Minor Pullback into March Before Higher into Q2!!

h Technical Analysis Weekly Comment Equities Sales Trading Commentary Global Michael Riesner Marc Müller 25/02/2014 michael.riesner@ubs.com marc.mueller@ubs.com +41-44-239 1676 +41-44-239 1789 Minor Pullback into March Before Higher into Q2!! Due to traveling, the next regular weekly comment will be published on March 11 th. However, in case of a significant change in market direction and/or our strategy, a short update will be sent out. US Trading: After the aggressive rally from the pivotal early February low at 1737 the SPX was overbought, so last week s breather wasn t a really big surprise. Without any divergence in our fast momentum work we can still see another bounce into later this week but we are sticking to our cyclical roadmap and expect a minor pullback from a late February trading peak into first half March before resuming the underlying bull trend into deeper Q2. On the sector basis, early cyclicals (financials/transport) and the Russell are capped by their broken 2011/2012 trends. The recent outperformer (biotech, DRG, SOX, materials and energy) are overbought and can pullback but after the recent high momentum moves we expect more strength in these sectors into deeper Q2. Buy the dips! As long as 1825 holds the SPX still has the chance to overshoot towards 1860 to best case 1885 into our preferred timing for a trading top later this week, whereas a break of 1825 would imply that our anticipated minor pullback into March is already underway. Aggressive traders we recommend taking profit into a potential bearish daily reversal candle later this week. From a price perspective we anticipate a 3% to 4% pullback into March. Into April/May we see new highs and the SPX moving towards 1920 to 1970. US Strategy: On track with our cyclical model we have seen a significant correction from our projected late December top into early February, and with 1737 the SPX has reached the lower end of our expected target zone, which represents a new medium-term reflection point for the SPX. As long as 1737 holds, the SPX remains bullish biased into later Q2 (May/June), which is our next significant cyclical top projection and the time window for a potential more important top in equities. From a price perspective, a break of 1850 would generally imply more upside towards 1920/1970, which remains our preferred target zone for a summer top in the SPX. European Trading: Whereas the Euro Stoxx, DAX FTSE-100 and the SMI are on the way of re-testing their January highs we see most of the periphery continuing to outperform and hitting new highs (Portugal, Ireland, Italy, CAC-40). Together with small and mid caps still outperforming large caps, the underlying trend in Europe remains healthy and intact. However, on a short-term basis Europe is overbought and we expect the Euro Stoxx to move into a trading top later this week followed by a minor pullback into March before starting the next bigger breakout attempt. Aggressive traders we recommend taking profits into strength. On the sector basis, construction, basic resource, autos, healthcare, travel, real estate and utilities are overbought and can pullback, but with intact trends in the bigger picture and a major breakout in utilities we would see short-term weakness as an opportunity to buy/add. Inter Market Analysis: Commodities remain on fire and we see more breakouts/gains in soft commodities, grains and the energy complex. After the recent momentum breakout, gold has reached our first target at $1330 and a break of $1330 implies more strength towards $1347 to best case $1370 before we expect a breather/minor pullback into March. Although short-term increasingly overbought and vulnerable for a pullback, we remain bullish commodities and related sector themes into summer. Asian Corner: On track with our cyclical model, Emerging Markets and Asia have set our anticipated early February low (as a new key support) and over the last 3 weeks we have seen a significant bounce/rally. However, despite the improving absolute picture, EM s and in particularly China remains weak relative to the world, which is disappointing given the momentum rally in the commodity space. Furthermore, over the last three sessions we saw a big bearish reversal in China and the SSEC is retesting its pivotal late January bottom at 1984. A break of this level would imply that a negative surprise in China is underway and this would also very likely cause some nervousness in the Western markets and risk in general, so keep an eye on China!! NOT FOR DISTRIBUTION INTO THE U.S. UBS 1

