The document provides an overview of recent macroeconomic and market developments from the perspective of FinLight Research. It discusses both positive and negative factors in the US and global economies. The US stock market is strong but a short-term pullback is seen as likely. Consumer confidence has declined sharply. Earnings growth is modest with revenues stable. Credit spreads remain tight but high yield is favored over investment grade. Treasury yields may retrace recently but are still seen heading higher eventually.

1. Market Perspectives
Nov 2013
October 31st, 2013
www.finlightresearch.com

2. MACRO VIEW
The Good
U.S. industrial production recorded its largest increase in seven months in September as utilities
output surged after several months of declines, but manufacturing showed signs of cooling.
After record-setting earnings in the first two quarters of 2013, the S&P 500 is on track to hit another
historic high in profits for 3Q13
ISM manufacturing was very strong, the best release in over two years.
China's PMI is stronger and compatible with a growth rate of 7.5%. The private HSBC/Markit PMI is
lower but still shows the same pattern.
Bloomberg's index of financial conditions reached a new all-time high
Case-Shiller home prices increased 12.8%, beating expectations. The latest Case-Shiller Index data
is continuing to demonstrate significant resiliency compared to past years
The Bad
U.S. economy isn't falling off a cliff, but it also doesn't appear to be accelerating
US employment releases continue to raise concerns about the health of the U.S. economy. The labor
market is stuck in slow growth mode All figures indicate that the U.S. labor market continues to have
difficulty creating new jobs
Other measures of economic activity - such as orders for durable goods and a sales forecast cut
from construction equipment company Caterpillar (CAT) - pointed toward slow growth as well.
2
FinLight Research | www.finlightresearch.com

3. MACRO VIEW
Consumer confidence is terrible. The major decline in the October confidence level is probably
attributable to the government shutdown and press focus on the congressional debt-ceiling
showdown
The year-over-year change in retail spending dipped last month to a rate that’s close to the slowest
pace in three years.
Earnings guidance has been weak according to Factset
Contracts to purchase previously owned U.S. homes fell by the most in more than three years in
September, probably due to higher mortgage rates and a softer economy.
The Ugly
Surprisingly nothing obvious… except the QE "infinity syndrome" that makes the Fed's ultimate
mission of turning off the tap without causing much asset price damage very difficult.
3
FinLight Research | www.finlightresearch.com

4. Industrial Production
Industrial production increased 0.6% in September vs. August, the best monthly comparison since
February
The upside surprise was, however, due mostly to factors other than manufacturing, which rose a sluggish
0.1% last month. Much of the increase was attributable to a curious 4.4% surge in utilities.
US Industrial production's 12-month trend turned higher with output expanding 3.2% last month vs. a year
earlier
Is the mismatch between IP and manufacturing ( a cyclically sensitive sector) simply due to the budget
crisis? Or is that an advanced sign of troubles ahead?
4
FinLight Research

5. Employment
US employment releases continue to raise
concerns about the health of the U.S. economy
Private-sector employment increased by a net
126,000 jobs last month on a seasonally
adjusted basis: very close to the slowest pace
this year.
The annual trend is stable around 2% yoy.
Unemployment Claims came in at 340 000
The U.S. unemployment rate dipped to 7.2%, a
five-year low, but this does not point to
increased employment, as the participation rate
remained at 63.8%, its lowest level since 1978.
5
FinLight Research

6. Retail Sales
Retail sales report for the month of September came in
weaker than expected, dragged down primarily by
weakness in the sales of Autos.
The headline reading for September declined 0.1%
month/month compared to expectations of no change.
Ex Autos, the September report was inline with
expectations.
Nominal 'discretionary' retail sales including home
furnishings, home garden and building materials,
consumer electronics and department store sales also
declined 0.1% from August, but still increased 2.1%
above the level seen in September 2012
Adjusted for inflation, 'real' discretionary retail sales
declined 0.1% on the month and increased 1.05% since
September 2012.
6
FinLight Research

7. Retail Sales
The September release appears as the latest in a string of deteriorating monthly updates
The YoY change came in at 3.2% but seems slipping dangerously close to the lowest level since 2010
7
FinLight Research

8. Retail Sales
The overall YoY trend for both headline and core (Ex-Auto) has been weakening since mid-2011.
8
FinLight Research

