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
Sep 2013
Aug 26th, 2013

2. MACRO VIEW
The Good
Manufacturing in China is improving. The preliminary HSBC PMI jumped to 50.1 points from 47.7 in
July
Copper is showing strength due to reduced inventories and Chinese demand
Jobless claims are holding at a lower level
Existing home sales were solid, but it is too early to tell about the impact of higher mortgage rates on
sales.
The Bad
Current uncertainty about Fed’s intentions as there is no greater clarity for when the Fed might begin
slowing the purchases of Treasuries/MBS that make up its current quantitative easing scheme
though the real estate data we got painted quite a mixed picture. New home sales disappointed,
probably as a reaction to higher mortgage rates
Healthy economy is not there yet… Household income (in real terms) has still not recovered from the
recession
The Ugly
Syria
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3. Unemployment
Initial Claims for unemployment have returned to levels not seen since the fall of 2007. Now we need to
see more job creation…
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4. Commercial & Industrial Lending
C&I Loans are the highest since Feb. 2009. This growth seems to be linked to Fed’s quantitative easing.
Easier financing should induce more capital spending
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5. Banks’ Treasury Holdings
US commercial banks are dumping treasuries at the fastest pace since 2000
The move accelerated after Bernanke’s speech in June
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6. Economic-Policy Confidence
Prospect of rising capital investment (fixed assets: buildings, equipment, lands…) is encouraged by
decreasing economic uncertainty
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7. Capital Goods Orders
New orders for capital goods climbed 9% last month to a record annual level, driving activity in the sector.
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8. Capital Goods vs S&P500
SPX is coherent with the level of capital goods produced, other than aircraft.
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9. Capital Goods Orders
the "real" durable goods orders per capita appear as a coincident macro-indicator of major shifts in
demand within the U.S. economy.
A key driver for healthy growth in durable goods orders is growth in household incomes
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10. Steel Production
US crude-steel production is expanding at the fastest pace in half a year
(manufacturing, domestic automotive sales, appliances to homes…)
Economic rebound
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11. Home Sales
NSA Existing home sales show a clear improvement over the last months
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12. Home Sales
New home sales decline sharply to 394 000 annual rate in July
The "distressing gap" appeared mostly because of distressed sales. The flood of distressed sales kept
existing home sales elevated, and depressed new home sales.
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13. Leading Indicators
33% of the data points have been
negative over the last six months.
ISM new orders printed four straight
negative prints, as did average
consumer expectations
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14. GS - GLI
the Advanced reading signals that
the GLI remains stuck between the
‘Slowdown’
and
‘Expansion’
phases for the fourth consecutive
month
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15. Earnings
World EPS is reaching a 2-year plateau. Should we wait for an imminent end for this earning stagnation?
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16. Earnings
Two potential sources of earning growth seem to be exhausted
Consumer spending is now needed to meet analyst’s earnings estimates. At this stage, it should be the
driver for US corporates growth
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17. PCE & DPI
DPI and PCE advance at rates that are in line with recent updates for the year-over-year comparisons.
The growth rates look however sluggish.
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18. EQUITY
Fluctuations of consumer / business confidence should be closely monitored.
One of the most ominous market indicators, the Hindenburg Omen (a highly technical indicator used to
predict major market crashes) has reared its ugly head this summer, flashing warning signs about the
health of the U.S. stock market..
Current valuation is based on near-record corporate profit margins. US corps currently report a profit
margin of 9.3%. It has gotten only slightly higher than his over the past six decades. In Q4-2011, it was
10%. The average since 1952 is 5.9%. At current high levels, a retreat seems likely. Should profit margins
simply revert to mean levels along with valuations stocks could easily lose half their value as they did
after the 2000 and 2007 peaks
Emerging markets are already showing cracks. The last time we saw such market action in Asia was
during the 1997 and 1998 crisis
Bottom line : Neutral to Underweight on stocks. Keep a long VIX as a hedge to long equities.
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19. US Stocks
The New Quarterly Lows (that
records, each trading day the
number of stocks in the S&p500
that are making new quarterly lows)
indicated that support has been
found around the 50d MA.
Unfortunately, this support has
been broken since…
The 20-day moving average line at
1680 is going to be the S&P 500′s
next make-or-break level.
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20. US Stocks
On the short-term, the SPX is expected to bounce on 1622, getting back to 1638 and then to 1671
Lower
Bound
Upper
Bound
Next Digit
Up
Proba
1
1800.0
Lower/Upper Bound
1700.0
0.75
1650.0
1600.0
0.5
1550.0
1500.0
0.25
1450.0
1400.0
1350.0
0
UpProba & Next Move (1=Up / 0=Down)
1750.0
31
177
254
217
100
164
165
285
250
375
373
271
112
340
172
269
351
333
328
343
34
400
356
224
System ID
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21. US Stocks
Since its high of May 22nd, the risk appetite has been drifting lower, driving down the 6m-momentum in
US stocks
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22. 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)
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23. US Stocks - Hindenburg Omen Indicator
Among the 2,000-plus common stocks listed on the NYSE, market analysts monitor four criteria
that trigger a signal
The daily number of stocks that hit 52-week highs AND the number of stocks that hit 52week lows are both 2.2% or more than the sum of NYSE issues that rise or fall that day.
New 52-week highs cannot total more than twice the number of new 52-week lows.
