ClearVIEWS™Macro multi-asset portfolio strategy anchored on a long-term factor-driven framework generated from the ClearENGINE™.

Want a short video explainer on what is covered in the report?

Please click this button

2

ClearVIEWS

Cycles do not typically just die of old age and this one will not be an exception. The Fed is likely to push too hard on the monetary brakes in response to accelerating inflation, and this will eventually hurt risk assets. EM equities are in the firing line. Underweight equities and bonds with a preference for the U.S. dollar.

Few asset classes have attractive long-term return prospects. Our factor-based analysis calls for a marginal preference for equities and a mistrust of bonds. Equity value is concentrated in the emerging and frontier markets, which also offer better growth prospects. Excess returns on US equities will be negative.

Our live theme overlay reinforces the defensive bias. There are a number of bubbles waiting to burst - including large and small cap equities and bonds - but the equity markets will be the hardest hit. The normalization of the term premium on Treasuries - as the Fed contracts its balance sheet - will be the dominant driver of market returns.

The Gathering Storm

Bottom Line: Investors should ensure that portfolios are well positioned to withstand the gathering storm that will hit asset asset prices hard in the next 6-12 months. We think investors should be already reducing risk.

Cred

it a

nd M

oney

Posi

tion

ing

Term Premium

Financial assets

Infla

tion

Monet

ary Polic

y

Dem

ogra

phic

s

ineq

ualit

y

Asset P

rice B

ubbles

Protectionism

L/T

Retu

rn P

rosp

ects

Gro

wth

Fac

tor

Inco

me Fa

ctor

Value Factor

Themes(6-12+m)

SAA(3-5+yrs)

2018-19

TAA (0-12m)

Figure 1: A stylized framework of how we expect the cycle to unfold

Globally Integrated Asset Allocation Strategy September 2018

3

If there is a theme in this month’s edition it is to stay invested, but recognize that the risks are rising and confidence is fragile. Late cycle imbalances abound, and credit quality is deteriorating, but at least margin debt does not yet seem to be a problem. Global economic conditions are following the contours of policy stances. In the US, a combination of easy fiscal and tightening, but still accommodative monetary conditions, have kept activity buoyant in contrast to the rest of the world. China - whose economy has been weakening - has also joined the party and is now embarking on a fiscal expansion. Although the boost is only likely to reach 1% to 1.5% of GDP compared to 3% in 2008/9, it should compensate for slowing export growth. In contrast, Germany has been running the biggest budget surplus this cycle and the US fiscal impulse - which added over 1% to GDP - will weaken. The Fed is also on track to raise rates as planned and any further spike in inflation could be the cue to raise rates faster. The real Fed funds rate has been falling this year as headline inflation has reached nearly 3%. For FOMC policymakers, giving themselves the optionality of cutting rates aggressively when the next downturn comes is at the forefront of their concerns.

Bottom Line:

● Global growth is still very reliant on policy. In contrast with the first nine years of the recovery, though, it is US fiscal policy rather than monetary policy which is carrying the day.

● US fiscal stimulus will fade over the coming quarter resulting in a much tighter monetary and fiscal policy mix.

1) Macro Overview

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

● EM is still vulnerable though the markets are getting cheaper and a Chinese fiscal boost could help. Events in Argentina, Turkey and South Africa all highlight the fragility of the EM.

Figure 2: US leading indicators still suggest buoyancy

Figure 3: Chinese fiscal policy will have to compensate for indifferent export growth

Figure 4: While the equity trend is your friend, the Fed will persist with tightening

4

● An 18% year-on-year improvement in S&P 500 profits has meant a reduction in non-cyclically adjusted US PEs. Other measures, such as EV/EBITDA are expensive and the earnings expectations seem likely to have peaked as the fiscal stimulus starts to fade. Unless wage growth starts accelerating from 3.2%, it also seems likely that consumer spending has also crested.

● Higher wage growth is a double edged sword. Reduced margins are a key reason for ClearMacro’s poor long-term US profit forecasts, but higher wages are necessary to maintain the near term economic momentum.

● There is a very short-term tactical opportunity in equities but stay underweight on a 12-month view especially EM and Europe to the benefit of the US. This is a counter trend call. The US equity market looks much riskier over the long haul.

● Further, reduce risk asset exposure on any short-term equity rally. High yield spreads are too low relative to the underlying risk.

● A negative term premium of 50 basis points on the US 10-year still gives plenty of scope for yields to spike above 3%, which would also threaten equities.

