Second Quarter 2010 GTAA Equities

8/9/2019 Second Quarter 2010 GTAA Equities

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o a ac casse oca on

GTAAEquities

March 26th, 2010

Damien Cleusix

Clue6 Second Quarter 2010

am en c ue .com


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1Executive Summary

StocksValuations are above the levels where future will not please the buy & hold crowd (in the developed ex Japan world),

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manner ,At 1200 on the S&P 500 will be priced more expensively than during all of the structural tops pre-2000 (well 1997-

2000) except the final tail of the 1929 move... And you have to remember that assets quality is not what it was in the past and

that there are signs that accountants are working overtime. This does not imply that the markets will fall in the short or eventhe medium term but that a further rise will only have speculative and no investment merit if bought and that if one buy

today to hold for the long-term, negative capital gains should be expected in the next 7-10 years.

Our base assumption remains that we will fall to significantly undervalued levels before a new secular bull market can start (in

the developed world as, as you know, you know we believe that we are in a secular bull market in emerging markets). This

currently imply a sub-530 level on the S&P 500 going up by 5- % a year. Emerging mar ets are getting too expensive even if

one consider that they are in a structural bull market (structural as we think that the 2003 and 2009 low should hold).

Option activity, insiders and most of the smart-money indicators we follow have deteriorated substantially from the

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context of the recent advance and market trend (higher highs and higher lows). So sentiment in itself does not imply that the

markets can not continue their ascent in the medium-term but more that it should at least consolidate in the short-term.

Breadth is giving diverging signals. The advance-decline and up down-volume line are making new highs, of the ahead of

the markets but their momentum is too high for the market to continue straight up. We experienced new breadth thrust, we

had two Lowrys 90% days after the February low and the McClellan summation index has moved above its January high .

No Hindenburg Omen has been triggered and the Fosback High-Low index remains low. This is hard to call for a

cyclical top in this environment. But we are seeing divergences between various indicators measuring the % of stocks


a ove certa n mov ng averages, vergences w c ave appeare s ort y e ore a correct on un o .


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2Executive Summary

On the liquidity side, inflows into US equity domestic funds remain low while money is pouring into emerging marketequity funds. This has historically been followed by underperforming EM markets. Fund managers have been heavy buyers

and have spend all the money they got in January and then some more, pushing the cash/asset ratio to new historical low.

Foreigners appetite for US equities has increased dramatically which is typical of ending cyclical bull markets.

There has been a slight pick up in buybacks but they remain very low while IPOs and secondaries ex US have been plentiful,

with bubble reminiscent level in Hong Kong and China. On the monetary front, real M2 and M1 growth is turning

negative in the US and decelerating markedly elsewhere. Emerging markets central banks reserve growth has been slowing

rap y which is a headwind for ris y assets.

Pension funds funding status has stabilized but imagine the what will happen if equity price falls while high quality

corporate bonds yields (used to discount liabilities to present value) do not rise as they did in 2008-2009.

Seasonals are still supportive but we are slowly entering into the time window where our seasonal model can trigger a sellsignal if markets trend deteriorates. The next cycle low are expected in June and October. We will have to see if the markets

top before or after the middle of the cycle (right or lest translation). If it tops early in the cycle this would be a clear sign of

cyclical topping process.

Intermarket relationships have deteriorated. While the Nasdaq is continuing to make relative highs along the Russell 2000

and equal-weighted indices, semiconductors stocks are underperforming as are many emerging markets and Europe. On

the credit side, neither high yield nor high quality corporate bonds have confirmed the recent markets highs. Finally, the

com ne momentum o cru e o , copper, go an t e years treasury y e s at eve s w ere t e equ ty mar ets ave

struggled in the past.

The trends have deteriorated since the January top. The US markets are one of the few making new highs but are now


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the short-term trend remains up as long as markets remain in the up channels they have formed since the February low.


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3Equities: Valuations

Valuations are not useful for short-term market projections but are essential in forecasting

long-term returns. They become informative in the shorter term when they reach extremes .

US Earnings VolatilityChart 1

When they are very high one should not allow the other indicators in ones arsenal to deteriorate

too much before pushing the exit button, the reverse is true when they reach very low levels.

The perpetual question is what constitutes high and low and which valuation ratios to look at. Welook at normalized price to earning ratios (normalized using a trailing reported earnings moving

average (R. Shiller method), average margins or peak earnings (J. Hussman method)) and price to

book value. We like to look at a historical dataset as long as possible. It is also important to

consider the quality of the data. One often hears that valuations should be higher because the

markets are less risky.

We disagree.

Main Street has clearly been less volatile in the past 30 years (well up to now), as has

inflation. The consequence is that companies have increased their leverage dramatically (cf.

A. Greenspans Paradox of Credibility or H. Minskys Unstable Stability) . In the

Source: R. Shiller, Clue

Chart 2 US Earnings Quality

process earnings volatility has increased rapidly in the past 10 years (C art 1). From t e mi

50s to the mid 80s, real annual earnings were rising or falling by 3.8% for every percent change

in annual real GDP growth. In the past 10 years if was 22%...

Furthermore the quality of those earnings has decreased dramatically (Chart 2). Dont be

oo e


Source: J. Hussman


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US Tangible Assets toTotal AssetsChart 3

This has been aggravated by a substantial

deterioration of assets where:

Chart 4Europe Tangible Assets

to Total Assets

1. intangibles have dramatically gained in

importance in some regions (Charts 3-6) (ask a

bondholder of a bankrupt high intangibles

company what intangibles are worth...),.

o man ac s as ca cu ate t at t e

500 constituents asset/equity ex-goodwill has

risen from 2.5 in the 80s to 4.4 today.

