SPX Corrective Below 2378 Reflation Trade Over?

h Equities Sales Trading Commentary Technical Analysis Weekly Comment Global Michael Riesner Marc Müller 11/04/2017 michael.riesner@ubs.com marc.mueller@ubs.com +41-44-239 1676 +41-44-239 1789 SPX Corrective Below 2378 Reflation Trade Over? The EXTEL 2017 survey is live until APRIL 28 th. The UBS Equities Technical Analysis team would greatly appreciate your vote in the Equity Technical Analysis & Charting category. If you have not received an invitation directly from EXTEL, please use this link www.extelsurveys.com/quickvote to access the survey. US Trading: Trading-wise, the key question remains whether our suggested late Q1 pullback from the March 1 st top was just a normal a-b-c corrective pattern, where the March 27 th low was the start of a new rally or if the late Q1 consolidation pattern takes a more complex form and extends into deeper/later April before we see the next breakout attempt starting? Our last week s view has not changed. After the break of the steep November bull trend, with key indicators still not at contrarian buy levels, and together with a mixed sector setup we see the risk of a more complex consolidation pattern forming where we favor one more down leg into next week as our preferred timing for starting the next broader breakout campaign into early summer. Last week, we got our anticipated lower trading high in the SPX and Russell-2000, which are representing new pivotal trading levels. As long as the SPX does not break 2378 and the Russell trades below 1390, the US market remains in neutral position with risk to see one more down leg into next week, where a break of 2322 would imply 2300 to worst case 2280, as contrarian buy levels. We recommend aggressive accounts to buy weakness and/or a break of 2378. On the sector front, the Q1 rebound in defensives is in its final inning, whereas more weakness in cyclicals (banks, energy, industry) we would use to buy. US Strategy: Since the February 2016 bottom, the SPX trades in a wave 5 bull cycle of a larger degree, and it remains our conviction that this bull cycle will last minimum into summer 2017, and best case into H1 2018. However, as we said over recent months, this bull market will not be one-way. Tactically, we saw the risk of a later Q1 mean reversion pullback before starting another rally from an early April trading bottom into deeper summer. So, regardless of any tactical scenarios, trendwise we remain underlying bullish into summer where we expect the SPX to reach our next strategic target of 2500. Thematically, rotation remains at the top of the agenda. Trend-wise, after our suggested Q1 rebound, we expect defensives to fall back into underperformance, whereas a pullback in cyclicals into deeper April would be a buying opportunity. European Trading: The selectivity in Europe is further increasing, with the IBEX and small and mid-caps continuing to outperform/hitting new reaction highs, against losing momentum in the DAX/Euro STOXX/SMI, and the FTSE-100 and the OMX sitting on the edge. Our last week s call is unchanged. With the outperformer markets being overbought, the Euro Stoxx reaching the upper end of its 2016 bull trend, mid-caps and the DAX facing key resistance (all-time highs), we expect some more near-term consolidation into ideally next week as the next tactical buying setup. Support in the Euro Stoxx is at 3450/3400 and worst case 3342. Our deeper/later summer target is unchanged between 3600 and 3700. Inter Market Analysis: It was a key call of our 2016 strategy to see our expected major bottoms in crude oil/commodities as the start of a 1.5- to best case 2 years lasting reflationary cycle as the main macro background of the wave 5 bull cycle in global equities and the start into a classic boom and bust cycle. Over the recent weeks, we have seen more and more market participants questioning the underlying reflation trade. From a technical perspective and pattern wise, we don t think the 2016 reflation trade is over yet and our key variable remains the US dollar, which we think has topped out, and which, from a correlation and trend perspective, suggests higher oil and commodity prices (copper) into summer/h2. Tactically, it was one of our 2017 macro key calls to expect a temporary pause in the 2016 reflation trade in Q1. On track with our cyclical model, we saw yields, US cyclicals and inflation expectations pulling back, whereas in defensives we got our favored multi-month rebound. Generally, after the Q1 correction, our suggested late March higher bottom in crude oil is in place, which remains underlying bullish with target $60/63 into later summer. The recent oversold bounce in the DXY we see near to complete, so an important bottom in the AUD (wave c) is not far. Correlation wise, a bottom and subsequent rally in the AUD we would see as a key indicator for starting a comeback of the 2016 reflation trade via triggering a new rally/up-leg in commodities, inflation expectations and yields into H2. Although on a very short-term basis we think we are 1 or 2 weeks too early with this call, higher yields into H2 would be the setup for a significant rotation from defensives back into cyclicals. Consequently, any further near-term weakness in cyclicals into later April we would use to buy/add. UBS 1

