Technical Analysis. Technical Outlook Global. Boom and Bust SPX Trades in Wave 5. Equities Sales Trading Commentary

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1 h Equities Sales Trading Commentary Technical Analysis Technical Outlook 2017 Global Michael Riesner Marc Müller 03/01/ These are sales views based on Technical Analysis. They do not represent the UBS House View. Boom and Bust SPX Trades in Wave 5 Despite the cyclical bear market event from the 2015 summer top into 2016, we always thought that a final wave 5 bull cycle would be missing to complete the 2009 long-term bull market. With the H rally, we have clear evidence that global equities are trading in a cyclical bull market, which is wave 5 in the S&P-500. The 2016 bull cycle is the last piece of an aging bull market, which we expect to continue into minimum summer 2017 and best case into H In the late stages of a bull market we usually see increasing volatility/selectivity, so we expect 2017 to be a highly volatile and trading-oriented year for investors. Here are our 2017 key calls: Post-election years have the worst track record in the presidential cycle, and in nearly "every" decade in the 7 th and/or 8 th year of the decennial cycle of the last 100 years, we had either a sharp correction if not even an outright bear market. With the US market and cyclical sectors starting on an extreme overbought position into 2017, investors being overly bullish, and the S&P-500 trading in wave 5, we see a high likelihood that the US market will move into a major top in the next 6-18 months, followed by a significant and longer lasting correction cycle. From a tactical/cyclical aspect, we expect a weaker start into the year with a corrective pullback from January into a late Q1 (March) trading bottom, as the basis for the last hurrah and potential overshooting of the 2016 reflationary cycle into a summer top, which we expect to be minimum the beginning of a volatile multi-month distributive process with increasing selectivity. Our wave 5 S&P-500 target is at a moderate 2400 to 2500, as also in 2017 our focus remains on sector rotation instead of expecting big index trend moves. Sector-wise, we remain bullish value but where early cyclicals (transport/semiconductors) are at risk of moving into a major summer top, late cyclicals (oil stocks) could continue to outperform into H2. Growth stocks will be key in 2017, and we see defensives at risk of starting another correction in H2 on the back of yields overshooting. On the macro side, the US dollar will be key variable in The DXY trades in a wave 5, which we expect to top out in late Q1 as the basis for an aggressive multi-month bear market into later 2017/early 2018, where we expect the US dollar to move into another long-term buying opportunity and resume its underlying 2008 longterm bull market. A multi-month Dollar correction is bullish commodities and Emerging Markets, where we see another rally into summer as the trigger for a climatic overshooting of the 2016 reflationary cycle. In bonds, after a Q1 mean reversion pullback, we expect US 10-year yields moving towards minimum 3.00% with risk to overshoot into H2. We see an overshooting in yields as the end game of a classic boom and bust cycle, which has the potential to bring the 2009 bull cycle to an ultimate end in H2 or at the latest in early In 2016, we saw our suggested major bottoms in crude oil, commodities and Emerging Markets as the basis for a 1.5 to 2 years lasting bear market rally in an underlying secular bear market. Into summer we expect commodities and EM's to overshoot but we see both moving into a major H2 top as the basis for a new bear market. In 2016, gold hit our suggested 8-year cycle bottom, which we continue to see as the basis for a new multi-year bull market. As in 2016, we expect 2017 to be a volatile trading year as well, where into summer we are bullish gold, silver, and gold mines before we expect another significant correction (due to higher yields) in H2. In Japan, the Nikkei-225 trades in a wave 5 bull cycle but we expect Japan to be a trading theme in 2017, where in H1 we see the risk of a negative surprise (correction in USDJPY) before starting another rally leg into H2 and tracking higher US yields, which should be bullish USDJPY. Europe is trading in a wave 5 bull cycle where the break of the 2015 bear trend and the cyclical leadership are bullish. After a tactical correction into late Q1 we expect another but final rally into summer where the Euro Stoxx should reach 3500 to However, with expecting the EUR to move into a major Q1 bottom as the basis for an aggressive rally towards 1.15/1.20 into H2 we see Europe vulnerable for a negative surprise in H2. UBS 1

2 The Late Stages of a Major Bull Market Structurally, the March 2009 low in the S&P-500 was a major bottom and we always said that nominally, this low was the starting point of a new secular bull market. In 2013, the S&P-500 broke out to a new all-time high and particularly into 2015 we have seen more and more markets globally joining the US via staging secular breakouts. Of course, no bull market is one-way and in this context (and following the 7-year cycle), we saw the risk of a cyclical bear market in summer 2015, which according to our cyclical model could last minimum into summer 2016 and where from a price perspective we saw the risk of a 20% to 30% correction in global equities. In the global context, we have effectively seen in most markets (Europe and Japan) our suggested 20% to 30% bear cycle. Emerging Markets corrected nearly 40% from their 2015 summer top. Even in the US, we had in most key sectors/markets bear cycles of 20% to 30% (Dow Transport, Russell-2000 and banks), whereas in the S&P-500 we just saw a relatively mild correction of 15%, and the market avoided reaching official bear market territory via the support of the massive outperformance of interest-sensitive and heavyweighted growth stocks. Ironically, we see especially growth stocks as a potential trigger for the beginning of the end of the wave 5 bull cycle and therefore of the 2009 bull market. Chart 1. ) S&P-500 Weekly Chart with Elliott Wave Global equities are trading in wave 5 Despite seeing the risk of a cyclical bear in the 2015/2016 time window, we always believed that a final bull wave was missing to complete the 2009 long-term bull market, which from an Elliott Wave perspective would represent a wave 5 of a larger degree. After correcting in a classic a-b-c formation (wave 4), the S&P-500 bottomed in February 2016 and therefore significantly earlier against our favored more complex wave 4 correction scenario for In early Q1, we got the bottoms in Emerging Markets, crude oil and in most commodities, which we saw as a comeback candidate in More on track with our cycle model, Europe and Japan bottomed in summer 2016 and in summer we also saw a larger breakout in cyclical/value sectors in the US and in Europe. Together with the impulsive break of the 2015 bear trends in Japan and the Euro Stoxx-50, as well as all the major US headline indices trading on all-time highs, we have clear evidence that global equities are trading in a wave 5 bull market. After the aggressive post-election rally, the key questions for 2017 will be how long and how high can this bull market still go. What will be the characteristics of this bull wave and what happens when we see wave 5 topping out? Cyclical headwind in 2017/2018 Chart 2. ) What is the most likely timing for wave 5 to top out? If we combine the principals of Elliott Wave with aspects of our cycle model, we should see wave 5 topping out in the next 6 to 18 months. According to the principals of the Elliott Wave, wave 5 is usually significantly shorter than wave 3, which lasted nearly 4 years from 2011 into So alone from this standpoint, wave 5 in the S&P-500 should last no longer than 2 years, which, projected from the February 2016 low, implies an idealized top somewhere in the next 12 months. This timing would fit very well into the cyclical nature of the markets. Post-election years have the worst track record in the presidential cycle, and in the decennial cycle it's amazing to see that in nearly "every" decade in the 7 th and/or 8 th year of the last 100 years we had minimum a sharp correction if not even an outright bear market. The only exception was the 1920's where the market continued to rally into the 1929 bubble top. In the 1940's there was a sharp bear market in 1946, where 1947 and 1948 were still part of this bear market pattern. UBS 2