● Financials have underperformed this year as the yield curve flattened. A normalization of the term premium as the Fed’s balance sheet maturity lengthens will add to pressure on bank performance.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

2) Investment Implications

Figure 5: The US may get a short-term boost, but valuations are demanding

Figure 6: US Profit margins are increasingly unstable

Figure 7: US earnings revisions are still upbeat, but it has a lot to do with the tax cuts and earnings buybacks

5

● The US data has remained upbeat led by US consumer confidence which rose to an 18-year high in August - the best since August 2000. But other data suggests that most of the strength in expenditures is occurring in the non-durable sector.

● While the 18% growth in US S&P earnings during the third quarter is impressive, strip out share buybacks and the fiscal boost, and the result is a little over 10%.

● Germany ran a budget surplus of 1.3% of GDP in 2017- the fourth consecutive annual surplus - the country is on track to exceed that this year running another record surplus in the first six months of 2018. While easy money is helping the eurozone, tight fiscal policy along with weakening exports are acting as a drag.

● The Chinese PMIs edged higher indicating that growth may be stabilizing and with the fiscal boost likely to reach 1.5%, the improvement can continue.

Bottom line:

● The global business cycle

desynchronization is continuing with ClearMacro signals pointing to a superior outcome for the US relative to the rest in the short term.

● EM is in the firing line as US financial conditions tighten with exchange rate flexibility only partially compensating, but China’s fiscal largesse should help.

● The dollar will get much stronger against most currencies except the yen with interest rate differentials moving in favor of USD.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

● Gold should get hurt further by the strong dollar, having failed to make headway in a favorable environment of falling real interest rates.

● Small cap US equities have been star performers with the strong dollar and easy fiscal conditions both helping. But valuations suggest a modicum of caution (see trade note).

3) The Most Important Developments Over the Past Month

Figure 8: US Consumer confidence has been soaring

Figure 9: German fiscal policy is too tight

Figure 10: This why China has started to ease fiscal policy

6

Figure 12: Model Asset Allocation.

Our Moderate Risk AA Model Portfolio (Figure 15 on the next page) aims to both maximise risk-adjusted long-term returns whilst minimizing short-term underperformance. Bottom Line:

● We temporarily reduce our cash bias and underweight to EM risk as we expect a short-term EM bounce.

● Longer-term return prospects are not inspiring, however, and while there is a marginal preference for equities over bonds, we still recommend a cautious portfolio risk level.

● EM and the Frontier markets rescue long-term equity returns, but the tactical outlook for the developing world in a rising rate environment is precarious.

● Nevertheless, on the back of an expectation of fiscal largesse from China, we look for a short term bounce from EM, and raise our allocations to EM equities, specifically to China (+1%) , Poland (+0.5%), and Russia (+0.5%), and EM sovereign debt (+3%).

● Notwithstanding this, ClearMacro’s model AA portfolio still remains heavily overweight cash and IG credit, and underweight both equities (especially US) and government bonds when compared to a balanced benchmark.

● Very high non-base (EUR) FX exposure especially US dollar.

● The portfolio is estimated to deliver 3.5% annualised excess return ahead of what we project for a 60/40 MSCI World/Barclays Global Aggregate allocation over the next 3-5+ years.

● Since inception the portfolio is down 1% in absolute terms, being hurt last month by the rally in EUR, and US equities..

4) Asset Allocation Portfolio Strategy

Figure 13: Model vs 60/40 MSCI World/Barclays Global Agg

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

Figure 11: Model Portfolio Specifications.

7

Figure 14: ClearMacro’s Investment Ratings rank investment universe return prospects by analysing return prospects across different investment horizons. An uninspiring outlook suggests portfolio caution.

A further breakdown of ClearMacro’s Multi-Horizon Investment Ratings and Model Portfolio is available on request (please click here).

Figure 15: Our recently launched Moderate Risk AA Model is estimated to have a 3-5+ year annualised return of just over 6%.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

Most asset classes are rated Neutral or Moderately Underweight

Portfolio Holdings

Long-Term return projections powered by the ClearENGINE

8

A systematic growth, income, and value factor framework.

ClearMacro’s SAA model portfolio (Figure 19) is optimised from ClearEngine’s long-term return projections. These are built up from the expected contributions to each asset class and market, of growth, income and value factors. Based on a set of target risks and constraints, the Engine identifies an efficient portfolio to maximise risk-adjusted returns over the long-term. CM Bottom Line:

● Low returns for passive asset class allocations - we project just over 2% annualised nominal return for an EUR investor invested passively in a 60%/40% allocation to MSCI World/Barclays Global Aggregate over the next 5 years.

● The best long-term return opportunities are in EM and relative value within asset classes.

● Developed market bonds will be hit by the shrinkage of the Fed balance sheet and rising inflation expectations.

● Inflation-linked bonds will benefit from rising inflation and falling real rates.

● High Yield valuations are expensive with mean reversion likely as the cycle matures. Negative excess returns are projected.

