These are our views (macro, technical as well as quantitative) on the financial markets for the month to come... FinLight Research is a quantitative cross-asset research firm with an expertise in real assets analysis and a focus on some specific issues: risk budgeting, asset allocation, trading systems and business intelligence. From here, we are rethinking, day after day, the investment paradigm, preparing optimally for what lies ahead… This is our pretension!

1. Market Perspectives
Oct 2013
October 2nd, 2013

2. MACRO VIEW
The Good
The Chinese flash PMI rose to 51.2, a six-month high.
Personal income and spending edged higher than expectations.
Households' financial health shows a continuous and significant improvement
Durable goods new orders and ISM appear to be recovering
The Bad
Inflation remains too low. With inflation continuing to undershoot the Fed's inflation target, and
millions remaining unemployed, policy action is needed more then ever
Clear weakening in pending home sales: The housing recovery has slowed, but it is still ongoing
Consumer confidence continues to disappoint on both the Conference Board and Michigan
measures. The September reading of the Michigan Consumer Sentiment is at its lowest level since
April. The confidence gap is higher then ever.
ISM-NY current business conditions index fell to 53.6 last month from 60.5 the previous month
September’s U.S. ADP jobs data (ex-agriculture and government) missed expectations (+166k vs.
+170k) and August’s gains were revised lower (to +159k from +176k)
This month, the government of Poland confiscated all bond holdings of the private pension funds in
the country to transfer them to the state pension vehicle (ZUS). In this scheme, new confiscated
assets net out sovereign debt liability, lowering the debt/GDP ratio.
The Ugly
US budget crisis: The two themes, the shutdown and the debt ceiling, have become linked. A
shutdown might cut GDP by as much as 1.4%. Consumers, foreigners, and markets may lose
confidence if the debt ceiling deadline is approached
Syria, although the reduced chance of military action against it, at this stage
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3. Households’ Financial Health
Household net worth now stands at $74.8 trillion, up some $4.5 trillion from the previous (March '13)
estimate, and up $18.4 trillion from the recession low. Virtually every metric (Debt, real estate, financial
assets) of households' financial health has shown significant improvement over the past several years.
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4. Consumer Confidence
The University of Michigan Consumer Sentiment final number for September came in at 76.5. This is a
4.6 decline from the August final reading of 82.1.
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5. Consumer Confidence
Although more volatile, the broad pattern and general trends of the Conference Board Index are
remarkably similar to those of the Michigan Index.
The NFIB Business Optimism Index shows that small business owners are in a similar mood
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6. Confidence Gap
The following chart from Bespoke tracks an interesting breakdown in consumer confidence -- those with
incomes of $35K versus $50K+. It clearly shows that the confidence gap is higher then ever.
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7. Unemployment
There was a dip in the Consumer Confidence Index in September. However, the percentage of
respondents to this survey who agreed that “jobs are hard to get” dropped to 32.7%, the lowest reading
since September 2008
Improving jobs-hard-to-get survey sees jobless rate under 7% soon
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8. Unemployment
Good news: the average unemployment duration is going down.
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9. Disposable Personal Income (DPI)
The August nominal 0.38% month-over-month and 2.03% year-over-year numbers put us approximately
back to the trend we saw near the end of last year prior to the forward pull of income and subsequent
plunge to manage expected tax increases.
However, when we adjust for inflation, the real MoM change is trimmed to 0.25%, and the real YoY is a
discouraging 0.87%
An economy without real disposable income growth is heading for trouble.
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10. Personal Consumption Expenditures & DPI
DPI and PCE are still in line. Their growth rates look however sluggish.
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11. Big Four Indicators
The overall picture of the US economy remains one of a ploddingly slow recovery from the Great
Recession
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12. Big Four Indicators
A zoom on the average of the big four indicators confirms that the economic improvement is still here but
slowing…
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13. Capital Spending
YoY percentage changes in orders for capital goods (ex-defense and aircraft) shows that capital spending
appears to be recovering, which should feed through to better earnings for the industrial and technology
sectors
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14. ISM
the ISM manufacturing index rose
from 55.7 in August to 56.2 in
September while the Markit
manufacturing
PMI’s
headline
declined from 53.1 to 52.8
The ISM nonmanufacturing index’s
headline fell from 58.6 in August to
54.4 in September, which was the
largest monthly decline since
November 2008
The drop-off in September brought
the ISM down to a level which is
more or less consistent with 2.0%
real GDP growth in 3Q.
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15. Economic Surprises
Citigroup Economic Surprises Index appear to have reached a high and turning lower.
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16. GS - GLI
The September Final GLI places
the global industrial cycle on the
border of the ‘Slowdown’ phase,
characterized by positive but falling
Momentum.
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17. EQUITY
The short-term setup for stocks is difficult to read.
The bulls still hold a slight but discernible advantage over the bears. For how long ? This is the question…
There are increasing signals of a material top building
In term of secular trend, the current level of Tobin’s Q-Ratio is close to the vicinity of market tops, with
Tech Bubble peak as an extreme outlier.
