Looking only at the VIX, the recent highs have not been confirmed by a VIX new low which is a negative while on the positive side it is still making


lower lows and lower highs… A break above 23.5 followed by a higher low would be needed to change the trend…



27Equities: Breadth

Nasdaq 100 and the New High New Low ModelChart 44S&P 1500 and its AD LineChart 43

After having showed sign of potential divergence in November and December, breadth is back in sync with the market…

The S&P 1500 Com osite Index cumulative advance decline line has now confirmed the market recent hi hs Chart 43 . The diver ence was due to


the poor showing of small caps stocks which have performed extremely well since mid-December. We will have to see if the rebound is simply the

traditional small caps rebound during this time of the year or is a sustainable move (breadth-wise) in the weeks to come…

The Nasdaq New High-Low Model is still on buy (Chart 44).


But one has also to keep in mind that volume remains anemic and that the up-down volume stats are not showing real buying behind the recent move

(real accumulation has been absent since October…)



28Equities: Breadth

MSCI Asia Ex Japan and Normalized Advance-Decline RatioChart 46Topix and Normalized Advance-Decline RatioChart 45

Our Japanese normalized advance-decline ratio moved to an extreme oversold level (<-40) in early December and has since moved back to positive


(Chart 45). You usually needs a move above 20 for the market to stale after such oversold readings…

In Asia, we did not have any breadth thrust in the past 3 months (Chart 46) and are slowly approaching the >5 levels where the market tend at least to

consolidate (if we expect the move out of extremely oversold level where it usually indicates continuation…)


E i i



29Equities: Breadth

S&P 500 and Hindenburg OmensChart 48S&P500 and Fosback High Low IndexChart 47

Since we have started to write those presentations, many years ago, we have used the following 2 studies to warn of impeding cyclical trend change.


On chart 47, one can see the Fosback High Low Index remains very low, indicating a lack of distribution. It is likely to remain low until mid-March

as many stocks plunged into March 2009 making a big rise in new lows unlikely.

We have yet to see any Hindenburg Omen triggered on any of the Major index (Chart 48)…


E i i



30Equities: Liquidity

Flows to Emerging Markets Mutual Funds and Future

Relative performanceChart 50Equity mutual fund assets and net cashChart 49

Source: Nomura

Net inflows into equity mutual flows continue to be negative (Chart 49) in the US while we are continuing to see huge inflows into emerging market

Source: ICI, Clue6

oriented funds (and while US investors have been net sellers of equity mutual funds they have been net buyers of emerging market equity funds…)

Such important inflows have been historically followed by a substantial underperformance of Emerging markets (Chart 50)..

The NYSE margin debts has now exceeded the 2000 levels on a % of market cap basis…


E iti




Number of Buybacks Announced per Month in JapanChart 52Number of Buybacks Announced per Month in the USChart 51

Buybacks have picked up slightly in the US in the past 2 months but remains at a very depressed level (Chart 51)…


In Japan, we have seen a slightly more robust pick up (Chart 52) but we would like to see more to be convinced that management is more confident

on their company prospect and more interested in the well-being of their shareholders…

Note that we remain wary of too much buybacks which, in aggregate, still remains a sign of management “short-terminism”… and in Japan we


wou pre er to see stoc s oug t ac t an new unpro uct ve cap ta expen ture…

E iti




China + Hong Kong IPOs and Secondaries (US mio.)Chart 54US IPOs and Secondaries (US mio.)Chart 53

The Banks TARP repayment have caused a big jump in the amount of secondaries in December (Chart 53). The market digested them surprisingly


well with banks shares only underperforming slightly (but still far from their September highs)

In China and Hong Kong, management are taking advantage of the current rebound to flood the market with new shares (Chart 54)…

Remember that management sell stocks mainly for 2 reasons. First when they have to in order for the company to survive (what happened in the US


ur ng t e rst mont s o or w en t ey wou e stup not to e ac stone n u y , na an ong ong at t e en o an

potentially now…)

E iti i idi




Japanese Middle to Young Cohort and Equity Funds

AssetsChart 56US Middle to Young Cohort and Equity Funds AssetsChart 55

The above 2 graphs are well-known for those who have been reading our research for a long-time.

Source: ICI, Census Bureau, Clue6 Source: BOJ, Japanese National Institute of Population and Social Security Research, Clue6

We believe that the long-term flows into and out of assets (the relative buying/selling urgency to be more precise as they are no money getting in or

out of the market… for each buyer there is a seller and vice-versa) have a demographic cause… It affects the assets relative value and can be best

seen on the secular trends in normalized valuation ratio.

In the US, one should not be surprised by the net outflows from equities into bonds, this is what should happen (Chart 55) while in Japan we should


see t e reverse (C art56)…

Equities: Li idi




Middle Age Population Growth ForecastChart 58Chart 57

the Next 5 Years

On chart 57 you can see the countries which have the most positve demographic dynamic according to the Middle to Young Cohort hypothesis…

Source: Census Bureau, Clue6 Source: Census Bureau, Clue6

But should not only the “Middle to Young Cohort” but the absolute growth of the middle age population (Chart 58).