● Global equity allocation of 55%, with better growth prospects and superior valuations driving a slight bias to EM and the Frontier markets.

● Commodities lose out due to slowing growth and rising rates.

● Negligible exposure to DM govt bonds but a significant weighting to EMFX, due largely to higher long-term growth prospects.

5) Strategic Asset Allocation (3-5+ years) Portfolio Strategy

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

Figure 16: SAA optimised model

Figure 17: Be wary of US assets over the long-term horizon. We show the histories below of the point-in-time projection of returns over the next 3-5+ year holding period. Both US equities and US HY (Figure 19) are estimated to underperform cash.

Figure 18: Long-term returns for US HY below are now estimated to underperform cash over the next 3-5+ years.

9

A further breakdown of ClearMacro’s Long-Term Investment Ratings and Model SAA Portfolio is available on request (please click here).

Figure 20: Below, we show the performance of our Low Constraint ETF SAA Optimised portfolio vs our 60/40 benchmark, since inception.

Figure 19: ClearMacro’s Long-Term Investment Ratings rank investment universe return prospects on a 3-5+ year investment horizon. Outside of EM, there are no attractive asset classes.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

10

ClearMacro’s framework assigns investability ratings to themes, driving allocations in our theme portfolio. Our 13 live themes come in 3 horizon categories:

● Within-cycle - typically early, mid, and late-cycle plays .

● Cyclical - two or three themes dominate over the cycle such as Large Cap equities and IT during the 1990s, and housing and commodities during the first decade of the new millennium, which often become bubbles.

● Multi-cycle - which are ordinarily indicative of structural change.

CM Bottom Line:

● Our theme allocations have a defensive bias and will benefit significantly from an equity sell-off, particularly in EM, higher fixed income yields, and higher volatility.

● There are cyclical bubbles in equities and bonds fuelled by QE that threaten to unravel as policy is tightened.

● But the secular bull market in bonds is not over. Yields may rise on a cyclical basis to correct overvaluation, but the structural forces of excess savings, globalization and technology remain substantial obstacles to sustained high inflation.

● Trade friction represents an assault on the rules-based institutional framework that has governed economic relations in the post-war period. The entrepot ports remain very vulnerable.

● The eurozone is a financial timebomb as Italy struggles in a debt trap. It cannot grow its way out of the problem, and it will need a central eurozone Treasury function to resolve the issue. In the face of German resistance, this is unlikely without a market riot.

6) Thematic Overlay (6-12+ months view)

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

Figure 21: Political risks are getting priced in. The chart below shows how much our implemented Eurozone break-up risk theme has already been discounted by the market. Although the basket is up +25% in 4 months, there is plenty to go!

Figure 22: Our Risk Appetite Outlooks evaluate country specific prospects. Italy’s immediate future looks bleak.

Figure 23: All of our political risk themes have performed very strongly over the last 3 months, and we have reduced exposures where themes are almost fully priced in by the market, such as Protectionism below.

11

A semi-systematic approach driven by rigorously tested tactical signals. Our 8 live trade positions have both attractive medium-term return drivers (valuation support and strong cycle prospects) and shorter-term favorable technical tailwinds.

CM Bottom Line:

● Our tactical trade overlay portfolio has a defensive bias and will benefit significantly from an equity sell-off, particularly in EM, higher fixed income yields, and higher volatility.

● There is a short-term tactical opportunity for equities to bounce. But we urge caution and selling into strength. The equity and bond flows are both skittish.

● The EM would be a buy if it were not for tightening US monetary policy. Valuations are cheap, and the markets offer the best 3-5-year factor derived excess returns.

● The Fed is not supplying enough dollars to the global financial system which should also hurt credit spreads.

● US headline inflation at 2.9% is worrying for Treasuries, though they should continue to benefit from a flight to quality.

● At least, US profit margins and earnings are not yet a cause for concern.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

7) Tactical Portfolio Strategy (0-12 months)

Figure 24: Developed market equity flows have been weak

Figure 25: It is a similar story in bonds - sentiment is fragile

Figure 26: At least US profit margins are not yet a cause for concern

12

Figure 27: ClearMacro’s Short and Medium-Term Investment Ratings are integrated to rank tactical return prospects on a 0 to 12 month time horizon. Long $/IG credit. Short EM/precious metals/govt bonds.

A further breakdown of ClearMacro’s Tactical Investment Ratings and Model Portfolio is available on request (please click here).

