Finlight Research - Market Perspectives - May 2016

Market Perspectives
May 2016
May. 9th, 2016
www.finlightresearch.com
Is the Bull just Smoke and Mirrors?

“Bull markets are born on pessimism, grow on
skepticism, mature on optimism, and die on
euphoria”
– Sir John Templeton
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FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation
Economic data have been mixed globally. But the levitation in stocks
held up mostly thanks to the strength in oil and the weakness in the US
dollar.
Falling earnings, declining growth forecasts, and macro uncertainties have
kept markets range bounded in a context where “If bad news is not
awful news, it must be good news”. We are just planting the seeds of
the next BIG correction.
The degree of skepticism of the bull market seems to back up a final leg
higher on the S&P500
We make minor adjustments to our asset allocation this month.
Given the high equity valuations and the poor growth outlook factored in
credit (specially US), we now prefer the latter (mainly IG).
We reiterate our view that a perfect storm is building… It combines
historically overvalued stocks with stretched government bonds. Unlike
previous storms (2000, 2008), investors would be left with almost no
place to hide
We reiterate our view that we are sailing a cyclical bull within a secular
bear. The current cyclical bull may go higher for longer. But, rising
volatility and stalling earnings growth may indicate we are in the late stage
of the cycle.
We summarize our views as follows
3

MACRO VIEW
The Good
US employment growth remains positive and wages improving (+2.5% YoY for average hourly /
weekly earnings)
Q1 Eurozone GDP was stronger than expected at 0.6% quarter-over-quarter
The Bad
Markit PMI data suggested weakness in manufacturing. Philly Fed’s manufacturing index took a
dive in April.
The Advance Estimate for Q1 US GDP came in at 0.5%, down from 1.4% in Q4-2015
April flash PMIs for manufacturing and services in Eurozone were both weaker than expected.
Composite PMI declined to 53.0 (vs 53.3 consensus)
The Ugly
Main systemic risk resides in China: China is not recovering but rather just re-leveraging.
Debt is used to create the illusion of growth. And that hardly ends well. The credit bubble is
unsustainable. Country’s debt-to-GDP ratio exceeds that of Japan at the time it entered into
crisis in 1989. Chinese equities seem on the cusp of another impulsive sell-off. Further US
dollar strengthening would oblige China to devalue its pegged yuan and accelerate foreign
capital outflows.
We still feel concerned about the credit market liquidity as turnover ratios are well below
pre-crisis levels and the bid-ask spreads are much wider.
4

5
The Big Four Economic Indicators
Industrial Production has been the weakest link in the economic recovery since the GFC
The current picture is characterized by relatively strong Employment and Income, a weak Industrial
Production (down in 9 of the last 12 months) and Real Retail Sales hovering around a flat line.
The average of these indicators has been trending lower since Nov. ‘14, suggesting that the economy is
still moving sideways.

6
US Manufacturing
The US Manufacturing continues to struggle.
April estimate of Markit’s Manufacturing PMI slept to its lowest reading in more than 6 years
The April ISM manufacturing index was down 1 point from the March reading and a bit lower than
expectations (50.8 vs. 51.4), but it is still at levels which are consistent with overall growth in the
economy of 2% or better.

7
US Capital Goods
The picture for Capital
Goods / New orders is
flashing that something was
off
Similar negative orders
levels are usually seen in a
recession.

8
GS – Global Leading Indicator (GLI)
The April Final GLI came in at
1.7%yoy. Its MoM momentum
came at 0.28% (up from
0.27% last month)
GLI has been in expansionary
territory since September
2015, according to last
estimates
Five of the ten underlying
components of the GLI
improved in April
This month’s data show a
substantive shift in the GLI
towards the slowdown area
We continue, however, to
think that the acceleration
we’ve been witnessing since
Jan. ‘15 is quite modest for
a typical expansion phase

9
Chinese Credit Bubble
Within the market for inter-bank
borrowings, borrowing, Chinese
banks are now pledging bond
positions larger than the entire
onshore bonds as collateral for
their short-term borrowing needs!
Since mid-2011, the onshore
bond market has almost doubled.
In the same time, pledge
positions has more than
quadrupled.
This expansion of "money-like"
financial claims is typical of
the terminal phase in the credit
cycle.

