First Quarter 2010 GTAA Equities

Global
Gl b l Tactical
T ti l
A t Allocation
Asset All ti
GTAA
Equities
First Quarter
January 9th , 2010
Damien Cleusix
d i @ l 6
damien@clue6.com
Clue6 First Quarter 2010

Executive Summary 1
Stocks
Valuations are now above levels where p performance g goingg forward will not pplease the buyy & hold crowd,, even if we g go
back to the good old days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200
on the S&P 500 will be priced more expensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of
the 1929 move... This does not imply that the market will fall in the short or even the medium term but that a further rise
will only have speculative and no investment merit if bought. 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 you know we believe that we are in a
secular bull market in emerging markets). This currently implies a sub-530 level on the S&P 500 going up by 5-6% a year.
Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in
the past.
past But even if sentiment is once again too greedy,
greedy it has to be put in the context of the recent advance and market
trend (higher highs and higher lows). This does not imply that the market can not continue to rise in the medium-term but more
that it should at least consolidate in the short-term. Small investors optimism has finally started to rise and is now deep in
overconfident territory…
Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...
On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging market
equity fund. This has historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks
b they
but h remain i very low
l while
hil IPO’s and d Secondaries
d i have
h b
been plentiful
l if l with
i h bubble
b bbl reminiscent
i i l l in
level i Hong Kong andd
China…Monetary aggregate momentum is turning down and this could prove to offer some headwind to risk assets…
Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of
liabilities
liabilities.

Executive Summary 2
Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month
in January, especially after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near
future…
Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative
good performance of defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good.
W are more worried
We i d about
b t the
th medium-term
di t momentum
t off bonds
b d and d commodities
diti which
hi h is
i in
i a configuration
fi ti where
h equity
it
market productivity has been poor historically…Sovereign CDS will continue to need your attention…
The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of
the channel expected before a potential resumption of the up move but the rest of the analysis points out to something
potentially bigger than the correction we had since March…

Equities: Valuations – A Repeat 3
Valuations
V l ti are nott useful
f l for
f short-term
h tt market
k t projections
j ti b t are essential
but ti l in
i forecasting
f ti
long-term returns. They become informative in the shorter term when they reach extremes.
When they are very high one should not allow the other indicators in one’s arsenal to deteriorate Chart 1 US Earnings Volatility
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.
at We
look at normalized price to earning ratios (normalized using an trailing reported earnings moving
average, average margins or peak earnings) 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 Greenspan
A. Greenspan’ss “Paradox
Paradox of Credibility
Credibility” or H.H Minsky
Minsky’ss “Unstable
Unstable Stability
Stability” . In the S
Source: R. Shill
Shiller, Clue6
Cl 6
process earnings volatility has increased rapidly in the past 10 years (Chart 1). From the mid
50’s to the mid 80’s, real annual earnings were rising or falling by 3.8% for every percent change Table 1 Tangible Book Value
in annual real GDP growth. In the past 10 years if was 22%...
This has been aggravated by a substantial deterioration of the assets where:
1. intangibles have become legion in some countries (Table 1) (ask a bondholder of a bankrupt
high intangibles company what intangibles are worth...),. Goldman Sachs has calculated that
the S&P 500 constituents asset/equity ex-goodwill has risen from 2.5 in the 80s to 4.4 today.
2 Financial asset have proportionally increased.
2. increased
3. Assets' mark to market which increase their pro-cyclicality. Source: Bloomberg, Clue6
In brief, as often repeated in the past, we think market should be valued at lower levels, not
higher levels than historically.
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.

Equities: Valuations – A Repeat 4
Investors attach a lots of importance to what happen to earnings on the very short term
S&P 500 and Middle to Young
while they have a very negligible influence on the intrinsic value of the markets. Indeed even Chart 2 Cohort
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
i looking
l ki at theh Saver/Spender
S /S d ratio i or Middle
iddl to Young cohort
h (Chart
(Ch 2). 2)
Source: Census Bureau, Clue6
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
low made between 2014-2016 (with a preference for 2014).
As we have said in the past 10 years, this does not mean that there won’t be cyclical bull markets
in between.
In the past we have showed that during structural bull markets the market rises around 85%
off the
th time
ti while
hil in
i structural
t t l bear
b market
k t it rises
i approximately
i t l 65% off the
th time…
ti
So where do we stand now…