2. Financial asset have proportionally increased.

3. Assets' mark to market which increase their

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In brief, as often repeated in the past, we think

market should be valued at lower levels, not

higher levels than historically.

Japan Tangible Assets toTotal AssetsChart 5 Chart 6

Emerging Markets TangibleAssets to Total Assets

Source: Bloomberg, ClueSource: Bloomberg, Clue

This is thus not surprising that AAA and AA

bonds represented almost 60% of the Barclays

Capital Investment Grade Index at the end of

the 70s while they only represent 25% today.


,,


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5Equities: Valuations A Repeat

Investors attach a lots of importance to what happen to earnings on the very short term

while they have a very ne li ible influence on the intrinsic value of the markets. Indeed even

S&P 500 and Middle to Young

CohortChart 7

if earnings were to be 0 in the next 2 years, this would not affect by more than a few percentage

points the intrinsic market value derived by a dividends or cash flows discount model.

Remember that markets are a claim on a very long-term stream of cash flows.

What moves market valuation around fair value in the short-term is investors risk appetite.

This is what we analyze extensively in the sentiment, breadth, liquidity, seasonality and cycle

section of our presentations.

In the long-term, we believe that the main driver of long-term generational fluctuation in

valuation ratios from very undervalued to very overvalued, is the reallocation of the stock of

wealth (as demonstrated by J. Tobin more than 40 years ago). One can see this phenomenon in

action looking at the Saver/Spender ratio or Middle to Young cohort (Chart 7).

This is the ratio of the population aged 40-49 years to 20-29 years (we will show graphs for other

markets later). For the US we think the time for the next structural bull market to start will be the

Source: Census Bureau, Clue6

low made between 2014-2016 (with a preference for 2014).

As we have been saying in the past 10 years, this does not mean that there wont be cyclical bull

markets to take advantage from in between.

In the past we have showed that during structural bull markets the market rises around 85%

of the time while in structural bear market it rises approximately 65% of the time



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6Equities: ValuationsFor longer-term return projections (7 years), we use a methodology similar to Grantham, Mayo,

Van Otterlo & Co so lets use their graphs (Chart 8 and 9) showing their estimated 7 yearsforward performance for the various categories if they trade at the average valuation normalized

to average margin in 7 years .

ears

Return ForecastChart 8

November 2009

Another indicator we look at is the Value Line Median Appreciation Potential (VLMAP) which P.

Bernstein used in his valuation estimation of the market. It is the median price appreciation

potential estimated by Value Line of the all of the 1700 stocks they cover for the following 3 to 5

years. It fell below 50% which is at the bottom end of its history One should startaccumulating stocks when it rises above 100%...

High quality stocks expected return has declined by 2/3% to 8.9%. This is where we still

would be greatly overweight (and as an aside valuation our macro scenario favor "bunker-

like" balance sheets).Source: Grantham, Mayo, Van Otterlo & Co

As we will show in the next few pages, we think there is a non-negligible risk (it is a risk

identified and not a prediction) that the markets will make THE bottom at levels up to50% below where the markets are now.

In 2000 we said that the S&P 500 would fall below 500 before the next structural bull market

Chart 9 February 2010

could start, we still believe that this is a potential outcome (but we would add 5-6% a year to this

objective going forward (would be a combination of extension and time to determine the final low

target I.e. the longer it takes the lower the required decline)

But we also know that timing the exact bottom is impossible so we will automatically increase

our recommended allocation on declines once we fall below 700-750 on the S&P 500 and we

see breadth extremes without regard to the trend. The allocation will be increase along

price declines exactly as we did in March 2009.

One need a plan to stick to in such environment and this is ours . We will also limit the extent


to which we take net short positions the closer we are to what we consider rock bottom

valuations.


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US PBChart 10We understand that in a service economy tangibleassets are not as important as when manufacturing

dominated (see the proportion of tangible assets in

emerging economies on Chart 6), but once more,

Chart 11 US Median Vs Mean PE

ask yourself what intangibles are worth in a

bankruptcy

On the various charts the semi-transparentarea represent time when the market was

cheaper than today on a book value basis.

The US are slightly expensive (remember that the

period 1996-2008 was a bubble so you wont see

the US at 3 times book value in your lifetime). On

a normalized PE basis the US are as expensive as

during all previous secular tops (once more exceptthe 1996-2008 episode)

On chart 11 one can see that both mean and

Europe PBChart 12 Chart 13 Global Tobin Q (MedianEV/Total Assets)


median PE are high. If the trend continue, do not

expect value factor to offer safety in the next

downturn (in 2000 we were bearish on the market

but bullish on value stocks as the median PE wasrelatively low after having hit an overvalued level

in 1998, in 2007 we repeatedly said that all the

market was overvalued history is starting to

repeat here)

Europe is slightly cheaper than the US but this is

Source: ML


justified. ,


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Japanese Small Caps PBChart 14All in all we would estimate the US and Europeanmarkets to be overvalued by 30-40% with a fair

value between 750-800 (and do not forget that we

will undershoot). Seems outrageous to many but

Chart 15 Asia ex Japan PB

we feel comfortable (and in good companyJ.

Grantham, A. Smithers, J. Hussman,)

Japan is cheap

Japanese small caps are extremely cheap

Japan remains undervalued and as said, the low

historical ROE should be seen as a potential to

mean revert to other countries standard now that

Japan is slowly, but surely, becoming more

shareholder friendly.