10
Cross-Asset Volatility
As the Fed decided to keep its dovish tone and delay its rate tightening, volatility went down across
asset classes
UST yield vol (as measured by BoA-ML MOVE Index) stands at a level not seen since end of 2014

11
EQUITY
We see this bull market as tired and old, but not finished. The market once again failed at the top of
the trading range. But, we still expect a final leg higher. The degree of skepticism of the bull market
seems to back up this view.
It’s worth noting that the rally since the lows of mid-February has been accompanied by strong breadth
readings in the S&P 50. The fact that the market remains expensive doesn’t preclude a breakout to the
upside into new record high territory
But any breakout to the upside will prove to be unsustainable in the absence of a real improvement in
corporate earnings prospects
Thus, we see limited upside from here, but the S&P 500 may challenge its old highs before turning
decisively south (unless we get a new round of QE). The bounce will soon become an opportunity
to sell into
Earnings reports were mixed:
US earnings recession continues. But analysts expect the Q1 to mark the bottom for earnings,
and earnings growth to turn positive by Q3
Earnings reports are slightly beating (significantly reduced) expectations
US Dollar appears as the main factor providing a (temporary?) lift for earnings. The weaker dollar
has boosted earnings expectations for multinationals, commodity prices and commodity stocks
We should keep in mind the gravity of the ongoing earnings recession in the context of very high
corporate debt levels.

12
EQUITY
Stocks seem more vulnerable than ever to any external choc (Central Banks action, China,
Crude oil…)
Several signs may be interpreted as a reminiscence of what happened in the late-stage of previous
economic expansions:
Large amounts involved in M&A activity and buybacks
Elevated levels reached on Debt/EBITDA for non-financial companies. U.S. corporate debt to
earnings ratios are at a 12-year high
Our main scenario from here (80% chance) : A massive top forming around 2135 – 2170 :
US profit margins are showing increasing evidence of peaking. On Price/Sales metric, equities
are trading at the top of the historical range.
A resumption of earnings growth going into 2016 will be necessary for equities to move higher.
Recent data shows more evidence of lower productivity, lower potential GDP growth and (later)
higher inflation risk. This is a bad scenario for stocks
Our alternative scenario (20% chance) : The S&P500 breaks the 2135-2170 resistance, opening
the way to 2225. Such a breakout would need a new round of QE and/or a new impulse to earnings
growth

13
EQUITY
Bottom line :
De-risking should continue. A higher allocation to cash is sensible in this late-stage stock bull.
We adjust our positioning rules on the S&P 500 as follows:
We remain OW (as we did since the index broke above 1903) as long as the 2020 level
is preserved. We still target 2110 and probably a new high around 2150-2170
Below 2020, we’ll turn Neutral and stay so as far as the ‘09 trend (1800-1850) is preserved
Any clean break below the ‘09 trend would make us move massively to UW
We like the low US beta. We remain Neutral on Europe and Japan vs. US despite the policy
divergence between the Fed and the ECB/BoJ:
Given the significant yen strengthening (despite the BoJ’s move to negative rates in late
January), we have turned cautious on the EPS outlook for Japanese stocks
Brexit/migration concerns are expected to weigh on Eurozone
Weak demand from China is expected to continue to weigh on Japan's production and
exporters in Eurozone.
We remain UW in US small caps vs large caps.
We remain OW defensive vs. cyclical stocks, given the low and/or falling bond yields
We remain UW EMs vs DMs despite the recent EM outperformance. We expect another (last)
leg of USD strengthening. Negative spillovers from China (and RMB one-off devaluation) and
Brazil will also likely have a strong impact on other EMs.

14
US Earnings
The S&P500 stands within an earnings
recession. For Q1 2016, the estimated
earnings decline is -7.1% YoY (-1.9% if
energy is excluded).
If the index reports a decline in Q1
earnings, it will mark the first time the
index has seen four consecutive
quarters of YoY declines since
2008/2009
For Q2 2016, 55 companies have issued
negative EPS guidance and 24
companies have issued positive EPS
guidance.
For all of 2016, the estimated S&P 500
growth rate is now projected at 0.9%
for earnings (down from 2.2% a
month ago) and 1.5% for revenues.

