a a - lyxor japan | · by lyxor cross asset research fourth quarter 2019 contact:...

CU T R I S K I N TO Y E A R- E N D

F O U R T H Q U A R T E R 2 0 1 9

GUILLAUME LASSERRE JEANNE ASSERAF-BITTON XAVIER DENIS

CIO for Active Investment Strategies Head of Market Research Head of Cross Asset Research

JEAN-BAPTISTE BERTHON PHILIPPE FERREIRA SOPHIE FOURNIER

Senior Strategist Senior Strategist Senior Strategist

GLOBAL GROWTH SLOWDOWN BUT NO RECESSION

PREFER U.S.EQUITIES

UW EZ AND EM EQUITIES

CONSTRUCTIVE ON HY CREDIT

AND EM DEBT

OVERWEIGHT L/S CREDIT

AND EM MACRO

OW MERGER ARBITRAGE

UW GLOBAL MACRO

I N V E ST M E N T ST RAT E G Y

LYXOR CROSS ASSET RESEARCH

INVESTMENT STRATEGY INVESTMENT STRATEGY

By LYXOR CROSS ASSET RESEARCH FOURTH QUARTER 2019

Contact: [email protected] +33 (0) 1 42 13 31 31

Report views finalized on September 24, 2019

Important Notice: For investors in the European Economic Area, this material is intended for clients

(current or potential) who meet the definition of “Professional Counterparty” or “Eligible

Counterparty” under the Markets in Financial Instruments Directive (“MiFiD”), and any products or

services described falling within the scope of the MiFiD are only available to such clients. This

document is considered marketing communication within the meaning of the MiFiD.

CONTENTS

IN SUM 3

MACRO OUTLOOK 4

Trade war drags global growth down 4

FIXED INCOME 6

Rates 6

Corporate bonds 7

FOREIGN EXCHANGE 10

DM FX: reign of king dollar unchallenged yet 10

COMMODITIES 12

Brent: a short-lived premium 12

Gold: fundamentals underpin a gold hedge 12

Copper: in cross currents 13

DM EQUITIES 14

U.S. equities: numerous headwinds limit upside potential 14

Underweight EMU equities: downside risks still loom 16

Neutral on UK equities: still a messy Brexit 17

Japanese equities: still a “yen play” for this cyclical market 17

Emerging Market equities: more differentiation 18

ALTERNATIVE STRATEGIES 20

CTA strategies’ winning streak reaches a ceiling 20

L/S Equity: prefer Market Neutral L/S over Directional L/S 21

Event-Driven: prefer Merger Arbitrage to Special Situations 21

CTA/Macro at Neutral 22

Fixed Income (FI): Prefer L/S Credit to FI Arbitrage 22

DISCLAIMER 24

mailto:[email protected]



2

OUR MARKET VIEWS

OUR THREE-MONTH VIEWS

UW Underweight

N Neutral

OW Overweight

delta Since previous quarter

UW N OW

Equities

U.S. Industrials

U.S. Materials

EMU Equities

EMU Cyclicals vs Defensive

Japan Equities

EM Equities

China Equities

South Korea Equities

Mexico Equities

Thailand Equities

U.S. Equities

U.S. Growth vs Value

US. Small vs Large

U.S. Cyclicals vs Defensives

EMU Banks

UK Equities

Taiwan Equities

India Equities

U.S. Staples

EMU Large vs Small

Indonesia Equities

Brazil Equities

Russia Equities

Fixed

Income

10Y US Treasury

10Y Bund

EU Credit IG

US Credit IG

US High-Yield Credit

Italian BTP vs German Bund

EU High-Yield Credit

EM Debt

FXUSDJPY

USDCHF

EURUSD

GBPUSD

CommoditiesBrent

CopperGold

Hedge

FundsL/S Equity Directional

Special Situations

FI Multi-Strategy

Global Macro Systematic

Global Macro Discretionary

CTAs

L/S Equity Market Neutral

Merger Arbitrage

L/S Credit

EM Global Macro



3

IN SUM

A tug-of-war between macro and liquidity

Markets are again flirting near historical highs. The trade war escalation continues to weigh on

market sentiment while the rates pullback is underpinning risky assets’ valuations. Macro

readings point to a growth deceleration as manufacturing has entered recession territory and

services are edging down. The manufacturing slump should worsen in the short run, with growth

bottoming out only in early 2020. Corporate profit expectations are likely to be revised down as

growth sputters and tariffs hit margins. The Federal Reserve (the “Fed”) may be reluctant to cut

rates to match what the market has priced in as a recession is not around the corner yet.

Meanwhile, the European Central Bank (“ECB”) is keen to pass the baton on to fiscal

policymakers given weak demand. By geographic area, China’s economy is deteriorating further,

suggesting yet again additional easing measures to support consumption and investment; Brexit

remains a wild card with PM Johnson threatening a “do or die” no-deal exit on October 31; and

heightened tensions in the Middle East and surging oil prices bring additional headwinds to

global growth. Our investment recommendations are based on a short-term global slowdown

and then stabilization – not a recession – in the U.S. and Europe.

Underweight global equities. Political and macro newsflow remain broadly negative, though

central banks’ easing, subdued inflation and robust consumption remain supportive. We still

prefer U.S. equities as the macro picture is brighter and earnings are increasingly geared towards

the domestic market. We have downgraded eurozone equities to Underweight, at par with the

Emerging Markets and Japan, as the trade war escalation, manufacturing downturn and slower

growth are set to weigh on overall equity performance.

Prefer credit over bonds. The overall backdrop remains highly supportive for credit due to easing

monetary policy, low default rates and the ongoing chase for yields. High-yield bonds should

remain a sweet spot due to attractive carry and shorter duration. Bonds have, surprisingly,

outperformed this year, but long-term yields are nearing a bottom and could easily rise on Fed

repricing and reflation policies in the euro area. This also bodes well for emerging bonds, as central

banks are keen to follow the Fed and yields will continue to attract positive inflows.

Gold as a safe haven. Appetite to hold gold in portfolios has surged given the negative yields for

a third of all sovereign bonds. We deem gold an attractive hedge due to the lingering uncertainty

and central banks’ diversifying reserves allocation out of the USD.

Market sentiment still highly sensitive to newsflow. We prefer to cut risk in our portfolios. The

business cycle is in a later stage and fading out. Political risks still loom with the unsolved Brexit

outcome, Middle-Eastern geopolitical tensions and trade war. Also, any, likely, downward

revision to earnings forecasts could imply a derating given already stretched valuations.

Alternative strategies

We believe current conditions remain supportive for carry strategies such as L/S Credit and EM-

focused Global Macro. From a general standpoint, we prefer L/S Credit and Event-Driven to L/S

Equity and Global Macro/CTA. Recent changes include the upgrade of Macro strategies to

Neutral from UW, as these strategies hedge against potential trend reversals in fixed income.

We maintain an OW stance on Merger Arbitrage. The strategy offers a low correlation to equities

and a low volatility in returns. These benefits currently offset the headwinds related to the

slowdown in U.S. M&A volumes and tight deal spreads. We also remain OW on L/S Credit to

capture upside risks related to mild signals of improvement in economic activity, while reducing

volatility in portfolios compared to L/S Equity strategies. Finally, we have Directional L/S Equity

strategies at UW even though they have been defensive of recent. Yet, Directional L/S strategies

could suffer if risk aversion rises in the coming months, as we fear. We prefer low/vol defensive

strategies to cyclical/value ones. Along these lines, we have Market Neutral L/S at OW.