Combining both, one see that the picture is somewhat less bullish than it seems for Japan, Spain, Poland, Portugal and Greece


35Equities: Li idit




Middle Age Population Growth ForecastChart 60Chart 59

the Next 5 Years

On chart 59 one can see the countries with the most bearish demographic configuration according to the Middle to Young Cohort hypothesis…

Source: Census Bureau, Clue6 Source: Census Bureau, Clue6

The middle age dynamic of those countries is presented on Chart 60…


36Equities: Li idit




Liquidity momentum has a slight tendency to lead markets, and this should be especially true given in the current environment…

M2 momentum is not supportive going forward…


Equities: Seasonality President Cycle and Monthly Seasonality 37



Equities: Seasonality – President Cycle and Monthly Seasonality 37

Return since 1927)

Chart 63 US Monthly Return (S&P 500 Total Return since 1944)Chart 64

The four year Presidential cycle has been distorted by the huge fiscal and monetary stimuli of last year. The rational behind the presidential cycle

Source: Clue6 Source: Clue6

market…

The market has a tendency to perform slightly better in January (Chart 64) but in the past 10-15 years we have witnessed a good start followed by a

nasty correction intra-month so…


Equities: Seasonality Sell in May and 38



Equities: Seasonality – Sell in May and … 38

Average Return MSCI Indices 1970-1998Chart 65 Average Return MSCI EM Indices 1970-1998Chart 66

Source: The Halloween Indicator, S. BoumanSource: The Halloween Indicator, S. Bouman

“ ”

a date but we want a technical confirmation during a given time-window) are also on buy…


Equities: Seasonality End of Month Anomaly 39



Equities: Seasonality – End of Month Anomaly 39

US Day of the Month (S&P 500 Total Return since

1944Chart 67 Japan Day of the Month (Topix Total Return since 1979Chart 68

The day of the month continue to exhibit its historical pattern in the US and Japan (Chart 67-68) (the same is true for most markets as showed


…


Equities: Seasonality – Cycles 40



Equities: Seasonality – Cycles 40

NYSE Composite and the 20 and 40 Weeks CyclesChart 69 Super Cycle Economic SeasonsChart 70

The next 20 weeks cycle low is expected for the middle to end of March (Chart 69).

Chart 70, courtesy of B. Bronson, has been used in the past to depict the relative assets movement during the Long Cycle (Kondratiev wave). Many analysts have

Source: Clue6 Source: Bronson Capital Market Research

tried to define this cycle by applying a fixed number of years but, as we have long said, we think that this is more of a generational cycle of leveraging and

deleveraging (was visible on price up to the creation of the Fed and on money velocity since then…). People who were young in the 30’s were allergic to

borrowing during all their life, organizing parties to celebrate their final mortgage payment… The same is slowly happening now in the developed world (it will

likely accelerate in the coming years when the weak foundation of the current upswing will become clear to all…)


, .

ask for more… It is followed by the Winter where interest rates and stocks valuations become highly correlated, both falling…

41Equities: Intermarket




S&P 500 and Nasdaq Composite Relative PerformanceChart 72S&P 500 and World Defensive Relative PerformanceChart 71

Defensive have been performing relatively well in the past3-4 months (Chart 71). To follow attentively in the next few weeks to see if they manage


to break out… This would be a negative for the market…

After having struggled, along with small caps in the past 5 months, the Nasdaq Composite has finally made a 52 weeks relative high against the

broader market (Chart 72). This is positive has the market tend to be most productive when the Nasdaq relative performance trends higher along with

the market as we have showed with various models in the past…






Chart 73

Performance

Corporate Bond Fund Net Asset ValueChart 74

Banks shares continued underperformance is worrying (Chart 73) as it is a logical consequence of our macro scenario but one could still say that


they performed relatively well given the huge amount of dilution they have to suffer in the recent past… and let’s not forget that they are in the

portfolio of quite a lot of the smart money managers we follow so…

High yield spreads are continuing to decline and junk bonds are making new price highs (Chart 74) despite the rapidly rising 10 years treasuries

which is impressive…






Chart 75 S&P 500 and US 2 Years Treasury Bonds S&P 500 and Eurodollar ModelChart 76

Two years treasuries have spiked higher recently (Chart 75) and this should be associated with struggling market in the current environment…


e same s true or n at on expectat on…

We also like to look at the relative behavior of the equity markets and the Eurodollar future. On chart 76 you can see what happen to the market

when the eurodollar falls (higher rate expected) 2 days in a row and the market falls at the same time… We had an episode mid October… Another

one could mark an peak of significance…


One of our most effective intermarket “consolidation forecaster” which simply looks at the combined medium-term momentum of bonds and

commodities is also flashing a warning signal…

Equities: Intermarket – US10 Years Govies against Stocks 44



q g

Blue area indicates when the momentum

Chart 77 S&P 500 and US 10 Years Treasury Bonds S&P 500 and US 10 Years Treasury BondsChart 78

positive. In this period, stocks performed

when the momentum was negative.