3 Chart 3. ) Russell-2000 Weekly Chart Chart 4. ) S&P-500 with AAII Percentage of Neutral Investors The start into 2017 extreme bullishness and value record overbought! How do we start into 2017? If we look at the market technical, the picture of a potential major top in 2017 makes even more sense. With the post-election rally, we have seen a vertical/exhaustive extension of the 2016 reflationary trade that started last summer. On the sentiment side, the rally of the last few months pushed our sentiment studies into contrarian territory. Just to be clear, after the 2015/2016 cyclical bear market event and having seen equity outflows over nearly 12 months, we do not think that investors are overinvested yet per se, which is a key argument why this bull market should still have legs. However, we start 2017 with a very high bullish consensus, high expectations and very high conviction. The number of neutral votes in the AAII survey plummeted to a 4-year low, which suggests investors are extremely convinced on what they think about This extreme bullishness is a burden for 2017! It suggests, the likelihood is high that the best of the 2016 reflationary trade is already behind us, and it implies that the risk for negative surprises over the course of 2017 is relatively high if the fundamental side does not deliver adequately. Into this picture fits that with the exhaustive/vertical Q4 rally, cyclical key sectors in the US (financials, transport) and the Russell-2000 are in a record-high overbought position on a weekly timeframe. This fact alone weighs, since it minimum caps further upside or worst case, we would need to see a multi-month correction to Chart 5. ) Shape of Major Tops in DJI bring these sectors back into a better risk/reward position for continuing the Q4 bull-run. With this technical setup, the risk is generally high that we either see a surprisingly weak start into the year with a mean reversion correction in Q1, and/or we get a final overshooting into summer where then the likelihood is high that this already represents our suggested wave 5 top, which could be minimum the beginning of a multi-week/month distribution process and worst case the start of a severe correction into early Q4. How does a major top look like? Apart from the classic technical ingredients we typically see at a major top, another key question is what kind of patterns shape a potential wave 5 top in the S&P-500 could have. If we look at the underlying macro set up we cannot rule out that the US market moves into a classic overshooting/blow-off scenario into summer The consequence would be that we get a relatively sharp market reversal without any real distribution or longer lasting top forming process. It's surprising to see how many bear markets started in the past where the relevant top was more a sharp reversal instead of forming a larger top formation. In the last 100 years, we saw 20 bear markets in the US (defined with a correction of >20%), where in 11 cases we saw a regular and distributive top building phase, and in 9 cases we just saw a sharp market reversal, such as in 1929 and/or UBS 3

4 Chart 6. ) Dow Jones Industrial with 1929 Top Chart 7. ) Dow Jones Industrial with 1998/2000/2001 and 2008 Tops Macro setup for a reflationary Boom and Bust Cycle In 2017, it is the macro side, where the US dollar and interest rates will very likely play a central role in the question of when and why the wave 5 bull market will top out. In 2015, we said that we believe the macro background of a wave 5 bull cycle will be different versus the deflationary/disinflationary background of the high momentum wave 3 bull-run from the 2011 low into the summer 2015 top. In 2016, we expected crude oil and commodities heading into major bottoms, and (as a late cyclical outperformance phenomena) starting a 1.5- to 2-year lasting bear market rally as part of an underlying secular bear market. This is why we believed that inflation would bottom in Together with ongoing QE in Europe and Japan, plus selective fiscal stimulus, we believed that a wave 5 bull cycle could have a strongly reflationary background, which could end in a classic boom and bust cycle with rising inflation and rising interest rates, which in the past was very often the source for big bull markets topping out. Where do we stand in this scenario? In the US and European bond market, the 2016 summer low represents a major low. In Q4, US inflation expectations finally broke their 2012 down trend and with cyclicals/value having broken the 2011 underperformance trend versus growth, we have clear evidence that a large reflationary cycle is underway. The question is when and how this reflationary cycle end? Tactically, after the vertical rally in yields and cyclical Chart 8. ) US Break-Even Inflation Expectation versus US Dollar (inverse) sectors (US banks), the 2016 reflation trade is extremely stretched, where we expect a mean reversion move in bond yields into later Q1. Nonetheless, it is a key call of our 2017 strategy to expect another leg up in yields into H2 where with respect to technical key levels we cannot rule out a temporary overshooting. Within this overshooting scenario, we think the US dollar will play a central role in 2017, where at the end of the day we expect bonds and the FX side to be the source for significantly higher cross-asset volatility where we can see quite aggressive multi-month moves, which is both opportunity and risk in UBS 4

5 Chart 9. ) US 10-Year Treasury Yield Weekly Chart Chart 10. ) German Bund 10-Year Yield US dollar correction as the trigger for inflation and yields overshooting? With the rally from the May 2016 low, the US dollar trades in a wave 5 of a larger degree, which we think will complete the 2011 bull cycle (as part of the 2008 long-term bull market). From a cyclical aspect, we expect this wave 5 to top out in later Q1 and this top should be the start of a multi-month sharp US dollar correction cycle into later 2017/early 2018, where we see the US dollar moving into another big bottom and resuming its underlying long-term bull market, which we expect to continue towards the end of the decade. From a macro standpoint, a bear cycle in the US dollar is strongly reflationary as it is aggressively bullish commodities, Emerging Markets, gold and particularly silver, which we all expect to overshoot into summer and which we see as one of the great trading opportunities of So, on one hand we are clearly bullish from our suggested late Q1 tactical risk low into summer. The problem is that in the bigger picture this rally could have the character of a climatic overshoot of the 2016 reflationary cycle, which would have severe consequence for the bond market. US and EU bonds will face key levels in 2017 A potential overshooting in commodities would be the setup for another big move in US inflation expectations as the trigger for further rising yields into H2. At this point, the pattern setup in the US bond market comes into play, where we see the US 10-year Treasury yield moving into a classic make or break setup in At 3.00%, we have the secular down trend coming in, and at 3.00% we have the neckline of a potential double bottom, which effectively means that the US 10-year Treasury yield chart moves into a classic double bottom speculation in 2017!! With a potential overshooting in commodities and inflation expectations into summer (on the back of a sharp Dollar correction), we effectively see the risk of US 10-year yields breaking 3.00%, which would trigger at least a temporary overshooting towards 3.50% if not even 4.00%, and this will very likely send shock waves into financials markets. In the European bond market, we have a similar setup as in the US. The long-term down trend in the German 10-year bund is not far. A break of this trend would imply a sharp move higher in German/EU interest rates and if so, we would see this as a trigger for a reversal in the US/EU rates differential, which would pave the way for a sharp EUR rally towards minimum 1.15 and best case With such a sharp EUR rally and an aggressive move higher in EU interest rates, we see the risk of Europe falling minimum back into underperformance if not even seeing an outright negative surprise in H2. As a consequence, we see an overshooting in US yields as the end game of a classic boom and bust cycle, where a new breakdown in interest rate sensitive sectors we would see as a leading indicator for the S&P-500 to move into a major top and into a subsequent correction cycle. UBS 5