4

MACRO OUTLOOK

TRADE WAR DRAGS GLOBAL GROWTH DOWN

The trade war escalated again between the U.S. and

China with the scheduling of a new set of tariffs.

Although negotiations have resumed, the ongoing trade

war is weighing on manufacturing which is now

contracting. Services are also weakening but remain

underpinned by a more buoyant job market and

subdued inflation. We expect further macro momentum

softening in Q4 2019 followed by a bottoming out in

early 2020 and do not forecast a recession next year.

Six key features shape the overall macro backdrop

The trade war: the ongoing trade war has reversed

globalization with rising tariffs and protectionism. Trade

is contracting at a faster pace than during the soft patch

of 2015-2016 weighing on the manufacturing sector and

on global growth. A fragile trade truce could be achieved

between the U.S. and China, but this is not a done deal

as market hopes have been dashed a few times already.

Manufacturing recession: global manufacturing has

slipped into contraction territory and could go further

yet to reflect China’s transitioning to a service-based

economy – somewhat accelerated by the U.S. trade war.

Some recoupling between manufacturing and services

is likely as weak external demand is impacting domestic

demand. However, this could drive the U.S. or the

eurozone into recession next year.

Resilient services: services have slowed but have

remained resilient so far. Indeed, manufacturing

accounts for a small fraction of GDP – 10% in the U.S.,

but over 20% in Germany. Private consumption is well

supported across the board by rising consumer

purchasing power, fueled by job creations, nominal

wages gains and subdued inflation.

U.S. growth outperformance: Global growth is slowing

but some countries are more exposed than others.

Inward-looking economies with room for policy easing

should be more resilient and the U.S. fits the bill.

Conversely, the eurozone, Japan, and China are

definitely more exposed to the global manufacturing

downturn.

China stays afloat: Despite a steady growth declaration

China still has room for maneuver to support economic

activity. The trade war escalation is a further blow that

could be mitigated by additional currency weakening,

further monetary policy easing, and increased fiscal

stimulus, but risks remain tilted to the downside.

KEY VIEWS

Global economy is ebbing and heading towards

the slowest growth path since 2009.

Recession remains unlikely in 2020 given the

implemented fiscal and policy easing and macro

imbalances remain in check.

The trade war has escalated further but both the

U.S. and China are now contemplating the risks of

higher tariffs, paving the way for a fragile

compromise.

Manufacturing activity is in the doldrums as the

trade war takes its toll and capex is slowing.

Services sector, a less volatile component of

growth, remains well anchored by robust private

consumption.

Political risks remain on the radar, with Brexit and

renewed tensions in the Middle East.

Global trade slump weighs on exports

Source: Macrobond, Lyxor AM

Services resilient, manufacturing nosediving




5

No-deal Brexit risk on the rise: The short-term outlook

remains uncertain as the UK Prime Minister seems

committed to leaving the EU by October 31, whether

with or without reaching a deal. A general election is

probable by year-end but the government and the

opposition have yet to agree on a timing that suits both.

Although we still foresee a soft-Brexit outcome, the risk

of a hard Brexit has increased as a hard-line Tory

government would push ahead for Brexit at any cost.

Political risks fuel market anxiety

Since the Great Financial Crisis (“GFC”), political

uncertainty has structurally crept up. Indeed, the rise of

populism has encouraged rulers to adopt protectionist

measures, promote bilateralism instead of

multilateralism and become more interventionist in the

economic sphere. A push towards deglobalization has

been ignited with Brexit, the reshuffling of NAFTA into

USMCA and the U.S.-China trade confrontation,

amongst others.

So far, monetary policy easing has been instrumental for

mitigating the impact on financial markets but any

renewed uncertainty tends to spook markets. Investors

should continue to scrutinize the impact of politics on

markets.

Policymakers in action

Central bankers are feeling the political heat. As global

growth has been disappointing, and inflation has

undershot targets in most DM economies, central

bankers have returned to easing mode on the back of

growth and inflation downside risks. The Fed shifted its

forward guidance as early as January 2019 before

reversing the normalization trend by a first rate cut in

July and a second in September. Meanwhile, the ECB

adopted an easing package as inflation remains

stubbornly low and growth is sputtering.

Yet, fiscal policy seems a more appropriate tool to revive

a dwindling demand, notably in the eurozone. The

rebalancing of the policy mix will be a key factor to

stabilize growth in the months to come.

Consumer confidence remains high


U.S. growth outperforms other DM economies


China’s growth rebalance towards services

Source: Macrobond, Lyxor AM Policy uncertainty has risen since the GFC




6

FIXED INCOME

RATES

Lower interest rates: how effective?

Analysts are now questioning the appropriateness of

ultra-dovish monetary policies. As signs of secular

stagnation abound, low policy rates are sometimes

blamed for anchoring growth and inflation expectations

at low levels. By cutting rates or keeping them at sub-

zero, central banks’ stance may eventually feed into self-

fulfilling prophecies. There is no consensus on this view,

but it is clear that monetary policies have failed to hit

their inflation targets for a decade or more in the

eurozone and Japan. Concomitantly, negative rates

have negative side effects on financial institutions –

banks, insurers, or asset managers – and may also fuel

asset price inflation as investors consider leverage to

chase yields or keep up with surging housing prices.

Fiscal policy could in fact be coordinated with monetary

policy – a taboo so far for promoters of central bank

independence.

United States: markets drive Fed policy

Although the economy is still sustained, the Fed started

easing in July, after turning dovish early 2019. There was

little evidence of a softening at the time, but both the

July and September cuts were related to trade-related

downside risks to economic activity. True, inflation has

remained moderate despite the U.S. economy running

at, or close to, full capacity. While the core Consumer

Price Index ("CPI”) recently rose to 2.4% YoY in August,

core Personal Consumption Expenditures (“PCE”) -the

Fed’s preferred measure for underlying inflationary

pressure) has remained tame, at 1.6% YoY in July.

The inflation outlook remains dull as wage increases

have not accelerated as much as feared, oil prices

should remain range bound, and imposed tariffs have,

in final, had a minimal impact on consumer prices.

Indeed, markets are pricing in three additional rate cuts

by late 2020, so a rather dovish expectation. We expect

the Fed to trim rates by an additional 25bps by

December ending the mid-cycle easing path. The Fed

backtrack would offset most of the 100bps rate rise

observed over 2018. Growth should bottom out in early

2020 and market expectations of Fed cuts could be

reassessed.

KEY VIEWS

Central banks. Lower rates for longer as global

growth is sputtering and inflation remains

subdued.

Sovereigns. Long-term bond yields have moved

downwards, inflation prints are weak and a

slowdown looms. We are Neutral on UST and

prefer peripheral debt in the Eurozone.

Duration. We see limited risks of yield pickup in

the short run, but pro-active policies should lift

LT yields higher into 2020. We are Neutral.

Corporate debt. The chase for yield continues as

a rising fraction of bond yields are in negative

territory. Prefer HY versus IG, as net debt service

is at historical lows.

Emerging debt (in USD). Macro factors and

technicals are supportive. Monitor idiosyncratic

factors as investors may turn complacent in a

rock bottom yield environment.

