Finlight Research - Market Perspectives - Aug 2015

Market Perspectives
August 2015
Aug. 10th, 2015
www.finlightresearch.com
Keep Your Powder Dry…

“if the generals are advancing by themselves
they’re not going to get very far !”
– Old saying
2
FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation
Caution is still the watchword for the months ahead
Economic fundamentals remain mixed to weak
There is very limited upside for risk assets, and probably a significant
downside over the near future.
We still believe that equity markets are living on borrowed time. Some
warning signals are already given by small caps underperformance and
market breadth weaknesses.
The song remains the same in commos. Commodities resumed their slide
without any sign of bottoming…
We pay a close attention to the VIX reading.
We continue to expect higher default rates and higher volatility as banks
are likely to be more restrictive in their lending standards
The prospect of rising interest rates, a stronger US dollar and economic
uncertainty , could also be a trigger for higher cross-asset volatility.
Thus, a confluence of forces are converging to disrupt global equity and debt
markets.
We reiterate our view: A perfect storm is building… It combines historically
overvalued stocks with stretched government bonds and corporate credits.
Unlike previous storms (2000, 2008), investors would be left with almost
no place to hide.
We summarize our views as follows
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MACRO VIEW
The Good
S&P500 earnings growth remains solid at its core
Durable goods orders beat expectations
ISM manufacturing and Non-Manufacturing remained solid
The Bad
Consumer confidence took a hit in July and missed expectations (90.9 versus 99.3 on the
Conference Board Consumer Confidence Index)
In June, retail sales fell by 0.6% (MoM) in the Eurozone, and by as much as 2.3 % in Germany
Chinese Caixin manufacturing purchasing managers index (PMI) for July dropped to a two-year
low of 47.8.
The Ugly
Main systemic risk resides in China: After a decade of economic boom, China has
accumulated significant imbalances. China’s economy is supported by approximately six trillion
dollars of 'shadow debt', coupled with an unprecedented credit-fueled construction madness.
Greece is still a wild card, as the reached deal doesn’t provide a permanent resolution to the
crisis.
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5
The Big Four Economic Indicators
The overall picture had been one of a slow recovery, but there is no indication of a recession using the
indicators monitored by the NBER.
The current picture is characterized by relatively strong Employment and Income, a weak Industrial
Production and an erratic to weak Real Sales.

6
GDP Growth
The Atlanta Fed's GDPNow model first
forecast for real GDP growth (annualized
SA) in Q3-2015 was 1.0% on Aug. 6th, well
below consensus
The model projects that lower inventories
will subtract 1.7% from Q3 real GDP growth
The advance estimate from the U.S. Bureau
of Economic Analysis of Q2 GDP was
reported at +2.3%, exactly in line with the
Atlanta Fed's GDPNow estimate.

7
ISM
Conditions in the service sectors of
both the Eurozone and U.S.
economies are improving.
ISM Manufacturing came in below
expectations (at 52.7, down from June’s
53.5).
US ISM Non-Manufacturing Composite
Index came in higher than expected, at
60.3 (versus 56.2), far above the June
56.3 reading
This is a 10-year high!

8
Consumer Confidence
Consumer confidence disappointed.
The Conference Board index fell from 99.8 to 90.9, while the Michigan Sentiment Index fell from 96.1
to 93.1

9
Economic Surprise
As shown by the JP Morgan Economic
Data Surprise Index (EDSI), recent
economic data have been relatively
worse than expected, pushing long-term
UST yields lower

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GS – Global Leading Indicator (GLI)
The July Final GLI came in at
1.5%yoy. It momentum stands at
0.20%.
According to last estimation, GLI
growth has been positive and
increasing since February. But this
‘Expansion’ phase is anemic and
crossing the border to the
“Slowdown” phase could occur
anytime.
Five of the ten underlying
components of the GLI improved in
July
We continue to think that the
acceleration we’ve been
witnessing since Jan. ‘15 is quite
modest for a typical expansion
phase

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Guessing the Next Crisis?
Since 2000, the state and local governments debt
rose at double the rate of nominal GDP (150% vs
77%)
Over the same period, state and local taxes have
increased at a rate twice that of wages (75% vs 38%),
and their expenditures have risen faster than GDP.
Is that a sustainable trend?
One day, borrowing will become prohibitive and
raising taxes will no longer generates more
revenues…
Cutting spending would become unavoidable.
Higher taxes, when earnings stagnate and household
income declines in real terms, will no doubt weigh on
consumption spending.
Lower private/public consumption = recession.
Defaulting on debt will trigger the crisis to come.