6 Chart 11. ) US/German 10-Year Rates Differential vs. DXY Chart 12. ) S&P-500 Scenario V-Shape Top Scenario 2017? Likelihood of a blow-off summer top? How does a top look like II? With such an aggressive macro scenario, we have the theoretical setup for a classic blow-off phase/top in the S&P-500 where in this case we would NOT see a classic distribution phase with forming of a classic top formation, which normally lasts several weeks if not even months. This is important since from a cyclical aspect we have two key scenarios for Looking at our cycle model, one of our key calls for 2017 is that we expect the S&P-500 to move into an important summer top. Scenario one is that we get the described blow-off top into summer, which would be the basis of a sharp market reversal and subsequent start of a significant correction leg into initially late Q3/early Q4 before starting a classic year end rebound/rally. Scenario two is, a potential summer top would be "just" the beginning of a multi-month volatile distributive top building phase, which may last into early 2018 before we see the ultimate breakdown into a bear cycle. Secular frame work remains bullish equities Regardless of any timing and how long this bull market will last, when we see wave 5 topping out, this market reversal will very likely be the beginning of a multi-year Chart 13. ) S&P-500 Secular Bull and Bear Markets corrective process (which we expect developing in a larger A-B-C pattern), which can last into early next decade and that could normally correct 38% to worst case 50% of the 2009 bull cycle, wherever and whenever the final top comes in. What would this type of correction/bear cycle mean for the secular market structure? Ironically, even a 50% multi-year bear market in the S&P-500 would still produce a higher low versus the March 2009 low at 666, which per definition would still be an intact bullish longterm price structure. In this context we remain a very long-term bull for equities. The only problem is, that in the in the next 3 to 4 years we could see a very volatile and tough time for risk assets. UBS 6

7 Chart 14. ) S&P-500 with Stocks Trading Above 200-Day MAV. Chart 15. ) STOXX-600 with Sector Weekly MACD Buy Signals What Does a Major Market Top Look Like? With the S&P-500 trading in wave 5 of a larger degree, the US market trades in the late stages of a long-term bull market. By anticipating a top in the next 6 to 18 months, one of the 2017 key questions will be what does a top look like in equities? What do we normally see as warning signals prior to a top - if we look at indicators, correlations and market internals but also with regards to our key macro scenario, where we favor a reflationary overshooting and where we see in particularly the US bond market and rising interest rates playing a central role in 2017? Increasing selectivity as a warning signal Deteriorating market breadth is a classic leading indicator for a major top. If we look at our market breadth indicators, we have to make a difference between long-term indicators and the more tactical setup in. In the bigger picture, the number of stocks and/or markets trading above their 200-day moving average gives us a very good indication of how healthy an underlying trend is. It doesn't matter whether we look at the US, at Europe or the global context; the Q4 postelection rally/breakout was relatively selective as it was just in favor of cyclical sectors, whereas defensive interest sensitive sectors suffered from strongly rising yields. Translated into market breadth, it has been producing initial divergences in the number of stock trading above their 200-day moving average in the S&P-500 and in the STOXX In Europe, we have a divergence in the STOXX-600 Chart 16. ) MSCI World with Markets Trading Above 200-Day MAV. versus the number of STOXX sectors with an intact weekly MACD buy signal, which is normally a very good trend indication and a leading indicator for important tops. In the global context, we see increasing selectivity, where the last breakout in the MSCI World was factually based on a deteriorating number of global equity markets trading above their 200-day moving average. In the bigger picture, we see these divergences as a clear warning indicator that we are trading in the late stages of a bull market and therefore also in the late stages of wave 5 in the S&P-500. However, what is missing to confirm that we are also trading-wise near to an important top are tactical divergences in our trading oriented breadth indicators, such as the number of 52-week highs and/or the ARMS index. UBS 7

8 Chart 17. ) Russell-2000 New 52-Weekly Highs Chart 18. ) S&P-500 with NYSE New 52-Week Highs In terms of momentum, the post-election rally and the breakout in December was very healthy, as it produced spikes in new 52-week highs in the S&P-500, and in the Russell The ARMS index is a flow-driven breadth indicator, where a lower extreme reading (as currently) suggests the market is pretty much overbought. Having said that, near to important tops, we normally see a multi-week if not even a multi-month divergence forming on very low levels. It visualizes upcoming internal selling pressure where the ARMS index starts moving up against the index marking a new high or trading in a distributive top building phase. Currently, we can clearly say that this is still not the case. Conclusion: Strategically, the 2016 bull cycle is starting to get selective, which indicates we have reached the mature stages of wave 5 in the S&P-500, and in the global bull cycle. Having said that, regardless whether we look at new 52- week highs and/or the ARMS index in the US or into Europe, in all these indicators we have yet no real divergence forming, which means it is minimum several months too early to get cautious let alone bearish on the markets. The extreme readings in the 50-day NYSE ARMS index and/or the number of 52-week highs in the US and/or Europe confirms that equities and particularly the post-election rally themes are massively overbought, and it makes the markets vulnerable for a pull-back in Q1. But to form a divergence in our tactical breadth work we would still need to see minimum one further rally leg that produces new highs but based on deteriorating momentum. Analytically, this has 2 implications for 2017: Chart 19. ) S&P-500 with NYSE 50-Day ARMS Index After a potential Q1 pullback, we should see another rally with new highs into summer, which, per definition, would be then the earliest timing for moving into a major top. Looking at the current overbought status of our tactical breadth work, it implies that the world in 2017 can only get more selective, which means 2017 will be very likely a stock-pickers year where even in the cyclical camp we will see more and more sectors rolling over into underperformance before the overall market tops out. UBS 8

