MARKET COMMENT Q1 2017 - CV INVEST · by CLSA Laurence Balanco shows that a US 10yr yield above 4%...

Market Comment

CV Invest Partners AG [email protected]

A LOOK AHEAD December 2016

A challenging year for financial markets is coming to an end soon. Most European equity markets are likely to finish 2016 in slightly

negative territory, U.S. equities are strongly up and yields spiked sharply in recent months. Along the way, Brexit and US elections

caused extreme volatility. Have equity markets topped out and is the more than 30 years old bull market in bonds over? On the following

pages we will try to find answers and provide you with a roadmap for the first half of 2017 and beyond.

A Look Back

Before providing you with our view of the next six months and

beyond, we would like to look back and reflect what our key

messages were back in July.

Equities

In July we said that we would “remain underweight equities in

anticipation of lower equities into late Q3/early Q4” and “after a

bounce following the Brexit sell-off, we expect the S&P 500 to

revisit 1928-1965”. While remaining underweight equities into late

Q3/early Q4 was right (the market bottomed on November 4th),

the S&P 500 did not fall as low as expected.

We also repeatedly said that “it was and still is our belief that

another, final rally has to follow to complete the bull market that

started in 2009. The anticipated 5th wave rally could lift the S&P

500 up to 2550, a Fibonacci extension and our preferred price

target for this bull market. Cycles suggest that this final rally could

last until summer 2017”. This view remains valid and we will

explain it in more detail on the following pages.

US Dollar

While many have already called a major top in the Dollar index

we said that we believe “one leg to the upside is still missing”. This

final leg “could last into late 2016/early 2017 and reach 112/113, a

fibonacci extension”. With the break of 100 in the Dollar index mid

November, we have a good reason to believe that the final rally in

the US dollar is underway.

Commodities

Already in December 2015 we said that commodities look

deeply oversold and that a multi-month rally would be likely.

Then in July we reiterated this call but warned at the same

time that “commodities are vulnerable for a correction”. This

correction took place in the month of July and since then, the

CRB index has been trading in a wide trading range.

Our target for oil between USD 35-38 was nearly hit. In early

August, light crude oil touched USD 39.

Gold

Last December we called for a major bottom in gold. In July

this year we said that “we continue to see much higher gold

prices in the coming years and believe that the rally off the

December lows was just the first rally wave of a new bull

market”. But we also warned of growing divergences:

“Following the Brexit vote, gold hit a new intraday high at

USD 1358 that was not confirmed by higher momentum,

which we view as an early warning signal. We would

welcome a correction towards USD 1240 and USD 1210”.

Gold recent correction did not stop at USD 1210. So what is

next?

Equities

We repeatedly said that we don’t believe the 2009 bull market to

be over yet. Despite the fact that this bull is already in its 8th year

and therefore one of the longest in history, we believe that the

final 5th wave is still missing. It is worth remembering that major

bull markets take place in five waves. This includes three

upwaves (waves 1, 3 and 5), interrupted by two corrective waves

(2 and 4). We view the correction that started in spring 2015 as

wave 4, the second corrective wave. Wave 4s are usually only an

interruption in a longer range uptrend. This wave 4 has likely

ended in February of this year.

1 – S&P 500 Weekly

Source: www.prorealtime.com

Market Comment


One of the main reasons why we believe so is market breadth.

The bounce off the lows was accompanied by strong breadth

such as the percentage of stocks trading above the 200day

moving average and the number of stocks making new 52-week

highs. Another encouraging sign is coming from the Dow

Tranportation Average. In early December, the index closed at a

new all-time high. According to Dow Theory, simultaneous all-

time highs in transport and industrial stocks trigger a buy signal

for U.S. stocks. During this 5th wave we expect the S&P 500 to

reach 2’550, a Fibonacci extension.

Cycles

Regular readers of our publications know that one key element of

our predictions is cycle analysis. Do cycles confirm our base case

scenario of another wave to the upside? Our focus is on the

presidential, decennial and the 34-year cycle.

Remember, the presidential cycle pattern shows similarities in the

stock market’s behaviour among presidential terms. 2017 is the

first year of the presidential cycle which on average peaks in

July/August. When looking at the cycle by excluding second term

presidents (Trump is a first term president), the curve has a similar

shape: Weak start into the new year with a low in February

followed by a peak in August.