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EQUITY
After the Greek & Chinese fears, the market is back to its previous sideways trading range, awaiting
again a catalyst to breakout one way or another.
The million-dollar question: Is that the sideways plateauing process that usually signal a major peak?
Or just a neutral range-bound consolidation preparing the way for a material break on either side of
the range?
At the top of the range, 2130 is the level that will make or break the market over the short-term.
For the moment, the bullish trend has been preserved. But a point of no return could be reached on the
S&P500 if it breaks its trendline across the lows since Oct. ‘11 at around 2000
Some warning signals are given by small caps underperformance and market breadth weaknesses.
Many of the individual stocks that make up the S&P 500 Index are suffering major corrections. The
advance is led by fewer and fewer stocks
Recent data shows more evidence of lower productivity, lower potential GDP growth and (later)
higher inflation risk. This is a bad scenario for stocks
We keep the same song. We still believe that equity markets are living on borrowed time because…
Earnings season hasn't provided the catalyst needed for the breakout to the upside
Valuations are well above historical norms, especially when we take into account the slower
revenue growth, the lower margins and the starting wage pressures
The coming rate hikes will depress all asset prices for at least a part of next year

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EQUITY
Bottom line :
Nothing new compared to our previous report. We remain Neutral equities as long as the indices
stay trapped in their sideways trading range. Our strategy is still to buy the lows and sell the highs,
until a material break on either side of the range is attained.
We may revise our view to OW after a clean break of the 2070-2130 range to the upside on the
S&P500, and to UW below the trend since Oct. ‘11 lows (currently at 2000)
We still think it is wise to incrementally "de-risk" your portfolios by focusing on higher quality / more
defensive / more favorably priced companies
We remain OW on Japan (always on an FX hedged basis) as a positive dynamic is still driving
the Japanese economy. But the 21 000 level on the NIKKEI will be key…
We remain Neutral on Europe vs. US despite the policy divergence between the Fed and the
ECB. According to the 12 month forward P/E, Europe is trading at 15 year highs, relative to the
US
We remain UW in US small caps vs large caps.

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US Earnings
For Q3 2015, 56 companies have issued negative
EPS guidance and 22 companies have issued
positive EPS guidance.
The 12-month forward P/E ratio for the S&P 500 now
stands at 16.5, well above historical averages: 5-
year (14.0), 10-year (14.1)
Most of the deterioration in earnings momentum
for the S&P 500 is due to the Energy sector
Q2 earnings decline -1.0%. The last time we saw a
YoY similar decline in earnings was Q3-2012 (the
Fed came with its QE4 later that year)
If the Energy sector is excluded, the earnings
growth rate would be at 5.7%
Of the 436 companies that have reported earnings
to date for Q2 2015, 73% have reported earnings
above the mean estimate and 51% have reported
sales above the mean estimate

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S&P500 – A Long-Term Perspective
Equity markets 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

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S&P500 – A Short-Term Perspective
The S&P500 has been rangy for a while, now. Is that the sideways plateauing process that
usually signal a peak? Or just a neutral range-bound consolidation preparing the way for a
material break on either side of the range?
The index hasn't seen a 20% correction over roughly 4 years. But the 200-day MA tests are
becoming more and more frequent.
The range we watch remains the same: 2040 – 2130. A clean break in either direction should
translate in a more impulsive movement: 2215 to the upside, and 1960 to the downside

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S&P500 – A Medium-Term Perspective
At major market peaks, the advance is
usually led by fewer and fewer stocks
The market breadth seems to be
deteriorating…
106 out of the 500 stocks in the
S&P500 index have suffered a 20%
decline from its 52-week high.
Additional 136 stocks are -10% from
its 52-week high.
Another warning signal is provided by
the under-performance of small-cap
stocks

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A third warning signal: The decoupling we
see between the S&P500 and market
internals is similar to the one we’ve
witnessed during the last financial crisis…

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On the MT, next levels to watch closely
are:
The 55 wMA at 2048. The index has
been above for 165 consecutive
weekly closes.
And the trendline across the lows
since Oct. ‘11 at around 2000
Only a material break below these
levels would signal that the
underlying trend is definitely
damaged.