Equities: Valuations 5
GMO 7 Years
For longer-term return projections (7 years), we use a methodology similar to Grantham, Mayo, Chart 3 Return Forecast
Van Otterlo & Co so let’s use their graphs (Chart 3 and 4). What is the performance of the August 2009
various categories if in 7 years they trade at the average valuation normalized to average margin.
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 60% which is at the bottom end of its history… One should start
accumulating stocks when it rises above 100%...
High quality stocks expected return has declined by more than 2% to 9.6%. 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 market will make “THE” bottom at levels up to
50% below where the markets are now.
Chart 4 November 2009
In 2000 we said that the S&P 500 would fall below 500 before the next structural bull market
starts, we still believe that this is a potential outcome (but we would add 5-6% a year to this
objective
bj i going i forward
f d (would
( ld be
b a combination
bi i off extension
i andd time
i f the
for h correction
i I.E the
h
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
b dth extremes
t without
ith t regard
d to
t the
th trend.
t d TheTh allocation
ll ti will ill be
b increase
i along
l
price declines exactly as we did in March this year.
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.
l ti

We have shown that the concept of book value has

changed in the last 15 years (Table 1 earlier). Chart 5 US PB Chart 6 Europe PB
This is especially true for the US and Europe.
In 2007, in our effort to convince clients of the

overvaluation of the market, we presented data
demonstrating that balance sheets had
experienced a radical mutation in the past 25
years. Not
N only l did we see a decline
d li off the
h
importance of the tangible assets, those were now
dominated by financial assets whose pro-
cyclicality was masking the potential problems
and over-leveraging.
S
Source: Bloomberg,
l b Clue6
Cl 6 S
Source: Bloomberg,
l b Clue6
Cl 6
We understand that in a service economy tangible
Chart 7 Japan PB Chart 8 Japan Small Caps PB
assets are not as important as when manufacturing
dominated (see the proportion of tangible assets in
emerging economies on table 3), but once more,
ask
k yourselflf what
h t intangibles
i t ibl are worth th in
i a
bankruptcy…
On the various charts the semi-transparent

area represent time when the market was
cheaper than today on a book value per share
basis.
A cursory look at the graphs confirm that

valuations are not as attractive as they were just 6
months ago…
ago Source: Bloomberg,
Bloomberg Clue6 Source: Bloomberg,
Bloomberg Clue6

Chart 9 Asia ex Japan PB Chart 10 Latin America PB

The picture is less flattening if one looks at price to
normalized earnings or price to replacement value
(Tobin Q)
All in all we would estimate the US and European

markets to be overvalued by 30-40% with a fair
value between 750-800 (and do not forget that we
will undershoot).
undershoot) Seems outrageous to many but we
feel comfortable (and in good company…J.
Grantham, A. Smithers, J. Hussman,…)
Japan remains undervalued and as said, the low

historical ROE should be seen as a potential to S
Source: Bloomberg,
l b Clue6
Cl 6 S
Source: Bloomberg,
l b Clue6
Cl 6
mean revert to other countries standard now that Japan is slowly, but surely, becoming more Chart 11 Eastern Europe PB
shareholder friendly.
Emerging markets are getting increasingly expensive here...They

here They are profiting most from the
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 finding a
bigger fool. Trend change should definitely be acted upon from here on...
Eastern Europe is slowly getting more expensive and we would now be careful given the macro
background... Buy aggressively on a return to 0.5-0.6 PB.
Source: Bloomberg,
Bloomberg Clue6

Equities: Valuation 8
Chart 12 USA and Europe Return on Equity S&P 500 Selling
Selling, General and
Chart 13
Administrative Expenses YoY
Source: Morgan Stanley Source: Goldman Sachs
Return on Equity is probably near a bottom in the US and there is still some work to be done in Europe which tends to lag by 12-18 months, as do
earnings
g ((Chart 12).
) Return on equity
q y analysts
y pprojection
j which we qqualified as overoptimistic
p earlier might
g come to ppass for 2010 ((well the one
they add a couple of months ago not the current ones.
At least US companies have been firing a lot of workers. The decline in nonfarm payrolls at more than 5% surpasses the decline in GDP... In
Europe we have only seen 1% decline...
The consequence has been that the annualized Q2/Q3 growth of the business sector GDP has been 1% while profit have increased by 46% (thanks
to financials which represents again more than 35% of total profits…)

Equities: Valuation 9
Chart 14 US Profit/GDP Chart 15 US Private Compensation/GDP
Source: Bloomberg, Clue6 Source: BEA, Clue6
The reliance of margins in the US has been in good part due to the foreign profits margin (Chart 14) (more on this later) … Note also that the
effective tax rate was 22% (it was 30% in 2007…)
2007 )
Longer-term we are expecting to see a mean-reversion in the Private compensation to GDP (Chart 15) which will weight on margins which might
stay lower for longer and not reach the 2007 and even 2000 high for quite some time. This should be associated by a reduction in inequalities,...
But more on this very important and under discussed problematic later in 2010…