9. Big Four Indicators
The overall picture of the US economy remains one of a ploddingly slow recovery from the Great
Recession
9
FinLight Research

10. Durable Goods Orders
U.S. releases were a big disappointment, as Core Durable Goods Orders posted its third consecutive
decline
Core Durable Goods Orders dropped -0.1%, well below the estimate of a 0.6% gain. This was the third
straight decline for the indicator. Durable Goods Orders looked much better, posting a strong gain of
3.7%.
10
FinLight Research

11. ISM Manufacturing Index
The ISM manufacturing index (PMI) suggests manufacturing expanded at a faster pace in October. The
PMI was at 56.4% in October, up from 56.2% in September and above expectations of 55.0%. The
employment index was at 53.2%, down from 55.4%, and the new orders index was at 60.6%, up from
60.5% in September.
It is worthwhile noting that ISM Manufacturing represents less than 10% of USA employment, and
approximately 20% of the business economy. The ISM non-manufacturing index was down.
11
FinLight Research

12. Euro PMI
Euro PMIs were weak across the board. PMI numbers of Germany, France and the eurozone were below
their estimates
All, except French Flash Manufacturing PMI remained above the 50 level
French PMI has been below the 50 level since January 2012, indicating ongoing contraction in the French
manufacturing sector
12
FinLight Research

13. China’s PMI
The data shows that manufacturing activity is expanding. China’s official manufacturing Purchasing
Managers Index (PMI) rose to an 18-month high in October, to 51.4 (51.1 in September)
Details show that the headline increase was led by stronger output, but new orders and new export orders
both pulled back in October, suggesting slower demand growth in the coming months
The private index from HSBC/Markit which gives more weight to small businesses climbed to 50.9 from
50.2
13
FinLight Research

14. Consumer Confidence
The Latest Conference Board Consumer
Confidence Index was based on data
collected through October 17. The 71.2
reading was 9.0 below the September 80.2.
The index is at its lowest level since April.
The government shutdown is probably the
key driver in the plunge.
Consumers'
expectations
decreased
sharply in October. Those expecting
business conditions to worsen increased to
17.5 % from 10.3%.
Consumers' outlook for the labor market
was also more pessimistic. Those
anticipating fewer jobs increased to 22.7%
from 19.1%.
14
FinLight Research

15. Consumer Confidence
The small business sentiment (as read in the National Federation of Independent Business Small
Business Optimism Index) seems to track very closely the consumer confidence
15
FinLight Research

16. Consumer Confidence
A similar mood was observed on the Michigan Consumer Sentiment Index
UoM Consumer Sentiment dropped from 77.5 to 73.2 points, its weakest showing in 2013. The estimate
stood at 78.2 points.
16
FinLight Research

17. Financial Conditions
Bloomberg's index of financial conditions reached a new all-time high. According to Scott Granis Blog,
“Swap, muni, agency and credit spreads are generally low, liquidity conditions are excellent, the yield
curve is positively sloped, implied equity index volatility is relatively low, and yields on Treasuries and
corporate bonds are relatively low”.
17
FinLight Research

18. GS - GLI
The October Final GLI places the
global industrial cycle in the
expansion phase, characterized by
positive and increasing Momentum,
but not so far from the slowdown
phase...
7 of the 10 underlying components
improved in October
18
FinLight Research

19. EQUITY
This is No Time to be Asleep at Wheel. It seems that investors are once again, exceedingly confident that
stocks are the only place to be for now.
An extreme bullish consensus is forming now, in an obvious contradiction with the famous “everybody
hates this market”
Future earnings growth through margin expansion seems unlikely, as an improving labor market and
higher interest rates will most likely squeeze margins. However, stable revenue growth, share buybacks
and the additional use of debt financing should support modest earnings gains in the year ahead
Bottom line:
We bet on a limited correction. we're set up for a test of 1700 and 1650 on the S&P 500
We continue to like Europe and EM which we overweight vs. the US and Japan.
We prefer more defensive high-yielding stocks and focus on investing in the pockets of strength in
the market. We like the technology sector. Tech companies remain reasonably priced. We dislike
financials
19
FinLight Research | www.finlightresearch.com

