Lighthouse Investment Management

Weekly Chart Window

June 24, 2013

Weekly Chart Window - June 24, 2013

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Lighthouse Investment Management

Contents
TIPS-derived Inflation Expectations .............................................................................................................. 3 Stock Market and TIPS-Derived Inflation Expectations ................................................................................ 4 Trend: Moving Averages ............................................................................................................................... 5 Trend: MACD................................................................................................................................................. 6 Divergence From 50-Day Moving Average ................................................................................................... 7 Stock Market Returns - Huge "Fat Tails"....................................................................................................... 8 Stock Market Returns - Huge "Fat Tails" (zoom view) .................................................................................. 9 Stocks Above 50-Day MAVG ....................................................................................................................... 10 Stocks Above 200-Day MAVG ..................................................................................................................... 11 Put-Call Ratio of Equity Options.................................................................................................................. 12 Net New Highs: NASDAQ ............................................................................................................................ 13 Net New Highs: NYSE .................................................................................................................................. 14 New Highs/Lows Ratio: NASDAQ ................................................................................................................ 15 New Highs/Lows Ratio: NYSE ...................................................................................................................... 16 Risk-on / Risk-Off ........................................................................................................................................ 17 Lighthouse Timing Index ............................................................................................................................. 18

Weekly Chart Window - June 24, 2013

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Lighthouse Investment Management

TIPS-derived Inflation Expectations

Observations: Inflation expectations are calculated by subtracting real (TIPS) yields from nominal yields Despite the recent rise in nominal yields, inflation expectations have declined further (real yields have risen faster than nominal yields, compressing inflation expectations)

Conclusion: Investors expect inflation to remain below the Fed's target (2% +/- 0.5) for the next 5 years. The Fed is not happy about reduced inflation expectations, as it does not force consumers to spend (as would happen in case of anticipated price hikes). This further depresses the velocity of money and counters the efforts of the Fed. It is likely the Fed will try even harder to raise inflation expectations by continuing, or even increasing, "quantitative easing" measures. The plan to gently take "the foot of the [QE] gas" has failed and will be reversed.

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Lighthouse Investment Management

Stock Market and TIPS-Derived Inflation Expectations

Observations: Since January 2012, the S&P 500 is basically uncorrelated to the yield of 10-year Treasury bonds (r2 = 0.02), but very much correlated to the expected rate of inflation over the next 10 years (r2 = up to 0.75). Since mid-February 2013, the strong correlation between expected inflation and the S&P 500 Index has reversed into a negative one. This is quite unusual.

Conclusion: Assuming the bond market (despite price manipulation by the Fed) correctly reflects market expectations, the S&P 500 should be closer to 1,400 points given inflation expectations.

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Lighthouse Investment Management

Trend: Moving Averages

Observations: All moving averages, except for the 10-day, still have a positive slope (pointing upwards) However, the 10-day mavg is about to breach the 50-day mavg, a first warning sign

Conclusion: The uptrend is still intact, but losing momentum

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Lighthouse Investment Management

Trend: MACD

Observations: The S&P 500 Index is around 10% above its 200-day moving average, which is quite 'extended'. Similar levels had been reached in April 2012. The S&P is less extended from its 50- and 100-day moving average (which is to be expected, as those averages tend to follow the index more quickly) All three derivatives of moving averages have peaked, suggesting the stock market is losing momentum.

Conclusion: Stock market needs to 'work off' its extended condition, especially from the 200-day moving average. This can be done by sideways movement. Such a 'solution' is unlikely, as the market has had no correction since November 2012 (and went up 23% since then). A significant downward move is therefore the likely solution.

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Lighthouse Investment Management

Divergence From 50-Day Moving Average

The S&P 500 Index is currently near its 50-day moving average. The index spends more time inside a +/- 1 standard deviation envelope around its average than a normal distribution would suggest (only 1,354 days outside versus 1,812 days expected). The number of days outside a 2 standard deviation envelope (265) were in line with expectations (260). However, the balance is skewed towards the downside (204 versus 61 days). The number of days outside a 3 standard deviation envelope (84) exceeded expectations (15) by far. The balance is extremely skewed towards the downside (84 versus 0 days). The Lehman-aftermath was a six standard deviation-event, which should happen only once every 2 million years.

CONCLUSION: Anything between +/- 1 standard deviation is statistical noise. +2 gets reached only after a sharp drop. -3 events much more frequent than expected under normal distribution.

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Stock Market Returns - Huge "Fat Tails"

Here we take the same data (S&P 500 Index deviation from 50-day mavg) and plot them as histogram (blue area). We overlay a normal distribution curve (red). Observed data is positively shifted and has a higher peak (more days with small and positive values). However, there is a huge "fat tail" on the negative side; observed values are up to 161,000 times higher than expected. The green boxes show which part of the curve is 'covered' by traditional VAR (value-at-risk) models (95% and 99% confidence intervals). The observed fat tail is far outside those boxes. Next page shows a zoomed-in view of the same chart

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Lighthouse Investment Management

Stock Market Returns - Huge "Fat Tails" (zoom view)

Look at how much blue (observations) occurs in the left tail, when the red line (normal distribution) suggested those observations shouldn't happen (actually only 1 at -12%) Those 'unexpected' events are far outside the range covered by VAR-based risk models (used by most banks).