Equities: Valuation – US Earnings 10
Chart 16 US NIPA and S&P 500 Operating Profits Chart 17 S&P 500 as Reported Earings and Margin Direction Model
Source: Clue6 Source: Clue6
We have used the Chart 16 a couple of times in the past (2000, 2002 and 2007) to forecast a turn in the S&P 500 operating earning cycle. NIPA
Profit leads byy 2 to more qquarters. This bodes well for at least the comingg 2 qquarters ((at the topp of the cycle
y accountants tries to mask the earningg
deterioration while at bottoms they do the reverse…)
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 hard… Finally our basic margin model is
has recently turned negative… If earnings grow beyond Q2 2010 it will have to be supported by top line growth.

Equities: Valuation – Style 11
Chart 18 Valuation Factor Dispersion Table 2 Speculative vs. Defensive
Source: Morgan Stanley Source: Zeelotes
There are many analysis 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 18 you can see the calculation for both Europe and the US of the value factor dispersion… When dispersion is spiking
hi h buy
higher, b junk
j k stocks
t k (we
( have
h d
demonstrated
t t d in
i the
th pastt that
th t the
th best
b t stocks
t k tot buy
b after
ft a bottom
b tt ( d it can also
(and l beb an intermediate
i t di t bottom
b tt i an
in
on-going bull markets) were the stocks appearing in short screens) when it 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
until we get the next bout of increasing dispersion,
dispersion BUY QUALITY STOCKS with stable growth, growth rock solid balance sheet,
sheet steadily increasing
dividends and book value per share and a moat…

Equities: Valuation – US Future GDP Growth 12
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

g g risk of deleveraging
g g and overcapacity
p y related deflation ((if Central Banks and Government do not ggo 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…

Equities: Sentiment – Surveys 13
Chart 19 Investor Intelligence Bull/Bear Ratio Chart 20 NAAIM Survey and S&P 500
Source: Investor Intelligence, Clue6 Source: NAAIM, Clue6
For the first time in a while, almost all of the Surveys we follow are indicating a very high level of confidence that the market will continue to rise…
On Chart 19 one can see the the Investor Intelligence Bull ratio which has recently reached its highest level in many, many years (with the Bearish
percentage at its lowest level since 1987, and thus 3 weeks in a row now…) The same configuration is starting to emerge when looking at the
American Association of Individual Investors survey with the bearish percentage at 23% (but it went below 10 a couple of times in the past)…
The National
Th N ti l Association
A i ti off Active
A ti Investment
I t t Managers
M allocation
ll ti survey (Chart
(Ch t 20) is
i also
l nott fare
f away from
f pastt highs
hi h during
d i the
th pastt 8
weeks… Markets have tended to struggle after such a long stretch of bullishness…

Chart 21 Greenwich Macro Managers Bearish% Chart 22 TSP Survey and S&P 500
Source: Greenwich Alternative Investments, Clue6 Source: TSP, Clue6
On Chart 21 one can see that the Macro Managers bearishness has abated but remains relatively highs (and we would not use it as a contrarian signal
at this
hi juncture)
j )
Finally the TSP Bull/Bear Survey (Chart 22) has recently moved sharply higher and has given a sell signal according to the methodology they use…

Chart 23 ML Fund Managers Survey Percentage Chart 24 ML Fund Managers Survey Percentage Net
Net Overweight Japan Overweight Emerging markets
Source: Merrill Lynch Source: Merrill Lynch
On a Country/Region basis there are 2 stand outs…
Everybody hates Japanese stocks (Chart 23) while the sky seems to be the limit for Emerging markets (Chart 24)…
2 potential surprises for 2010? Probably but the timing will have to be right with probably 3-4 phases during the year but with the Topix beating EM
by the end of the year….