Emerging markets are getting increasingly

expensive here They are profiting most from the

Latin America PBChart 16 Chart 17 Eastern Europe PB


excess liquidity pumped by central banks around

the world and from the cheap USD but... The USD

won't fall forever and once you reach a certain

level of valuation you are only counting on findinga bigger fool. Trend change should definitely be

acte upon from ere on...

Eastern Europe is slowly getting more expensive

and we would now be careful given the macro

background... Buy aggressively on a return to 0.5-


. . ,,


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Equities: Valuation 9US Profit/GDPChart 19Global Developed MSCI Trailing and Forecasted EPSChart 18

Source: MS

Global EPS forecast are extremely optimistic (Chart 18), expecting earnings to be more than 50% above their long-term trend by the end of2012 With margin rapidly reaching pre-2007 high in the US and elsewhere (Chart 19),.This is not going to happen

Source: BEA, Clue6

Looking on a regional basis, we still feel the US will outperform having profited from the downturn to rationalize The % workforce decline

has been much higher than the decline in GDP while this wasn't the case elsewhere (only 1% decline in workforce in Europe).

As an aside we will investigate in a future note how increased outsourcing could be impacting the GDP statistics, artificially increasing it for the


outsourcer so maybe the workforce did not decline more than GDP in the US, ceteris paribus but still better than others)


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Equities: Valuation 10Hours of Work to Buy the S&P 500Chart 21US Private Compensation/GDPChart 20

Longer-term we are expecting to see a mean-reversion in the Private compensation to GDP (Chart 21) which will weight on margins whichmight stay lower for longer and not reach the 2007 and even 2000 high for quite some time if ever. Workers will ask for their fair share of

Source: Thechartstore.comSource: Bloomberg, Clue6

profits.

This should be associated with a reduction in inequalities,... And lower economic growth

On Chart 21, one can see another reason of the increase in wealth inequalityFinancial assets price have risen much more than average income


This will also mean revert (and not as a consequence of rapidly rising average income)


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Equities: Valuation US Earnings 11S&P 500 as Reported Earnings and Margin Direction ModelChart 23US NIPA and S&P 500 Operating ProfitsChart 22

We have used the Chart 22 a couple of times in the past (2000, 2002 and 2007) to forecast a turn in the S&P 500 operating earning cycle. NIPA

profits lead by 2 to more quarters. This bodes well for at least the coming 2 quarters (at the top of the cycle accountants tries to mask the earnings

Source: Shiller, Clue6Source: BEA, Clue6

A few remarks First the big increase in the last quarters NIPA profit was mainly due to financials. Profits in the sector rebounded strongly

because of a decline in both charge offs One has also to see that the current ratio of as reported (according to GAAP) to operating earning at 14%

is the lowest in history (last low was 60% during the 2000-2002 bear market). Accountant are working overtime.


Finally our basic margin model is has recently turned negative (Chart 23) If earnings grow beyond Q2 2010 they will have to be supported bytop line growth.


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Equities: Valuation The Price has to be Right 12Emerging Markets Real GDP Vs Real

Stock Return (1988-2007)Chart 25Real GDP Growth Vs Real Stock

Return 1899-2008)Chart 24

Source: Societe GeneraleSource: Smithers & Co

Do not confound good potential secular macro growth with good investment . As W. Buffet said Price is what you pay, value is what you get.

As you can see on Chart 24, even if you knew in hindsight which countries would grow the fastest, you would not have outperformed. One has to

take into account that the 2 World War have had a significant impact (some of the less directly impacted lands have had the best performance) but

the same is true for the past 25 years in emerging markets (Chart 25)

The price you pay (in term of valuation) is determinant Countries with high expected growth are expensive to buy Only buy them on


panic


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Equities: Valuation Style 13Style PerformanceChart 27Valuation Factor DispersionChart 26

CAGR Year to Date CAGR March 2009-Today

Note: Buy to Quintile / Sell Bottom Quintile

Source: CSFB

There are many strategies one can use to time styles. One we use and have advised to use for many years, is factors dispersion. There are many

ways to calculate it On Chart 26 you can see the calculation for both Europe and the US of the value factor dispersion When dispersion is

Source: Morgan Stanley

sp ng g er, uy un stoc s we ave emonstrate n t e past t at t e est stoc s to uy a ter a ottom an t can a so e an nterme ate

bottom in an on-going bull markets) arethe stocks appearing in short screens) when dispersion is low, buy quality

The messages are: the outperformance of simply buying low PB stocks vs. high PB stocks is likely to be much below average going forward

(until dispersion increase again but dispersion could decrease further before we would short them), speculative factors are likely to underperform


un we ge e nex ou o ncreas ng spers on, we can on y repea w a we ave een recommen ng s nce as a

STOCKS with stable growth, rock solid balance sheet, steadily increasing dividends and book value per share and a moat


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Equities: Valuation US Future GDP Growth 14

Source: CBO,Clue6 Idea: J.Hussman

As said in the past, in the long run, earnings tend to grow slightly less than GDP. The above concept to estimate forward growth was first

proposed by J.Hussman. For the US real GDP to reach the CBO potential real GDP forecast in 10 years, the growth should be 2.7% which is one of

the lowest in history.