20. Earnings
With nearly half the companies in the S&P 500 Index reporting results, 75% beat earnings expectations.
That’s above the average for the last four quarters of 70% and the average for the last four years of 73%,
according to FactSet.
Here’s the rub, though … the rate at which companies are beating expectations is hardly impressive.
Earnings came in a mere 0.8% above expectations. That compares to an average surprise of 3.7% over
the last four quarters and 6.5% over the last four years.
So far this quarter, actual earnings are on track to increase 2.3% in the third quarter. Yet third-quarter
sales are only on pace to grow 2%.
Most top-down market forecasters approached Q3 13 expecting flat to no growth year over year in
earnings from continuing operations. Even the bottom-up compilation of analyst estimates - usually a
more bullish number, based on analysts' too-comfy relationships with CFOs - indicated flat to no annual
EPS growth in Q3 13.
Over the past few quarters, margins have stagnated, limiting their contribution to earnings growth
Future earnings growth through margin expansion seems unlikely, as an improving labor market and
higher interest rates will most likely squeeze margins. However, stable revenue growth, share buybacks
and the additional use of debt financing should support modest earnings gains in the year ahead.
20
FinLight Research

21. Revenues
S&P 500 company revenues grow at about the same rate as nominal global GDP growth. Revenue
growth hasn’t been spectacular but still steady
Sources: Standard & Poor's, J.P. Morgan Economics, J.P. Morgan Asset
Management. Data are as of 10/28/13.
21
FinLight Research

22. SPX
The stock market is strong, with a clear trend, a momentum that is in a pretty good shape and earnings at
a record high. With the economy still growing the bulls get the benefit of the doubt.
22
FinLight Research

23. SPX
The stock market is strong, with a clear trend, a momentum that is in a pretty good shape and earnings at
a record high. With the economy still growing (even if it is at a low pace), the bulls get the benefit of the
doubt.
A short-term retracement appears increasingly probable as the percentages the index stands above its
usual daily moving averages become extreme.
23
FinLight Research

24. SPX
Our previous bias to be long S&P500 is no longer valid. As said in our previous report, our trading
model becomes short as soon as the S&P500 breaches 1722.
The market seems to be approaching potential congestion at 1774 – 1792. The model calls for a
pullback targeting 1757 – 1739 and 1671.
24
FinLight Research

25. Caterpillar as an alarming signal
Caterpillar is clearly lagging the market.
Caterpillar has reported negative earnings surprises in all the past four quarters. Guidance for 2014 is
uninspiring enough to make analysts downgrade the stock to a "strong sell“
Under real economic recovery and sustainable organic growth, companies like Caterpillar usually report
very strong profits in many fields. Unfortunately, they do not!
25
FinLight Research

26. Equity Fund Inflows
So far this year, $277 billion have flowed into equity funds. Investors have apparently put almost as much
money into equity mutual funds as in 2000, which continues to be the record year for inflows
26
FinLight Research

27. Enterprise value
The enterprise value (value of corporate equity plus debt net of cash) to revenues ratio is at the highest
value ever, except for the 2000 peak.
27
FinLight Research

28. Market Sentiment
A new record high in speculative net long exposure has just been recorded. This extreme bullish
consensus is rare.
28
FinLight Research

29. Market Sentiment
Another red flag:The amount of assets held in Rydex money market funds is at the very low end of the
historical range
29
FinLight Research

30. Market Sentiment
The bear percentages of the Investors Intelligence and American Association of Individual Investors polls,
declined to near record low levels.
Mark Hulbert's HNNSI (Hulbert Nasdaq newsletter sentiment index) is also at an extreme, showing a rare
peak in the bullish consensus of newsletter writers
30
FinLight Research

31. US Stocks
Nothing new since last report. The RAI stands in neutral territories.
31
FinLight Research

32. Equity Volatility
Volatility continued to trend down. VIX is back on
its lowest regime according to our HMM model.
In the same time, hedging activity has intensified
during the past month. We are seeing the highest
volume of VIX contracts on record
The vol of vol has collapsed.
There is not a lot of room for the market to keep
moving higher with the VIX at this level.
Higher real rates and lower inflation will drug the
volatility higher
Volatility will become more volatile very soon.
The VIX at 13 is attractive. Buying it through
futures is less because of the contango term
structure and the negative roll-down.
The S&P 500 term structure steepened sharply to
close to its steepest slope this year, as shortdated ATM volatilities fell heavily during the postshutdown rally
VIX Vs.10-Year Inflation Premium
32
FinLight Research