Forward short-term rates track bond yields


Markets still expect more rate cuts




7

Prefer short-dated Treasuries

U.S. 10-year yields crashed during the summer, breaking

down the 1.5% mark just as it had in 2016, as growth

concerns spiked within a context of trade war

escalation. Looking at yield components, the main

culprit for the fall is the drop in term premium, now at -

1.1%. Real short-term rates and 10-year inflation

breakevens have hardly moved. We see limited upside

risk to long-term yields as the Fed has returned as a net

buyer of U.S. Treasuries and the macro momentum may

worsen in the months ahead. So, we maintain a Neutral

stance on the long end of the curve. As we expect 10-

year yields to gradually pick up on a 12-month horizon,

we may also turn more defensive when growth

concerns are dispelled, and markets stop discounting

further cuts. Conversely, we keep an Overweight stance

on the 2-year yield as expected returns seem more

attractive both in the short and longer run.

Eurozone: ECB calls for fiscal policy action

The ECB released new macro forecasts pointing to

underwhelming inflation prints next year, with headline

inflation at 1.0% in 2020. The 1.5% forecast for 2021

seems like wishful thinking in the current context.

Eurozone central bankers are worried about a de-

anchoring of long-term inflation expectations as the

5y5y inflation swap has been hovering around 1.2%

since June. As the growth outlook is steadily

deteriorating, the ECB strived to meet market

expectations of a broad-based package. This would

include deposit rate cuts and a tiering system to

mitigate the impact of another QE program sweetener

for TLTRO operations with lower rates and longer

maturities.

However, monetary easing seems increasingly unable

to address Eurozone economic woes linked to weak

external growth and paltry credit demand. Mario Draghi,

the ECB Chairman at the helm of the institution until late

October, called for more fiscal activism, stating that

monetary policy was reaching its limits.

Such a rebalancing is not a done deal, as Germany, the

country with the best action potential, has been

dragging its feet to use fiscal stance as a policy tool. Yet,

the rapidly deteriorating business climate and the

urgency to address the global warming challenge

should push German leaders to increase public

spending to address environmental issues. A

reassessment of the EU fiscal rule book is already a hot

topic for members, but country positions strongly differ,

and Germany is set to remain a hawk.

U.S. term premium hits new record lows


Eurozone inflation expectations fall further


Liquidity is already abundant


ECB struggles to revive credit growth




8

Spread compression ahead for BTP vs. Bund

Italy has been a laggard in terms of spread compression

between peripheral debt and the German Bund since

last Spring. For instance, Greece, which still faces a

massive debt overhang, has experienced a +200bps

compression and trades only 40bps above Italy.

We expect some additional spread compression in Italy.

The new coalition, shaped by the Five Star and the

Democratic Parties, should be more fiscally responsible

and keen to find some common ground with the EU’s

fiscal surveillance rules than the former collation. Yet,

the 2020 budget discussion will be a testing time for

both the coalition parties and the relationship with the

EU, given the remaining fiscal slippage. However,

several factors should continue to underpin the current

spread compression. In a nutshell, the restart of the

Asset Purchase Programme (“APP”) should be

supportive for peripheral bonds. We reiterate on

constructive view on the BTP/Bund spread.

CORPORATE BONDS

The hunt for yield continues as the drop in benchmark

yields is pushing investors to look for yield in credit

markets. The macro backdrop remains supportive to

the overall credit asset class, but we see credit risk as

more compelling than duration risk given the steady

overdone drop in benchmark yields. We maintain a

constructive view on credit markets but prefer the high-

yield buckets both in the U.S. and in the Eurozone where

we are Overweight. We maintain a Neutral weighting on

IG in EUR and USD and we still look for carry in the EM

space, and reiterate our Overweight stance.

Too early to move away from U.S. credit markets.

We still see potential in the short run despite greater

recession signals, with leading indicators pointing to a

likely spread widening in 2020. Financing conditions will

remain very accommodative. Growth is on a slowing

path, but a downturn is not in sight yet. High-yield

spreads are trading at fair value and default rates are

below historical average. Risk-adjusted returns tend to

favor credit versus equities in the current environment.

Eurozone HY to outperform IG

High-yield spreads have declined markedly since early

2019 but have now levelled off above the 300bps mark.

However, spreads have not returned to 2017 lows, and

thus offer some protection. We maintain our

preference for HY bonds, as carry is more attractive, but

also because IG valuation is certainly less stretched.

Growing share of negative yielding bonds


Room for compression on BTP/Bund spread


Spreads in line with expected default rates


HY still outperforms in the FI space




9

The ballooned BBB-bucket over past years now looks

overcrowded and underpriced, pointing to some likely

downgrades. ECB easing measures with improved

TLTRO conditions and the reopening of APP bode well

in particular for the lowest rated issuers. However,

selectivity is advised as markets have become more

expensive.

EM debt remains attractive

Liquidity conditions are supportive although the trade

war and Chinese growth deceleration have created an

idiosyncratic risk to the asset class. With curbed inflation

in most EM countries, central banks are keen to follow

the path of rate cuts set by the Fed. Spreads have

remained rather stable and do no point to market

exuberance. A simple modelling using EM forex index,

U.S. Treasuries 10-year yield, commodity prices, macro

momentum, and China credit impulse point to a spread

level justified by macro fundamentals.

Technicals are also supportive with continuous inflows

into EM funds that reflect sustained investor appetite to

hold EM debt denominated in hard currencies. With the

EMBIG yield trading above 5%, this carry will remain

compelling enough to keep money flowing into EMs.

Prefer EUR HY to IG as BBB spreads are too tight


Fundamentals justify EM debt spread levels




10

FOREIGN EXCHANGE

DM FX: REIGN OF KING DOLLAR

UNCHALLENGED YET

The dollar could still moderately appreciate, boosted by

its safe-haven status and the U.S. economic and

monetary differentials vs. its main trading partners. JPY

could also be boosted by safe haven flows and by the lack

of BOJ leeway. Downside risks remain in the eurozone,

but a lower political risk premium should keep the euro in

a trading range. A no-deal could be avoided on October

31st but lingering uncertainty should continue to cap GBP.

The trade-weighted USD: no weakness in sight

Most USD drivers remain supportive in the short run

though only moderately.

In recent weeks, the U.S.-China trade war showed signs

of easing (between the U.S. and China, Japan, and

Europe), while the odds of a no-deal Brexit on October

31 have risen. Yet, we doubt both these issues will be

resolved quickly. With the bulk of the U.S.-China trade

tariffs likely to remain in place, pressure on exports and

capex could continue to slow global growth.

Therefore, the search for safe haven is likely to

continue in the coming quarter, thus supporting the

dollar, as well as JPY and CHF.

As growth momentum and yield differential favor the

U.S. versus its trade partners, the USD is set to remain

well underpinned for the time being. Another QE in

Europe and other countries’ rate cuts are offsetting the

Fed’s cuts. The weighted yield differentials between

the U.S. and other G3 countries still shows a

comfortable 2% lead. Relative economic trends are

conveying a similar picture. The resilience of U.S.

consumption contrasts with the deceleration

observed in more trade-oriented economies such as

Germany, Japan, or China.

As a result, purchases of U.S. assets have intensified.

We observe that flows from petro-dollar recycling, or

from Asian investors, have all accelerated.

Dollar downside forces remain but have not gained

enough weight yet to sustainably challenge the reign

of the king dollar. Dollar market patterns also remain

adverse. Long dollar positions and long-term relative

valuations are increasingly stretched. However,

market patterns have historically been insufficient to

overwhelm fundamental forces. External and internal

KEY VIEWS

USD trade-weighted Safe-haven flows and

favorable economic and monetary differential

should lead to moderate dollar strength. Pressure

from deteriorating national balances and stretched

valuations are not strong enough.