9 Chart 20. ) Dow Jones Transport versus S&P-500 Chart 21. ) US Semiconductor Index versus S&P-500 Early cyclicals as a key indicator for identifying market tops In Q2 2016, it was the strength and breakouts in US early cyclical sectors (semiconductors, banks, consumer discretionary and/or transport) that gave us evidence/confirmation that the S&P-500 trades in wave 5, although we still did not have the ultimate breakout confirmation on the index front. In the end phase of a bull market we usually see a similar picture, where weakness in early cyclicals and/or divergences between key sectors and the S&P-500 are sending out warning signals, that also tactically, the market trades in the ultimate end phase of a bull cycle. In this context it is also important in which kind of macro pattern the markets are trading, since this has implications on the Dow Theory, so whether it is likely to see a divergence forming in transport or in the interest rate sensitive utilities sector versus the overall market. A classic leading indicator for an important market top is that we very often see the Dow Jones Transport topping out earlier versus the S&P-500. In the same context, we can see US financials and/or semiconductors. They are early cyclical and in both the bigger picture and tactically we often see banks or the SOX index basing or topping out earlier than the S&P-500. So implicitly, as long as we do not see any divergences between transport, banks and/or semiconductors versus the S&P-500, it is definitely too early to get concerned about the US market, whereas at the point where we see relative weakness coming into these sectors, and this results in a non-confirmation versus the overall market, the lights for the 2016 bull market turn from yellow to almost red!! With regards to the overbought breadth indicators this has two implications for Over recent weeks, we had all key markets and early cyclical sectors hand-in-hand going higher, which is still bullish. We basically think that this picture will start changing very soon in 2017, which implies that the one or other sector in the early cyclical camp will start underperforming, and this means that selectivity will very likely rise in Defensives a superb leading in a boom and bust cycle On the other hand, we have defensive sectors and particularly the utilities sector, which in the context of the Dow Theory we see very often forming a non-confirmation versus the S&P-500, as a leading indicator for a major top. This phenomenon is obviously related to the underlying macro background and normally to a classic boom and bust cycle where we see rising inflation and rising interest rates ahead of a major market top. It is important to understand that ahead of nearly every recession in the US, we saw rising inflation and rising interest rates, and it was set up for a major bear market in the S&P-500. So it's actually very simple. We can see corrections and even see stronger corrections, such as the 2015/2016 cyclical bear market but a real bear market (with an average loss of 37% in the last 100 years), we normally only see if the US economy falls into a recession. In this context it is worth highlighting that due to the fact UBS 9

10 Chart 22. ) Dow Jones Utilities versus S&P-500 Chart 23. ) S&P Consumer Staples Weekly Chart that since the March 2009 low the S&P-500 never corrected more than 20%, the March 2009 bull market is in the meantime (see chart 24.) the 3 rd longest bull market since Given what we said so far, we see a high probability that the 2009 bull market finally gets minimum the 2 nd longest (94 months from 1990 to 1998) if not even the longest, which (98 months) was the bull market from 1921 into the 1929 bubble peak. What does this mean for equities? If we look into the current market structure, we have increasing evidence for a classic boom and bust cycle. In 2016, inflation and interest rates bottomed out, and rising interest rates from summer into December were the trigger for significant corrections in utilities, staples and healthcare stocks. In both utilities and the S&P consumer staples, we are so far just talking about "normal" corrections, which can be seen as classic mean reversion in the still intact 2009 long bull trend. Tactically, defensives were clearly oversold in December and on track with our December call defensives are bouncing. With our weekly trend work turning bullish in oversold territory, this bounce can last easily into deeper/later Q1, which is the time window where we see yields pulling back. December bottoms in utilities and consumer staples are pivotal in 2017! However, regardless of any bounce scenario, particularly in utilities and consumer staples, the December bottoms have an absolutely pivotal character for With a break of these Chart 24. ) DJI Cyclical Bull Markets Since 1900 bottoms, the key sectors would break their 2009 bull cycle, which means they would fall into a real bear cycle!! Again, tactically, defensives are bouncing but in the bigger context we see this bounce more as part of a long-term top building process instead of expecting a new broad based breakout. With our core scenario on the macro side, where after a pullback into later Q1 we expect further rising interest rates with risk to overshoot into H2, it is just a question of time before we see a new down leg starting in defensives. A break of the December low in utilities and staples would be outright bearish and it would be a clear warning signal and a leading indicator for the overall market. UBS 10

11 Chart 25. ) S&P-500 with Investor Intelligence Bullish Consensus Chart 26. ) S&P-500 with NAAIM Exposure Index Sentiment too complacent risk for negative surprises in 2017 How does a major market top look like in terms of sentiment? On the sentiment side, the post-election rally pushed almost all of our sentiment studies into contrarian territory. More importantly, with the outcome of the US election and the suspected economic conclusions, we are starting 2017 with a very one-sided investor sentiment, where the percentage of neutral investors in the AAII survey (see chart 4.) collapsed from last year's record level to the lowest reading of the last 4 years. So from last year's record uncertainty we have seen a super sharp swing in the investor sentiment towards a very decisive bullish conviction. Regardless of any tactical timing, extreme bullishness in combination with high conviction is contrarian and suggests a high risk to see negative surprises in It can mean a) that the markets have priced in too much and if the fundamental world does not deliver we will see mean reversion corrections or b) see the described reflationary overshooting where sharp moves on the FX side and in bonds are choking off any improving factor on the economic side. Again, after the 2015/2016 cyclical bear market and having seen equity outflows of 12 months in a row, we do not think that investors are already this kind of over-invested that we generally need to get worried about the market. Even in the cyclical key themes such as banks, where we saw a massive rally in Q4, we don t think that investors are really overinvested. However, in later Q4, we have clearly seen investors chasing the market so the herd is obviously running and this is a process we expect to continue into Chart 27. ) S&P-500 with CBOE SKEW/VIX Ratio summer. If we are correct with this call, we could move into a sentiment setup where in summer we get the real contrarian setup, where positioning and "talking" finally fits together. It's furthermore important to understand that at major market tops, we also see in sentiment studies the same kind of nonconfirmations, such as in classic price indicators and/or breadth indicators. If we look at the Investor Intelligence or the NAAIM exposure index, both have reached extreme readings, so without seeing any divergence in these sentiment studies, it's too early to get bearish on the market but on the other hand it is the mirror of how overbought and with what kind of high expectations we are starting Tactically, we see this overly bullish sentiment as a burden and a reason why we anticipate a tactical correction/pullback into later Q1 before starting the UBS 11