US Equity Market Update: Chart 1. ) S&P-500 Daily Chart Chart 2. ) S&P-500 with NYSE McClellan Oscillator Chart 3. ) Russell-2000 Daily Chart Minor Top This Week!! The fresh buy signals in our daily trend work and our weekly momentum indicators were the ultimate and formal confirmation that our anticipated deeper Q1 trading bottom is in place, which makes the February 5 th low at 1737 a new pivotal support. As long as 1737 holds, the underlying technical picture in the US remains intact bullish, whereas a break of this level would imply that a more important top is in place, and in this context 1737 represents a medium-term key support for the SPX. After the aggressive rally from the early February low the SPX is overbought, so last week s breather wasn t a really big surprise. However, without any non-confirmation in our fast momentum indicators and as long as trading above 1825 we still have the chance to get another bounce and potential new reaction high into later this week before seeing a somewhat more significant pullback into deeper March as the next buying setup into Q2. Keep in mind, our medium-term momentum indictors have reached overbought extremes (NYSE McClellan Oscillator) and our sentiment work (50-day CBOE put/call ratio) is still at very low levels historically seen. Another point is certainly that the outperformer sectors that have pushed the market higher (technology, SOX, DRG, materials, biotech and oil stocks) are significantly overbought and have reached our next target projection, whereas the underperformer sectors (Russell-2000, XBD, BKX, DJT, and retail) that have broken their 2011/2012 bull trends during the January correction are now facing increasing resistance by these broken trends as a cap on the upside, which also averts any potential short-term rotation. Conclusion: The US market is short-term overbought but what is still missing to complete a short-term trading top is a classic non-confirmation in our fast momentum work and in this context we can still see another bounce into later this week where the SPX could mark a marginal new breakout. On a short-term basis we wouldn t see a new breakout in the SPX as sustainable since from a cyclical perspective we continue to favor a minor pullback from a late February trading peak into first half March before resuming the underlying bull trend into deeper Q2. As long as 1825 holds the SPX still has the chance to overshoot towards 1860 to best case 1885 into ideally later this week, whereas a break of 1825 would imply that our anticipated minor pullback into March is already underway. We would take profit with a potential bearish reversal candle later this week, since we anticipate a 3% to 4% pullback into March. Into April/May we see new highs and the SPX moving towards 1920 to 1970. NOT FOR DISTRIBUTION INTO THE U.S. UBS 2

US Equity Market Update: Outperformer Sectors Overbought. Last week we highlighted the increasing selectivity in the US market via the very weak expansion of the number of new 52-week highs at the NYSE, which remains in stark contrast to a new high in the S&P-500 Advance/Decline line. It is finally a relative point, which makes the difference. In several key sectors the January correction has caused significant technical damage, which you cannot see in any kind of Advance/Decline line. So on the one hand the Russell-2000, the S&P-600 Small Cap, US Bank, broker stocks, transport and the US retail sector have all been bouncing and contributing to an increasing Advance/Decline line. But during the January correction all these sectors have also broken their 2011 or 2012 bull trends, which in fact now acts as a cap in the current rally and this also averts any potential new rotation from the overbought outperformer sectors into the recent underperformer. Conclusion: The recent outperformers that have pushed the market (technology, SOX, DRG, materials, biotech, oil) are significantly overbought and the DRG and BTK have reached our next target projection and after nearly vertical moves we can definitely see some near-term weakness in these sectors. So if we do not see a new rotation into the recent underperformer (which is unlikely via the cap on the upside) it simply means that the SPX will be vulnerable for a pullback. However, no bull market ends in a high momentum top, and this means after a pullback we should see renewed strength and new highs in the recent outperformer into minimum deeper Q2 and in this context we remain underlying bullish on biotech and late cyclical sectors (materials and oil), where we would still use weakness to buy/add! Chart 4. ) S&P-500 Daily Chart with NYSE New 52-Week Highs Chart 6. ) US Semiconductor (SOX) Daily Chart Chart 5. ) Nasdaq Composite Daily Chart Chart 7. ) US Healthcare (DRG) Daily Chart NOT FOR DISTRIBUTION INTO THE U.S. UBS 3