If one add that there is a non-negligible risk of deleveraging and overcapacity related deflation (if Central Banks and Government do not go all-in


where inflation might become a problem) this does not bode well for nominal growth which is what people and companies use for they

investment and consumption decisions


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15Equities: Sentiment SurveysNAAIM Survey and S&P 500Chart 29Investor Intelligence Bull/Bear RatioChart 28

Surveys are slowly but surely getting back to levels where markets have struggled in the past.

Source: NAAIM, Clue6Source: Investor Intelligence, Clue6

The Investor Intelligence bull ratio is still 10% below the January highs (Chart 28).

The NAAIM survey bullish% has risen to the mid-70s (Chart 29).

In the last AAII surve , bears have declined to 20% and bulls risen to 45% with a ver hi h 35% in correction mode The Hulbert Nasda and S&P


500 newsletter writers sentiment survey are at levels where the market has had a negative performance going forward on average since 1998


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16Equities: Sentiment SurveysTSP Survey and S&P 500Chart 31Greenwich Macro Managers Bearish%Chart 30

On Chart 30 one can see that the Macro Managers bearishness has increased recently.

Source: TSP, Clue6Source: Greenwich Alternative Investments, Clue6

The TSP Bull/Bear Survey (Chart 31) is very close to the level where it will give a sell signal (2 I.e. bulls outnumbering bears by 2 times) at above

1.9



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17Equities: Sentiment SurveysShillers Buy-On-Dips Confidence IndexChart 33Shillers Crash Confidence IndexChart 32

The crash confidence index (Chart 32) measures the percent of the population who attach little probability to a stock market crash in the next-six months.

After having reached its lowest level at the end of 2008-beginning of 2009, the index has been steadily rising since. The analysis of this index is trickyClearly, low levels occurrin after prolon ed decline are bullish, but you want the index to rise stron ly alon the markets (remember the crowd is wron

Source: R. Shiller, Clue6Source: R. Shiller, Clue6

at the end of the trend not during a trend). So the fact that it has failed to raise as much as what the recent markets performance would suggest indicates

that investors might be quick to push the sell button on a decline

But this is not confirmed, on the institutional side, by the buy-on-dips index (The percent of the population expecting a rebound the next day should the

market ever drop 3% in one day) (Chart 33)


So, maybe small declines will be bought, as they have in the past 9 months but if the selling pressure is strong enough to push the market lower, the movecould start to cascade downward.


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18Equities: Sentiment SurveysML Fund Managers Survey Percentage Net

Overweight Emerging marketsChart 35ML Fund Managers Survey Percentage

Net Overweight JapanChart 34

Source: Merrill LynchSource: Merrill Lynch

On a Country/Region basis we identified two stands out for 2010 in the Q1 presentation.

Everybody hated Japanese stocks (Chart 34) while Emerging Markets were everyones darling (Chart 35)

So far so good Japan has outperformed Emerging Markets There are now more managers overweight Japan than at anytime in the past two and

an half years but Emerging Markets are still the most loved region



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19Equities: Sentiment Put Call RatiosS&P 500 and Equity PC RatioChart 37S&P 500 and OEX PC RatioChart 36

The OEX put call ratio (Chart 36) is currently low but we have started to get some daily higher reading. Remember that one ought to get defensive

Source: Clue6Source: Clue6

.

The equity put call ratio (Chart 37) with some daily reading which have historically been followed by nasty down days is now displaying a high

level of optimism



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20Equities: Sentiment Put Call RatiosS&P 500 and Small Traders Buy to Open Put/Call RatioChart 39S&P 500 and Small Traders Option ActivityChart 38

Small traders (up to 10 contracts traded) puts buy to open activity represents 16% of their total activity which is near an historic low while their call

buy to open activity represents 39% of their transaction not far from the 40-42% extremes reached in the past

Source: OCC, Clue6Source: OCC, Clue6

If one add option sell to open activity (Chart 38), one can see that almost 60% of the volume is concentrated in bullish strategies (buy to open

calls and sell to open puts) which is near le historical highs (data from 2000)

The buy to open put call ratio is at 0.42 (Chart 39)


This is confirming the equity put call ratio status discussed in the previous page


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21Equities: Sentiment InsidersFootsie and InsidersChart 41S&P 500 and Russell 3000 InsidersChart 40

Both the number of insiders sell transactions and the sell to buy ratio are reaching historically high levels in the US (Chart 40). Be

Source: ML, Clue6Source: Bloomberg, Clue6

cautious

In the UK, the buy to sell ratio is hovering at a low level but we would like to see more sell transactions This seems to be happening in the past

two weeks


ut remem er, ns ers act v ty s espec a y use u n con gurat ons: ots o re at ve uy ng or ncrease se ng w en t e mar ets ec ne


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22Equities: Sentiment Smart MoneyS&P 500 and Leuthold Core Beta ExposureChart 43S&P 500 and Hussman Strategic Growth Beta ExposureChart 42


J. Hussman strategy here is clear. He buys small on weakness and re-hedge completely on strength. According to our calculation he is currently

fully hedged (Chart 42) and he has been out recently saying that a >20% correction is likely (but not certain) to start in the next 8-12 weeks

S. Leuthold, who has been bullish and right since early in 2009, has started to sound more cautious, at least for the short-term (Chart 43)



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23Equities: Sentiment Smart/Dumb MoneyS&P 500 and Strategists Stock AllocationChart 45Nasdaq 100 and Non-Commerical Net Long Future PositionChart 44

Non-Commercial are still net short Nasdaq Future but they have dramatically reduced their position (Chart 44) but so far so good.