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

13

Long Large cap US equities versus Small caps (conviction medium) Yes, we know this is a ballsy call. The confluence of a strong dollar and easy fiscal conditions have put a tailwind behind small cap equities this year, with healthcare a big stand out, along with the technology and energy sectors. The tax cuts at the beginning of the year had a much bigger impact on the small cap sector because the rate fell to 21% from 32% compared with the reduction from 28% for large caps - an 11% versus a 7% reduction. And when GDP growth is around average to above average, small caps typically tend to outperform, with four fifths of revenue growth emanating from the domestic economy compared with 70% in the case of big caps.

More recently, the trade tariff dispute has also frightened investors out of large into small caps. But these stocks also tend to be more leveraged and have a much higher beta into a market downturn. Small caps have delivered an excess risk premium return of 2.4% over the long term, and typically, small cap outperformance has lasted around 7-years - this latest has lasted nearly 20-years! The stocks are now expensive and would suffer most in a margin unwind.

Our large vs small cap systematic risk premium model highlights the high sensitivity of relative performance to volatility and high yield spreads. With high yield margins trading near the lows, despite the deterioration in credit quality, the risks for small caps are to the downside. If nothing else, the US midterm elections in November are going to add to the uncertainty, while the ongoing tightening by the Fed will put further pressure on the high yield market, which has been recently rescued by the rise in the oil price.

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

8) Tactical Trade of the Month

Figure 28: The chart below shows the ratio-based out performance of MSCI US small caps against large caps over the last 20 years. The spread has been in a range since 2011.

Figure 29: Our valuation signal is not yet at the lows, but is certainly a negative.

Figure 30: Small cap outperformance (white line) is negatively correlated to the performance of the TW$ (yellow line). We expect this to be the major driver of small cap underperformance over the next 12 months.

>> Click here to view our full tactical portfolio

14

ClearVIEWS

Globally Integrated Asset Allocation Strategy September 2018

Trade Implementation

15

DISCLAIMER Copyright 2018©, ClearMacro Ltd. All rights reserved. ClearMacro Ltd. is not a registered investment advisor and the general information, recommendations and other materials contained in its research and reports are for information purposes only and should not be considered as an offer or solicitation to sell or buy securities or other financial instruments or products, nor to constitute any advice or recommendation with respect to such securities or financial instruments or products. ClearMacro’s research and reports have been prepared without regard to the circumstances and objectives of those who receive it, and do not provide individually tailored investment advice. ClearMacro Ltd. does not accept any liability for what is written in its research and reports, or for any actions that occur because of the information contained in its research and reports. ClearMacro Ltd. research and reports are provided to its clients through its website [www.clearmacro.com] and are also distributed electronically. ClearMacro Ltd. relies on a variety of data providers for economic and financial market information. The data used in this report are judged to be reliable, but ClearMacro. cannot be held accountable for the accuracy of data used herein. ClearMacro Ltd., its directors, officers, employees or contractors may have some financial interest in any or related securities mentioned in its research and reports. This document is the property of ClearMacro Ltd. and should not be circulated without the express authorisation of ClearMacro Ltd. Any use of graphs, text or other material from this report by the recipient must acknowledge ClearMacro Ltd. as the source and requires express written permission.

To read our Privacy Policy please click here

ClearMacro is an independent WealthTECH solution empowering smarter investment decisions.

Imagine… A centralised, modular platform generating forward-looking, global, multi-asset investment insight to power investment decisions across short, medium and long term investment horizons. Integrating systematic and thematic investment frameworks using a global macro screening capability. Your portfolio running LIVE - with profitable opportunities and risks highlighted.

This is …ClearENGINE™’... ‘Next Generation’ Investment Framework.

SAA Return Factor Projections

Investment Theme Framework

TAA Signal Library

Risk Appetite Gauges

Systematic Strategy Suites

Investment Committee Support

Global Macro Screening

Portfolio Diagnostic

Powering Smarter Investment Decisions

INVESTMENT DECISION-MAKING 2.0

+44 (0) 203 435 5600

info@clearmacro.com

www.clearmacro.com CLEAR THE NOISE … CONNECT THE DOTS.

Investment Rating Dashboards Bespoke Builds

>> TAA Signal Primer >> Signal Glossary >>Systematic

Strategies>> Thematics Framework

>> Portfolio Diagnostic

“I wished to be able to answer two simple questions - what am I missing and what does it mean to me? I am delighted to say that we can now not only answer these questions with our portfolio running within the ClearENGINE Global Investment Framework but apply this intelligence LIVE to optimise our performance- CIO/Head of Multi-Asset : Inst. Asset Manager - London UK.

Our senior team harnesses decades of experience gained across the asset management and investment strategy industries with the very best expertise in data science. To discuss how ClearMacro can add value to your investment decisions, please call +44 (0) 203 972 6680 or simply email Head of Client Relations, chris.sandfield@clearmacro.com and we will be delighted to get back in touch.