EURUSD The ECB’s QE, Brexit uncertainties, and

German economic transition could continue the

downside pressure, but could be offset by the lower

Italian risk, disappointing fiscal expansion and

cheap valuations.

GBPUSD A no-deal should be averted by October

31, but all bets would be off in case of general

elections. A dovish BoE and signs of economic

deceleration could also cap GBP.

USDJPY The JPY remains hostage to its safe-haven

status and the lack of BoJ ammunition. We see

moderate downside for this cross.

U.S. vs. RoW macro differentials


U.S. vs. RoW rate differentials




11

U.S. balances (including current account, budget

deficit, domestic debt leverage) continued

deteriorating. However, these long-term forces should

drag down the dollar, albeit over the medium term.

Finally, any new U.S.-China trade war escalation could

increasingly threaten consumers, which have been the

stronghold of the U.S. economy. The last targeted

tranches of imports from China are heavily geared

toward consumer discretionary and tech goods. The

dollar could start to peak if the tariffs announced for

December 1 were implemented.

In summary, we see continued dollar resilience,

especially against several cyclical currencies sensitive

to commodities, global trade and China. Conversely,

USD would weaken against other safe havens (JPY and

CHF) that strengthen when risk aversion mounts.

EURUSD: Range trading thanks to receding risks

The euro has steadily lost ground versus the dollar

over 2019 returning to levels unseen since 2017.

Lingering pressures could maintain a lid on the euro

despite its cheap valuation. The announced ECB’s

quantitative easing would match the Fed’s easing,

despite the limited expected impact of the package

on inflation and growth. The receding odds of a no-

deal Brexit on October 31 only temporarily improved

sentiment in our view. with uncertainty likely to come

back and forth slowing GDP growth in the euro area

amplified by the German recession will warrant

continuous monetary support

Yet, EUR downside seems limited. The risk premium

from the Italian political instability has faded.

Prospects of early elections are delayed for several

months at least. Talks of a meaningful fiscal

expansion will intensify but may eventually

disappoint. Speculative positioning remain euro

short. Finally, the bad news is already priced in.

We expect some range trading in the quarter to come,

with volatility paced by Brexit developments. We see

EURUSD at 1.09 in three months and 1.15 in one year.

GBPUSD: Brexit still the wild card

The standoff between the UK government, pushing to

achieve Brexit by October 31, and Parliament, a

majority of which is opposed to a no-deal, is not over

yet! PM Johnson lost key votes in Parliament and faces

legal challenges regarding its suspension. While

striving to reach an agreement with the EU, he will

probably seek to bypass legislation forcing him to

request a delay. If the PM refuses to abide, his

resignation or a no-confidence vote could be in the

cards.

Therefore, general elections are increasingly likely

by year-end, although the government and the

opposition will fight to set the date that suits them

best. Even if the fragmented opposition manages

to avoid a no-deal by October 31, it might fail to

campaign along coherent lines. A hard-Brexit Tory

government remains possible which may force a

withdrawal by year-end or early next year. The

probability of a disorderly exit remains below

50%, in our view.

Meanwhile, the political turmoil comes at a time

of a UK economic deceleration. This would also

contribute to cap any GBP valuation catch-up.

Accordingly, we expect GBP to hover in a 1.20-1.25

range in the coming quarter. We retain a GBPUSD

three-month target at 1.22. Longer-term targets

currently seem unreliable as they above all

strongly depend on the forthcoming political

developments.

USDJPY: Further downside

The slowing Chinese growth and trade war

uncertainties are likely to keep boosting domestic

repatriation flows (driven by a slight tightening in

the U.S.-Japan yield differential), while pushing

the BoJ for action.

However, there is only so much the BoJ can do to

reflate the economy. A small rate cut coupled with

a limited fiscal boost might not be decisive

enough to stem safe-haven flows. These are likely

to persist if economic global downside risks

worsen.

While supported by its safe-haven status, JPY

could also gain ground versus Asian currencies,

including CNY if trade tariffs rise further.

We see USDJPY at 105 in three months and 107 in

one year.

Receding odds for a Brexit as of October 31

Source: PredictIt, Macrobond, Lyxor AM



12

COMMODITIES

BRENT: A SHORT-LIVED PREMIUM

Three days after the drone attack on Saudi key oil

infrastructures, which disrupted half of its production

and sent Brent above $70/b, the newly appointed

Saudi Energy Minister alleged that output would be

restored by month-end. Exports would be largely

unaffected, and the premium on oil prices is unlikely

to last without further geopolitical stress.

The U.S.’s maximum pressure policy on Iran seems to

have failed so far. If Iran is behind the attack, this

would stress its determination to deflect U.S.

pressure amid heavy economic sanctions. Ready to

risk retaliations, President Rouhani may be gambling

on Trump’s reluctance to get drawn into a military

conflict, while seeking leverage to negotiate the

nuclear deal. In response, the U.S. may increase

sanctions and pressure its local allies to retaliate,

starting with Saudi Arabia.

The vulnerability of Saudi’s oil infrastructures to

additional strikes and the likely response to the

recent attack – albeit cautious enough to avoid

inflaming the region – could keep Brent prices

around $65/b in the short run. This $5 premium

would be consistent with heightened tensions in the

Middle East and protracted uncertainties in Libya and

Venezuela.

In the medium term, we see Brent prices returning to

the lower range of our $60-65 range on a 12-month

horizon. Recent events are testing the solidity of the

OPEC+ alliance (and its output discipline), which

could be hard to rebuild if broken. Higher oil prices

could also encourage U.S. producers to increase

output, thus rebalancing the market. A structural oil

market oversupply and a slowing demand, caused by

the global economic deceleration, would also cap the

upside.

GOLD: FUNDAMENTALS UNDERPIN A GOLD

HEDGE

We have stayed Neutral on gold in H1. However, the

brutal trade war escalation since August, and

crushing bond yields, has led us to turn Overweight.

We reiterate our stance as we see further upside

potential.

KEY VIEWS

Brent. Heightened geopolitical tensions in the

Middle East warrant a modest risk premium.

Prospects of renewed strikes and a likely

response to the drone attack calls for a modest

premium. Brent would ultimately revert to the

low range of our 12M [$60-65/b] target

Gold. We still see a case for holding gold on the

back of low yield environment, downside

economic risks, and additional investors and

central banks’ purchase.

Copper. The backdrop would remain contrasted

amid adverse macro drivers and Chinese end-use

copper demand. We have a mild constructive view

as valuation is undemanding and long-term

demand is supportive.

Prices after major oil disruptions


Slowing oil demand




13

Gold should also remain supported by the growing

stock of global debt trading below zero (~30%), and

investors are increasingly seeking alternative income.

Furthermore, there is room for extra gold allocation

and central bank purchases, which stand below

levels observed in previous late cycles.

Gold prices should benefit from a favorable

risk/reward asymmetry. The downside seems modest

at this stage as uncertainty remains elevated. Gold

offers protection in the event of a recession or should

trade negotiations fail.

Several factors could limit potential price rises,

namely the absence of market tightness, muted

inflation and the firmness of the dollar (which may

eventually cap the upside). We raise our 3M target to

$1600/oz, and our 12M target to $1700/oz.