15
US Earnings
A common story is a company beating
on the bottom line, but missing on sales
Among the (87%) S&P500 companies
that have already reported earnings, the
beat rate was 71% for earnings (above
the 5-year average of 67%) and 53% for
sales (below average).
But this EPS beating story is
misguiding. Corporate earnings
reports have been beating REDUCED
expectations
And it’s NOT just an energy problem,
as earnings expectations are being
revised significantly lower across most
sectors

16
US Earnings
Based on declining earnings, we may expect a topping formation on the S&P 500.
But, for the moment, most analysts expect earning growth to resume in H2-2016. The market would
resume its upside move after a short consolidation.

17
S&P500 – A Long-Term Perspective
Equity markets still appear at lofty valuations, whatever the valuation metric we use.
We see only a few quarters (during the dot.com bubble) with higher valuations
Valuation alone is very rarely a timing tool for a major market top
Nevertheless, all these indicators suggest a cautious long-term outlook and weak long-term return
expectations These measures are consistent with flat (0%) 12 year S&P 500 nominal total returns

18
Equity Market Breadth
The breadth in stocks is improving, but it is
probably nearing a top.

19
Equity vs Financial Stress
The chart below puts the S&P500 next to a composite index (compiled by Financial Sense) of widely
followed financial stress indicators.
Financial conditions have been favorable for stocks till mid-2014. But since then:
they have diverged from the S&P500 uptrend
they have deteriorated and finally went negative in 2016

20
Market Sentiment
The current low bullish
readings in the AAII index
point to a significant
skepticism from investors
From a contrarian point of
view, prevailing bearishness
is usually a bullish omen for
the market
This excessive skepticism
may indicate that the
cyclical bull is not finished
yet.

21
Market Sentiment
Bearishness is also visible in
Newsletter Writers views
Newsletter writers are the most
bearish they have been since 2008.
Such a pessimistic reading is
hardly compatible with a top.

22
Market Sentiment
The amount of shares outstanding
in the VXX (VIX Short-Term Futures
ETN) has jumped up, showing that
investors have already protected
themselves against another
selloff.
They did so despite the high cost of
carry of the VXX, due to the sharp
contango in the VIX futures curve.

23
Market Sentiment
Based on the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI), short-term Nasdaq-oriented
stock market timers have reduced aggressively their recommended equity exposure.
The average Nasdaq market timer is now allocating 27% of his equity portfolio on the short side,
down from a 70% long position at the end of April.

24
Market Sentiment
Because of low returns on cash,
Mutual fund managers have
reduced their cash holdings to the
lowest level in 50 years.
Given these meager cash
reserves, any sharp selloff
would be amplified by forced
selling induced by redemptions

25
S&P 500 – A Short-Term Perspective
In the same time, households
are already massively invested
in equities.
At 38%, the proportion of
household financial assets
invested in stocks stands at a
level never seen since the 2000
tech bubble.
Little money is left on the
sideline for additional
investing in stocks.

26
S&P 500 – A Short-Term Perspective
Reminder: we’ve turned
from Neutral to OW on the
S&P500 as the index broke
above the 1903 level
For now, we stay OW, as
we expect a final leg up
(target ~ 2160!).
But, we keep a cautious eye
on the 2020 – 2035 range
We will switch to a Neutral
stance as soon as this
range is materially broken
to the downside.

27
S&P500 – A Short-Term Perspective
Our prop. Short-Term trading model has been mildly short over April and switched to mildly long on
May 4 S&P500 close (@2051.12)
The model is now Long SPX, targeting 2082

28
FIXED INCOME & CREDIT
GOVIES
The Fed left interest rates unchanged during its last meeting. The market is betting on another hike in
September. But the possibility of a hike in June/July is still alive, and we feel the market unprepared
for such a rate hike.
Treasuries have been range-bound for the past three months, and we see no obvious catalyst to break
out of this range
For now, government bond yields are back on the range lows. Valuations appear to be so stretched
that it seems reasonable to keep away from the asset class.
We see US inflation higher over 6-12 months horizon and we see little reason for US 10-year yields to
trade below current levels for long. Over the medium-term, we maintain our bearish directional view
on duration in the US
Tactically, however, we remain Neutral on 10y USTs as long as the 1.97 level is preserved. Above,
we’ll move to UW again. Our ultimate target on US 10y yields was revised down to 2.45 by H2-2016
We expect realized rates volatility to move up from its current (low) level, given the uncertainties
surrounding the pace of Fed’s hikes, the easing interventions of the ECB, global growth data and the
trend in inflation.
We maintain our relative view of US Treasuries underperforming Bunds and JGBs