The McClellan Oscillator, which measures the difference between the number of rising
stocks versus the number of falling stocks, is negative.
The NYSE Index rises above its 10-week moving average –meaning it’s greater in value
than it was 50 trading days ago.
If ALL of these measures are hit on the same day, we start to get nervous. If this occurs a second
time, within a 30-day period, the Hindenburg Omen is triggered, and a serious stock market
decline is expected to follow within the next 40 days.
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24. US Stocks - Hindenburg Omen Indicator
Multiple Hindenburg Omens have been triggered over the past few months
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25. US Stocks
Consumer confidence has tended to lead the downturns in S&P500.
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26. 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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27. US Stocks
Consumer / business confidence may be essential for stocks to draw another leg up
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28. US Stocks
P/E-VIX ratio points to complacency : Investors are becoming overly about equity prospects
volatility is likely to accompany any additional gain in PEs.
A higher
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29. EM Stocks
Emerging markets tend to perform better than developed markets when the US dollar is loosing value.
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30. FIXED INCOME & CREDIT
Tightening US labor market (due to slow labor force growth and moderate job gains) will push the Fed to
phase out its QE, implying higher rates and underperformance of all rate-sensitive sectors
Credit market losses in August have been large, making 2013 among the worst years on record for
investment grade credit
The last time the spread of stocks to investment grade credit was this high was in 1999 - a rather ominous
sign.
The Treasury market appears fully priced for a September taper. Though this is the most likely scenario,
we should consider alternative scenarios and their potential impact on the markets
Bottom line : UW on US / € Govies, Neutral to UW on HY, UW on TIPS (at least till the September FOMC
meeting). OW European vs. US IG credit because of the improving economic data in Europe
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31. FIXED INCOME & CREDIT
Since early May, 10-year Treasury yields have risen more than 110bp and the mortgage universe has
extended by roughly 2 years
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32. FIXED INCOME & CREDIT
End-user demand for Treasuries has deteriorated rapidly in 2013.
But net issuance in Treasuries (net of the Fed’s purchases) is on an upward trend
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33. FIXED INCOME & CREDIT
Positive macro momentum continued in the Euro area. The strong Euro area PMI points to higher govies
yields
Stay short duration in 10Y Bunds (bund target ~2.0 – 2.1%)
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34. FIXED INCOME & CREDIT
With Treasury yields at a multi-year high and the market awaiting a host of catalysts in September, the
downside risk looks predominant in HY
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35. FIXED INCOME & CREDIT
With Treasury yields at a multi-year high and the market awaiting a host of catalysts in September, the
downside risk looks predominant in HY
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36. FIXED INCOME & CREDIT
Over the past few weeks, TIPS
breakeven
rates
narrowed
substantially.
Breakevens
have
become
increasingly negatively correlated
with rates as nominal yields have
risen.
Outflows from TIPS ETFs are also
signaling new selling pressures on
TIPS.
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37. COMMODITY
WTI crude oil has staged an important break out. Spot WTI surged by more than $10 per bbl since the
end of June, as its term structure steepened.
The strength and clarity of this move provides the signal we were waiting for to raise commodities (energy
+ industrial metals) to ‘overweight’ (OW). Crops are still weak (UW).
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38. Crude Oil
In July, commodity markets delivered a 5/5 message. This is only the second 5/5 month in WTI crude
oil in the past six years (the other one is July 2007), which points to a marked increase in commodity
prices and volatility.
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39. Precious Metals
Given the debt limit trend, the
fall in gold seems hardly
sustainable.
Next ST target = 1475
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40. Precious Metals
However, our theoretical price (using US$, sovereign CDS and Real Rates) is stuck at 1200
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
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41. Precious Metals
The bull trend in silver will be more clear above the 26-26.40 area
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42. Precious Metals
Geopolitical risk from the Middle East is once again a huge issue leading to sharp increases in oil / gold
prices
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43. EXCHANGE RATES
Despite positive economic surprises out of Europe and China, the downside risks on several EM
currencies (particularly those with large current account deficits, deterioration on the fiscal front and high
inflation) have increased over the last month.
Overweight DXY
Neutral EUR vs USD : the currency will stay in a range 1.30-1.35
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44. DXY Index
DXY has held the important support at
81.00/80.30.
According to JPM, a break above
82.50 should set the stage for a
deeper
recovery
toward
the
83.50/83.80 zone
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45. EUR-USD
Compared to the sovereign spread between Germany and US, EUR-USD seems too expensive.
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46. EUR-USD
Our preference is the short side of the EURUSD. The list of EU problems continues. They soon will be
making headlines.
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47. USD-JPY
USD/JPY is attempting to base above important support levels in the 95.60/93.50 zone (38.2% retrace
from Nov 2012)
The pair has dropped below its 26-week moving average. A further decline in the pair is likely to push
hedge funds to unwind their positions
Short-term target ~ 95 then 92
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48. Bottom Line: Global Asset Allocation
Monetary conditions are tightening in the US, without a better economy. This creates downsides to both
equities and fixed income on the short-term, and thus the risk of asset deflation.
Overweight high yield relative to investment grade. There is still a bit of value in HY
Underweight govies and TIPS
Underweight EM relative to DM
Buy volatility as a hedge for stocks
Overweight commodities except crops and precious metals
Overweight Gold & Silver to play ST targets with very close stops
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