COPPER: IN CROSS CURRENTS

The fundamental landscape should remain contrasted

in Q4, eclipsing the longer-term bullish drivers. Slowing

demand has led to some stock rebuilding. In particular,

demand from China has been volatile with only a

modest impulse to infrastructure spending. Meaningful

Chinese stimulus measures have merely matched the

various rounds of higher trade tariffs and have been

modest in infrastructures. The Chinese economy is only

just stabilizing, but not improving yet. At a broader

macro level, downside risks to the global economy,

muted inflation, and a firm dollar should not provide

tailwinds either.

In the short term, cheap relative valuations, oversold

technicals, and a persisting backwardation could

limit the downside.

We remain cautious given our base case of continued

trade frictions, and reactive rather than proactive

Chinese stimulus. A trade truce could provide the

conditions for a rally, but it is premature to be long in our

view. Our 3M and 12M copper targets stand at $5700/t

and $6000/t, respectively.

Gold and real yield correlation persists


Central banks purchases have further potential


Copper demand slowed in sync with global trade




14

DM EQUITIES

U.S. EQUITIES: NUMEROUS HEADWINDS

LIMIT UPSIDE POTENTIAL

The Fed and the trade war are the main culprits. While

the trade war is a drag on growth, so far Fed easing has

mitigated the impact on equity markets. However, both

the U.S. and China now seem keen to resume

negotiations to reach a truce. Yet, a tariffs elimination is

not on the agenda, so manufacturing and exports will

continue to slump.

The Fed is willing to provide preemptive cuts As such, we

expect the Fed funds rate to be lowered by 75bps in final;

this should help protect markets from a sell-off.

Nevertheless, the lingering political uncertainty and

dullish macro outlook suggest keeping a Neutral stance.

We expect a directionless market into year-end with

wobbles triggered by the trade war newsflow and other

political issues (Brexit, or Middle-Eastern geopolitics).

Corporate profit growth should continue to slow in

coming months as sales decelerate and margins come

under pressure from rising costs. We estimate that top-

line revenues should grow at a low single-digit pace this

year and next. We slightly downgraded our forecast to

include lower GDP growth, a still firm USD and range-

bound oil prices above 60 $/b.

Based on our proprietary model, we expect S&P 500’s

sales-per-share to grow 2.8% in 2019 and 4.1% in 2020,

a significant deceleration compared to 2018 (+9.3%).

Our forecast points to slightly lower EPS growth than

currently estimated by the consensus. We believe U.S.

companies could continue to buy back their stocks, with

an estimated accretion of 1%, albeit at a slower pace

than in prior years.

The critical point for earnings-per-share (EPS) is the risk

of further profit margin compression. Given the

sustained job market, wages are growing at 3% YoY,

faster than labor productivity (around 2%). Even if the

resulting rise in unit labor costs is partly passed on into

selling prices, margins should narrow. Overall, we

believe S&P 500’s EPS should hardly grow on average

this year before picking up slightly by around 4% next

year, giving little support to the equity market.

KEY VIEWS

UW Global equities. As global growth falters and

earnings forecasts are set to be trimmed, we reduce

risk despite broad-based policy easing.

Neutral U.S. Resilient growth, defensive features,

and a bias towards growth stocks make the U.S.

our preferred market among DM.

UW Eurozone. With manufacturing activity in the

doldrums, and fiscal stimulus still elusive, Eurozone

equities may feel the brunt of the global slowdown.

Neutral UK. A no-deal Brexit is still looming ahead,

but fair valuation, high yielding stocks and

sensitivity to the GBP could provide protection.

UW Japan. Valuation is undemanding, but the

macro outlook remains impaired by the trade war.

A yen appreciation is another downside risk.

Low single digit sales growth next year


U.S. margins are under pressure




15

Given slower economic growth, higher input costs and

rising trade tensions, the bottom-up consensus has

revised down EPS forecasts for 2019 to 1.9%, from close

to 5% at the beginning of the year. Looking ahead, the

consensus still appears too optimistic with a 10% EPS

growth projection for next year. Further downgrades are

very likely in the coming months, so expect some

disappointments during the upcoming quarterly

reporting season.

Given lackluster profit growth, the stock market

performance has been driven mainly by higher

multiples since the beginning of the year. The price-to-

earnings (P/E) ratio of the S&P 500 has risen by 2pp to

17.4 from 15.4 early this year, contributing to 60% of the

total return year-to-date. As current valuations look

expensive – at well above 10-year averages – this gives

limited cushion in case of a negative surprise. We expect

some mild P/E compression by year-end due to lower

PMI prints and a rebound in inflation expectations.

Within sectors, we prefer selectivity and quality stocks.

As bond yields have decreased on the back of lower

growth expectations, investors are chasing for yields in

credit, and equities too. As global growth is ebbing,

investors remain stuck to stocks offering stable and

robust growth, warranting a steady outperformance of

the IT sector.

Too early for Value to outperform Growth: Neutral.

Growth stocks have outperformed Value stocks since

2009, the longest streak since the 1970s. U.S. Growth

stocks are expensive, with a relative trailing P/E at 1.6

versus Value stocks. However, they offer higher EPS

growth prospects than Value companies, an important

factor when growth becomes more sluggish.

Traditionally, weak economic growth and low bond

yields have not been supportive for Value stocks as

banks account for a significant fraction of the bucket.

Neutral U.S. Small caps versus Large caps. The Russell

2000 index grew 17.5% YTD, under-performing the S&P

500 that grew 19.6% YTD. Small caps valuation looks

attractive, at one standard-deviation below long-term

average.

However, the U.S. slowdown and rising wages do not

bode well for SMEs earnings growth. Although they are

less exposed to global trade uncertainty, they also have

less leeway to deal with rising cost pressure and to

preserve their profit margins than large caps.

Bottom-up earnings forecast too bullish


Growth stocks highly priced versus value


Wage growth detrimental to small caps


U.S. equities more expensive than European ones




16

UNDERWEIGHT EMU EQUITIES: DOWNSIDE

RISKS STILL LOOM

Eurozone equities have been resilient despite

underwhelming macro prints and lingering political

risks, so far. From a total return perspective, the Euro

Stoxx is at par with S&P 500 posting a 21% jump YTD.

Eurozone stocks performance has been underpinned

by a pullback in yields and a softening euro. With a

growing fraction of bond markets posting negative

yields, investors are seeking dividend yield in the equity

space. However, we see risks tilted to the downside,

warranting an Underweight stance. Inflation remains

stubbornly low and the recent ECB package is unlikely

to lift it much higher. Growth is being hit by the trade

war, the manufacturing recession and political risks

(Brexit, Italy). Consensus forecasts have been reduced to

only 1.1% for 2020 GDP and could be downgraded

lower. From a bottom-up perspective, EPS growth

expectations currently above 10% for 2020 (after 1.2% in

2019) look too optimistic and could be trimmed.

Underweight EMU Cyclical versus Defensive. As the

business climate is worsening, we are keen to shift

exposure to defensive stocks. Cyclical stocks valuation

looks unappealing, while defensives could outperform

as a growth bottom is not yet in sight.

Overweight EMU Large caps versus Small caps. Small

caps relative performance versus large caps is mainly

driven by currency valuation. As we foresee the EURUSD

trading at, or below, current spot prices, we expect large

caps to outperform small caps. Yet, possible auto tariffs

and further weakening Chinese demand could be

adverse factors that require close monitoring.