29
INFLATION-LINKED
Inflation data start to show some signs of revival in the US (but not in Europe). Breakeven may
have structurally bottomed here. Reflation should gain the upper hand in H2-2016
Thus, in the US, we expect an increase in the market pricing of long-term inflation. Inflationary signs
should be watched closely as they will foreshadow a steepening decline in Govies.
Inflows into TIPS-related ETFs remain strong in recent weeks, suggesting that breakevens have
further room to widen
We remain Neutral HICP Inflation as we expect breakevens to trade sideways in the Eurozone
We remain OW on 10y-TIPS breakevens
CORPORATE CREDIT
More signs tend to show that the US credit market is already in the late-cycle stage. Credit
quality is deteriorating, but at a measured pace. Financing gap has turned strongly negative, making
corporates more and more dependent on external sources of liquidity. But low cost of funding and
continued investor demand have kept the asset class afloat…
We still expect more pressure on corporate ratings (particularly in troubled sectors like energy and
materials) given the uncertain macro, revenues / earnings weaknesses, the deteriorating credit cycle,
the rising idiosyncratic risk and the increasing net leverage.
We keep our bias towards higher quality. Any unpriced rate hike (and/or dollar strengthening) would
weigh on low quality bonds (High Yield and EM debt)

30
Given the large carry differential between the US and other DM markets and negative yields on Govies
in Europe / Japan, we expect the foreign bid to be very supportive for US HG credit, especially if less
M&A induces a lower primary bond supply.
The aggressive QE in Europe and Japan is also weighing on spreads and pushing HG credit higher
For high-yield bonds, the rally has extended alongside a climb in oil and stocks, higher inflows, a drop
in market volatility and an attenuation of global fears (global growth, CNY devaluation, equity
earnings…).
We remain concerned about the outlook for the US HY market, where default rates continue
moving up and balance sheets are deteriorating. Renewed weakness in oil prices will bring this issue
under the spotlights again.
As expected, credit markets outperformed equities over the last few weeks. We still see a better value
in corporate debt (specially IG) than in equities, as spreads already price a worse growth
environment.
We prefer to trade up in quality. We still prefer IG over HY on a risk-adjusted basis as we expect
volatility on spreads to remain elevated and we believe IG corporates better positioned to absorb the
impact of rising rates and bad news from China
We remain UW on HY and Neutral on IG, due to valuation, to rising volatility, to position within the
credit cycle and given the weak total return forecast for credit as a whole.

31
We expect volatility to go up again and think that an additional liquidity premium is needed to make
HY attractive. A high volatility justifies wider spreads, in our view, even if default risk remains benign.
We expect the focus on liquidity to remain. As said in previous reports, we feel concerned about the
credit market liquidity as the rate of turnover in corporate bonds has steadily declined since 2009,
despite the huge inflows.
Within the credit pocket, we remain Neutral on USD vs. EUR HY spreads, but we prefer USD on a
total return basis, despite its higher beta to energy sector.
Within the HY pocket, we see a more favorable risk/reward tradeoff in the BB and B rating buckets
We stick with our preference for US IG over Eurozone.IG, as we missed the recent ECB QE effect
and as:
we think that more attractive spread valuations and higher carry should fuel a stronger bid for US
credit.
We think that the ECB effect is already priced in and would be balanced by an increased corporate
supply
we see a gap between what the ECB is technically allowed to buy, and what it is really doable
given liquidity constraints

32
EM DEBT
Like for HY, the rally in EM fixed income has gained momentum over the month, across both EM hard
and local currency
The dollar strengthening that we expect would erase some of the gains in EM debt
For long-term investors, EM bonds denominated in local currencies offer the most value,
especially for currencies that suffered the most against USD
Bottom line : We change nothing to our previous positioning: Neutral Govies, UW US vs Eurozone
Govies, remain long flatteners on the US yield curve and short duration in 2y USTs, UW credit mainly
through HY and Neutral on IG, Neutral Eurozone vs US HY credit, UW Eurozone vs US IG credit, OW
10y-TIPS and Neutral HICP Inflation, UW High Yield vs High Grade, Neutral on EM sovereigns with a
little preference for local bonds