Source: Bloomberg, Clue6Source: Bloomberg, Clue6

Wall Street Strategists are still recommending investors to allocate approximately 60% of their assets to stocks (Chart 45). While it remains

lower than the average of the past 12 years this would probably not be the case if a longer history was available.



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24Equities: Sentiment Dumb MoneyAnalysts US Stock Recommendations 3 Months ChangeChart 46 Topix and Percentage Analysts Sell Recommendations JapanChart 47

Analysts recommendations momentum is not very informative at the moment with both buy and sell recommendations being lower than 3 months

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

ago (Chart 46)

In Japan after a pick up in sell recommendations at the end of 2008 we are seeing continuing decrease in the momentum of buy recommendations

(Chart 47).



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25Equities: Sentiment Dumb MoneyTopix and Shares Sold on Margin Profit/Loss RatioChart 49Topix and Shares Bought on Margin Profit/Loss RatioChart 48

In Japan analysts have access to the performance of the margin buyers and sellers.


n art one can see t at w en nvestors are start ng to ma e money on t e stoc s oug t on marg n or even os ng ess t an , t e ra y s

usually very near a reversal slowly reaching this point.

The same is true on stocks sold short on margin (Chart 49) when they start to make a profit, a reversal to the upside is not very far we had a good

example in December. Losing approximately 10% now.


Margin traders are currently losing both way the winner? Brokers we guess.


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26Equities: Sentiment VolatilityS&P 500 and CFTC VIX Large Speculator Net PositionChart 51S&P 500 and Vix Time-SpreadChart 50

Our VIX Indicators are giving warning signals.


The time-spread is at levels where volatility has increased and markets have struggled to make sustained advances (Chart 50).

Non-commercials have now a small net long position indicating that they believe the VIX will rise in the near-term (Chart 51). Remember that they

are the smart-money here (but note that they were dead wrong with their highest net long position in December so)



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Equities: Sentiment 27

ource: ue

Our composite sentiment indicator is currently spiking higher at levels where market shave struggled even in cyclical bull markets.

It is time for at least a pause even bulls need to breathe



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E i i


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29Equities: BreadthS&P 500 and Selling PressureChart 53S&P 1500 and its AD LineChart 52

The breadth indicators are mixed even if the majority of indicators remains supportive for a continuation of the current cyclical bull market and thus

a buy the dips strategy


The S&P 1500 Composite Index cumulative advance decline line is displaying a lot of strength, having made new cyclical highs ahead of the

markets (Chart 52). The AD line momentum is also very high and it indicates either the beginning of a new dynamic move to the upside or a

potential medium-term top. The cyclical up move being more than a year old we would vote for the later


ur se ng ressure n ca or as sp e g e r recen y ar . sua y w en s a ove . an e mar e s ma ng new wee s g , a

cycle trend is aheadThis was the case in 1962, 1968, 1972 and 2007

E i i


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30Equities: BreadthLowrys 90% DaysChart 55Nasdaq 100 and the New High New Low ModelChart 54

The Nasdaq New High-Low Model is on buy (Chart 54). Note that we are not seeing the same strength as the one we say after the 2003 bottom.


The recent spike is due to the timing of the bottom in 2009 approximately 52 weeks ago.

We have documented the rapid increase in breadth volatility in the past few years and the same is true for Lowrys 90% days (to have an 90%

up days, >90% of the volume should be in rising stocks, >90% of the issues should be rising and >90% of the points moves should be made by rising

stocks). While the recent bottom was followed by two 90% up days, we are not seeing the same strength as in March and July 2009 (Chart 55) but


it is etter t an none.

E iti


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31Equities: BreadthMSCI Asia Ex Japan and Normalized Advance-Decline RatioChart 57Topix and Normalized Advance-Decline RatioChart 56

Our Ja anese normalized advance-decline ratio moved to an extreme oversold level


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32Equities: BreadthS&P Emer in BMI and Com onents above theirS&P 1500 and Com onents above their

10 and 50 Days Moving AverageChart 59

10 and 50 Days Moving AverageChart 58

-


This indicates that at least a short-term correction/consolidation is in the offspring


E iti d h


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33Equities: BreadthS&P 500 and Hindenburg OmensChart 61S&P500 and Fosback High Low IndexChart 60

In the past we have used the following 2 studies to warn of impeding cyclical trend change.


On chart 60, one can see that the Fosback High Low Index remains very low, indicating a lack of distribution. We are now moving away from the

1 year anniversary of the Marc 2009 bottom and the behavior of the indicator will be very informative in the weeks/months to come

As for the Hindenburg Omen none has been triggered since the 2007 peak on the major indices (Chart 61)


Equities: Li idi


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34Equities: LiquidityFlows to Emerging Markets Mutual Funds and Future

Relative performanceChart 63Equity mutual fund assets and net cashChart 62

Source: Nomura

Net inflows into equity mutual flows have been positive in January (January is usually strong) and so far in March (Chart 62). Inflows are

Source: ICI, Clue6

needed to give some buying power to manager given the cash/asset level (see next page)

Inflows into emerging market funds have been extremely high and have historically been followed by a substantial underperformance of

Emerging markets (Chart 63)


35Equities: Li idit


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35Equities: LiquidityEuropean Mutual Funds Asset AllocationChart 65US Mutual Funds Asset AllocationChart 64

ource: ource:

. .

in January and then some more They are now fully invested and are dependent on public inflows to buy more stocks

On an overall allocation basis (Chart 64-65) money markets are seeing large outflows.