33. Equity Volatility
Short-dated implied volatilities have fallen near cycle lows
Put on stock replacement trade (sell long
stock positions and replace them with call options to keep upside exposure) to lock your gains and
extract cash.
33
FinLight Research

34. FIXED INCOME & CREDIT
On the short term, overall risks seem skewed towards lower rates in the US. Some signals point to
increased chances of a material retrace of the recent up move in UST yields
We stay biased towards higher yields over the medium-term, but wait for better levels to put on our shorts.
Eurozone disinflation will persist for some time, provoking a rate cut from the ECB (in December?)
a tactical position, OW German Schatz / Bobl
As
The US curve continues its flattening movement that we’ve mentioned in our previous report. We should
keep the US 10yr-2yr spread on the radar.
We have changed our view on overall credit from OW to neutral after a pronounced
tightening in the third quarter.
Spreads continue to tighten across all credit but mostly in higher-yielding credits: US HY and EM
sovereign credit spreads. The current slow growth conditions (with low default rates) are enough to make
the high yield market (as a source of carry) attractive. The current search-for-yield environment remains
strong and may push spreads a bit tighter from here. But on the medium term, the downside risk looks
predominant there
We are OW High-Yield vs Investment Grade
Bottom line : OW Govies and wait for better levels to enter shorts, set curve flatteners, Neutral credit,
keep our OW High Yield and EM sovereigns vs High Grade
34
FinLight Research | www.finlightresearch.com

35. FIXED INCOME & CREDIT
We maintain our last month view.
The retrace of the recent up move
in UST yields seems to continue.
Our important pivot at 2.53 was
reached.
With daily oscillators at the base of
their range it’s important to watch
for any confirmation of a base
Next big pivot / support to watch ~
2.42-2.27.
We’re still waiting for the best entry
point go short treasuries.
35
FinLight Research

36. US Treasuries
As said last month, the U.S. 10yr/2-yr curve has potentially begun
a trend flattening
Given the technical setup in place,
the curve should flatten quite
materially over time.
The next notable pivot to watch
~205 bps. But ultimately a move to
121bps looks quite possible.
36
FinLight Research

37. High Yield
The spread difference between bonds rated BBB and BB is 28bp, compared with the long term
average of 103bp.
37
FinLight Research

38. High Yield
At this stage, the biggest risk for credit seems to be higher leverage
38
FinLight Research

39. EXCHANGE RATES
The weak readings in US statistics have been putting pressure on the U.S. dollar, which finds itself at twoyear lows against the euro
However, the recent rally on EUR-USD is fading. It seems an attractive time to look for signs of EURUSD
topping
Given the exhaustion patterns we saw on it, the DXY also seems to be close to its range base…
We continue to see commodity linked currencies losing their luster, pressurized by central bank governor
rhetoric
Bottom line: the Euro enjoyed a strong surge higher, breaking from its sideways range, to move through
to its highest level in nearly two years just above 1.38. The hesitation we’ve seen at this level is enough
for us to have a long bias towards the US Dollars against EUR with a target at 1.3460 – 1.32 (stop at
1.4000) and JPY with a target at 101.40 (stop at 96.85).
39
FinLight Research | www.finlightresearch.com

40. EUR-USD
EURUSD seems topping as we close below the prior interim high from 1st Feb. at 1.3711.
40
FinLight Research

41. DXY
We’re still bullish on the DXY. With weekly
oscillators attempting to turn up from near
oversold levels, the DXY seems to form a
range base around 78.60 – 78.92.
Only a clear break above 79.63 would stop
the downtrend and confirm our favorite
scenario.
41
FinLight Research

42. USD-JPY
USD-JPY is moving in a triangle range. Given the clustering in MAs, the market seems increasingly
“trend ready”.
Pivots to watch are at 99.01-26 and 97.13-96.94. A break in either direction is imminent.
We still have a bias towards an eventual upside push. We target 101.40
42
FinLight Research

43. EUR-USD
USD/EUR exchange rate movements can be
explained by:
changes in the size of the Fed's balance
sheet relative to the size of the balance
sheet of the ECB
&
changes in the short-term interest rate
differential between the US and
Europe(Germany).
At this stage, these factors have opposite effects
on the EUR-USD
43
FinLight Research