2 – Cycles 2017

Source: CV Invest Partners AG, Bloomberg

The decennial cycle segregates annual market returns through a

decade. Interestingly this cycle has a very similar shape also: a

relatively weak start is followed by gains the following months

before the market tops in July. The main difference to the other

cylces lies in the months following the top in July/August. The 7th

year of a decade is one with the lowest returns which all

accumulate in the second half of the year. According to this cycle,

we will see heavy losses following a top in early Q3.

3 – Decennial Cycle

Source: CV Invest Partners AG, Bloomberg

This scenario is further fueled by the 34-year cycle. The cycle

rises for about 17/18 years and then declines for about 16/17

years. Previous bull markets lasted from 1949-1966 (17 years)

and 1982-2000 (18). Bear markets included the periods

between 1929-1949 (20 years), 1966-1982 (16) and in our

view from 2000 until now. In other words, we are in the 17th

year of this secular bear.

4 – 34-Year Cycle

Source: CV Invest Partners AG, www.prorealtime.com

Clearly, it does not feel like we still are in the midst of a

secular bear market with U.S. indices trading at all-time

highs. But in recent years, markets have been strongly

influenced if not manipulated by central banks. An interesting

analysis by Ned Davis Research shows that the S&P 500 has

not increased since 1997 if price change the day and the day

before Fed meetings are excluded. Arguing that the market is

still trapped in a secular bear market is much easier in

Europe where the STOXX 600 stll trades some 15% below

the 2000 highs (the EuroSTOXX 50 still trades more than 40%

lower!).

5 – STOXX 600 Europe


6 – EuroSTOXX 50 Monthly


Market Comment


Most secular bear markets have gone through three major

declines. So far we have only suffered two (2000 and 2008).

Reasons for another sharp market decline are numerous.

Traditional valuation measures such as the Shiller P/E or the

Tobin Q ratio are very rich and are both signalling a very

expensive market. The US dollar could be a trigger as global

credit in USD extended for non-bank borrowers outside America

has risen dramatically. From USD 6.1tn in 2009 to USD 9.8tn at the

end of 1Q16. Also, with over 30% of revenues and almost half of

profit from overseas for the S&P 500 members, dollar strength is

clearly a headwind for U.S. equities, especially for large-cap

stocks. Or will a breakup of the Eurozone cause market turmoil?

In 2017 we have elections in key member such as in the

Netherlands (March), France (April) and Germany (October).

Another reason for trouble could come from interest rates. A study

by CLSA Laurence Balanco shows that a US 10yr yield above 4%

has been a major headwind for equities. This time, higher yields

could have another damaging effect: The debt-to-EBITDA ratio of

US corporates is now at the highest in history. Share buybacks, a

main driver of rising equity prices, are mainly funded by debt.

Last but not least, earnings have become increasingly misleading.

The growing use of non-GAAP metrics is worrying. Companies are

obliged to present their earnings using GAAP but are allowed to

use non-GAAP measures to supplement the information. Data

Sectors

7 – Buybacks vs Debt

Source: SG Cross Asset Research

show that the spread between GAAP earnings per share and

non GAAP earnings per share has widened significantly in

just a few years. Non-GAAP EPS was higher than GAAP EPS

by an average of 25% in 2015, compared with just 6% in

2013. This becomes even more significant as 90% of S&P 500

companies reported non-GAAP numbers in 2015, up from

about 70% in 2009.

We will disucss a possible serious bear market more in detail

in our next issue in June/July. But before we believe in a few

more very good months for equities as part of the final fifth

wave.

We expect this final bull wave to be rather selective. Buying the

index will pay off but picking the “right” sectors will result in strong

outperformance. We expect this outperformance to come from

cyclical sectors. Inflation expectations are on the rise, commodities

are expected to do well and many of the sectors we like are still

trading way below their all-time highs. We know that the reflation

trade is popular and this is something we usually don’t like. But

short-term, these sectors are heavily overbought and we expect

them to take a break first. This should shake off some of the bulls.

We expect the underperforming defensives to take the lead in the

coming weeks before cyclicals should to start their next rally

around February when the cycles are bottoming. Sectors we

expect to outperform the U.S. and in Europe include materials,

carmakers, financials, transports, chemicals and oil & gas. Due to

our expectation of a stronger dollar into mid 2017 (hence a weaker

Euro) we favour European stocks over the U.S. This is also the

reason why you mainly find European sector charts.