UW US stocks, OW VIX
OW EM stocks and European stocks vs US stocks
The rebound in global manufacturing is confirmed by September’s global PMI, implying a OW position on
Cyclical vs. Defensive sectors.
We prefer to keep a long volatility bias into October, given policy uncertainties…
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18. Secular Trends: Q-Ratio
The Q Ratio (developed by J. Tobin) is the equity market value divided by the replacement cost of all its
companies. The calculation is done with the Federal Reserve Z.1 Financial Accounts of the United States
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19. Secular Trends: Q-Ratio
The current level is close to the vicinity of market tops, with Tech Bubble peak as an extreme outlier.
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20. Secular Trends: Crestmont P/E
Crestmont P/E is similar to the Cyclical P/E10 ratio
Its current level of 23.5 is 70% above its average of 13.8. It puts the current valuation at the 96th
percentile of these 140 years.
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21. Equity : Value vs Growth
The market is playing the divergence between a maturing cycle in the U.S., and Europe where we are
leaving the double dip
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22. Equity: Quality-Index Ratio
The S&P 500 High Quality Rankings Index
comprises those constituents in the S&P
500 with a Quality Ranking of A- and
above.
The S&P 500 Low Quality Rankings Index
comprises those constituents in the S&P
500 with a Quality Ranking of B and
below, excluding companies with scores of
D or in liquidation.
The S&P500 seems in line with the Highto-Low Quality Rankings ratio, but
approaching a top
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23. US Stocks
The bulls still hold a slight but discernible advantage over the bears
The 50-day MA has acted as technical
support, which the index has not breached
yet
The behavior of the higher beta small cap
Russell 2000 Index confirms the bullish
trend. The Russell 2000 has achieved
double breakouts and remains in an uptrend
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24. US Stocks
But the momentum of the S&P500
uptrend remains poor. There a
real risk of another retrace
towards the uptrend from the Nov.
‘12 low at 1,665. Going below that
point seems unjustified, at this
stage.
If a break below 1665 coincided
with a break of the June peak on
the VIX (21.9), it could be a
bearish signal.
Bulls would feel more comfortable
if S&P500 close back above the
recent highs (1710)
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25. US Stocks
Our trading model became massively short as soon as we breached 1722. Under 1700, it became
long, targeting 1722 again. However, 2 systems are still short with a target at 1638 and 1622.
There is a little bias to be long, at this stage, as far as the 1655 level is preserved.
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26. EU Stocks
We see a steady increase in demand for equities from European investors. Driven by improvements in
the data. The flows we are seeing are consistent with the pick-up in the survey data
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27. EU Stocks
The CAC is still testing the 4170-4360 pivot area. There is, however, no reason to be aggressively
bullish …
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28. US Stocks
Since its high of May 22nd, the risk appetite index (RAI) has been drifting lower, driving down the 6mmomentum in US stocks. The RAI stands in neutral territories.
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29. US Stocks
VIX is now oscillating between the low and medium regimes. It has been doing so since the beginning
of 2013 (similar to 2004 but with more uncertainty in macro data).
Since Aug 15th, VIX is back in Medium Regime. The probability of being in Low Regime is going down.
Source : Bloomberg & FinLight Research calculation
85
VIX Index
100.0%
Probability in Low Regime
Most Probable
Regime
75.0%
75
65
50.0%
55
25.0%
45
0.0%
35
25
15
5
01/01/19907/09/19924/06/19950/03/19984/12/20000/09/20036/06/20062/03/20097/11/20113/08/20149/05/2017
2
2
2
1
1
0
0
2
2
1
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30. US Stocks
Factory orders (a good proxy for the physical side of the economy) seems to validate the performance of
the equity market. It is less the case for Durable Goods Orders
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31. 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.
The curves appear to be set to flatten over time. The UST curve has started to flatten quite significantly.
We should keep the US 10yr-2yr spread on the radar.
On the medium term, the downside risk looks predominant in HY
Bottom line : OW Govies and wait for better levels to enter shorts, set curve flatteners, OW European
High Yield vs High Grade because of continued good economic news in Europe, OW EM sovereigns
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32. FIXED INCOME & CREDIT
Some signals point to increased
chances of a material retrace of the
recent up move in UST yields : The
10y UST yield broke the uptrend
from May 3rd, and failed in
preserving the 2.70 support.
A clean weekly close back below
2.65 (old primary downtrend from
2700) could start a more significant
retrace
Next big pivot / support to watch ~
2.53, then the 2.42-2.35 area
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33. FIXED INCOME & CREDIT
Current CFTC net speculative
positions are highly skewed to the
short side, suggesting limited
appetite to enter new shorts… That
points to an imminent upward
movement in treasuries. Shortcovering could accelerate the
move.
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34. FIXED INCOME & CREDIT
Given the technical setup in place,
the curve should flatten quite
materially over time.
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35. FIXED INCOME & CREDIT
Italian 10-yr yields seem to be
forming a reverse head &
shoulders. There is a bias towards
higher yields on Italian bonds. The
opposite with regard to Eurozone
sentiment.