33
US Govies – TIPS & Inflation
Despite the mild growth,
inflation expectation is
trending up after having
reached extremes in early
2016.
TIPS breakevens imply the
highest inflation expectation
since Aug. '15
We've been OW on TIPS
breakevens since Dec ’15,
given their historically-low
levels.
We keep our OW
positioning

34
US Govies – Curve Flattening
We have been long flatteners (2-10y) on
the US yield curve since Dec. ’14, playing
the view that “when the Fed hikes, the yield
curve flattens”
In our Monthly Report of Dec. ‘15, we also
said “We remain long flatteners on the US
yield curve, targeting 50 to 75bps flattening
over H1-2016.”
We’ve proven right on both bets.
Over April, the 2-10yr curve has flattened
again as long duration outperformed.
We keep our flattening bet as we think
that the market is not prepared for a rate
hike in June or July.

35
US Credit – IG Basis
In Nov. ‘15, we started warning against the
significantly negative CDS-Cash basis (on
IG, but especially on HY), induced by
supply fears and the increasing use of CDS
indices to get (through protection selling)
exposed to the credit market with a
reasonable liquidity
But since the February bottom, bonds have
outperformed their CDS, significantly
narrowing the negative CDS-Bond basis.
We are back to levels last seen in Jun. ’15.
This basis tightening may be explained
by the dovish tone of the Fed (like other
CBs) that created more demand for bonds
and pushed swap spreads higher.
Given our cautious view on credit
liquidity, we think that this basis
normalization is only temporary.

36
US Govies – 10y-UST
We change nothing to our
previous positioning.
Tactically, we remain
Neutral on 10y USTs as
long as the 1.94 level is
preserved. Above, we’ll
move to UW again.
Our ultimate target on US
10y yields was revised
down to 2.45 by H2-2016
A base may develop
anywhere inside the 1.60-
1.77 range.

37
EXCHANGE RATES
Nothing new under the sun…
We moderate our view for the dollar as the (dovish) Fed keeps pressure on it, capping any higher
yields attempts.
But, the long-term dollar bull trend is not over. We continue to believe the USD should rally from
current levels as the Fed normalizes its policy and the ECB / BoJ both move the other way.
Historically, USD cycles have been persistent, lasting 5-6 years in the appreciation phase. We thus
see further medium term USD gains against the major crosses (especially EUR) and expect a
cyclical low in EUR/USD somewhere in H2-2016 (before the ECB tapering)
Besides the Fed being in hiking mode, we expect the US dollar to be supported by the fears of a global
recession, weaker-than-expected inflation dynamics and “Brexit” risks in Europe. The risks to our
view reside in delayed Fed action and disappointing ECB action. But we think that most of that is
already priced in.
We remain Neutral on the EUR-USD. But we expect a downtrend to develop from here. To gain
confidence in such a scenario, the spot needs to break below 1.13.
Our positioning rules are adjusted as follows:
Remain Neutral within the 1.13 - 1.15 range
Move to OW if the spot breaks above the 1.15 resistance to target 1.165-1.17
Move to UW after a clean break below 1.13. Target = 1.0725 and then 1.04 to parity over 2H

38
EXCHANGE RATES
Last month, we turned to Neutral on USD-JPY, “watching for signs of near-term stability or
basement somewhere between 108 and 106”.
Only a clean break above 111 could make us turn to OW
On the other side, a break below the 105.75 – 106.00 area could make us switch to UW as it may
open downside risks to 102. Such a breakout would indicate that Japan's fiscal and monetary
stimulus is doomed and induce a risk-off behavior globally.
The more dovish tone from the Fed has certainly halted the USD’s rapid rise, giving EM currencies
some respite
We anticipate that pressure on EM currencies will resume and continue until we see a more
constructive / fundamental improvement for global growth and commodities supply/demand
imbalances.
We remain UW EM and Commodity FX

39
US Dollar Index
The US dollar has been in a
range over more than a year
Like the advance in oil, the recent
decline in the USD was extreme,
but an impulsive reversal
seems to be imminent
Our primary scenario remains
a reversal formation in the
92.5-93.5 area. The oscillators
we watch seem to signal that a
low is already in place.
We will gain confidence in this
scenario if the resistance of 94.16
is exceeded.
Breaking the support area of
92.5-93.5 to the downside will
open the door to a much more
substantial correction.