12 Chart 28. ) S&P-500 with VIX Index Chart 29. ) S&P-500 with VIX Index Decennial Cycle next move higher into Q2. Keep in mind, it does not matter whether we look at the volatility which is at a 4-year low, the SKEW/VIX ratio or the CBOE put/call ratio, all our tactical sentiment measures are at extreme levels as well, which suggests that very soon in January the air will be getting thin for the market. Rising volatility as a late cycle phenomena Another very classic signal we usually see at important market tops, is that on the way higher into this top we already see gradually increasing volatility before in the following decline volatility really starts taking off. Translated into patterns, it is just another divergence we see forming at or around market tops, and it is a phenomenon we see at tactical tops as well as in the bigger picture. Prior to the 2008 top, we saw gradually increasing volatility as evidence that there was something cooking. So implicitly, it is another key call of our 2017 strategy to expect rising volatility in equities, as a reflation of the significant higher cross-asset volatility on the back of our overshooting scenario of the H reflationary cycle. In the bigger picture, we reiterate our 2015 call. After nearly 3 years of a low volatility regime, we expected in 2015 a comeback of volatility, which we effectively saw with the 2015/2016 bear cycle. In this context, we again highlight the 10- year cycle/pattern in the market volatility, where in the middle of a decade we very often have a low volatility regime, whereas towards the end of a decade we usually see increasing volatility across the board. Analytically, this phenomenon is obviously linked to the decennial cycle, where since the 1890's we had in nearly "every" decade in the 7 th and/or 8 th year, either a sharp correction if not even an outright bear market. With the S&P-500 trading in wave 5 and the QE/zero interest rate regime coming to an end, it remains a high conviction call that we ll see the markets moving into a high volatility regime in the next 4 to 5 years! UBS 12

13 Chart 30. ) S&P-500 Weekly Chart Chart 31. ) S&P Roadmap Daily Chart Conclusion tactical roadmap for 2017 From an Elliott Wave perspective, the 2016 bull cycle represents a wave 5 of a larger degree, so we see the S&P-500 trading in a mature and aging long-term bull market. From a cyclical aspect, 2017 will be a year with a lot of headwind for equities from the presidential cycle (post-election years have the worst track record in the presidential cycle) we well as from the decennial cycle, where since the 1890's we had in nearly "every" decade in the 7 th and/or 8 th year, either a sharp correction if not even an outright bear market. In this context, and taking into account our cyclical roadmap, we see a risk that the wave 5 bull cycle in the S&P-500 will move into a major top in the next 6 to 18 months. Even if we were to be wrong with our thesis that the S&P-500 moves into a major wave 5, with the overall cyclical and technical set up in 2017, we see minimum the risk of a significant correction preferable in H2 and if so this correction should be significantly more than 10%. Risk of correction into later March before higher into summer top Tactically, we are starting into 2017 with more or less all major US headline indices at all-time highs, and without any divergence in early cyclical transport, banks and semiconductors versus the S&P-500, the internal market structure in the US is still outright bullish. However, after the vertical and exhaustive post-election rally, the US market and cyclical themes are extremely overbought. Our weekly and daily price indicators in the Russell-2000 are on record levels, our sentiment indicators have reached contrarian territory and in our tactical breadth indicators we have seen spikes to extreme levels as well. With this technical set up, we see the US market/global equities vulnerable for a tactical pullback from a deeper/late January top into late Q1 (later March timing), as the basis for the next rally and leg higher into deeper summer, where we have a first important major top projection. The late December weakness in the S&P-500 we see as the beginning of a tactical top building process, with support at On the upside we can reach 2300 into mid/later January., whereas a break of 2230, would be tactically bearish and imply that our suggested January top is in place with risk to a pull back into later March towards 2190 and 2150 (200-day moving average) and 2100/2085. H2 will be very likely a challenging time for equities The best case scenario for 2017 is that our projected early summer top is just the start of a multi-month distribution phase into H and ideally into early 2018, where in this timeframe we would expect to see more selective outperformance in late cyclical sectors. Worst case is that in the context of a potential reflationary overshooting, we see a classic blow-off top into summer where the subsequent reversal would be the beginning of a big correction into a later Q3/early Q4 bottom. This cyclical roadmap is getting support from the presidential cycle and the decennial cycle (years ending "7") where from a later Q1 bottom is very often the basis for another significant rally into a deeper summer top followed by a big UBS 13

14 Chart 32. ) Dow Jones Industrial Post Election Years ( ) Chart 33. ) Dow Jones Industrial Decennial Cycle (Year's ending in "7") correction into early Q4. Even if we exclude the 1987 crash as an "out of the box" event, in the average of years ending in "7" we have this very decisive cycle, which suggests the risk of moving into an important summer top in The best of wave 5 is already behind us Given the extreme readings in our indicator setup we think that the best of wave 5 and the reflationary bull cycle is already behind us. So, although tactically we remain bullish into summer, we clearly expect increasing selectivity, which implies further slowing momentum on the index front. This is the main reason why we see the final S&P-500 target at a rather limited 2400 to 2500, whereas we continue to see the real momentum on the sector front. On the back of rising cross-asset volatility, we expect aggressive multi-month moves on the macro side, where into summer we remain selectively bullish cyclical themes and particularly commodity-related sectors and Emerging Markets, where we expect a countertrend wave C into summer to complete the 2016 bear market rally. Defensives/Growth sectors as a risk factor in H2 One of the risk factors in 2017, which we see as a key indication for an overall market top, are defensive stocks. On the macro side, it is our base case scenario that on the back of a sharp US dollar correction, from a Q1 top into summer, we get a reflationary overshooting, where a new and potential aggressive rally leg in commodities would be the trigger for inflation and interest rates to overshoot into H2. After the H correction leg, defensive sectors were oversold and bouncing from our suggested December bottom. This December bottom represents a pivotal support for all growth sectors/stocks. A break of the December lows in the Dow Jones Utilities and the S&P consumer staples would break the 2009 bull trend. It would be ultimately bearish defensives and in our view a leading indicator for an overall market top; in which case, we cannot rule out quite a sharp reversal and subsequent correction starting. Wave 5 top as the basis for a larger corrective bear cycle Regardless of any timing and how long this bull market will finally last, when we see wave 5 topping out, this market reversal will be very likely the beginning of a tough time for equities. After a wave 5 top of a larger degree we normally see a very sharp bear market or a larger corrective process (which we basically expect developing in a larger A-B-C pattern), which can last several years. From a price perspective, we have to take into account a 38% to worst case 50% correction of the 2009 bull cycle wherever and whenever the final top comes in. UBS 14