Blue area indicates when the momentum

in 10 years government bond yield is

positive. In this period, stocks performed

when the momentum was positive.

We have long argued that one the characteristics of the current structural bear market (and we are talking US, Europe and Japan here...) was


.

But one has also to take into account the fact that while they are positively correlated, when yields have risen too much too quickly the stocks will

struggle. The sequence is usually rising rate, acceleration to the upside, yield starting to fall just before stocks do it to…


Equities: Intermarket 45



qChart 79 MSCI Emerging Markets and Dollar Index S&P 500 and Sovereign CDSChart 80

We already identified potential headwinds for emerging markets (Valuation, investor bullishness,…)

Source: Clue6 Source: Bloomberg, Clue6

Don’t forget to look at the USD… A rising USD has rarely been a positive for emerging markets (Chart 79)…

2010 or 2011 could be years of major sovereign negative surprises… on the next page one will find the countries to have especially an eye on…


… …

Equities: Intermarket 46



q

Source: RBS

Canaries in the coal mine candidates… To observe attentively in the coming months…

Candidates have been selected using the methodology of “Rules of Thumb' for Sovereign Debt Crises” by P. Manasse and N. Roubini, 2005


47Equities: Graphs



qS&P 500

Shoulder

Shoulder

Head

The S&P 500 continues its march upward inside a well-defined up channel. We continue to see higher highs and higher lows.

The inversed head & shoulders and June-July flag targets are still above us at 1200-1250 while the descending 2007-2008 channel

should offer resistance at the 1100-1130 levels.


A series of narrow range day has usually been a warning of an impending correction in the past 12 month… Had the first on

Wednesday this week…

48Equities: Graphs



qDJ Euro Stoxx 50

ShoulderShoulder

Head

Europe has been slightly underperforming recently but has now managed to make new cyclical highs. The head & shoulders target is at around

3300.

We would continue our strategy of selling strength (top of channel) and buying weakness (bottom of channel) until our tactical model becomes a

seller…


We would now move from selling upside volatilities to outright reduction of the equity exposure and even a small net short positions when

reaching the top of the channel…

49Equities: Graphs



Topix

ShoulderHead

Shoulder

Shoulder

Shoulder

Head

The Topix reacted strongly by rebounding from its December oversold level… It has now formed an inversed head and shoulder

with a 1000 target…


50Equities: Graphs



MSCI Asia ex-Japan

Asia rose strongly at the in the past 2 weeks has everything which is associated with risk… As everywhere the gain have been made

on low volume…

Yet one has to respect a market making a new 12 months high after having consolidated during 4 months…


To be honest it smells a bull trap but…

51Equities: Graphs



MSCI EM Latin America

Similar as in Asia but with less impetus…


52Equities: Graphs



MSCI Eastern Europe

Eastern Europe still remains one of the least discounted "unavoidable accident" in the market today (it is was mostly discounted in

the Eastern European markets last year but the second round effects to ward other part of the world are not…… The stronger IMF

has voided the "end of their world" scenario, but…


… …

things in the Czech Republic for example…

53Equities: Conclusion



Valuations are now above levels where performance going forward will not please the buy & hold crowd, even if we go back to the good old

days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200 on the S&P 500 will be priced moreexpensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of the 1929 move... This does not imply that the market

will fall in the short or even the medium term but that a further rise will only have speculative and no investment merit if bought . Our base

assumption remains t at we will fall to significantly un ervalue levels efore a new secular ull mar et can start (in t e evelope worl as you

know we believe that we are in a secular bull market in emerging markets). This currently imply a sub-530 level on the S&P 500 going up by 5-6% a

year.

Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in the past. But even if

sent ment s once aga n too gree y, t as to e put n t e context o t e recent a vance an mar et tren g er g s an g er ows . s

does not imply that the market can not continue to rise in the medium-term but more that it should at least consolidate in the short-term. Small

investors optimism has finally started to rise and is now deep in overconfident territory…

Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...

On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging market equity fund. This has

historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks but they remain very low while IPO’s andSecondaries have been plentiful with bubble reminiscent level in Hong Kong and China…Monetary aggregate momentum is turning down and this

could prove to offer some headwind to risk assets…

Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of liabilities...

Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month in January, especially

after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near future…

Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative good performance of

defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good. We are more worried about the medium-

term momentum of bonds and commodities which is in a configuration where equity market productivity has been poor historically…Sovereign CDS

will continue to need your attention…


54Equities: Conclusion



The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of the channel expected

before a potential resumption of the up move but the rest of the analysis points out to something potentially bigger than the correction we had sinceMarch…


First Quarter 2010 GTAA Equities

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Transcript of First Quarter 2010 GTAA Equities