Equities: Sentiment – Put Call Ratios 16
Chart 25 S&P 500 and OEX PC Ratio Chart 26 S&P 500 and Equity PC Ratio
Looking at option activity the picture is similar…
On Chart 25 one can see that the OEX put call ratio rose above 2 4 times in the past few weeks… this is something very worrying.
At the same time the Equity put call ratio is hovering at a low level (Chart 26).
If both
b th were combined
bi d on a single
i l graph,
h one would
ld see the
th “Jaw
“J Pattern”
P tt ” we have
h di
discussed
d in
i the
th past…
t

Equities: Sentiment – Put Call Ratios 17
Chart 27 S&P 500 and Small Traders Option Activity Chart 28 S&P 500 and Small Traders Buy to Open Put/Call Ratio
Source: OCC, Clue6 Source: OCC, Clue6
In the meantime,
meantime digging further into the data,
data one can see that small traders (up to 10 contracts traded) puts buy to open activity represents less than
16% of their total activity which is near an historic high while their call buy to open activity represents 36% of their transaction… not far from the
40-42% extremes reached in the past (Chart 27 and 28)…

Equities: Sentiment – Insiders 18
Chart 29 S&P 500 and Russell 3000 Insiders Chart 30 Footsie and Insiders
Source: Bloomberg, Clue6 Source: ML, Clue6
The number of sell transactions in the US is reaching a high level (especially given the fact that at year end activity usually abate somehow…) while
b i remains
buying i low
l (Chart
(Ch 29).
29)
The same is true in the UK where the buy to sell ratio is historically low (Chart 30)…
But remember, insiders activity is especially useful in 2 configurations: lots of relative buying or increased selling when the market decline…

Chart 31 Europe Directors’ Buying (in eur mio.) (transactions Chart 32 Europe Directors’ Selling (in eur mio.) (transactions
capped at eur 1 mio.) capped at eur 1 mio.)
S
Source: D t h B
Deutsche Bankk Source: Deutsche
h Bankk
In Europe we have seen a big increase in selling during the past 8 weeks consolidation (Chart 32) while buying has remained low (Chart 31)…

Table 3 Global Insiders Activity Table 4 Global Insiders Activity
Source: Bloomberg, Clue6 Source: Bloomberg, Clue6
Looking at other markets around the world, one can see that insiders have become increasingly bearish in Hong Kong notably (Table 3-4)…
Note that the last quarterly ratios where already much higher than the very bullish (lots of insiders buying) that we witnessed at the end of 2008 and
the start of 2009…

Equities: Sentiment – Smart Money 21
Chart 33 S&P 500 and Hussman Strategic Growth Beta Exposure Chart 34 S&P 500 and Leuthold Core Beta Exposure
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
h d d andd he
hedged h has
h been
b out recentlyl saying
i that
h a >20%
20% correction
i isi likely
lik l (but
(b not certain…)
i ) to start in
i the
h next 8-12
8 12 weeks…
k
S. Leuthold, who has been bullish and right since early in 2009, has started to sound more cautious, at least for the short-term… His exposure is still
high though (Chart 34)…

Equities: Sentiment – Smart/Dumb Money 22
Chart 35 Nasdaq 100 and Non-Commerical Net Long Future Position Chart 36 S&P 500 and Strategists Stock Allocation
Non-Commercial have dramatically diminished their Nasdaq 100 futures net long positions from an all-time high to approximately 2000 contracts
(Ch 35).
(Chart 35)
Wall Street Strategists have dramatically increased their equity allocation recommendation in the past few weeks (Chart 36) and while it remains
lower than average if one look at the past 12 years history this would probably not be the case if a longer history was available…

Equities: Sentiment – Dumb Money 23
Chart 37 Analysts US Stock Recommendations 3 Months Change Chart 38 Topix and Percentage Analysts Sell Recommendations Japan
Analysts recommendation momentum is not very informative here with both buy and sell recommendations being lower than 3 months ago (Chart
37)
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 38).

Equities: Sentiment – Dumb Money 24
Chart 39 Topix and Shares Bought on Margin Profit/Loss Ratio Chart 40 Topix and Shares Sold on Margin Profit/Loss Ratio
In Japan analysts have access to the performance of the margin buyers and sellers.
On Chart
O Ch t 39 one can see that
th t when
h investors
i t are starting
t ti to t make
k money on the
th stocks
t k bought
b ht on margin
i (or
( even losing
l i less
l th 5%),
than 5%) the
th rally
ll is
i
usually very near a reversal…
The same is true on stocks sold short on margin (Chart 40)… when they start to make a profit, a reversal to the upside is not very far… we had a
good example in December…
Margin traders are currently losing both way…

Equities: Sentiment – Volatility 25
Chart 41 S&P 500 and Vix Time-Spread Chart 42 S&P 500 and CFTC VIX Large Speculator Net Position
Our VIX Indicators are giving conflicting signals…
The time-spread is at levels where market volatility has increased and markets have struggle to make sustain advances (Chart 41) while non-
commercials have an important net short position indicating that they believe the VIX will continue to decline in the near-term (Chart 42).
Remember that they are the smart-money here (but note that they were dead wrong with their highest net long position in December so…
Looking only at the VIX, the recent highs have not been confirmed by a VIX new low which is a negative while on the positive side it is still making
lower lows and lower highs… A break above 23.5 followed by a higher low would be needed to change the trend…