15 Chart 34. ) S&P-500 with Earlier Top as Scenario 1 Chart 35. ) S&P-500 with Wave 5 Extension as Scenario 2 Where s the risk of being wrong in our 2017 outlook? As every year, we ask ourselves where could we be wrong in our 2017 outlook. Last year it was the timing and not the underlying thematic view where we saw commodities moving into a major buying opportunity and the 2015/2016 wave 4 cycle bear market moving into a low as the basis for a final bull wave in global equities. From a timing standpoint, wave 5 in the S&P-500 and the whole reflationary bull cycle started earlier than expected, where in early Q1 we saw the bottoms in the US market, in commodities, crude oil and Emerging Markets, whereas in Europe and Japan the wave 5 bull cycle started only in summer. Where could we be wrong in 2017? Global equities are trading in a bull market, and apart from expecting a tactical correction in Q1 we remain bullish into minimum summer 2017 and best case into early On the macro side, the current bull cycle has a clear reflationary character with major bottoms confirmed in 2016 in interest rates, commodities and inflation. Our base case scenario is that via a sharp US dollar correction in H1 2017, we are moving into a reflation overshooting, where in a classic boom and bust scenario, rising yields should finally be the death of the wave 5 bull cycle. Where we can be wrong is obviously the timing and the shape of a potential top. In a first scenario, we can see the top in equities earlier than expected, and it means that with the current record overbought stance in cyclicals and particularly the Russell-2000, we see the S&P-500 topping out in deeper/later January and start of a bear cycle. Translated into fundamentals, this would suggest that the postelection rally and the economic implications would just be hot air. We have the lowest probability for this scenario, as apart from the one or other divergence in our price indicators, we have the classic non-confirmations missing between early cyclical key sectors versus the S&P-500. We do not have the classic divergences in our tactical breadth work, flow-driven indicators (ARMS index), and sentiment studies. And with regards to the positioning, we also do not think we are yet at levels where investors are really overinvested, where on the contrary, it is likely that the squeeze particularly into the cyclical camp and in banks will continue into summer. A second scenario is that we underestimate the length and the potential of wave 5 in the S&P-500, so that the whole 2016 bull extends significantly in price and time, which would mean into deeper if not even later It is a scenario where we wouldn't really complain about being wrong since our call anyway is to see a top in 6 to 18 months, so where we see a good chance this bull market can still go into early The key point is, this scenario/discussion is pretty much related to the underlying sub wave structure of wave 5 in the S&P-500; and, whether we ll see an impulsive extension on the upside or we see more an overlapping wave structure, which very often develops in a wedge formation or in a complex top building phase. In case of seeing an impulsive extension of wave 5 we would have to label the 2016 rally as sub wave 1 of 5. Taking into account the magnitude of wave 1 of 5 (about 460 index points) and suggesting that wave 3 (which after a wave 2 pullback into later Q1 we should see developing into summer), per definition can never be the shortest wave, implicitly, we would UBS 15

16 Chart 36. ) US Trade Weights Dollar (DXY) Monthly Chart Chart 37. ) US Trade Weights Dollar (DXY) Weekly Chart finally get a very ambitious price target of minimum around 2800 in the S&P-500 into How likely is that? If we look at how overbought we start into 2017 where cyclical themes and particularly the Russell-2000 are record overbought, we have to ask ourselves how we can see and what could drive the S&P-500 into an impulsive wave 3 bull cycle into summer? Consequently, with anticipating increasing selectivity, slowing index momentum, and expecting the S&P-500 to be capped between 2400 and 2500, we clearly favor an overlapping wave structure (which is a best case scenario) and if so it suggests that 2017 could be a very tough year for equities. Macro Our 2017 Key Calls! In 2016 and on track with our cyclical model, we got our suggested major bottoms in crude oil, commodities, and Emerging Markets, which we saw and continue to see as the basis for a 1 to 1.5 bear market rally before we expect commodities and also Emerging Markets to move into an important top and resume its 2011 secular bear market. With the bottom in commodities, inflation bottomed out in 2016, and together with ongoing QE in Europe and Japan, plus selective fiscal stimulus we saw this macro setup as the trigger for rising interest rates, which at the end of the day should end in a classic boom and bust cycle. In the US and European bond market, the summer 2016 low represents a major low. In Q4, US inflation expectations finally broke their 2012 down trend and with value sectors having broken their 2011 underperformance trend versus growth stocks we have clear evidence that a large reflationary cycle is underway. The question is how long will this cycle last and what do we expect after this cycle? We expect a major wave 5 US Dollar top in Q1 2017!! In the current underlying reflationary cycle, we expect the US dollar playing a central role in 2017, and it will very likely be the key trigger for much higher cross-asset volatility in the next 12 to 15 months. Strategically, we have a dominant 10-year cycle in the US dollar where we saw major direction trend changes in early 1980, in early 1990, and in 2000 the DXY completed a major top. This underlying 10-year cycle was one reason why we saw the 2011 bottom in the US dollar as part of a major long-term basing process and the start into a new long-term Dollar bull market, which at the end of the day we see continuing into minimum the end of this decade and more likely into early next decade. In 2014, we had a hard Dollar bull call, where after the vertical bull-run into the March 2015 top, the US dollar was extremely overbought. From a wave perspective, we always believed that the sharp 2014 bull-run represents a classic impulsive wave 3, and in this context we always believed that after the 2015 sideways dollar correction we could see minimum one more bull cycle (wave 5) before we could see a more significant and longer lasting US dollar correction within its underlying long-term bull market. UBS 16