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36. FIXED INCOME & CREDIT
HY looks a bit expensive to IG
now. This situation should persist
for a while as we expect the highyield default rate to remain well
below its 4.0% long-term average
over the next year (unless
exceptional tail risk crisis).
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37. FIXED INCOME & CREDIT
Given the rolling default rate of barely 1%, there seems to be good medium-term value in US high
yield spreads.
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38. FIXED INCOME & CREDIT
However, High Yield has never been so expensive compared to equities.
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39. FIXED INCOME & CREDIT
An upgrade-to-downgrade ratio degradation should give the signal for an upturn in default rates (like
end 2007). On the medium term, the downside risk looks predominant in HY
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40. EXCHANGE RATES
Last week, we saw commodity linked currencies losing their luster. This week, EM currencies were the
key movers, all shifting back towards strength
EURUSD remains around 1.35, which is quite a high level relative to Treasury-bund spreads. Keep an
eye on the 2y spread between Germany and US. It would give a strong signal on the EURUSD spot
Neutral EUR vs USD between 1.33 and 1.37. Given the configuration of DXY, the 1.3711 resistance
should hold.
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41. EUR-USD
Two things are acting against the UD dollar:
The US budget crisis, government shutdown and debt ceiling
Fed's decision to delay tapering
The Commitment of Traders speculative positioning in the CME currency futures shows that:
The net long euro (vs US$) position is the largest since May 2011.
The euro has the largest gross long speculative position of almost 130k contracts.
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42. EUR-USD ?
Net non-commercial futures positions is more compatible with a level of 1.40-1.50 on the EUR-USD
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43. EUR-USD
Compared to the sovereign spread between Germany and US, EUR-USD stays too expensive.
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44. EUR-USD
When the 2-year spread does eventually make a clean break from its multi-year consolidation (0bps and 35bps) it will probably give a very strong signal on the EURUSD spot
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45. EUR-USD
Based on its historical behavior since 2010, a weekly close of EUR spot back below the 200-wma (1.335)
would indicate a reversal to the downside.
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46. COMMODITY
On precious metals (gold and silver), the market seems increasingly at risk of resuming its prior trend
lower
UW gold & Silver. Wait for a trend to develop before entering the market
The rebound in PMIs justifies our OW in commodities as a whole, but also in energy and base metals
(copper in particular). Take profit from the high roll premium of over 1% per month in BRENT futures
(half in WTI futures)
OW grains as supply expectations continue to be revised down sharply
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47. Grains
Corn, wheat and soybeans cost 28% less today than they did a year earlier, as supply expectations
continually surprised to the upside.
Agriculture prices have stabilized somewhat over the last couple of months
The downside trend seems
to be coming to an end.
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48. Precious Metals
Last week we saw one huge withdrawal out of COMEX eligible gold stocks that led to a new cyclical low
for total COMEX gold inventories, and brought them down to a level not seen since 2005.
This large withdrawal, done in one day from the HSBC warehouse, represents more than 5 tonnes of
gold, 3% of total COMEX gold inventories, and 5% of all gold held at the HSBC warehouse. This move is
curious enough to be worth noting… Is it the beginning of a new hemorrhage?
Source: http://www.sharelynx.com
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49. Precious Metals
After the corrective move from the
Jun. 28 low to the Aug. 28 high,
the market seems increasingly at
risk of resuming its prior trend
lower.
1275 is the important pivot to
watch.
If the downturn is confirmed, 1180
would be the short term target.
Source: http://www.sharelynx.com
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50. Precious Metals
Our theoretical price (using US$,
sovereign CDS and Real Rates) stands at
1260, versus a market price 5% higher.
2150
1950
GOLDS Index
1750
GOLD Fair Value (USTW$+CDS+Real Rates adjusted)
GOLDS Index
1550
1350
1150
950
2000
550
-1.5
Gold
1800
Source : Bloomberg data, FinLight Research calculations
350
28/05/2005
10/10/2006
22/02/2008
06/07/2009
US 10y-TIPS (r.h.s,
inv.)
1600
18/11/2010
01/04/2012
14/08/2013
-1
27/12/2014
-0.5
Real yields increase explains a big portion of the
downside move on gold
0
1200
Gold
1400
0.5
1000
1
800
1.5
600
2
400
2.5
200
3
Source: Bloomberg.data & FLR calculation
0
3.5
Jul-15
Feb-14
Oct-12
May-11
Jan-10
Aug-08
Apr-07
Dec-05
Jul-04
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10y - US Real Rates
750

51. Bottom Line: Global Asset Allocation
OW EM stocks and European stocks vs US stocks
OW position on Cyclical vs. Defensive sectors.
Keep a long volatility position
OW Govies and wait for better levels to enter shorts, set curve flatteners, OW European High Yield vs
High Grade because of continued good economic news in Europe, OW EM sovereigns
Overweight commodities, base metals, energy and grains. Underweight precious metals
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