Equities: Breadth 26
Why breadth and volume can help us gauge the future prospective risk/reward ratio of the market. We have tried for 10 years to explain it… Well
J.Hussman explains it brilliantly… as always
“A goodd way to
t think
thi k about
b t prices
i andd trading
t di volumel i to
is t abandon
b d theth idea
id that
th t money goes in
i or out,
t andd to
t think
thi k instead
i t d about
b t the
th market
k t as
a collection of various groups. Imagine there being fundamental investors, who are interested primarily in value (buying on weakness and selling
on strength), and technical investors, who are interested primarily in trends (selling on weakness and buying on strength). These people also trade
on different horizons and base their trading on different extent of movement.
In this sort of equilibrium,

equilibrium trading volume is a measure of strong views and disagreement.
disagreement As the market turns weaker,
weaker trend-following
trend following investors
typically abandon stocks, while fundamental investors accumulate. The reverse is true on significant strength. So spikes in trading volume tend to
occur primarily at extremes relative to the target prices of fundamental investors. Volume spikes also tend to be correlated with a series of positive or
negative shocks that then abate. In contrast, dull volume is a measure of low sponsorship, strong agreement, and lack of external shocks.
Equally important is that net incipient buying from both technical and fundamental investors cannot exist,
exist so large price movements are typically
required to relieve the disequilibrium. If you've got an overvalued market which then loses technical support, the outcome can be extremely
negative, because technical investors are prompted to sell, but fundamental investors have weak sponsorship at that point, so large price declines
are required to induce the fundamental investors to absorb the supply.
In contrast,
contrast if you
you've
ve got an undervalued market where fundamental investors raise their outlook,
outlook the demand from fundamental investors is not
typically provided by technical investors (who would tend instead to buy on advances in price), so the price must increase enough to induce
fundamental investors with shorter horizons to supply the stock.
All of these dynamics have been active in the market over the past two years, but the most significant outlier has clearly been the past few months,
where volume behavior has demonstrated much weaker sponsorship than we would have expected for an advance of this size. size Normally,
Normally the volume
characteristics we've seen have been much more typical of short-squeezes and less durable advances.”
J.Hussman

Chart 43 S&P 1500 and its AD Line Chart 44 Nasdaq 100 and the New High New Low Model
After having showed sign of potential divergence in November and December, breadth is back in sync with the market…
The S&P 1500 Composite Index cumulative advance decline line has now confirmed the market recent highs (Chart 43). The divergence was due to
the poor showing of small caps stocks which have performed extremely well since mid-December. We will have to see if the rebound is simply the
traditional small caps rebound during this time of the year or is a sustainable move (breadth-wise) in the weeks to come…
The Nasdaq New High-Low Model is still on buy (Chart 44).
But one has also to keep in mind that volume remains anemic and that the up-down volume stats are not showing real buying behind the recent move
(real accumulation has been absent since October…)

Chart 45 Topix and Normalized Advance-Decline Ratio Chart 46 MSCI Asia Ex Japan and Normalized Advance-Decline Ratio
Our Japanese normalized advance-decline ratio moved to an extreme oversold level (<-40) in early December and has since moved back to positive
(Ch 45).
(Chart 45) You
Y usually
ll needs
d a move above
b 20 for
f the
h market
k to stale
l after
f suchh oversoldld readings…
di
In Asia, we did not have any breadth thrust in the past 3 months (Chart 46) and are slowly approaching the >5 levels where the market tend at least to
consolidate (if we expect the move out of extremely oversold level where it usually indicates continuation…)

Chart 47 S&P500 and Fosback High Low Index Chart 48 S&P 500 and Hindenburg Omens
Since we have started to write those presentations, many years ago, we have used the following 2 studies to warn of impeding cyclical trend change.
On chart 47, one can see the Fosback High Low Index remains very low, indicating a lack of distribution. It is likely to remain low until mid-March
as many stocks plunged into March 2009 making a big rise in new lows unlikely.
We have yet to see any Hindenburg Omen triggered on any of the Major index (Chart 48)…