36Equities: Li idit


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36Equities: LiquidityNumber of Buybacks Announced per Month in JapanChart 67Number of Buybacks Announced per Month in the USChart 66

Buybacks have picked up modestly in the US in the past 4-5 months but remains at depressed level (Chart 66) It was encouraging to see the

number of buybacks announcement to rise to around 100 a month in January (with a big increase a the end of the month) and February (at the


.

In Japan, we have seen a slightly more robust pick up (Chart 67), especially during the most recent correction but we would like to see more to be

convinced that management is more confident on their company prospect and more interested in the well-being of their shareholders

-


, , -

management (insiders)is selling their own shares and in Japan we would prefer to see stocks bought back than new unproductive capital

expenditures.

37Equities: Liquidity


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37Equities: LiquidityChina + Hong Kong IPOs and Secondaries (US mio.)Chart 69US IPOs and Secondaries (US mio.)Chart 68

We are seeing a pick up in IPOs in the US after many month of drought (Chart 68). No excess here


In China and Hong Kong, management are taking advantage of the current rebound to flood the markets with new shares (Chart 69)

Remember that management sell stocks mainly for 2 reasons. First when they have to in order for the company to survive (what happened in the US

during the first 4 months of 2009) or when they would be stupid not to (like Blackstone in July 2007, China and Hong Kong at the end of 2007 and


, ,



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38Equities: LiquidityHedge Fund Ownership of US EquitiesChart 71US Hedge Fund Net Long ExposureChart 70

Source: Goldman Sachs Source: Goldman Sachs

. .

Another reason why it will be very difficult for long-only manager, even skilled one, to avoid a lots of pain when the cycle finally turns




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39Equities: LiquidityShort Interest as a Percent of FloatChart 73Foreigners US Equity Net BuyingChart 72

Foreigners like to bash the US but they have an incredible propensity to buy US equities near cyclical tops (Chart 72).

Source: Goldman Sachs Source: Goldman Sachs

With regard to short interest, we have long said that while large cap shorts tend to be dumb money on aggregate, small caps short tends to be

better informed The spreads between small and large cap short interest as a percentage of float is rising again (Chart 73)

The NYSE margin debt has now exceeded the 2000 levels on a % of market cap basis.




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40Equities: LiquidityJapanese Middle to Young Cohort and Equity Funds

AssetsChart 75US Middle to Young Cohort and Equity Funds AssetsChart 74

The above 2 graphs are well-known for those who have been reading our research for a long-time.

Source: ICI, Census Bureau, Clue6 Source: BOJ, Japanese National Institute of Population and Social Security Research, Clue6

We believe that the long-term flows into and out of assets (the relative buying/selling urgency to be more precise as they are no money getting in or

out of the market for each buyer there is a seller and vice-versa) have a demographic cause It affects the assets relative value and can be best

seen on the secular trends in normalized valuation ratios.

In the US, one should not be surprised by the net outflows from equities into bonds, this is what should happen (Chart 74) while in Japan we should


see t e reverse (C art 75)



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41Equities: LiquidityMiddle Age Population Growth ForecastChart 77Chart 76

the Next 5 Years

On chart 76 you can see the countries which have the most positive demographic dynamic according to the Middle to Young Cohort hypothesis

Source: Census Bureau, Clue6 Source: Census Bureau, Clue6

But should not only the Middle to Young Cohort but the absolute growth of the middle age population (Chart 77).

Combining both, one see that the picture is somewhat less bullish than it seems for Japan, Spain, Poland, Portugal and Greece




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42Equities: LiquidityMiddle Age Population Growth ForecastChart 79Chart 78

the Next 5 Years

On chart 78 one can see the countries with the most bearish demographic configuration according to the Middle to Young Cohort hypothesis

Source: Census Bureau, Clue6 Source: Census Bureau, Clue6

The middle age dynamic of those countries is presented on Chart 79




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43Equities: LiquidityLabor Force Growth (15-64 years)Chart 80

Source: NewGeography.com, Joel Kotkin

One has to keep in mind that, ceteris paribus, US growth is likely to surprise to the upside relative to its main competitors (Chart 80) Emerging

market capital increase will probably more than compensate the labor factor decline but not in Europe, Japan or even South Korea




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q q yUS Pension Assets Sensitivity to Markets

Movements (as a % of ttm Earnings)Chart 82Towers Watson US Pension IndexChart 81

hange)

StocksPrice(%

US Pension Liabilities Sensitivity to theChart 83

Bonds Yields (Bps Change)

Source: Bloomber , Clue6

Discount Rates(Bps Change)

Pension, both private and public, are an accident waiting to happen

ource: owers atson

In the US, listed corporate programs are underfunded by almost 30% (Chart 81). This represents more than US bn. 300 or almost 60% of ttm net

earnings.

On the chart 82 and 83 you will find rough estimates of the impact on markets movement on the assets and liability side The 2008-2009 carnage


. .



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q q yPension Funds Funded RatioChart 86Pension Funds Investment ReturnsChart 84

Pension Funds Liability GrowthChart 85

And here is the situation in some other countries

Source: Towers Watson Source: Towers Watson

And lets not forget the poor state of many public pension schemes Future retirees will not get what they were promised when they will

realize, they will see that they have massively under saved (and we would say that the situation is dearest in many European countries). This will

serve as a wake up call for younger generations.