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Japanese Equities
A positive dynamic is developing in
Japanese stocks, mainly due to
Yen weakening, but not only.
Stocks are taking advantage from
the exit from deflation, the
improvement in macro data and
corporate earnings momentum
We remain OW on Japan (always
on an FX hedged basis)
But given the toppish view we have
on USD-JPY and the closeness of
the next important level of 21 000,
we are not far from moving back to
Neutral again.

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Chinese Equities
According to a GS estimate, the
Chinese government has spent
around Rmb 900bn to support the
domestic equity market through the
so-called 'national team' institution.
In spite of this massive
government intervention, we still
expect the Chinese equity
market to resume its decline
Technically speaking, we interpret
the triangle pattern we see on the
Shanghai Composite Index as a
trend continuation formation.

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Chinese Equities
The picture is even more
frightening when equity market
is compared to the underlying
economic activity…
Over the last 12 months, the
Shanghai Composite has
completely decoupled from the
PMI
Filling the gap will necessitate
tears and blood.

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Trading Model – S&P500
As of Aug. 10th, our prop. Short-Term trading model is modestly short on the S&P500 (2104.18).
Out of the 4 active systems, 4 are short with 2082, 2061 and 2041 as targets
The model has boosted its return generation since Oct. ‘14, exhibiting a pattern similar to the one
we’ve seen after Jun. ‘07

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FIXED INCOME & CREDIT
We believe the Fed is on track for a September rate hike, when the market continues to price such a
scenario very partially. UST yields remain underpriced relative to this scenario.
Our excitement about inflation expectations was calmed down by the new slide in commodity prices.
Nevertheless, inflationary signs should be watched closely as they will foreshadow a steepening
decline in govies.
We expect negative total returns on USTs. We still look for the bear market on USTs to resume.
Last month, we moved UW 10y USTs but switched back to Neutral as the 10-year yield moved below
2.30. We wait for a material break either above 2.45-2.50 or below 2.00 to change our positioning
Our ultimate target on 10y yields stands at 2.75 by end of 2015.
On German Bund, our target zone of 0.75-0.90 were reached and, as expected, we switched from
UW to Neutral. We remain Neutral on German Bund (within the sovereign FI asset class) as long as
the 10-year yield stays above the 0.45 – 0.50 area.
We will switch to UW again as the 10-year yield breaks above 0.90-1.00.
Inflation breakevens have risen since the start of the year. We remain OW HICP Inflation through 5y
inflation swaps (long HICP inflation breakevens = receiving HICP vs payind fixed rate) as we expect
a steady pick-up in HICP inflation over 2H15
We expect TIPS to underperform as energy prices continue to decline and Fed tightening tends to
push real rates up in the absence of accelerating inflation.

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Credit quality further deteriorates in H1, both in IG and HY, as the releveraging continues to rise at
a sustained pace (especially in HY space)
Lower rated new-issue volume has been increasing since the financial crisis. That should drive the
default rate higher and HY spreads wider.
But, the risk that the faster debt accumulation on US balance sheets will drive corporate defaults and
downgrades higher remains low in the near to medium term, in our view
With the Chinese hard landing fears resurfacing, pressure resumed on commodity prices, pushing
down credits in the Energy, Metals & Mining sectors, especially in US HY
We feel more cautious about EUR HY as it continues to show an extremely low level of volatility that
hardly capture the underlying single name event risk
We remain UW on corporate credit, due to valuation, to rising corporate leverage (specially in the
US), to rising volatility, to position within the credit cycle and given the weak total return forecast
Within the credit pocket, and over the very short-term, we move out of our preference for Eurozone
HY corps vs US HY corps, initially inspired by the ECB massive QE (influencing Institutional
allocation), and more resilient macro in the Eurozone. We are now Neutral on USD vs. EUR HY
spreads, but we prefer USD on a total return basis, despite its higher beta to energy sector