44. Commodity Currencies
The commodity currency bloc (CAD, AUD and NZD) continues to be pressurized by central bank
governor rhetoric:
CAD had weaker support from Poloz last week,
the AUD had Stevens saying that AUD level isn’t supported by costs and productivity in the economy
(and that it seems quite likely that the AUD will be materially lower than its current level)
the NZD had their governor Wheeler suggesting that a strong Kiwi would delay a rate-hike.
44
FinLight Research

45. EUR-USD
Net non-commercial futures positions is more compatible with a level of 1.40-1.50 on the EUR-USD
45
FinLight Research

46. EUR-USD
Compared to the sovereign spread between Germany and US, EUR-USD stays too expensive.
46
FinLight Research

47. COMMODITY
On precious metals (gold and silver), and after an expected consolidation to the upside, the market seems
increasingly at risk of resuming its prior trend lower with a target at 1200 on gold and 17 on silver!
UW
gold & Silver. Wait for a trend to develop before entering the market
Keep an eye on the bullish pattern that develops on gold miners
With inflation fears fading, financial demand for commodities will weaken further
Neutral commodities
overall. and look for a single digit total return (~3%) over the next 12 months
On the ST, we stay OW base metals, copper (because of China’s PMI) and energy but see significant
downside risk on Copper an Aluminium on the MT.
We are OW livestock
47
FinLight Research | www.finlightresearch.com

48. Gold
The long-term trend has been broken over the past year. The gold fell sharply regardless of the high debt
ceiling and increasing money supply
48
FinLight Research

49. Gold Miners
Are we finally reaching a bottom in
precious metal?
The Market Vectors Gold Miners
(GDX) is hitting new lows when the
RSI and the MACD are making
higher lows
This diverging configuration is a
classic bullish pattern
49
FinLight Research

50. Precious Metals
Our theoretical price (using US$,
sovereign CDS and Real Rates) stands at
1270, versus a market price at 1314.
2150
1950
GOLDS Index
1750
GOLD Fair Value (USTW$+CDS+Real Rates adjusted)
GOLDS Index
1550
1350
1150
950
750
550
Source : Bloomberg data, FinLight Research calculations
350
28/05/2005
10/10/2006
22/02/2008
06/07/2009
18/11/2010
01/04/2012
14/08/2013
27/12/2014
Real yields increase explains a big part of the
downside move on gold
50
FinLight Research

51. Precious Metals
Technically, another ABC correction seems possible with 1420 as a target. But according to GS chartists,
this configuration should ultimately suggest an eventual move significantly lower (1200 – 1170 ?)
51
FinLight Research

52. Crude Oil
A top is building on the Brent. The big downside pivot to watch is around 102.67 (200w MA)
52
FinLight Research

53. Live Cattle
Live cattle prices continue to rise, as a big winter storm wiped out entire herds in the US northwest.
53
FinLight Research

54. ALTERNATIVE INVESTMENTS
We are OW on AI as we expect a 10% return in the coming year versus 5% on a traditional balanced
portfolio (stocks + bonds+ cash).
Our overweight position focuses on Commercial Real Estate (even if the current message is still mixed)
We are OW Equity long-short market-neutral, Convertible arbitrage, CTA’s
54
FinLight Research | www.finlightresearch.com

55. Real Estate
Last release of the S&P/Case-Shiller home price
indices for August reported that the nonseasonally adjusted Composite-10 price index
rose a notable 1.33% since July and 1.32% for
the Composite-20 index.
The 10-city composite index increased 12.75%
as compared to August 2012 while the 20-city
composite increased 12.82% over the same
period.
Both of the broad composite indices still show
significant peak declines slumping around -20%
from the peak.
Contracts to purchase previously owned U.S.
homes fell by the most in more than three years
in September, probably due to higher mortgage
rates.
55
FinLight Research

56. Bottom Line: Global Asset Allocation
UW equity overall. OW EM stocks and European stocks vs US and Japanese stocks. OW defensive
high-yielding stocks
UW VIX because of the cost of carry. Put on stock replacement trade to lock gains and extract cash
OW Govies and wait for better levels to enter shorts, keep curve flatteners
Neutral on credit. OW High Yield and EM sovereigns vs High Grade
Neutral commodities overall. OW base metals, copper, livestock and energy. Underweight precious
metals.
OW Alternative Inv (OW Equity long-short market-neutral, Convertible arbitrage, CTA’s) + Commercial
real estate.
56
FinLight Research | www.finlightresearch.com