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q q y

Liquidity momentum has a slight tendency to lead markets, and this should be especially true given in the current environment

M2 momentum is supportive when using a 8 weeks rate of change but on a year on year basis the picture does not look good




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q

Emerging markets foreign reserve holding have been increasing much more rapidly than what the US current account deficit would have implied

This means that massive short USD position are being build through the speculative inflows

This is OK as long as the momentum remains but when it turns


Momentum seems to be abating now watch out

Equities: Seasonality President Cycle and Monthly Seasonality 48


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q

Return since 1927)Chart 87 US Monthly Return (S&P 500 Total Return since 1944)Chart 88

The four ear Presidential c cle Chart 87 has been distorted b the hu e fiscal and monetar stimuli of last ear. The rational behind the

Source: Clue6 Source: Clue6

presidential cycle theory is that public money is spend to optimize the chance of the incumbent (s) to be reelected and that is followed by some pay

back for the market.

The market has a tendency to perform well in April (Chart 88).


Equities: Seasonality Sell in May and 49


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Average Return MSCI Indices 1970-1998Chart 89 Average Return MSCI EM Indices 1970-1998Chart 90

Source: The Halloween Indicator, S. BoumanSource: The Halloween Indicator, S. Bouman

We are now in the positive half of the year (Chart 89 and 90) and our sell in may seasonal quant models (where the switch is not based solely on

a date but we want a technical confirmation during a given time-window) are also on buy.


Equities: Seasonality End of Month Anomaly 50


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US Day of the Month (S&P 500 Total Return since 1944Chart 91 Japan Day of the Month (Topix Total Return since 1979Chart 92

The day of the month continue to exhibit its historical pattern in the


-

showed previously).

In the US the first day of the month remains the stand-out winner

while in Japan, the 8 positive days continue to display an outstanding


.

Source: Macquarie

Equities: Seasonality Cycles 51


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NYSE Composite and the 20 and 40 Weeks CyclesChart 93 Super Cycle Economic SeasonsChart 94

The next 20 and weeks cycles low are expected for the middle of June with the next 20 weeks cycle low in October (Chart 93).

Source: Clue6 Source: Bronson Capital Market Research

, . , .

analysts have tried to define this cycle by applying a fixed number of years but, as we have long said, we think that this is more of a generational cycle of

leveraging and deleveraging (was visible on price up to the creation of the Fed and on money velocity since then). People who were young in the 30swere allergic to borrowing during all their life, organizing parties to celebrate their final mortgage payment The same is slowly happening now in the

developed world (it will likely accelerate in the coming years when the weak foundation of the current upswing will become clear to all)


The Autumn Season is the harbor of the biggest bubbles (1929 and 2007), stocks valuation are rising while interest rates falls from a high level. What

could we ask for more It is followed by the Winter where interest rates and stocks valuations become highly correlated, both falling

52Equities: Intermarket


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S&P 500 and US Defensive Relative PerformanceChart 96S&P 500 and World Defensive Relative PerformanceChart 95

Defensives have been performing relatively well in the past 6 months globally (Chart 95) while they have failed to break to the upside in the


US yet (Chart 96)

We are in a situation where we would overweight defensive when they get in the lower part of their relative performance channel so now is the

time in the US


53Equities: Intermarket5 d hil d l hi i d


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S&P 500 and Philadel hia Semiconductor

Index Relative PerformanceChart 98S&P 500 and Nasdaq Composite Relative PerformanceChart 97


The Nasdaq Composite is continuing to outperform the S&P 500 (Chart 97) which is supportive for the overall market

but the Philadelphia Semiconductor index is not (Chart 98) which is a negative for the overall market in general and the Nasdaq Composite in

particular


54Equities: IntermarketS&P 500 d h KBW B k I d S&P 500 d iSh iB Hi h Yi ld


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S&P 500 and the KBW Bank Index S&P 500 and iShares iBoxx Hi h YieldChart 99

Relative Performance

Corporate Bond Fund Net Asset ValueChart 100

Banks have been performing well recently (Chart 99) but are still below their August 2009 relative peak. The sector relative performance will be a


key to understand how the new wave of mortgages reset, the end of central bank accommodation and new accounting rules will affect the rest of the

market but lets not forget that they are in the portfolio of quite a lot of the smart money managers we follow so.

High yield bonds are diverging with the equity market as they are not making new highs (Chart 100). Investment grade 5 years CDS indices

have also failed to confirm the past 10 days strength. Check those graphs daily they will lead, this time again.


55Equities: Intermarket


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Chart 101 S&P 500 and US 2 Years Treasury Bonds S&P 500 and Eurodollar ModelChart 102

Two years treasuries above 1% have been associated with struggling market in the past 18 months (Chart 101). This wont last but spike-like

movement have always been a warning worth listening to


We also like to look at the relative behavior of the equity markets and the Eurodollar future. On chart 102 you can see what happen to the market

when the eurodollar falls (higher rate expected) 2 days in a row and the market falls at the same time We had an episode mid October Another

one could mark an peak of significance

One of our most effective intermarket consolidation forecaster which sim l looks at the combined medium-term momentum of bonds and


commodities is also flashing a warning signal

Equities: Intermarket US10 Years Govies against Stocks 56


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S&P 500 and US 10 Years Treasury BondsChart 104Chart 103 S&P 500 and US 10 Years Treasury Bonds

Blue area indicates when the momentum

in 10 years government bond yield is

positive. In this period, stocks performed

when the momentum was negative.

Blue area indicates when the momentum

in 10 years government bond yield is

. ,

when the momentum was positive.