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We still prefer US IG over Eurozone.IG, as we think that more attractive spread valuations and
higher carry should fuel a stronger bid for US credit.
We still prefer IG over HY on a risk-adjusted basis as we expect higher volatility on spreads and we
believe IG corporates better positioned to absorb the impact of rising rates
Bottom line : UW Govies, UW US vs Eurozone Govies, remain long flatteners on the US yield curve,
UW credit, Neutral Eurozone vs US HY credit, UW Eurozone vs US IG credit, Neutral TIPS and OW
HICP Inflation, UW High Yield vs High Grade, Neutral on EM corporates

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US Govies – 10y UST
Last month, we decided to switch
from Neutral to UW 10y USTs and
moved to 2.30 the threshold below
which we become Neutral again.
We keep this same positioning rule
Tactically, we are now Neutral
again, waiting for a break either
above 2.50 or below 2.00 to
change our positioning.
We think that the risk is still
biased to the upside on the 10y
yield.
A better labor market would
translate into higher inflation
expectation later this year (or in
2016) and higher LT yields.
In order to confirm our bearish
view, a clean move above 2.40-
2.50 is needed..

28
US TIPS
Inflation expectations have resumed
their decline, probably because of
lower oil / gasoline prices…
Five-year breakevens are now at
their lowest level since Jan. ‘15.
Breakevens will stay under pressure
until energy prices stabilize.
We expect TIPS to underperform
as energy prices continue to decline
and Fed tightening tends to push
real rates up in the absence of
accelerating inflation
As a consequence of this slide in
inflation expectation, nominal yields
have stayed relatively low despite
the imminent Fed rate hike

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US Credit
The renewed decline in oil prices induced another leg up in the spread on high-yield energy bonds,
reaching new post-recession levels
As the default risk in the high-yield energy sector heads up, the risk of a credit default contagion is
getting on the radars. But so far, there is no sign of such a contagion.

30
US Credit
IG spreads have reached a 3-year peak, driven
by heavy supply and concerns about commodity
prices.
With the Chinese hard landing fears resurfacing,
pressure resumed on commodity prices,
pushing down credits in the Energy, Metals &
Mining sectors, and putting pressure on HY
bond prices
We still prefer IG over HY (both in US and
Eurozone) on a risk-adjusted basis as we
expect higher volatility on spreads and we
believe IG corporates better positioned to
absorb the impact of rising rates

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Credit – Any Warning?
2-yr swap spreads acted as an advance warning
of widening risk in HY spreads and fundamental
deterioration in the broad economy
At this stage, swap spreads are trading
around 20-30 bps. No risk is seen on the
horizon yet!

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EXCHANGE RATES
We reiterate our bullish view on USD over the medium-term and expect a rival of the appreciation cycle of
the '90s
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 JPY) and expect a
cyclical low in EUR/USD somewhere in 2016 (with the ECB tapering)
The DXY uptrend is still intact even if the pace slows. But current dollar valuation implies 25 to 50 bps
higher rates in the US. Without a September hike the uptrend on the US dollar may be damaged
seriously.
The line in the sand for the DXY index is provided by the lows of May and June. A break below would
derail the strength phase.
Our positioning on USD is driven by (almost) the same trading rules:
During the month, we moved UW as the spot broke below 1.1040 and reached our first target around
1.08.
We remain UW on EUR-USD as long as it stays below 1.1080. We will move back to Neutral if the
spot breaks above 1.1080, and to OW above 1.12
On USD-JPY, we remain Neutral for the moment, as the spot failed to hold a break above 124-125
resistance

33
US Dollar
The dollar index remains near a
12-year high
We still think that the upward
movement in US Dollar should
continue and expect a further
10%-20% appreciation
At this stage, the dollar (on a real
trade-weighted basis) is back to its
average level against other
currencies. The upside move has
further room to go…
Fundamental US data are also
supportive for the USD: the
federal deficit is under control, the
economy seems in a good shape
and the Fed is preparing to
tighten.