8 – U.S. versus European equities

Source: www.stockcharts.com

9 – Dow Jones Transport Weekly


10 – STOXX 600 Automobiles & Parts Weekly


Market Comment


11 – STOXX 600 Basic Resources Weekly


12 – STOXX 600 Banks Weekly


13 – STOXX 600 Chemicals Weekly


14 – STOXX 600 Oil & Gas Weekly


Interest Rates

To many, the sharp rise in yields in the second half of 2016 came

as a surprise. While the size of the move and the speed was

surprising indeed, the direction had to be expected. When looking

at the long-term charts it becomes clear that the multi-decade

decline in yields had to come to an end rather sooner than later.

Similar to the stock market, yields move in a cycle of 30-35 years. In

1981, yields in the U.S. started to fall and now, 35 years later, it is

likely that the huge bull market in bonds is about to end.

15 – Long-Term Cycle US Yields

Source: CLSA

At the same time it needs to be mentioned that such turns

don’t come overnight. The transition from a bull to a bear

market takes time, often years. This is why we do not believe

that the recovery in yields takes a V-shape. Especially as they

have reached massive resistance. Long-term moving

averages have not been broken to the upside yet (see charts)

which from a pure technical point of view means that we are

still in a downtrend. But it is our belief that we have seen the

low in yields for many years to come.

16 – US 10yr Weekly


Market Comment


17 – US 30yr Yield Monthly


Investors will have to prepare for rising yields what will be a

completely new experience for most of us as a whole generation

has never gone through a bond bear market. Such a bear market

will cause turbulences. Also because of a lack of liquidity in the

credit markets. Due to increased capital requirements following the

financial crisis, financial intermediaries have closed bond desks

and reduced trading books in a large scale. An interesting

comment by CLSA Greed & Fear mentions the “dramatic increase

in holdings of corporate bonds and related ETFs relative to the

inventory of these securities held by financial intermediaries”.

According to their report, the ratio of US mutual funds’ and ETFs’

holdings of corporate bonds over brokers’ and dealers’ holdings

has soared from 1.7x in 2007 to 31x in 2016! Just imagine if

everyone decides to leave the party at the same time. And as

mentioned earlier, a 10yr yield above 4% starts to bite equities.

18 – US 10yr Yield Monthly


It seems, turbulent times are ahead of us in the coming years.

But before, we expect yields to retrace parts of their advance

in the first months of 2017. They are overbought on a weekly

timeframe and as mentioned before, have reached strong

resistance.

We would not be surprised to see the 10yr yield correction

towards 1.75%-1.90% Nevertheless, the long-term path seems

clear: Yields will move higher. Levels to get final confirmation

of a change in trend in the US 30yr are 3.40% (96m

exponential moving average) and then 4% which would be

equivalent to a higher high versus December 2013 and the

break of the 1987-2016 downtrend. The levels in the 10yr are

2.55% (96m EMA) and 3.05%, the high from December 2013.

The 1987 downtrend will be broken at 3.70%.

Foreign Exchange

While many have already called a major top in the Dollar index

we said in July that we believe “one leg to the upside is still

missing”. This final leg “could last into late 2016/early 2017 and

reach 112/113, a fibonacci extension”. With the break of 100 in the

Dollar index a couple of weeks ago, we have a good reason to

believe that the final rally in the US dollar is underway.

Since its low in 2011, the US dollar index has moved in four waves

with the final fifth wave still missing.

19 – US Dollar Cycle


We believe, this final rally has started in May 2015 and could

lift the dollar index up to 113, a fibonacci extension. At the

same time this means, that we are in the late stage of this

multi-year dollar rally. That is also what the dollar cycle is

pointing to. As you can see on the table below, the dollar

index is moving in cycles of 7-8 years. The current cycle

already lasts for 8 years and 9 months and therefore is

mature. We expect the dollar to top out by mid 2017.

20 - Major Dollar Trends

1971 – October 1978 7yrs 5mos

October 1978 – February 1985 6yrs 4mos

February 1985 – September 1992 7yrs 7mos

September 1992 – July 2001 8yrs 10mos

July 2001 – March 2008 6yrs 8mos

March 2008 – ? ?

Source: CV Invest Partners AG

Being bullish for the dollar automatically translates into a

bearish view on the Euro, which accounts for 57% of the

dollar index. Indeed the Euro looks very vulnerable. As you

can see on the monthly chart, the Euro trades at a key

support. First, there is the trendline that connects the lows

Market Comment


from 1985 and 2001, currently crossing at around 1.06/1.07.