We have long argued that one the characteristics of the current structural bear market (and we are talking US, Europe and Japan here...) was


.

But one has also to take into account the fact that while they are positively correlated, when yields have risen too much too quickly the stocks will

struggle. The sequence is usually rising rate, acceleration to the upside, yield starting to fall just before stocks do it to


Equities: Intermarket 57


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Chart 105 MSCI Emerging Markets and Dollar Index S&P 500 and Sovereign CDSChart 106

We already identified potential headwinds for emerging markets (valuation, investors bullishness,)

Source: Clue6 Source: Bloomberg, Clue6

Dont forget to look at the USD A rising USD has rarely been a positive for emerging markets (Chart 105).

2010 or 2011 could be years of major sovereign negative surprises on the next page one will find the countries to have especially an eye on

On Chart 106 you will find the usual suspects We could have put the UK , Poland, Austria in the mix and we feel Australia will join this


group in the next 12-24 months.

Equities: Intermarket 58


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Source: RBS

Canaries in the coal mine candidates To observe attentively in the coming months

Candidates have been selected using the methodology ofRules of Thumb' for Sovereign Debt Crises by P. Manasse and N. Roubini, 2005


59Equities: PatternS&P 500 Deviation from 50 S&P 500 Deviation from 50 Da s

Ch 107


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Chart 107 Days Moving Average Moving AverageChart 108

We are now in an environment where the S&P 500 will struggle to stay 4-5% above its 50 days moving average (Chart 107 and 108)


A move above this threshold will likely be followed by a close more than 4% below the moving average later

So do not accept any deterioration in other factors when the market is over-extended


60Equities: GraphsS&P 500


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S&P 500

We are short US stocks

(using the Russell 2000).

Shoulder

Head

Shoulder

ShoulderWe will start to cover below

1100.

A short position would be

Head

pro a y reentere on a c ose

below 1040.

The S&P 500 is slowly but surely approaching to the top of its rising channel after having broken out of the down channel formed

during 2008. The trend is up.

The inversed head & shoulders and June-July flag targets are still above us at 1200-1250.


A series of narrow range day has usually been a warning of an impending correction in the past 12 month. So be on the look out.

61Equities: GraphsDJ Euro Stoxx 50


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DJ Euro Stoxx 50

Megaphone

Top

Head

ShoulderShoulder

ShoulderShoulder

.

We will increase ourposition on a move to

3000.

Head

Europe has continued to underperform as expected and has yet to make new cyclical highs. The head & shoulders target is at around 3300.

We would continue our strategy of selling strength (top of channel) and buying weakness (bottom of channel) until our tactical model becomes a

seller


reaching the top of the channel

62Equities: GraphsTopix


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Topix

ShoulderHead Shoulder

We are observing.

We will buy on weakness as

Shoulder Shoulder

Head

directional models is on buy.

We will start to buy

methodically on weakness

below 800 independently on

the directional models.

The Topix has broken out of its down trend with determination. But has yet to make a higher high to confirm an eventual up trend.

The 975-1000 area is likely to offer strong resistance.


63Equities: GraphsMSCI Asia ex-Japan


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MSCI Asia ex Japan

Megaphone

Top

We are short and would

increase our position on a

move toward 450.

Likely to cover some short

below 390.

A move below 330 would

signify the beginning of a

cyclical bear market.

Could be forming a megaphone top or an head & shoulder.

Short aggressively if the index move toward 450.


64Equities: GraphsMSCI EM Latin America


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Megaphone

Top

We are short and would

increase our position on a

move toward 4500.

Likely to cover some short

below 3600.

A move below 3500 would

signify the beginning of a

cyclical bear market.

Has been underperforming markedly in the past few days.


65Equities: GraphsMSCI Eastern Europe


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We are short.

Will cover on a move

above 235 and increaseon a move below 190.

Eastern Europe still remains one of the least discounted "unavoidable accident" in the market today (it is was mostly discounted in

the Eastern European markets last year but the second round effects toward other part of the world are not The stronger IMF has

voided the "end of their world" scenario, but)


things in the Czech Republic for example


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67Equities: Conclusion


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reminiscent level in Hong Kong and China. On the monetary front, real M2 and M1 growth is turning negative in the US and decelerating

markedly elsewhere. Emerging markets central banks reserve growth has been slowing rapidly which is a headwind for risky assets.

Pension funds funding status has stabilized but imagine the what will happen if equity price falls while high quality corporate bonds yields

(used to discount liabilities to present value) do not rise as they did in 2008-2009.

Seasonals are still supportive but we are slowly entering into the time window where our seasonal model can trigger a sell signal if markets trend

deteriorates. The next cycle low are expected in June and October. We will have to see if the markets top before or after the middle of the cycle

(right or lest translation). If it tops early in the cycle this would be a clear sign of cyclical topping process.

Intermarket relationships have deteriorated. While the Nasdaq is continuing to make relative highs along the Russell 2000 and equal-weighted

indices, semiconductors stocks are underperforming as are many emerging markets and Europe. On the credit side, neither high yield nor

high quality corporate bonds have confirmed the recent markets highs. Finally, the combined momentum of crude oil, copper, gold and the 10

years treasury yield is at levels where the equity markets have struggled in the past.

The trends have deteriorated since the January top. The US markets are one of the few making new highs but are now sitting at the top of their

respective rising channels. We are seeing a multitude of potential megaphone tops being formed, but the short-term trend remains up as long asmarkets remain in the up channels they have formed since the February low.


Documents

Second Quarter 2010 GTAA Equities