40
EUR-USD
In our previous Monthly Report,
we said “Over the short-term, we
expect a local correction towards
1.12 before moving higher.”.
We’ve got both…
The picture on EUR-USD is not
clear. But, given our view on the
DXY index, we expect a
downtrend to develop from
here.
To gain confidence in such a
scenario, the spot needs to
break below 1.13.
We remain Neutral for now.
Over the medium-term (2H-
2016), we maintain our downside
projections towards 1.04-parity.

41
USD-JPY
Last month, we turned to
Neutral, “watching for signs of
near-term stability or basement
somewhere between current
levels (~108) and 106”.
We change nothing to our
previous positioning. We remain
Neutral.
Only a clean break above 111
could make us turn to OW
On the other side, a break below
the 105.75 – 106.00 area could
make us switch to UW as it may
open downside risks to 102

42
COMMODITY
The softness in the dollar has provided a perfect ground for commodities to move up during
the month. The DJ Commodity and S&P GSCI total return indices gained 9.1% and 10.1%,
respectively, in April.
But all commodities except four (copper, gold, cotton, lean hogs) are now in backwardation, implying
that the move is not supported by better supply/demand fundamentals
We remain UW commodities over 3-6 months as we believe the recent rally might be short-lived
The supply side has adjusted but still has a way to go in many commodities before erasing
current imbalances. In order to get more cuts in supply, we think there needs another leg
down in prices to force capitulation
US dollar strengthening should resume. Dollar will dictate both direction and velocity in commos
Despite the dovish tone from the Fed, the tightening cycle will continue in the US (with 2 or 3
hikes over 2016). Higher rates are usually bearish for commos as they put a higher cost on
carrying them in inventories
China’s investment slowdown continues
We don’t see any sustainable recovery without a pick-up in global growth or a substantial
shrinkage in supply. It is likely that supply destruction will be the main catalyst for the next recovery
in prices.
The downtrend in commodities looks about to bottom out. We see one last leg down in energy
and metals.

43
COMMODITY
Bottom Line :
Energy:
A technical look at oil prices suggests near-term profit taking in energy-related positions is likely a
good idea. As the contango disappears, the incentive to buy and store crude decreases.
Oil remains a wild card but a bottom may be forming with supply/demand imbalances coming to
an end by mid-2017
Oil prices rallied, in large part due to a weaker US dollar (due to the dovish Fed tone), some relief in
Chinese economy and a reduction in short specs positions
Fundamentals (oversupply, global inventories, mild growth and demand, OPEC failure to reach any
binding production cuts, Iran return to markets) continue to put pressure on prices.
We think that the bottom is in for oil, but we don’t expect a significant rally from current
levels (~$40 for WTI). We expect the spot to test again the 25-30 area before putting in a
permanent rebound
We expect oil to remain within the US$25-45 range for a while, and volatility to persist.
Last month, we switched from OW to Neutral as WTI broke above 39. We remain Neutral.
We’ve adjusted our tactical rules accordingly:
Remain Neutral if the spot stays between 36 and 47
Turn UW below 36
Move to OW if the WTI breaks above the Feb uptrend channel (currently ~ 47) or below 29.