17 Chart 38. ) DXY with Advance/Decline Line (20 Key Dollar Pairs) Chart 39. ) US Dollar with Presidential Cycle Tactically, we have been bullish US dollar since the May 2016 bottom, which is the base of wave 5. It's interesting that in terms of patterns and indicators we see the same kind of divergences and selectivity, which we see in the late stages of a bull market in equities. On the indicator side, the new breakout in the DXY is producing non-confirmations on the upper weekly and monthly timeframe, which analytically confirms a wave 5. The weak momentum in our proprietary US Dollar Advance/Decline line (which includes 20 key dollar pairs in EU, EM/Asia and commodity block) shows, that the current bull cycle is quite selective where in several key pairs particularly in the commodity block we already have major bottoms in place. In Asia and Europe, we have pairs (KRW, TWD, IDR, GBP) which are already showing relative strength, whereas it has been mainly the weak EUR (50% index weight in the DXY) and JPY that have been pushing the DXY above its 104 key breakout level. With this deteriorating internal breadth, it is actually just a question of time before we see the US dollar moving into a major top, which on the back of the underlying wave structure would be the beginning of a sharp and significant correction. Another interesting phenomena is the cyclical nature in the underlying presidential cycle where we usually see a very strong US dollar in a presidential election year followed by a major top in the post-election year, which in the past, was very often the start into a multi-year bear market. In this context, last year was a very "normal" bullish US dollar year. Following this cycle we should see the US dollar moving into an important Q1 top as the basis for minimum a stronger and larger correction if not even a bigger bear market. Q1 Dollar top as the basis for a sharp correction Following our cyclical model/roadmap, it is a key call of our 2017 strategy to see the US dollar moving into a major top in deeper/later Q1, which we see as the basis for a sharp and multi-month correction into minimum H and best case into early 2018, where we have our next long-term low projection. Again, with respect to our long-term Dollar cycle, we think that a potential 2017 US dollar correction will just be a temporary phenomenon and not a multi-year event, and in this regard, we see a potential H DXY bottom as the basis for starting a new major US Dollar bull leg towards minimum the end of this decade. On the macro side, a major Dollar top and subsequent strong correction cycler would have far reaching consequences in A bearish US dollar is purely reflationary, as it is bullish commodities. Last year's bottoms in crude oil, commodities and Emerging Markets was triggered by our expected Q1 tactical Dollar correction. From a wave perspective, we see last year's rally in commodities and Emerging Markets as wave A of a classic A-B-C corrective counter rally. A multi-month US dollar correction, we would see as the trigger for an aggressive wave C rally in commodities and Emerging Markets, which we see as one of the great trading opportunities in Having said that, with anticipating a major US dollar low in H we obviously also expect commodities and Emerging Markets to move into an important cycle top in H2 2017, where from a timing standpoint we see a top in Emerging Markets as a leading indicator for a wave 5 top in the S&P-500. UBS 17

18 Chart 40. ) USDSEK Weekly Chart Chart 41. ) CHFUSD Weekly Chart With last year's wave A rally in commodities, we saw a first significant bounce in US inflation expectations, which then pulled back into summer (see chart 8.) on the back of a wave 5 starting in the US dollar and commodities correcting. The post-election reflation rally, as an external shock event, was the trigger for US inflation expectations to break the 2012 down trend against the strong US dollar. In this context, we see a multimonth dollar correction as the trigger for a positive surprise and potential overshooting in US inflation expectations and interest rates, which would be the beginning of the end of a classic boom and bust cycle. From a pure price point of view, the December pull back we expect to move into an early/mid-january bottom as the basis for the final up-leg into deeper/later Q1 where we anticipate a potential wave 5 top in the DXY between 106 and 108. Into H2 2017, we expect the DXY to correct down to the base of wave 4, which is at 93. Translated into key pairs we expect the EUR, CHF, SEK, and GBP to move into major Q1 bottoms as the basis for big and aggressive rallies into H2. In GBP, we see a potential Q1 low as a major 8-year cycle bottom and therefore a long-term buying opportunity for minimum a big rally into early In the commodity block, the AUD, CAD and NZD have bottomed in Q A major Q1 DXY top could be the basis for a second and potentially aggressive rally into H We are bullish AUD, CAD and NZD in 2017! Chart 42. ) GBPUSD Monthly Chart Chart 43. ) AUDUSD Weekly Chart UBS 18

19 Chart 44. ) EURUSD Weekly Chart Chart 45. ) EURUSD Daily Chart We expect the EUR to rally aggressively from a late Q1 low around parity towards 1.15 and best case 1.20 into later Nonetheless, a 2017 EUR rally will post another lower high into its intact secular bear trend. So, although into 2017 we are EUR bullish, following our cyclical model we remain structurally bearish where from a late 2017/early 2018 top we expect the EUR to start another multi-year bear cycle into the end of the decade. A sharp EUR rally in 2017 will be latently bearish Europe, so we do NOT believe in a broad-based outperformance of Europe versus the US. On the contrary, with such a move we see a high risk for the next negative surprise in Europe. Yields overshooting into a late 2017/early 2018 Per our cyclical model, the 2016 summer low represents a major low in the US and European bond market. Structurally, it is important to understand that after the temporary BREXIT undershooting below its 2012 all-time low, with the following strong up-move in yields, the US 10-year Treasury yield factually confirmed its 2012 bottom, which translated means that US yields remain in an intact secular basing process within their underlying 30-year cycle. This is important, since alone from a pattern standpoint, the US bond market moves into a major double bottom speculation (see chart 9.) and therefore into a classic make or break setup. From a timing standpoint and on the back of our core macro scenario to see a reflation overshooting, this will be Chart 46. ) US Long Bond Yearly Chart with 30-Year Cycle very likely one of the 2017 key events. Tactically, after the vertical rally in yields into December, we expect a pullback and mean reversion move in US 10-year yields towards 2.00% into later Q1. Having said that, it is a key call of our 2017 strategy that on the back of our US dollar correction scenario, a second aggressive rally leg in commodities, and a potential overshooting in US inflation, we expect another leg up in yields into H2, where the US 10-year Treasury yields will face and test a very important resistance level at 3.00 %. At 3.00% we have the secular down trend coming in from the 1990s, and at 3.00% we have UBS 19

20 Chart 47. ) US 10-Year Treasury Yield Chart Chart 48. ) JP Morgan Global Bond Market Index the neckline of a potential double bottom. With a potential overshooting in the reflation trade, we effectively see the risk of breaking this level, which would trigger at least a temporary overshooting towards 3.50% if not even 4.00%. An overshooting in US yields would be the end game of a classic boom and bust cycle where we would see a new breakdown in interest rate sensitive sectors as a leading indicator for the S&P-500 completing wave 5. Ironically, after an overshooting bonds are a buying opportunity Ironically, at this point where we see risk and the wave 5 bull cycle in the S&P-500 topping out, and equities starting a larger and longer lasting bear cycle, the US bond market turns into a buying opportunity for another significant down cycle in yields towards the end of the decade. Translated into macro it obviously implies, that after the 2016/2017 reflationary comeback/intermezzo we expect the world falling back into a deflationary cycle, where we can see a re-test of the 2012 lows into yields towards the end of the decade. So on the one hand, we see a potential overshooting in yields as a risk factor for the 2009 bull cycle breaking down, which on the other hand will create a big buying opportunity in bonds in later 2017/early On the macro side, our scenario of rising yields in H2 will have further cross-asset implications on the markets. Tactically, as seen from last summer s low in yields into December, rising yields would be again tactically bearish gold. After a potential rally into summer, we see the yellow metal vulnerable for another correction into deeper/later H2 2017, which however should bring us a higher low for further upside into Rising yields could be clearly headwind for Emerging Markets and China, which we expect to move into a big top in later summer/h and which should complete the 2016/2017 bear market rally. With rising yields, we see a high chance that tactically, Emerging Markets will top out earlier than developed markets. Rising yields will be bearish (as in H2 2016) interest rate sensitive sectors. Given our key scenario for 2017 to expect a potential overshooting in yields, we see interest rate sensitive sectors as a leading indicator for a potential major market top. Again, tactically, utilities and staples are pretty oversold and we should see a significant bounce into later Q1. However, if we are correct and we see a new up-leg in yields into H2, we would very likely see a new breakdown in interest rate sensitive sectors, and in this case most of these sectors would generate long-term sell signals. Correlation wise, the one or other would see a conflict in our expectation of a sharp US dollar correction and rising yields in H2. It's interesting that most of the sharp moves in rising US yields were very often accompanied by a weak US dollar. At the end of the day, it is the question of what European rates are doing relative to US rates, and since the base for European rates to rise is much lower than in the US, we see a high likelihood that we get a reversal in interest rate differentials (see chart 11.), which in fact would be bullish EUR. UBS 20