34
EUR-USD
EUR-USD is still consolidating
below its July ‘14 downtrend
(currently around 1.10).
During the month, we moved UW
as the spot broke below 1.1040
and reached our first target around
1.08.
We will move back to Neutral if the
spot breaks above 1.1080 and to
OW above 1.12
Only a clean break in either
direction (below 1.074 or above
1.108) is able to shed light on the
next short-term move.
We keep our bearish bias, for
the moment.

35
USD-JPY
In our June Monthly Report, we
said “We decide to switch from OW
to Neutral and wait to see how the
pivot behaves near the 124.73
level. ”
From a multi-month/year
perspective, the 124-125 range
appears to be very important and
should be watched closely for signs
of a turning point formation
JPY is already at historical low
levels in terms of real effective
exchange rate
We stay Neutral for the moment,
as the spot failed to hold a break
above 124-125 resistance

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COMMODITY
The song remains the same in commos. Commodities resumed their slide in July, led by crude
oil and base metals.
All commodity families are struggling, but reasons are quite specific to each.
The price trend is probably reflecting the mixed news given by the world economy. The headwinds
responsible for this weakness (supply glut in oil, slowing growth in China, precious metals loosing
their luster as a safe heaven…) are likely to continue.
The expected Fed rate hike would put more pressure on the asset class as higher interest rates put a
higher cost on holding commodities
We remain neutral-to-bearish across all complexes in the near term. To mid-2016, return forecasts
are negative for commodities as a whole.
Despite the rally seen in April (mainly driven by a weaker US dollar and expectation of more
stimulus in China), the trend remains bearish. There is no indication of a bottom formation yet.
We still think that it is still too early to get in the “reflation trade” of a weaker dollar and higher
commodity prices
We remain UW commodities. We continue, however, to like owning the GSCI index, and think
that commodities hold value as cross-asset portfolio diversifiers and as an inflation hedge.

37
COMMODITY
Bottom Line :
Base Metals: Base metals don’t appear to be stabilizing yet. We remain Neutral on base metals, but
do not like holding Copper as it appears highly overvalued relative to the dollar, the global growth and
the Chinese demand.
Agriculture: In our May Report, we decided to tactically switch from UW to Neutral because of the
bearish bets on agricultural commodities accumulated by managed money. A crowded deal we didn’t
like. We stayed Neutral despite the sharp gains posted over June, gains that were reversed in July (-
9.34% on the GSCI Agri Index)
Energy: We remain of the view that the oil market is oversupplied, still think it is too early to expect
major upside for the price and that the risks remain substantially skewed to the downside
On July 2nd, we moved from Neutral to UW, as the spot dropped below 56, and targeted the
recent lows on WTI at $45/bbl. Since then, our target level has been already reached.
We will move to Neutral again if the WTI goes above 56.5 and to OW if the it breaks above 63
Given the daily oscillators level, we will also move to Neutral again around 42 and wait to see how
the spot behaves near the previous low of March

38
COMMODITY
Precious Metals: As trumpeted for months now, the Gold has finally broken its trading range to the
downside (1150). But we still believe that betting on a reversal is premature…
Applying our trading rule, we decided to switch from UW to Neutral.
We change nothing to our view on precious metals. The stimulus provided by the ECB & BoJ is
already factored in gold prices. Precious metals are vulnerable to higher US real yields,
stronger dollar and weaker gold flows to Asia (unlike in 2013) We maintain the view that Q3
15 is likely to be the weakest quarter for gold
We think that as long as gold is trading below 1225, it could be heading back down to test the
March low
As said in our previous reports, we will move progressively to OW (accumulate) as the spot
slides down towards 1000-980, which is likely the final leg down. Only a clean break above
1225 may push us to reconsider our view.
Our first target on silver at 14.70 has been reached. We still think that Silver (like gold) is probably
ready for its final leg down towards 12.50. We remain UW as no material break has occurred
below 14.70. We will switch progressively to OW (accumulate) if the spot breaks the 14.70
resistance and slides down towards 12.50
We may reconsider our UW position if the Silver breaks above 16.7-17.