Equities: Liquidity 30
Chart 49 Equity mutual fund assets and net cash Chart 50 Flows to Emerging Markets Mutual Funds and Future
Relative performance
Source: Nomura
Source: ICI, Clue6
Net inflows into equity mutual flows continue to be negative (Chart 49) in the US while we are continuing to see huge inflows into emerging market
oriented
i d funds
f d (and
( d while
hil US investors
i h
have b
been net sellers
ll off equity
i mutuall funds
f d they
h have
h b
been net buyers
b off emerging
i market
k equityi funds…)
f d )
Such important inflows have been historically followed by a substantial underperformance of Emerging markets (Chart 50)..
The NYSE margin debts has now exceeded the 2000 levels on a % of market cap basis…

Chart 51 Number of Buybacks Announced per Month in the US Chart 52 Number of Buybacks Announced per Month in Japan
Buybacks have picked up slightly in the US in the past 2 months but remains at a very depressed level (Chart 51)…
In Japan, we have seen a slightly more robust pick up (Chart 52) 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…
Note that we remain wary of too much buybacks which, in aggregate, still remains a sign of management “short-terminism”… and in Japan we
would
ld prefer
f to
t see stocks
t k bought
b ht back
b k than
th new unproductive
d ti capital
it l expenditure…
dit

Chart 53 US IPOs and Secondaries (US mio.) Chart 54 China + Hong Kong IPOs and Secondaries (US mio.)
The Banks TARP repayment have caused a big jump in the amount of secondaries in December (Chart 53). The market digested them surprisingly
well
ll with
i h banks
b k shares
h only
l underperforming
d f i slightly
li h l (but
(b still
ill far
f from
f their
h i September
S b highs)
hi h )
In China and Hong Kong, management are taking advantage of the current rebound to flood the market with new shares (Chart 54)…
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
d i the
during th first
fi t 4 months
th off 2009) or when
h they
th would
ld be
b stupid
t id nott to
t (like
(lik Blackstone
Bl k t i July
in J l 2007,
2007 China
Chi andd Hong
H K
Kong att the
th endd off 2007 andd
potentially now…)

Chart 55 US Middle to Young Cohort and Equity Funds Assets Chart 56 Japanese Middle to Young Cohort and Equity Funds
Assets
Source: ICI, Census Bureau, Clue6 Source: BOJ, Japanese National Institute of Population and Social Security Research, Clue6
The above 2 graphs are well-known for those who have been reading our research for a long-time.
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 ratio.
In the US, one should not be surprised by the net outflows from equities into bonds, this is what should happen (Chart 55) while in Japan we should
see the
h reverse (Chart56)…
(Ch 56)

Most Bullish Middle to Young Cohort for
Chart 57 Chart 58 Middle Age Population Growth Forecast
the Next 5 Years
Source: Census Bureau, Clue6 Source: Census Bureau, Clue6
On chart 57 you can see the countries which have the most positve demographic dynamic according to the Middle to Young Cohort hypothesis…
But should not only the “Middle to Young Cohort” but the absolute growth of the middle age population (Chart 58).
Combining both, one see that the picture is somewhat less bullish than it seems for Japan, Spain, Poland, Portugal and Greece

Most Bearish Middle to Young Cohort for
Chart 59 Chart 60 Middle Age Population Growth Forecast
the Next 5 Years
Source: Census Bureau, Clue6 Source: Census Bureau, Clue6
On chart 59 one can see the countries with the most bearish demographic configuration according to the Middle to Young Cohort hypothesis…
The middle age dynamic of those countries is presented on Chart 60…

Liquidity momentum has a slight tendency to lead markets, and this should be especially true given in the current environment…
M2 momentum is not supportive going forward…

Equities: Seasonality – President Cycle and Monthly Seasonality 37
US Four Year Presidential Cycle (S&P 500 Total
Chart 63 Chart 64 US Monthly Return (S&P 500 Total Return since 1944)
Return since 1927)
The four year Presidential cycle has been distorted by the huge fiscal and monetary stimuli of last year. The rational behind the 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 slightly better in January (Chart 64) but in the past 10-15 years we have witnessed a good start followed by a
nasty correction intra-month so…

Equities: Seasonality – Sell in May and … 38
Chart 65 Average Return MSCI Indices 1970-1998 Chart 66 Average Return MSCI EM Indices 1970-1998
Source: The Halloween Indicator, S. Bouman Source: The Halloween Indicator, S. Bouman
We are now in the positive half of the year (Chart 65 and 66) and our “sell
sell in may
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 39
Chart 67 US Day of the Month (S&P 500 Total Return since Chart 68 Japan Day of the Month (Topix Total Return since 1979
1944
The day of the month continue to exhibit its historical pattern in the US and Japan (Chart 67-68) (the same is true for most markets as showed
previously)
previously)…