US Equity Market Update: Chart 8. ) US Biotech (BTK) Daily Chart On the sector basis we highlighted the breakout in US biotech and the BTK in November as one of the few sectors that were able to mark a new reaction and therefore strongly outperformed during the recent weeks. On Friday the BTK reached our next target projection at 2790, and on the indicator side we have a potential non-confirmation forming, which is short-term toppish. We expect a pullback starting this week, which should however bring us a higher low versus its early February low as the next buying trigger into March. Short-term we would take profit with a daily reversal below 2721. Chart 9. ) XOI Daily Chart It was a key call of our 2014 strategy to expect outperformance in late cyclical sectors such as materials and energy stocks. The recent breakout in the materials sector we have highlighted. In early February we called a major bottom in oil service and last week the OSX has broken its November bear trend as well as the XOI has negated its November/December double top. Yesterday the energy complex was again the outperformer in the US. The XOI is heading towards its November/December high at 1500 and with a break of 281 the OSX would be also on the way of testing its November top. Short-term energy is increasingly overbought and we expect a pull back into deeper March but weakness we would still see as an opportunity to buy/add. On the other hand we see continued relative weakness in early cyclicals such as financials and transport and in this context the BKX remains at risk of forming a lower high into this week as a short-term selling setup. We reiterate last week s call and would use strength to sell. Chart 10. ) Oil Service (OSX) Daily Chart Chart 11. ) US Bank (BKX) Daily Chart NOT FOR DISTRIBUTION INTO THE U.S. UBS 4

Inter Market Update: Further Breakouts in Commodities Watch Nat Gas!! It was a key call of our 2014 strategy to expect a broader and longer lasting bear market rally in the commodities space into minimum summer if not even into later this year as a classic late cycle outperformance theme in the current risk bull cycle. After the Tactically we saw more and more momentum breakouts during the recent week and with last week s continued strength commodities remain on fire albeit increasingly overbought short-term. Last week we saw further strength in grains, with corn completing a larger bottom and wheat taking out its next resistance. In the soft commodity area sugar has completed a bigger inverted H&S bottom and the break of its 200-day moving average paves the way towards its 2010 long-term bear trend!! On the energy side, last November we highlighted the contracting volatility in Natural Gas as a trigger for a trend impulse into later Q4 (Weekly Report November 19 th ). In recent weeks we have seen an aggressive rally in Natural Gas but with a bigger divergence forming in our daily trend work, the ADX as our trend measuring tool reaching extreme territory and after hitting strong resistance (upper trend resistance and 38% retracement of the 2008/2012 bear cycle) Natural Gas is vulnerable for a tactical setback. Yesterday we saw a first bigger reversal, which is in fact just the start of a more significant set back towards 5.00 to worst case 4.50 into March before we also expect Natural Gas resuming its underlying bull trend into summer. The medium-term setup in the metals area remains bullish. Chart 12. ) Sugar Daily Chart After the recent momentum breakout gold has reached our first target at $1330 and a break of $1330 implies more strength towards $1347 to $1370. However, with a bigger momentum divergence forming in our daily momentum work we also see gold moving into a near-term trading top this week, followed by a minor pullback into March before starting the next breakout attempt. Short-term we would use more strength to take some profits, but from a trend perspective we remain bullish since a pullback in gold and silver is very likely bringing us a higher low versus the December bottom as the next bullish tactical trading setup. Chart 13. ) Natural Gas Daily Chart Chart 14. ) Gold Daily Chart NOT FOR DISTRIBUTION INTO THE U.S. UBS 5

Asian Corner Update: Q1 Bottom in Place in Asia But Watch China!!! On the back of the weakness in Emerging Markets, the January correction/setback in most Asian markets was stronger as anticipated. However, in late January (January 18 th weekly report) we highlighted the washout character in the Emerging Market complex and by anticipating risk assets moving into our deeper Q1 bottom and given an increasing number of nonconfirmations in our indicator work our call was to buy into weakness and position for a broader rebound/rally of EM s and Asia into summer as part of our broader bear market rally scenario in the AUD and for commodities. On track with our cyclical model, Emerging Markets and Asia have set our anticipated Q1 bottom and China was even leading in forming this pivotal bottom since the Shanghai Composite has set its Q1 bottom in late January at 1984. Similar to the SPX and the European markets, the Q1 low represents a key support for all Asian markets. So as long as Asia trades above this low the underlying tactical picture remains per definition bullish. Having said that, despite the nice rally of the last 2 to 3 weeks and the improving absolute picture, from a relative perspective Emerging Markets remain weak relative to the world and this is clearly disappointing given the momentum rally we have in the commodity space underway as well as it is also interesting to see that despite the aggressive rally in the commodity area, the US inflation expectations remain very weak and flattish, which is suspicious! Finally, keep an eye on China!! Over the last three sessions we had a high momentum bear reversal in the Shanghai Composite (chart 18.), which cements another lower high versus its December top into the long-term chart structure, which is negative and which clearly represents another negative surprise. From a cyclical perspective the January low at Chart 15. ) MSCI Emerging Market Daily Chart 1984 is a key support and it is also not far away from the massive long-term support at 1950 to 1920. With a fresh momentum sell signal in place and on the back of the relative weakness it seems that a major litmus test on the downside is underway in China. In this context it is important to know that the CSI 300 (where we have an index weigh of 36% in financials) is already sitting on its pivotal January low (chart 19.). Generally, a break of 1984 in the SSEC would be clearly bearish and suggest that a test of the 1950/1920 major support is underway. Taking out this obvious support area would be a warning signal since a negative surprise in China would also very likely bring up some nervousness and volatility into the Western markets!! Chart 16. ) MSCI Emerging Market versus MSCI World Chart 17. ) CCI Index with US Inflation Expectations NOT FOR DISTRIBUTION INTO THE U.S. UBS 6