Neutral on Banks, with a tactical Buy. Banks have

underperformed the market with a 5% total return fully

attributable to dividend distribution. Despite mainly

elevated dividend yields, the sector does not appeal to

most investors. Solvency issues have been addressed

and the share of non-performing loans is steadily

declining across the region. With the ECB’s new tiering

system on excess liquidity, the bank is signaling it is

addressing some side effects of negative yields. But the

sector remains plagued by weak profitability amid flat

revenue growth, rising regulatory requirements and

sticky operational costs. The modest uptick in bank

lending is insufficient to lift returns on equity, and

certainly not yet at par with the cost of equity. The

perspective of low rates for longer is a powerful drag on

the overall sector valuation, which may have fallen in a

value trap. All in all, we keep a Neutral stance on EMU

banks as most of the bad news looks already priced in,

and any positive surprise in terms of growth or, less

likely, regulations could unleash upside potential.

Low EPS growth undermines Eurozone


Prefer defensive to cyclicals


Weak EUR favors large caps


Banks dependent on the macro outlook




17

NEUTRAL ON UK EQUITIES: STILL A MESSY

BREXIT

UK politics are still on shaky ground and investors

remain concerned about the Brexit outcome. Although

we believe a softer Brexit is more likely, the odds of a no-

deal Brexit have risen and have put UK assets under

pressure. Equity markets have underperformed

European peers and the GBP tested historical lows this

summer. UK stocks remain highly sensitive to oil prices

given the share of oil and commodity multinationals

stocks in the basket. They also appear negatively

correlated to GBP - currency weakness tends to boost

the equity market.

The uncertain environment has sent the UK economy

sliding, implying a drag on future earnings growth for

domestic focused companies. Note also that range-

bound commodity prices, in particular oil, are not

conducive to a strong performance of commodity-

related multinational companies listed in London.

However, UK equities could remain supported by fair

valuation, high dividend yields (around 5%) and a weak

pound.

JAPANESE EQUITIES: STILL A “YEN PLAY” FOR

THIS CYCLICAL MARKET

Japanese equities remain heavily driven by overall

market sentiment and global macro momentum.

The business outlook has deteriorated significantly on

the back of the global trade slump, diplomatic row with

South Korea, and a struggling overseas car market. As an

export-geared economy, the Japanese stock market is

highly dependent on global growth. The worsening

business outlook is driving down Topix EPS growth.

Also, the negative correlation between the yen and the

stock market is still elevated. As we expect a moderate

appreciation of the yen against dollar, this should impair

equity performance. The ongoing progress in corporate

governance aimed at improving stock holders return

and attractive valuation are not strong enough to offset

international headwinds. We remain on the sidelines

while maintaining an Underweight stance on Japanese

equities.

UK equities linked to oil and GBP


UK stocks trade at fair valuation


Japanese earnings driven by business outlook


JP equities: still a currency play




18

EMERGING MARKET EQUITIES: MORE

DIFFERENTIATION

The Chinese long-term transition, firm dollar and

trade war could still weigh on EM economies - even in

the likely case of a truce. However, Chinese stimulus

measures and dovish EM policies will mitigate the

impact. We see more dispersion across EM markets,

given their sensitivity to trade, China and the dollar, as

well as uneven valuation and risk pricing. We are

moderately Underweight, with more differentiated

positioning by country.

EM EQUITIES: CONTINUED PRESSURE WITH MITIGATING FACTORS

EM economies haven’t reached their bottom yet

Forecasts for the real GDP in EM economies have been

cut by -0.3% in aggregate since the summer. We expect

continued pressure for three reasons.

First, the trade war should continue to hit exports and

Asian economies. The chances of a trade truce between

the U.S. and China are rising but a partial deal would not

lead to a substantial rollback of tariffs, while persisting

uncertainty should still weigh on corporate capex.

Second, China’s transition to a services-based economy

is a game-changer for global manufacturing and is not

over yet. Chinese growth is still decelerating despite

several broad-based easing measures, which is

spreading to most EM economies.

Third, a firm dollar, boosted by favorable economic and

monetary differentials as well as by safe-haven flows

could remain a drag.

Mitigating factors are pending

Since 2018 Chinese exports to the U.S. have weakened

by 8% and extra tariffs since September could cost

another -0.2% of Chinese growth (possibly -0.6% if a

maximum tariff escalation). China could keep adding

targeted stimulus, the size of which would be

determined by trade tariffs. Tax cuts, monetary easing,

infrastructure spending could absorb about half of the

impact. Weaker CNY (down -2% since July) would also

contribute in case of a full escalation scenario. These

measures will benefit most EM economies.

Moderate fiscal expansion and central bank rate cuts in

EM economies would also cushion their growth

slowdown. Rate cuts worth about -40bp in aggregate

are expected within the next twelve months.

Increased EM differentiation is in store

We expect EM economies to differ according to their

exposure to trade, China and the dollar. Supply

chains revamping would ultimately benefit Taiwan

(tech exports substitution), Vietnam (manufactured

goods), Brazil (agricultural products), or Mexico (a re-

export hub). Meanwhile, Argentina, South Africa,

Turkey, Indonesia, and South Korea would remain

sensitive to dollar trends and liquidity conditions.

Receding Trump’s trade negotiation leeway?

Source: Bloomberg, Lyxor AM

Chinese exports to the U.S. reduced by 8%


Chinese stimulus failing to turn the economy yet




19

We also observe that trade risks are unevenly priced.

Trade-sensitive stocks are not factoring in extra tariffs,

while EM and Chinese equities might only partially price

in the global trade issues and China’s GDP at 6%. In

contrast, underperforming EM vs. developed markets

might be phasing out, on the back of more appealing

relative P/E multiples and dividend yields and fading EM

assets outflows.

We acknowledge that a U.S.-China trade truce could be

tactically supportive for EM markets. Yet, we remain

strategically UW for now and expect greater country

dispersion.

EM Asia

We are UW Chinese equities. China could seek to delay

any further tariff escalation without strategic

concessions. In return, the U.S. could keep most tariffs in

place but refrain from further increases. Increased

stimulus would partially offset the extra drag on China’s

GDP but would not fully overcome the slowdown

induced by the long-term Chinese transition. Greater

financial access will be a positive for the long term. A

fragile trade truce seems in sight, but we see limited

upside given the moderate trade pricing.

We remain OW on Indonesian equities. The macro pulse

is resilient. The trade war impacts are mitigated by

monetary easing and fiscal expansion, tame inflation

and low budget deficits. Key risks stem from the current

account deficits and the dried-up global liquidity. Long-

term upside will be provided by the U.S. and China

supply-chain revamping and Chinese investments.

Equities are cheap after the recent correction.

We downgrade Thai equities to UW. Economic and

export trends are weaker due to slower global demand

and tourism. The strong resilience to the trade war could

be tested by a new tariff escalation, though greater fiscal

support could mitigate the impact. The military junta

government should maintain stability and support

infrastructure initiatives such as China’s Belt and Road

initiative. But political risks will resurface ahead of the

2024 elections. Valuations have become rich.

We are Neutral on Indian equities. Key challenges

remain intact, such as to: 1) revive growth through

consumption, 2) fix high unemployment through

reforms, 3) fix a weak financial system and NPL, 4)

navigate the alliance with the U.S. while resisting

pressure on U.S. imports from India (a partial trade

agreement is imminent). Steps to reinforce territorial

integrity and the long-term Kashmir struggle imply

some tail risks. On the positive side, isolation from the

trade war, cheap valuations and an attractive tactical

backdrop are keepingus Neutral.