CONCLUSION: The use of VAR-based risk models does not prevent banks (or hedge funds) from suffering devastating trading losses. For investors, the occurrence of a 3, 4 or 5-sigma event does not constitute a buying opportunity, as a 6-sigma event could easily happen (and there is no way to tell at which sigma a market drop will stop).

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Lighthouse Investment Management

Stocks Above 50-Day MAVG

Observations: 36% (from 66%) of the 500 stocks within the S&P Index are above their 50-day moving average

Conclusion: Less than half of the S&P 500 members are in a medium-term uptrend. This is a worrying sign. Any reading below 50% indicates trouble for the bulls.

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Lighthouse Investment Management

Stocks Above 200-Day MAVG

Observations: 79% (down from 89% a week ago) of the 500 stocks within the S&P Index are above their 200-day moving average

Conclusion: More half of the stocks in the S&P 500 Index are in a long-term uptrend. This is a healthy sign. A drop below 50% would indicate trouble.

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Lighthouse Investment Management

Put-Call Ratio of Equity Options

Observations: The equity put-call ratio (volume of puts traded relative to calls on individual stocks) has recently risen to 0.67 (from 0.64). Please note the inverse scale on the left. The reading is near the mean, but trending towards a bearish view.

Conclusion: The put-call ratio shows neither bullish nor bearish sentiment among option traders.

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Lighthouse Investment Management

Net New Highs: NASDAQ

Observations: The number of Nasdaq-listed stocks with new 52-week highs exceeds the number of stocks with new 52-week lows.

Conclusion: This means the current record highs for the S&P 500 Index are supported by a large number of individual stocks. The rally has a good 'breadth'. No warning flag, but the trend is deteriorating.

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Lighthouse Investment Management

Net New Highs: NYSE

Observations: The number of NYSE-listed stocks with new 52-week highs is less than the number of stocks with new 52-week lows.

Conclusion: The breadth of the recent stock market rally has deteriorated further. Should the correction continue, the cumulative number of net new highs will soon breach its 30-day moving average. This would be a sell signal.

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Lighthouse Investment Management

New Highs/Lows Ratio: NASDAQ

Observations: Nasdaq-listed stocks with new 52-week highs exceeds the number of stocks with new 52-week lows by a ratio of 12:1, with a falling trend (previous week = 8:1). The rally since the beginning of 2013 has been accompanied by falling peaks in the ratio, which can be interpreted as a sign of weakening.

Conclusion: A fall in the ratio below 1 would indicate trouble. This is currently not the case. However, the ratio has breached its 50-day moving average. This is a warning sign.

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Lighthouse Investment Management

New Highs/Lows Ratio: NYSE

Observations: NYSE-listed stocks with new 52-week highs exceeds the number of stocks with new 52-week lows by a ratio of 7:1, with a falling trend (previous week = 7:1). The rally since the beginning of 2013 has been accompanied by falling peaks in the ratio, which can be interpreted as a sign of weakening. As a lot of fixed-income ETF's are listed on the NYSE they distort the picture (bond ETF's often rise as stocks fall).

Conclusion: The ratio's 20-day moving average (2.3) has now fallen below 5. This is a sell signal.

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Lighthouse Investment Management

Risk-on / Risk-Off
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The general market (SPY) is outperforming high dividend shares (SDY), (red line, bullish) Stocks are outperforming bonds (blue line, bullish, but slowing momentum) The high-yield bond ETF (HGY) is outperforming investment-grade ETF (LQD); green line (bullish)

Equal-weight ETF (RSP) is underperforming market cap-weighted ETF (SPY); red line (bearish)

CONCLUSION: 3 out of 4 indicators suggest stock market is in an uptrend

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Lighthouse Investment Management

Lighthouse Timing Index

Observations: The Lighthouse Timing Index fell to 0 (previous week: +4 points)

Conclusion: Our composite index suggests that the upwards trend has ended, and delivered a "sell" signal.

Note: This index is a trend-confirming indicator, and will not be able to anticipate market tops or bottoms in advance. Due to smoothing of data, a certain time lag of about two weeks is to be expected.

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Lighthouse Investment Management

Any questions or feedback highly welcome. Alex.Gloy@LighthouseInvestmentManagement.com

Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that accounts managed by Lighthouse Investment Management or the author may have financial interests in any instruments mentioned in these posts. We may buy or sell at any time, might not disclose those actions and we might not necessarily disclose updated information should we discover a fault with our analysis. The author has no obligation to update any information posted here. We reserve the right to make investment decisions inconsistent with the views expressed here. We can't make any representations or warranties as to the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions, misinterpretation or misuse of any information posted is excluded. +++++++++++++++++++++++++++++++++++++++ All clients have their own individual accounts held at an independent, well-known brokerage company (US) or bank (Europe). This institution executes trades, sends confirms and statements. Lighthouse Investment Management does not take custody of any client assets.

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