44
COMMODITY
Precious Metals:
Outlook for precious metals continues to be dominated by the potential hiking pace of the Fed
and the subsequent impacts on US dollar and real yields.
Stronger US dollar and higher real rates should drive gold prices lower
At this stage, we think that gold / silver are still due for a final leg down. Our ultimate target was
raised to 1000 – 1040 on gold and 12.5-13 on silver.
We’ve been OW gold since the spot broke above the 1070-1120 range. Our view was confirmed
when the 1200 threshold was exceeded.
Last month, we decided to turn Neutral and to watch for a clean break above 1270 to become OW
again
The break above 1270 was short-lived and we remained Neutral.
Our positioning rules are adjusted as follows:
Neutral between 1200 and 1295
Turn UW if the spot breaks below 1200
Go OW below 1070 and above 1295 (to target 1380 – 1420)

45
COMMODITY
Base Metals:
We continue to expect industrial metals price weakness due to a combination of excess supply and
weak demand
The developments surrounding Chinese economy will continue to dictate prices in 2016
Metals prices have rebounded even as fundamental conditions have not improved. The recent price
increases are more a technically-driven move, mainly linked to the last round of Chinese easing. So
when China's stockpiling ends, these metals will go south
From our point of view, lower prices are still needed to oblige producers to cut production and to
rebalance oversupplied markets.
We still forecast one last leg down in prices. We remain UW on base metals.
Agriculture:
The S&P GSCI Agriculture Index gained 4.5% in April (after 4.5% in March)
We continue to believe in a limited downside to grain prices from here when upside seems very
interesting, especially for a medium-to-long-term investor.
We see more weather events weighing on grain harvests specially in Latin America (like soybean in
Brazil due to dry weather)
Nevertheless, we choose to remain Neutral, waiting for a better entry price on crops.

46
Crude Oil
Fundamentals remain weak for crude oil. This pessimistic fundamental view is confirmed by the
long-end of the futures curve which is getting flatter near US $50
Production levels in the US have started to decline.
But, the total inventory of crude oil continues to build…

47
Crude Oil
US oil rig count tends to lead oil
field production by roughly 18
months.
Given this relationship, a plunge
in US output seems possible,
and would imply a bias to higher
prices.
But, on the other hand, and
according to a Reuters study,
most US frackers have “drilled
but uncompleted” wells that they
halted when oil prices went
down. As soon as prices
bounce, these wells could be
brought online, weighing on
prices again.
We expect oil price to remain
in its current range, as far as
the fundamental gap between
supply and demand is not
reduced significantly.

48
Industrial Metals
At current price and profit margins, the Chinese steel industry has no incentive to reduce production.
Chinese steel producers have actually boosted their output by bringing online their spare capacity.
A glut is forming… A collapse in prices should be expected.
Keep away from steel and other industrial metals.

49
Crude – Tech. Perspective
According to our positioning
rules, we’ve been OW on crude
since Jan. 19th, before
switching to Neutral as the
WTI broke above 39 mid-
March.
Key support levels to watch
stand around 36. We need to
break below to call for another
test of the 25-29 range.
We’ve adjusted our tactical rules
accordingly:
Remain Neutral if the spot
stays between 36 and 47
Turn UW below 36
Move to OW if the WTI
breaks above the Feb
uptrend channel (currently
~ 47) or below 29.

50
Gold – Tech. Perspective
We’ve been OW gold since
the spot broke above the
1070-1120 range. Our view
was confirmed when the 1200
threshold was exceeded.
Last month, we decided to turn
Neutral and to watch for a
clean break above 1270 to
become OW again
The break above 1270 was
short-lived.
Our positioning rules are
adjusted as follows:
Neutral between 1200
and 1295
Turn UW if the spot breaks
below 1200
Go OW below 1070 and
above 1295 (to target 1380
– 1420)

51
ALTERNATIVE STRATEGIES
The HFRI Fund Weighted Composite Index posted gains of 1.0% in April. Gains were led by
credit / fixed-income Relative Value Arbitrage strategies, as credit and arbitrage deal spreads
tightened and UST yields headed up.
CTAs mild performance (-0.8% MoM, +2.3% Ytd) was mainly driven by their long fixed income (in the
US and Europe). Over the last two months, they reduced markedly their long fixed income exposure
but were still exposed to the rise in bond yields. Losses were partially offset by gains in equities and
precious metals. Year to date, CTAs remain among the best performers.
Global Macro funds advanced +0.9% in April, benefitting from their long equity exposures, partially
offset by losses on USD and commos. We expect Global Macro funds to be the prime beneficiaries
from a change in the Fed’s stance (to hawkish) as they remain long USD and short on commodities..
In a world where most assets seem highly correlated, the potential for diversification has been limited.
We believe that diversifying portfolios with an increased allocation to alternatives is particularly
attractive at this stage of the cycle, given the current macroeconomic and interest rate uncertainties.
The volatile current market environment, mixing powerful trends and sharp reversals, clearly favors
CTAs