We are UW on South Korean equities. The country

would ultimately benefit from the tech supply chain

revamping but growth is slowing rapidly with the

ongoing trade war, slower growth in China and USD

strength. Japanese sanctions hitting South Korean

key industries (tech and chemicals) are likely to

worsen. The issue is not systemic, but is another

challenge. Equities are not cheap, margins are

declining, and a high beta to tech and China is

keepingus on the sidelines, for now.

Latin America

We upgrade Brazilian equities to OW. The economy

is accelerating, driven by capex and consumption.

Further progress will hinge on the pace of reforms.

Brazil is likely to benefit from the trade war, and

equities show limited correlation to China. Valuation

is increasingly stretched, but we see further upside

from lower rates supported by tame inflation.

We downgrade Mexican equities to UW. Despite

limited fiscal slippage and contained inflation, the

unfavorable backdrop from slowing U.S.

manufacturing, uncertain USMCA ratification, U.S.

upcoming election, and a negative macro pulse

makeus cautious. We see limited catalysts until

budget clarity improves. So far, the budget proposal

is based on an optimistic +17% in oil output.

Valuation is cheap but offers limited upside.

EMEA

We upgrade Russian equities to OW. The macro

pulse has lost traction, but fundamentals should

help weather sanctions and oil volatility. Case in

point: a low public debt, current account surplus

boosting FX reserves and assumed oil prices at only

$40/b. Russia is also strengthening trade ties with

non-Western partners. The U.S. or the EU do not

seem determined to escalate tensions. A lower risk

premium due to signs of détente, oil prices above

$60/b, affordable valuations, high carry, and Russia’s

relative trade war isolation all look attractive.

Dovish EM central banks




20

ALTERNATIVE STRATEGIES

CTA STRATEGIES’ WINNING STREAK

REACHES A CEILING

CTA strategies delivered buoyant returns in Q3 (+2.1%

up to September 17), according to Lyxor UCITS Peer

groups. CTAs were fueled by trends in fixed-income

markets and, to a lower extent, in FX and commodity

markets. The dramatic fall in bond yields more than

offset volatile equity returns following the escalation of

trade tensions between the U.S. and China in August.

But in early September, the bond trend reversal was

harmful for CTAs. Despite the severity of the hit (CTAs

down -5.1% between September 3 and September 17),

it did not erase gains achieved earlier in Q3.

Concurrently, L/S Credit and Global Macro strategies

also outperformed (+1.2%). The former benefitted from

supportive credit market conditions while the later,

despite being heterogeneous, appears to have

benefitted from a flattening Treasury curve in the 2s10s

segment and short positions on FX carry.

Going forward, we maintain exposure to “carry” via

strategies such as Global Macro in EM and L/S Credit. In

our view, the recent rise in bond yields is likely

temporary. The search for yield is thus an investment

theme likely to stay relevant in the quarters to come.

Concurrently, elevated political risks lead us to maintain

a defensive set of recommendations for the remaining

strategies. We maintain Market Neutral L/S Equity and

Merger Arbitrage at Overweight. Both strategies have an

equity market beta below 15% (based on monthly

returns of the HFRI over the past ten years). They also

offer a solid track record in bad times, when risk assets

suffer important losses. Along these lines, Directional

L/S Equity stands at Underweight. The strategy was

rather defensive in August, but is highly unlikely to

deliver positive returns if market conditions deteriorate.

We believe risks on equity markets are asymmetric at

present, with major markets close to all-time highs amid

a global manufacturing recession and elevated political

risks (trade wars, Brexit). We are concerned investors

might move earlier than usual over the course of Q4-19

to lock in their annual performance, after an exceptional

year for both equity and bond markets. Finally, CTA,

Global Macro and Special Situations stand at Neutral.

KEY VIEWS

L/S Equity (Neutral)

OW L/S Market Neutral

UW Directional L/S

Event Driven (Overweight)

OW Merger Arbitrage

N Special Situations

L/S Credit/FI Arb. (Overweight)

OW L/S Credit

N Multi-Credit FI Arbitrage

Global Macro (N)

OW EM Macro

N Systematic and Discretionary Macro

CTAs (Neutral)

Performance of Lyxor UCITS Peer Groups in Q3

Lyxor Peer Groups aggregate 241 liquid alternative

strategies (as of September 2019).


Investment views on hedge-fund strategies

Source: Lyxor AM

UW N OW

Hedge

Funds

L/S Equity Directional Special Situations

FI Multi-Strategy

Systematic Macro

Discretionary Macro

CTAs

L/S Equity Market

Neutral

Merger Arbitrage

L/S Credit

EM Global Macro



21

L/S EQUITY: PREFER MARKET NEUTRAL L/S

OVER DIRECTIONAL L/S

Equity markets remain prone to sudden bouts of

volatility due to the likely escalation of trade tensions in

Q4-19, the global manufacturing recession and Brexit-

related tail risks. Such headwinds are counterbalanced

by Central Banks’ dovishness. Yet, we believe the

Federal Reserve is likely to act cautiously for now to keep

some ammunition to fight the next recession. Our views

thus maintain a defensive bias.

We stay constructive on Market Neutral L/S strategies

(OW) over Directional L/S Equity (UW) ones. The former

offers protection due to their low equity market beta.

This has helped protect portfolios during market selloffs

in recent decades. However, the strategy tends to have

a momentum bias in equity markets. Recently, several

strategies were negatively impacted by the momentum

reversal. We believe this shock is likely to be short lived,

however. Momentum stocks are currently tightly

correlated with low beta stocks, which we find

appealing due to elevated policy uncertainties.

Directional L/S Equity strategies have been resilient. We

estimate a stabilized market beta below 20% since May,

which was helpful when risk aversion rose in August.

Alpha generation from such strategies has improved.

Yet, if risk aversion rises in the coming months, as we

fear, Directional L/S strategies would suffer. Prefer

low/vol defensive strategies to cyclical/value ones.

EVENT-DRIVEN: PREFER MERGER ARBITRAGE

TO SPECIAL SITUATIONS

In Event-Driven, we maintain our preference for Merger

Arbitrage (OW) vs. Special Situation strategies (N) as

part of our defensive market bias.

Lower M&A volume in Q3 hit Merger Arbitrage

strategies and consequently deal spreads tightened.

Yet, deal spreads can be volatile and mid- to long-term

investment decisions should not rely solely on the level

of deal spreads.

Our appetite for Merger Arbitrage lies on its defensive

properties, which, in our view, are increasingly

appealing in a context of low or negative interest rates.

If trade tensions between the U.S. and China escalate

further, then the low beta/low volatility features of the

strategy will help protect portfolios.

Regarding Special Situations, we stand at Neutral. The

strategy has reduced its market exposure in a similar

fashion to Directional L/S equity strategies. Yet, its

market beta remains structurally higher than Merger

Arbitrage strategies and would thus face more hurdles

if market conditions deteriorate.

Prefer low beta vs. high beta L/S Equity strategies

Source: HFR, Macrobond, Lyxor AM

We assume the momentum crash to be short lived

Dow Jones market neutral indices. Source: Macrobond, Lyxor AM

U.S. M&A volumes eased during the summer

Source: Eikon, Macrobond, Lyxor AM

Deal spreads stand below the 3-year average

Deal universe includes spreads in the 0-30% range.