Second, the Euro is now testing the 1.05 support for the third time

since early 2015. In case of a breakdown, the 1.00 handle will

surely be tested which is more or less equivalent to the lower end

of the falling trend channel. Worse, between 2008 and 2014 a

huge symmetrical triangle was formed. The price target of this

formation is around 0.80, the lows from 2000! We cannot rule out

such a move. Clearly an extreme event but very likely a major

buying opportunity.

Why do we still have a relatively conservative price target for the

dollar index (113)? The reason is the British pound (accounts for

12% in the dollar index). Every 8th year, GBPUSD hits a major

bottom. The last one was in January 2009. It could well be that the

October 2016 low was THE low, especially as momentum

indicators are deeply oversold and about to turn bullish.

Interestingly the price target of the 2009-2014 triangle is at 1.237,

which was also met this October. We see a good chance of a

major bottom in GBPUSD and therefore expect it to trade

significantly higher in 2017.

21 – EURUSD Monthly


22 – GBPUSD Monthly


Commodities

Last December we said that commodities look very oversold and

that a multi-month rally would be likely. At the same time, we were

saying that we did not expect this to be the beginning of a new

super-cycle. Still we do believe in further advances especially as

in November, the price of the CRB index crossed the 12month

exponential moving average to the upside. In the past, this

indicator has given very reliable signals that were followed by

multi-month advances.

23 – CRB Index with 12month EMA


One could argue that our expectation of a stronger dollar will

weigh on commodities. While this negative correlation is indeed

valid most of the time, it is during the late stages of a dollar rally

when they often advance together.

Crude oil, with 23% a key component of the CRB index, has more

than doubled since early February. Despite this strong move, we

expect further gains. Oil is about to complete an inverted head

and shoulder pattern The break of the neckline at USD 51

translates into a price target of USD 76! The break of the

downtrend in the monthly RSI seems to confirm our bullish

view. But first, we will focus on USD 60-62, the highs from

May/June 2015.

24 – Light Crude Oil Weekly


Copper has broken out of a symmetrical triangle in

November and has reached its first price target at around

USD 2.60. This move was significant as it violated a multi-

year downtrend. We expect further gains in the months

ahead but not before a correction as the metal looks heavily

overbought.

25 – Copper Weekly


Market Comment


Gold

Last December we published a bullish call on gold, expecting the

metal to start a new multi-year bull market. Then in July, we

warned of a correction towards USD 1240 or USD 1210 as part of

wave 2. As gold is currently trading below USD 1200 it is worth to

review our bullish gold call. The rally off the December lows was

strong and in our view, was the first wave of a new bull market. So

far, gold has retraced 76.4% of the December-July advance. Such

a correction in this magnitude is very common for wave 2 which

often gives back between 50% (USD 1210) and 76% (USD 1123)

of its earlier gains. The main trigger in our view was the sharp rise

in U.S. yields and to a lesser degree the strong U.S. dollar. As

mentioned above, we expect yields to pull back as they look

increasingly ouverbought and have hit strong resistance. For this

reason and the fact that the structure of this decline looks like a

typical a-b-c correction, we believe that gold will find a bottom

around the current level (USD 1123 = 76% retracement!) and start

another wave to the upside very soon.

26 – Gold Weekly


In our issue from last December we mentioned the presence of

an 8yr cycle in gold. Approximately every 8th year, gold makes an

important bottom. That was the case in late 2016 and was one

reason why we recommended to go long gold. Another reason

was the fact that gold corrected exactly 50% of the 2001-2011

rally. We compared this to the situation in the 70’s when gold

increased 5-fold before it corrected 50%. When there was nearly

no gold bull left, gold started an impressive rally and gained

nearly 700% in the ensuing years.

27 – Gold 8yr Cycle


One factor to watch closely in the months and years ahead is

real interest rates (the situation when the inflation rate is

higher than the nominal interest rate). In our view, this is the

single most important factor for gold. Gold prices tend to

increase significantly only during periods of negative AND

falling negative real interest rates (see chart; though it ends in

2013 it clearly visualizes the relationship).

28 – Real Gold Prices and Real Interest Rates

Source: www.sunshineprofits.com

A good example of the importance of this factor was during

the financial crisis when you could have expected gold to do

very well. Yet gold prices actually declined in the second half

of 2008 even though the crisis intensified. During that time,

the level of real interest rates spiked which weighed on the

price of gold.

We recommend to closely watch goldminers which not only

offer greater upside potential than gold itself, but often

bottom before the metal. Stabilizing or rising miners while

gold is still falling is often a great indication, that the metal is

bottoming.