Equities: Seasonality – Cycles 40
Chart 69 NYSE Composite and the 20 and 40 Weeks Cycles Chart 70 Super Cycle Economic Seasons
Source: Clue6 Source: Bronson Capital Market Research
The next 20 weeks cycle low is expected for the middle to end of March (Chart 69).
Chart 70, courtesy of B. Bronson, has been used in the past to depict the relative assets movement during the Long Cycle (Kondratiev wave). Many 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 30’s were 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),
2007) stocks valuation are rising while interest rates falls from a high level.
level What could we
ask for more… It is followed by the Winter where interest rates and stocks valuations become highly correlated, both falling…

Equities: Intermarket 41
Chart 71 S&P 500 and World Defensive Relative Performance Chart 72 S&P 500 and Nasdaq Composite Relative Performance
Defensive have been performing relatively well in the past3-4 months (Chart 71). To follow attentively in the next few weeks to see if they manage
to break
b k out… This
Thi would
ld be
b a negative
i for
f the
h market…
k
After having struggled, along with small caps in the past 5 months, the Nasdaq Composite has finally made a 52 weeks relative high against the
broader market (Chart 72). This is positive has the market tend to be most productive when the Nasdaq relative performance trends higher along with
the market as we have showed with various models in the past…

S&P 500 and the KBW Bank Index Relative S&P 500 and iShares iBoxx $ High Yield
Chart 73 Chart 74
Performance Corporate Bond Fund Net Asset Value
Banks shares continued underperformance is worrying (Chart 73) as it is a logical consequence of our macro scenario but one could still say that
they
h performed
f d relatively
l i l well ll given
i the
h huge
h amount off dilution
dil i they
h have
h to suffer
ff ini the
h recent past… andd let’s
l ’ not forget
f that
h they
h are ini the
h
portfolio of quite a lot of the smart money managers we follow so…
High yield spreads are continuing to decline and junk bonds are making new price highs (Chart 74) despite the rapidly rising 10 years treasuries
which is impressive…

Chart 75 S&P 500 and US 2 Years Treasury Bonds Chart 76 S&P 500 and Eurodollar Model
Two years treasuries have spiked higher recently (Chart 75) and this should be associated with struggling market in the current environment…
Th same is
The i true
t f inflation
for i fl ti expectation…
t ti
We also like to look at the relative behavior of the equity markets and the Eurodollar future. On chart 76 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 simply looks at the combined medium-term momentum of bonds and
commodities is also flashing a warning signal…
Equities: Intermarket – US10 Years Govies against Stocks 44
Chart 77 S&P 500 and US 10 Years Treasury Bonds Chart 78 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
positive. In this period, stocks performed
when the momentum was positive.
p
We have long argued that one the characteristics of the current structural bear market (and we are talking US, Europe and Japan here...) was
the positive correlation between stocks and government bond yields.
yields
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…

Chart 79 MSCI Emerging Markets and Dollar Index Chart 80 S&P 500 and Sovereign CDS
Source: Clue6 Source: Bloomberg, Clue6
We already identified potential headwinds for emerging markets (Valuation, investor bullishness,…)
Don’t forget to look at the USD… A rising USD has rarely been a positive for emerging markets (Chart 79)…
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 80 you will find the usual suspects…

suspects We could have put Austria in the mix…
mix

Source: RBS
Canaries in the coal mine candidates… To observe attentively in the coming months…
Candidates have been selected using the methodology of “Rules of Thumb' for Sovereign Debt Crises” by P. Manasse and N. Roubini, 2005

Equities: Graphs 47
S&P 500
Shoulder
Shoulder
Head
The S&P 500 continues its march upward inside a well-defined up channel. We continue to see higher highs and higher lows.
The inversed head & shoulders and June-July flag targets are still above us at 1200-1250 while the descending 2007-2008 channel
should offer resistance at the 1100-1130 levels.
A series of narrow range day has usually been a warning of an impending correction in the past 12 month… Had the first on
Wednesday this week…

Equities: Graphs 48
DJ Euro
E Stoxx
S 50
Shoulder
Shoulder
Head
Europe has been slightly underperforming recently but has now managed 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…
We would now move from selling upside volatilities to outright reduction of the equity exposure and even a small net short positions when
reaching the top of the channel…

Equities: Graphs 49
T i
Topix
Head
Shoulder Shoulder
Shoulder
Shoulder
Head
The Topix reacted strongly by rebounding from its December oversold level… It has now formed an inversed head and shoulder
with a 1000 target…