Source: UBS, Macrobond, Lyxor AM

0

1

2

3

4

5

6

7

8

9

Jul-16

Sep-1

6

Nov-1

6

Jan-1

7

Mar-

17

May-1

7

Jul-17

Sep-1

7

Nov-1

7

Jan-1

8

Mar-

18

May-1

8

Jul-18

Sep-1

8

Nov-1

8

Jan-1

9

Mar-

19

May-1

9

Jul-19

US M&A deal spreads (median, annualized, %)

3Y Average



22

CTA/MACRO AT NEUTRAL

Over the course of Q3, we neutralized our preference for

CTA vs. Global Macro to bring them both at Neutral at

present (from Global Macro at UW previously). We

maintain this stance.

The rationale for aligning the stance on CTA and Global

Macro was related to concerns about potential trend

reversals in fixed income. Bond yields reached

extremely low levels during the summer, in particular in

Europe. The upward trend in bond prices was stretched,

in our view, and we upgraded strategies providing a

hedge against a spike in bond yields, which materialized

in early September. Several Global Macro strategies

were positioned for such an event and benefitted from

it, while CTAs suffered a drawdown. Both strategies

remain complementary going forward.

CTAs’ elevated net long positions on fixed income have

normalized at lower levels since the late-summer spike

in bond yields. Meanwhile, the bleak macro picture and

elevated policy risks do not suggest they should

continue to rise sustainably in the short- to medium

term. We keep CTAs at Neutral. The strategy provides, at

the time of writing, a cushion against a “no deal” Brexit

thanks to limited positions on equities and short GBP vs.

USD trades in FX.

We also maintain exposure to EM-Global Macro

strategies (OW). The search for yield is an investment

theme which is likely to stay relevant for the quarters to

come as major central banks have engaged in

additional monetary easing.

FIXED INCOME (FI): PREFER L/S CREDIT TO FI

ARBITRAGE

Our views on L/S Credit have been constructive in

recent months, assuming that i) sovereign bond yields

are low and will remain so for longer; ii) carry strategies

such as HY Credit benefit from a portfolio rebalancing

effect, whereby low bond yields on safe long-term

securities compress the risk premia for lower graded

securities; and iii) L/S Credit strategies benefit from this

compression in risk premia while reducing volatility in

portfolios.

We estimate that L/S Credit strategies have halved

volatility in HY Credit returns over the past ten years.

We calculated that the information ratio of L/S Credit

has been close to 2, significantly above both the Euro

and USD HY ratio over the same period (1.2).

We downgraded the Fixed-Income Arbitrage strategy

in Q2 to incorporate carry strategies such as L/S Credit

and EM Global Macro. We maintain this stance going

forward.

The bond trend reversal was painful for CTAs

Total return, local currency indices. Standardized series

return a normalized series (mean is 0 & standard deviation

is 1). Sources: Bloomberg, Macrobond, Lyxor AM We stay OW EM-Global Macro strategies

Source: Macrobond, Lyxor AM HY spread tightening should support L/S Credit

OAS spreads vs. government benchmarks. Source: BAML,

Macrobond, Lyxor AM L/S Credit vs. HY: higher risk adjusted returns




23



24

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Past performance is not indicative of future results, and it is impossible to predict whether the value of any fund

or index will rise or fall over time.

While the information in this material has been obtained from sources deemed reliable, neither Société Générale

(“SG”), Lyxor Asset Management S.A.S. (“Lyxor AM”) nor their affiliates guarantee its accuracy, timeliness or

completeness. We are under no obligation to update or otherwise revise such information if and when it changes.

Any opinions expressed herein are statements of our judgment on this date and are subject to change without

notice. SG, Lyxor AM and their affiliates assume no fiduciary responsibility or liability for any consequences,

financial or otherwise, arising from an investment in any security or financial instrument described herein or in any

other security, or from the implementation of any investment strategy. Lyxor AM and its affiliates may from time to

time deal in, profit from the trading of, hold, have positions in, or act as market-makers, advisers, brokers or

otherwise in relation to the securities and financial instruments described herein. Service marks appearing herein

are the exclusive property of SG and its affiliates, as the case may be.

Hedge funds may invest in futures and other derivative instruments. Futures trading and other derivatives may

permit extremely high degrees of leverage and expose the funds to, among other things, volatility, market

illiquidity, market risks, legal risks and operational risks. Hedge funds may be exposed to risks relating to non-

domestic markets, including, but not limited to, risks relating to currency exchange, tax, lack of liquidity, market

manipulation, political instability and transaction costs. An investment in a hedge fund can be subject to total loss.

This presentation contains the views of Lyxor AM analysts and/or strategies. The views espoused in this

presentation may differ from opinions and recommendations produced by other departments of SG.

Note about Indices: Indices are not available for direct investment. A comparison to an index is not meant to imply

that an investment in a fund is comparable to an investment in the funds or securities represented by such index.

A fund is actively managed while an index is a passive index of securities. Indices are not investable themselves,

and thus do not include the deduction of fees and other expenses associated with an investment in a fund. Not all



25

the funds that comprise indices cited herein are suitable for U.S. Investors as a result of, among other things, the

implementation of the Volcker Rule. Please see the offering documentation for these funds for more details.

Notice to U.S. Investors: Any potential investment in any securities or financial instruments, the categories of which

are described herein, may not be suitable for all investors. Any prospective investment will require you to represent

that you are an “accredited investor,” as defined in Regulation D under the Securities Act of 1933, as amended, and

a “qualified purchaser,” as defined in Section 2(a)(51) of the Investment Company Act of 1940, as amended (the

“40 Act”). The securities and financial instruments described herein may not be available in all jurisdictions.

Investments in or linked to hedge funds are highly speculative and may be adversely affected by the unregulated

nature of hedge funds and the use of trading strategies and techniques that are typically prohibited for funds

registered under the ’40 Act. Also, hedge funds are typically less transparent in terms of information and pricing

and have much higher fees than registered funds. Investors in hedge funds may not be afforded the same

protections as investors in funds registered under the ’40 Act including limitations on fees, controls over

investment policies and reporting requirements.

Notice to Canadian Investors: Any potential investment in any securities or financial instruments, the categories

of which are described herein, may not be suitable for all investors. Any prospective investment will require you to

represent that you are a “permitted client,” as defined in Canadian Regulation National Instrument 31-103, and an

“accredited investor,” as defined in National Instrument 45-106. The securities and financial instruments described

herein may not be available in all jurisdictions of Canada.

For more information, U.S. and Canadian investors and recipients should contact Lyxor Asset Management Inc.,

1251 Avenue of the Americas, New York, NY 10020 or [email protected].

Notice to U.K. Investors: This communication is issued in the UK by Lyxor Asset Management UK LLP, which is

authorised and regulated by the Financial Conduct Authority in the UK under Registration Number 435658.

Source: This document has been prepared by Lyxor Asset Management S.A.S., 17 cours Valmy, 92800 Puteaux.

Lyxor AM is a French management company authorized by the Autorité des marchés financiers and placed under

the regulations of the UCITS (2014/91/UE) and AIFM (2011/61/EU) Directives. Lyxor AM is also registered with the

U.S. Commodity Futures Trading Commission as a registered commodity pool operator and a commodity trading

advisor.

mailto:[email protected]



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Lyxor Asset Management

Tours Société Générale - 17 Cours Valmy 92987 Paris La Défense Cedex - France

www.lyxor.com [email protected]

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