21 Chart 49. ) CCI Index (Equally Weighted) Weekly Chart Chart 50. ) Wheat Weekly Chart Wave C bull cycle in commodities into H Strategically, the Q2 top in 2011 represents a secular top in commodities and secular bear markets can last 10 to 15 years. However, no bull and no bear market is one-way and in this context, and following our cyclical model, it was a key call of our 2016 strategy to expect crude oil and commodities in general moving into a major bottom as the basis for a 1 to 1.5- year lasting bear market rally, which we expected developing into a classic A-B-C corrective shape, before topping out and starting a new major bear leg as part of its underlying secular bear market. Tactically, crude oil and the major commodity indices bottomed in early Q and from a pattern standpoint we see the first rally leg into summer as wave A. The pullback pattern from last year's summer top is so far pretty corrective, which we label as a wave B. Keep in mind, given the strong US dollar and rising interest rates, the H pullback in commodities has actually a very healthy and constructive shape, which we see as underlying bullish. We expect a potential late Q1 US dollar top and the start of a multi-month correction cycle into later H to be the springboard for a wave C rally in commodities so we remain underlying bullish commodities and related sector themes into minimum summer. What are our top pics in the commodity area for 2017? The agricultural segment and grains have been lagging the recovery in This is something we expect to change. Wheat trades in a basing process where a break of 429 would imply a rally towards minimum testing its 2012 down trend at 500. So all in all we wouldn't be surprised to see the agricultural sector and related sector themes outperforming in a wave C bull cycle in the commodity area. Chart 51. ) Crude Oil Monthly Chart Chart 52. ) Crude Oil with CFTC Speculative Long Positioning UBS 21

22 Chart 53. ) Crude Oil with IBOXX High Yield Chart 54. ) Copper with CFTC Speculative Long Positioning Oil and copper heading into major tops in 2017 When we talk about the perspectives of commodities in 2017 we have to talk about the speculative positioning in crude oil and copper, which has hit or is heading towards all-time highs. So yes, we are tactically bullish commodities and expect another significant rally into summer where we especially expect a catch-up rally in the lagging grains and agricultural commodities. However, our key call is, that with a wave C bull leg, we expect commodities and particularly copper and crude oil to move into major tops in later summer/h Given the all-time highs in speculative positioning we have the risk that a potential 2017 top will be the basis for a new big bear market, where we expect copper and crude oil hitting new lows into the end of the decade. On the upside, we are sticking to our crude oil target we gave out last year, and continue to see oil moving towards $62 to best case $69. From a timing standpoint, we anticipate crude oil moving into an important summer top. From a macro standpoint, this would have far reaching consequences. A major top and subsequent bear market in crude oil would imply that after the 2016/2017 comeback of inflation, we see the macro background falling back into a deflationary cycle into 2018 and towards the end of the decade. A major top in crude oil would suggest the 2016/2017 recovery cycle in high yields topping out and starting a new bear cycle, which fits the call where we expect to see higher volatility, which is normally one to one correlated to high-yield bonds. We would use strength into summer to sell high-yield!! Gold bullish in 2017 but it remains a trading theme Strategically, we called a major bottom in gold in December 2015 and we continue to think that this bottom represents an 8-year cycle low and therefore the basis of a new multi-year bull market, which we expect to move minimum into the end of this decade and more likely into early next decade where we anticipate new all-time highs in gold. So regardless of any tactical timing, we are and we remain bullish gold into minimum the end of the decade. Tactically, after last year's aggressive and nearly vertical H1 rally in gold and after having seen gold mines performing 180% in only 6 months, we warned in summer about seeing a mean reversion correction leg in gold into H2 on the back of expecting the US dollar to rally and rising interest rates on the macro side. However, in both gold and gold mines the correction has definitely been stronger than expected, which raises the question whether the 2015 December low was really the 8-year bottom in gold? UBS 22

23 Chart 55. ) Gold 8-Year Cycle Monthly Chart Chart 56. ) US Inflation Expectations versus Gold Generally, from a macro standpoint, in H2 2016, we in fact had the setup for a perfect storm for gold, with yields rising vertically and therefore real interest rates rising, plus the US dollar trading in a wave 5 bull cycle. Having said that, for this kind of perfect storm it is remarkable that gold and silver are still trading above their December 2015 low. On the dollar side we see light at the end of the tunnel, since we expect the US dollar moving into a major wave 5 top in deeper/later Q1 and starting a multi-month sharp correction cycle. So alone in this context we see gold moving into another major buying opportunity, and where we would see any further weakness as unsustainable. Risk of final undershooting into Q1 The key question is whether gold is at risk of undershooting into deeper Q1, and if so if the December 2015 bottom holds before we see a big rally starting? If we just look at the US dollar, we cannot rule out a final undershooting into deeper Q1 where we effectively have our top projection for the current wave 5 bull cycle in the US dollar. On the other hand, we expect a pullback in US yields from the extremely overbought December levels into later Q1, as a reflection of a mean reversion move in risk assets, and where a final overshooting in the US dollar could be the trigger for US equities to correct tactically. All in all, we see this as a mixed setup, which should minimum suggest a volatile stabilization. However, even in case of seeing a tactical negative surprise, we would see this as a temporary phenomenon into Q1, which in the bigger picture we would still see in the context of our 8-year cycle low projection. Taking this into account, it remains our core scenario that even in case of seeing an undershooting, we would see this move as a bear trap and therefore the basis for a big rally/comeback into initially later summer and finally into deeper Chart 57. ) Gold Weekly Chart Chart 58. ) Gold Bugs Index Weekly Chart UBS 23