29 – Gold & Silver Index Monthly (Miners)


We expect gold to trade higher by the end of next year and,

over the course of the next few years, to reach new all-time

highs.

Market Comment


Conclusion

Despite being one of the longest bull markets in history we do not

believe this equity bull market to be over yet. Strong market

breadth, the breakout to new highs and the healthy sector rotation

are all indications, that we are in the middle of the final 5th wave

(we label the correction between spring 2015 and early 2016 as

wave 4). Following a dip in Q1, we expect this rally to resume and

to last until July/August, when different cycles turn bearish. Our

price target in the S&P 500 is at 2’550, which could mark a major

top.

But until then, we believe in the reflation trade and would focus on

cyclical sectors. Although short-term overbought, these sectors

should outperform the market following a February low.

Following the massive rally of recent months, interest rates in the

U.S. have reached strong resistance. They look increasingly

overbought and we expect yields to come down in the next few

months. At the same time we believe that the 35 year old bond

bull market has ended. But the transformation to a new bear

market takes time and won’t happen overnight.

After nearly nine years, the dollar bull market is mature and

in our view in its final stage. We expect the U.S. dollar to top

out in the coming months. Until then, the Euro is at risk of

undershooting.

In November we got a monthly buy signal in the CRB index.

Rising inflation expectations and rising yields should support

the commodities complex in 2017. In our view, the rising

dollar does not have to be negative. In the late stage of a

dollar bull market, they often rise together. We are bullish for

crude oil, which could reach USD 76 in 2017.

Gold has corrected 76.4% of the rally that lasted from last

December until July. While the correction exceeded our

downside target, it is still within the range of a wave 2

correction. We continue to believe that the rally off the

December lows was the first part of a new bull market and

expect gold and goldminers to do well in the coming months

and years.

Market Comment


Appendix

Regular readers of our publication know that traditional valuation

measures are at very elevated levels and, as we believe, will

sooner or later cause the market to correct significantly. Despite

that, we believe that one more rally leg is missing.

S&P 500 Long-Term


Shiller PE with Annualized 10-Year Real Returns

Source: blog.alphaarchitect.com

Shiller PE (1800–current)

Source: www.multpl.com/shiller-pe/

Buffett Indicator (Market Cap to GDP)

Source: www.advisorperspectives.com

Tobin’s Q Ratio

Source: FRED Federal Reserve Economic Data

Disclaimer

This document has been prepared by CV Invest Partners AG. It is not considered as financial analysis regarding the SBA directives aimed at guaranteeing independence in financial analysis. As such,

these directives do not apply to it. The information contained herein is based on sources believed to be reliable, but no assurance can be given that such information is current, accurate or complete.

This document is for information purposes only and shall not be construed as an offer, invitation or solicitation to enter into any particular transaction or trading strategy. This document does not take

into account the investment objectives, financial situation or particular needs of any particular investor. Investors should obtain individual financial advice based on their own particular circumstances

before making an investment decision on the basis of the recommendations in this document. Opinions and references to prices and yields expressed are subject to change at any time without notice.

CV Invest Partners AG may from time to time, on their own behalf or on behalf of third parties, engage in transactions in the financial instruments described herein, take positions with, perform or seek

to perform investment banking or other services for any company mentioned herein or any of its parents, subsidiaries and/or affiliates. This document is intended only for the recipient named. It may

not be photocopied or otherwise reproduced, or distributed without the prior permission of CV Invest Partners AG. The delivery of this document to any US person shall not be deemed a

recommendation of CV Invest Partners AG to effect any transactions in the securities discussed herein or an endorsement of any opinion expressed herein. CV Invest Partners AG may furnish upon

request all investment information available to it supporting any recommendations made in this document. This document is not for distribution to Private Customers in the United Kingdom and

investments mentioned in this report will not be available to such persons. Email transmission cannot be guaranteed to be secured or error-free as information could be intercepted, corrupted, lost,

destroyed, arrive late or incomplete, or contain viruses. The sender does not therefore accept any liability as a result. If you are not the intended recipient of this message, please immediately notify

the sender and delete this message. Any disclosure, copy and/or distribution thereof is prohibited.

© 2015, CV Invest Partners AG

MARKET COMMENT Q1 2017 - CV INVEST · by CLSA Laurence Balanco shows that a US 10yr yield above 4%...

Documents

Transcript of MARKET COMMENT Q1 2017 - CV INVEST · by CLSA Laurence Balanco shows that a US 10yr yield above 4%...