Asian Corner Update: Chart 18. ) Shanghai Composite Daily Chart Chart 19. ) CSI-300 Daily Chart China Testing Key Support!! All eyes on China!! Inline with our cyclical model we got our anticipated Q1 trading bottom as the basis for a significant rally/bounce. However, the reversal of the last 3 sessions is significant and cements another lower high in the SSEC, which underpins the bearish tone in the long-term chart. A break of the late January low at 1984 would imply that a litmus test of the 1950/1920 key support is underway and since the CSI-300 (where we have a bigger weigh of the financial sector) is already testing its January low, which effectively means the likelihood is increasing to see a negative surprise in China!! 1) From a pure pattern standpoint the break of the 1950/1920 would trigger a trend continuation bear signal in the SSEC with far reaching consequences for risk. 2) Tactically, a break down in China would minimum bring up some nervousness and volatility in the Western markets, which would fit our short-term scenario to see a pull back in equities into deeper March. 3) The shire size of the pattern in the SSEC has to be seen as a threat for risk. So a break down in China could trigger also in the Western markets a negative surprise, minimum a bigger set back in commodities after the recent aggressive rally and it would also definitely question our scenario to see a longer lasting and significant bear market rally in the Emerging Market complex. Tactically markets such as the KOSPI, Hang Seng and other markets in Asia are still relatively resilient. Given the current vulnerable background in China we would take profit and wait what kind of reaction we see into deeper March! Chart 20. ) Shanghai Composite Weekly Chart Chart 21. ) Hang Seng Index Daily Chart NOT FOR DISTRIBUTION INTO THE U.S. UBS 7

European Equity Market Update: Trading Top This Week Take Profits!! The Euro Stoxx, DAX FTSE-100 and the SMI are on the way to re-testing their January highs, whereas most of the periphery continues to outperform and has hitting new highs (Portugal, Ireland, Italy, CAC-40) and together with small and mid caps still outperforming large caps the underlying trend in Europe remains healthy and intact bullish. On a shortterm basis Europe is overbought and following our cyclical model we expect the Euro Stoxx to move into a trading top later this week followed by a minor pullback into March before starting the next bigger breakout attempt. Aggressive traders can take profits into strength and/or a daily re-break below 3132, which is the last minor breakout level. On the sector basis, construction, basic resource, autos, healthcare, travel, real estate and utilities are overbought and can pullback, but with intact trends in the bigger picture and a major breakout in utilities we would see short-term weakness as an opportunity to buy/add. Chart 22. ) Euro Stoxx 50 Daily Chart Euro Stoxx 50: After last week s sideways trading the Euro Stoxx broke higher to a new reaction high, which effectively means that a test of the January reaction high and key resistance at 3170 is underway. On a very short-term basis Europe is overbought and following our cyclical road map we expect a pull back into March before starting its next bigger rally attempt into Q2. A daily re-break below 3132 would be initially negative and aggressive traders can use this level for profit taking. 3079 is the last more significant higher low and represents a more significant support level. Key support is unchanged the early February low at 2944 and as long as this holds the underlying long-term structure in Europe remains bullish. Chart 23. ) European Small Caps vs. Large Caps Small Caps vs. Large Caps: It is a key call of our 2014 strategy to expect further increasing selectivity and higher volatility in the markets, so that, apart from our H2 correction scenario we generally expect 2014 to be a stock pickers year and much more trading oriented than 2013 was. On the back of the liquidity cycle, Q1 is traditionally/seasonally strong for small and mid caps and with a new high in the European Advance/Decline line as well as small and mid caps still outperforming large caps the underlying breadth in Europe is definitely still bullish and supportive and this also implies that despite the risk of a pull back into deeper March it is too early to anticipate a bigger market top let alone getting bearish on Europe. In this context we reiterate our recent call and see weakness into March as an opportunity to buy/add. NOT FOR DISTRIBUTION INTO THE U.S. UBS 8