39
Commodities
As expected, commodity prices
have resumed their downward
slide as Chinese hard landing
fears have resurfaced
The downtrend in commos seems
unable to find a bottom.
Keep away from the asset class.
The move has further room to
go…

40
Precious Metals
Gold is loosing its glitter…
Gold downtrend remains in line with
the increase in real rates (implied by 5y
TIPS).
Since end of 2011, investors have
liquidated about 50% gold ETF
holdings
Betting on a reversal is still
premature…

41
Crude Oil – The Supply-Side
Strong supply is one of the
main factors weighing on oil
prices.
OPEC output is near an all-time
high
The same is true for US
production despite a near halving
of drilling activity and near 30%
drop in capex.
Future production cuts should
finally materialize next year and
help oil prices to find a bottom in
the $35-40 range (for WTI)

42
Crude Oil – Tech. Perspective
Since our May report, we’ve
emphasized the signs of
exhaustion the spot has shown
near 63, and specified 52.3 as the
next important support to watch.
We’ve been UW since July 2nd.
We expected WTI to retrace its
recent lows of $45/bbl by October.
Our target level has been
already reached.
Given the daily oscillators level,
we will move to Neutral again
around 42 and wait to see how the
spot behaves near the previous
low of March.

43
ALTERNATIVE STRATEGIES
The HFRI Fund Weighted Composite Index was flat in July (+2.5% Ytd), mirroring a large
dispersion among its underlying strategies: global macro managers performed well (+2.12% on HFRI
Systematic, and 1.24% on HFRI Macro) while their event driven peers did poorly (-0.96% on HFRI
Special Sit. sub-index and -0.30% on HFRI Event-Driven). Within the RV strategy, HFRI RV-Vol Index
did the best with +2.09%
The solid performance of CTAs and Macro traders reversed the sharp losses from Jun, thanks to the
resumption of global themes in July. Part of this performance is indeed related to short positions on
commodities and longs in US Dollar and FI.
Conversely, event driven strategies suffered oil price weakness and some disappointing earnings
calls.
We stick to our preference for risk diversifiers (pure alpha generation strategies) over return
enhancers.
We believe that diversifying portfolios with an increased allocation to alternatives is particularly
attractive at this stage of the cycle.
We are not changing our recommendations on alternatives which we consider to be suited to current
market conditions. 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. These strategies should outperform as
FX and commodity current trends are likely to persist.
Vol. Arb strategy and prefer funds that trade volatility globally (all assets / all regions). This is our
way to position for a higher volatility regime.

44
CTA Funds
CTAs remains our favorite HF strategy.
After years of outflows, CTAs have
attracted huge inflows in 2015 thanks to
their solid performance.
The momentum has decreased since the
top reached In April on the strategy

Bottom Line: Global Asset Allocation
Caution is still the watchword for the months ahead
Economic fundamentals remain mixed to weak
There is very limited upside for risk assets, and probably a significant
downside over the near future.
We still believe that equity markets are living on borrowed time. Some
warning signals are already given by small caps underperformance and
market breadth weaknesses.
The song remains the same in commos. Commodities resumed their slide
without any sign of bottoming…
We pay a close attention to the VIX reading.
We continue to expect higher default rates and higher volatility as banks
are likely to be more restrictive in their lending standards
The prospect of rising interest rates, a stronger US dollar and economic
uncertainty , could also be a trigger for higher cross-asset volatility.
Thus, a confluence of forces are converging to disrupt global equity and debt
markets.
We reiterate our view: A perfect storm is building… It combines historically
overvalued stocks with stretched government bonds and corporate credits.
Unlike previous storms (2000, 2008), investors would be left with almost
no place to hide.
We summarize our views as follows
45

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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.

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Finlight Research - Market Perspectives - Aug 2015

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