52
ALTERNATIVE STRATEGIES
We stick to our preference for risk diversifiers (pure alpha generation strategies) over return
enhancers.
These strategies offer an interesting risk/return tradeoff, help buffer market shocks and offer
decent returns in rangy markets
We think that the divergence between the Fed and ECB monetary policies (and its subsequent
impacts on US dollar, commodities and Govies) is supportive for CTAs and Global Macros on
which we remain overweight
We are not changing our recommendations on alternatives which we consider to be suited to current
market conditions / dislocations .
We maintain our OW positioning on:
Equity Market Neutrals both for their “intelligent” beta and their alpha contribution.
CTA’s and Global Macro as a diversifier and tail hedge.
Vol. Arb strategy and prefer funds that trade volatility globally (all assets / all regions). This is our
way to take advantage from the higher volatility regime.

53
Equity Long/Short
It’s worth noting the Equity L/S funds
positioning between cyclicals and
defensive stocks since end of 2015.
During Jan-Feb, Equity L/S increased
their exposure to cyclicals.
But since the beginning of March,
Equity L/S cut their net exposure to
Cyclicals and reallocated to
Defensive again (like during 2015)

54
HF Duration Exposure
According to a JP Morgan analysis
(based on betas calculation of
investable indices / funds),
discretionary macro funds appear to be
maintaining their duration shorts near
their historical tops.
But, CTAs and risk parity funds
seem to have significantly reduced
their rate (long) exposure, over the
last few weeks
This clearly reduces the vulnerability in
bond markets to position unwinds in a
selloff, a risk we warned of in our
January Report.

Bottom Line: Global Asset Allocation
Economic data have been mixed globally. But the levitation in stocks
held up mostly thanks to the strength in oil and the weakness in the US
dollar.
Falling earnings, declining growth forecasts, and macro uncertainties have
kept markets range bounded in a context where “If bad news is not
awful news, it must be good news”. We are just planting the seeds of
the next BIG correction.
The degree of skepticism of the bull market seems to back up a final leg
higher on the S&P500
We make minor adjustments to our asset allocation this month.
Given the high equity valuations and the poor growth outlook factored in
credit (specially US), we now prefer the latter (mainly IG).
We reiterate our view that a perfect storm is building… It combines
historically overvalued stocks with stretched government bonds. Unlike
previous storms (2000, 2008), investors would be left with almost no
place to hide
We reiterate our view that we are sailing a cyclical bull within a secular
bear. The current cyclical bull may go higher for longer. But, rising
volatility and stalling earnings growth may indicate we are in the late stage
of the cycle.
We summarize our views as follows
55

56
Disclaimer
This writing is for informational purposes only and does not constitute an
offer to sell, a solicitation to buy, or a recommendation regarding any
securities transaction, or as an offer to provide advisory or other services
by FinLight Research in any jurisdiction in which such offer, solicitation,
purchase or sale would be unlawful under the securities laws of such
jurisdiction. The information contained in this writing should not be
construed as financial or investment advice on any subject matter.
FinLight Research expressly disclaims all liability in respect to actions
taken based on any or all of the information on this writing.

About Us…
FinLight Research is a research-centric company focused on Asset Allocation from a top-down
perspective, on Portfolio Construction, and all related quantitative aspects and risk management issues.
Our expertise expands along 3 axes:
Asset Allocation with risk control and/or risk budgeting techniques
Allocation to alternative investments : Hedge funds, rule-based strategies (momentum, value,
carry, volatility), real assets (real estate, infrastructure, farmland, timberland and natural resources).
Private equity and venture capital should be the next step…
Allocation with a factorial approach built on the understanding (profiling) of the risk/return drivers of
the different asset classes
FinLight Research is an innovation-oriented company. We target to fill the gap between the
academic research and the investment community, especially on real assets and alternatives. We survey
on a continuous basis the academic literature for interesting published and working papers related to
quantitative investing, non-linear profiling, asset allocation, real assets...
57

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58

Finlight Research - Market Perspectives - May 2016

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