European Equity Market Update: Chart 24. ) FTSE-100 Daily Chart Chart 25. ) DAX-30 Daily Chart FTSE-100: Supported by ongoing strength in the healthcare sector and the recent bullish break out of miners, which also has improved the relative picture of the SXPP, the FTSE extended its February rally leg toward the major resistance at 6875/6950. With the short-term situation overbought as well as the most recent index leaders, we continue to expect 6875/6950 to cap the tactical trading upside. A reversal day is pending so that a test at 6875/6950 is potentially in the cards but with the daily momentum in overbought territory we are not in a breakout setup. Another breather is favored within the intact multi-month trading range which could act as a springboard for a real attempt to break to the upside in Q2. DAX-30: Last week saw the DAX trading below its last reaction but with upside momentum waning, we didn t see a test of the last reaction high at 9795. Early this week, limited strength remains potentially in the cards while holding above 9504, whereas the break of the latter would complete a tactical reversal pattern. Apart from limited attempts towards the January high, the next bigger move should be a corrective pullback towards the 2011 trend support into March, which is expected to form a higher low versus the early February low at 9071. Chart 26. ) Swiss Market Index Daily Chart Swiss Market Index: Another minor upside extension would produce the missing momentum non-confirmation as a leading indication that a tactical high is underway. With most single stocks also below their last reaction highs, which indicate an ongoing consolidation in the large cap camp, we do not expect a high momentum break above 8544 on the index front. The muted situation on the single stock front provides further confidence that the February bounce leg will remain capped in the period immediately ahead. A minor support for this week is at 8332 and a break would call for a pullback at least towards 8250. The last low at 8066 is currently not at risk and this remains a key support. NOT FOR DISTRIBUTION INTO THE U.S. UBS 9

European Equity Market Update: Breakout in Utilities Industrials Losing Momentum!! The recent trends on the European sector basis are getting more and more stable and it is particularly the late cyclical outperformance in construction and basic resource, which is striking. The relative trends in autos, healthcare, travel, real estate are also still intact but one of the key developments in Europe is certainly the big breakout in the utilities sector, which from a pattern standpoint has a very similar shape as the breakout in the telecom sector last year. Keep in mind, last year, after the hyped bond proxy sectors such as food, personal and healthcare have topped out in April we anticipated a major and broad based rotation into cyclicals and we also favoured telecoms and utilities as potential larger rotation candidates in the defensive camp. Telecoms have broken out and with completing a major long-term base last years breakout represents a major long-term trend change!! In utilities, the German plays have been weighing on the sector but last but not least we also got in the SX6P a major breakout, and the pattern in the SX6P is a perfect fit to the major base in telecoms. Tactically, telecoms are moving into its next target projection at 320 and after the recent high momentum breakout utilities are also overbought. However, the momentum in the SX6P was very strong, so that any nearterm weakness into March we would use to buy/add. On the other hand we see continue relative weakness in the industry sector, which is just another piece of evidence for the latent change in sector leadership in the cyclical camp, where basic resource has broken its 2011 bear trend (which is in line with our 2014 strategy call) and construction has broken its 2007 relative bear trend versus industry, which is at risk to complete a major relative top. Chart 27. ) STOXX Europe Utilities (SX6P) Daily Chart Chart 29. ) STOXX Europe Basic Resource (SXPP) Daily Chart Chart 28. ) STOXX Europe Telecom (SXKP) Daily Chart Chart 30. ) STOXX Europe Industry versus STOXX-600 1.28 1.26 1.24 1.22 1.20 1.18 1.16 1.14 1.12 F M A M J J A S O N D J F M A M J J A S O N D J F INDUSTRIAL GOODS/DJSTOXX Source: Thomson Reuters Datastream NOT FOR DISTRIBUTION INTO THE U.S. UBS 10

STOXX Europe 600 Index Sector Overview: NOT FOR DISTRIBUTION INTO THE U.S. UBS 11

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