Equities: Graphs 50
MSCI A
Asia
i ex-Japan
J
Asia rose strongly at the in the past 2 weeks has everything which is associated with risk… As everywhere the gain have been made
on low volume…
Yet one has to respect a market making a new 12 months high after having consolidated during 4 months…
To be honest it smells a bull trap but…

Equities: Graphs 51
MSCI EM L
Latin
i AAmerica
i
Similar as in Asia but with less impetus…

Equities: Graphs 52
MSCI E
Eastern E
Europe
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 to ward other part of the world are not…… The stronger IMF
has voided the "end of their world" scenario, but…
We repeat what we said last time…

time Do not forget to pick some of the dominoes falling by contagion…
contagion there are plenty of good
things in the Czech Republic for example…

Equities: Conclusion 53
Valuations are now above levels where performance going forward will not please the buy & hold crowd, even if we go back to the good old
days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200 on the S&P 500 will be priced more
expensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of the 1929 move... This does not imply that the market
will fall in the short or even the medium term but that a further rise will only have speculative and no investment merit if bought. Our base
assumption
i remainsi that
h we will ill fall
f ll to significantly
i ifi l undervalued
d l d levels
l l before
b f a new secularl bull
b ll market
k can start (in
(i the
h developed
d l d world ld as 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 5-6% a
year.
Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in the past. But even if
sentiment
ti t is
i once again
i too
t greedy,d it has
h to t be
b putt in
i the
th context
t t off the
th recentt advance
d and
d market
k t trend
t d (higher
(hi h highs
hi h andd higher
hi h lows).
l ) This
Thi
does not imply that the market can not continue to rise in the medium-term but more that it should at least consolidate in the short-term. Small
investors optimism has finally started to rise and is now deep in overconfident territory…
Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...
On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging market equity fund. This has
historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks but they remain very low while IPO’s and
Secondaries have been plentiful with bubble reminiscent level in Hong Kong and China…Monetary aggregate momentum is turning down and this
could prove to offer some headwind to risk assets…
Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of liabilities...
Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month in January, especially
after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near future…
Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative good performance of
defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good. We are more worried about the medium-
term momentum of bonds and commodities which is in a configuration where equity market productivity has been poor historically…Sovereign CDS
will continue to need your attention…

Equities: Conclusion 54
The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of the channel expected
before a potential resumption of the up move but the rest of the analysis points out to something potentially bigger than the correction we had since
March…

First Quarter 2010 GTAA Equities

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Global

Clue6 First Quarter 2010

Clue6 First Quarter 2010

Clue6 First Quarter 2010

This has been aggravated by a substantial deterioration of the assets where:

Clue6 First Quarter 2010

So where do we stand now…

Clue6 First Quarter 2010

Clue6 First Quarter 2010

We have shown that the concept of book value has

This is especially true for the US and Europe.

In 2007, in our effort to convince clients of the

On the various charts the semi-transparent

A cursory look at the graphs confirm that

Clue6 First Quarter 2010

Chart 9 Asia ex Japan PB Chart 10 Latin America PB

All in all we would estimate the US and European

Japan remains undervalued and as said, the low

Emerging markets are getting increasingly expensive here...They

Clue6 First Quarter 2010

Source: Morgan Stanley Source: Goldman Sachs

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: BEA, Clue6

Clue6 First Quarter 2010

Source: Clue6 Source: Clue6

Clue6 First Quarter 2010

Source: Morgan Stanley Source: Zeelotes

Clue6 First Quarter 2010

Source: CBO,Clue6 Idea: J.Hussman

If one add that there is a non-negligible

Clue6 First Quarter 2010

Source: Investor Intelligence, Clue6 Source: NAAIM, Clue6

Clue6 First Quarter 2010

Source: Greenwich Alternative Investments, Clue6 Source: TSP, Clue6

Clue6 First Quarter 2010

Source: Merrill Lynch Source: Merrill Lynch

On a Country/Region basis there are 2 stand outs…

Clue6 First Quarter 2010

Source: Clue6 Source: Clue6

Looking at option activity the picture is similar…

Clue6 First Quarter 2010

Source: OCC, Clue6 Source: OCC, Clue6

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: ML, Clue6

Clue6 First Quarter 2010

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Clue6 First Quarter 2010

Source: Clue6 Source: Clue6

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Margin traders are currently losing both way…

Clue6 First Quarter 2010

Source: Bloomberg, Clue6 Source: Bloomberg, Clue6

Our VIX Indicators are giving conflicting signals…

Clue6 First Quarter 2010

In this sort of equilibrium,

Clue6 First Quarter 2010

Source: Clue6 Source: Clue6