US Equity Market Update: Chart 1. ) S&P-500 Daily Chart Chart 2. ) Russell-2000 Daily Chart Chart 3. ) S&P-500 Daily Chart with Key Scenario Breakout Setup This Week Tactically, the March 1 st reaction high at 2401 was de facto the beginning of our suggested late Q1 pullback pattern, which on the sector front has been mostly led by cyclical sectors. Regardless of any tactical scenarios, our core view was and remains that this late Q1 pullback/consolidation pattern will be the setup for more bullishness and therefore the continuation of the underlying wave 5 bull cycle into summer, but where the break of the steep November bull trend would nonetheless suggest gradually increasing selectivity and deteriorating overall momentum in the US market into summer. However, on a very short-term basis, the key question remains whether the pullback from the March 1 st top was just a normal a-b-c corrective pattern, where the March 27 th low was already be the basis of a new broader based breakout campaign rally or will the late Q1 consolidation pattern finally develop in a more complex form and extend into (a-b-c-d-e pattern) deeper/later April before we see the next breakout attempt starting? Our last week s view has not changed. At least on the momentum side, the break of the steep November bull trend was a game changer for the SPX. Key indicators such as the SKEW/VIX ratio or our daily trend work have still not reached contrarian buy levels, and on the sector front we have a mixed setup with key sectors such as DRG, staples and semiconductors sitting on the edge, discretionary being toppish, banks and broker stocks in short mode, and transport being capped by its broken 2016 bull trend. All these are reasons why on a very short-term basis we still see the risk of forming a more complex consolidation pattern where we cannot rule out one more down leg into next week as our preferred timing for starting the next broader breakout campaign into early summer. Conclusion: Last week, we got our anticipated lower trading high in the SPX and Russell-2000, which are representing new pivotal trading levels. Consequently, as long as the SPX and the Russell-2000 are unable to break these lower highs at 2378 (SPX) and 1390 (Russell), the US market remains in neutral position with risk to see another down test into next week, where a break of 2350 would be initially negative and where a break of 2322 would imply a washout towards 2300 to worst case 2280, as contrarian buy levels. Aggressive accounts we recommend buying weakness and/or a break of 2378. UBS 2

US Equity Market Update: Chart 4. ) S&P-500 with SKEW/VIX Ratio Apart from our daily trend work, key indicators such as the SKEW/VIX ratio are still at relatively high readings. This does not necessarily mean that we cannot see the start of a new up-leg but the key question is whether it s realistic to expect the SPX to start a new several week s lasting bull cycle from current levels or if we should realistically expect a pullback towards readings we saw during the November or July bottoms last year before starting a new broader rally leg? Chart 5. ) NDX-100 Daily Chart Technology mega caps have been outperforming over recent weeks and months, and from a wave perspective the Nasdaq-100 trades in wave 3. However, with forming a potential broadening top and an intact bearish divergence in our daily trend work we see the technology camp still vulnerable for a short washout move before resuming its underlying bull trend. If so, then the most likely timing for this is the next two weeks. Chart 6. ) S&P-500 with 10-Day CBOE Put/Call Ratio Most of the survey-driven sentiment indicators (AAII, Investor Intelligence, NAAIM Exposure index) are in pullback mode, which basically sends out a constructive picture. However, if we look at flow-driven indicators such as the CBOE put/call ratio, we have a very different picture. Since last year s major market bottom we have a clear and intact trend of a gradually deteriorating put/call ratio where, in a historical context, we currently have relatively low levels. It is in our view very unlikely to see a new larger breakout campaign starting with this low put/call ratio. On the contrary, the low put/call ratio clearly shows that we have very few hedges in the market, which does make the market vulnerable for negative surprises. UBS 3

US Equity Market Update: Watch Banks and Semiconductors The technical picture on the sector front remains unchanged. From a relative perspective, the Q1 relative trend of defensive outperformance versus cyclicals pulling back is intact. However, at least in absolute terms it is striking that in the defensive camp we have with consumer staples and healthcare two key sectors sitting on or near obvious short-term support levels, where a break of 560 in consumer staples and 504 in the DRG would imply at least in absolute terms some kind of weakness, which would certainly weigh on the overall market. The best performer in defensives remains the utilities sector. Again, as long as the DJU trades above 683 (December bull trend) the sector remains in a constructive setup where on the back of expecting further short-term strength in bonds we would favor minimum to see one more bounce attempt towards its 2015 all-time high at around 724. In the cyclical camp we have intact short signal in banks, which we continue to see trading in a wave C. As long as we do not see a break of the last lower reaction high at 93.40, the BKX remains short-biased with risk to underperform into next week. Given our overall market low projection we would see price levels between 89 and 85 as contrarian buy levels. Keep an eye on semiconductors, where in the SOX index we have an obvious trading support at 985. A break of this level would complete a bigger price top and suggest at least on a very short-term basis more weakness towards 956/950. Oil service and the XOI have both failed to break their highlighted breakout levels. As long as the XOI trades below 1194, the sector remains in a larger basing process but we reiterate our underlying bull case to see more strength and outperformance into summer. Chart 7. ) US Banking Index (BKX) Daily Chart Chart 9. ) US Healthcare Index (DRG) Daily Chart Chart 8. ) S&P Consumer Staples Daily Chart Chart 10. ) US Semiconductor Index (SOX) Daily Chart UBS 4

Inter Market Update: Global Reflation Trade Just a Pause or Reversal? Strategically, and following our long-term cycles, we expected in 2016 major bottoms in crude oil/commodities and Emerging Markets, which from a macro standpoint should be the starting point of a 1.5- to best case 2 years lasting reflationary cycle, also with consequences for equities. After the 2011 2015 disinflation/deflationary bull cycle (and defensives outperforming) we expected the wave 5 bull cycle in global equities to have a reflationary background. On the sector front we anticipated a major reversal/bottom in the cyclical performance versus defensives in H1 2016. However, our key message was and remains that we see the 2016 bottom in inflation and yields as the starting point into a classic boom and bust cycle, where a potential but temporary overshooting in inflation and yields should finally bring us the wave 5 top of the 2009 long-term bull cycle in global equities and therefore the start into a real and major bear market. Over the recent weeks, with cyclicals pulling back and inflation rolling over we have seen more and more market participants questioning the underlying reflation trade. From a technical perspective and pattern wise, we don t think the 2016 reflation trade is over yet and our key arguments are unchanged. After last year s break of the 2012 down trend in US inflation expectations we saw the US dollar in 2017 as a potential trigger for a temporary overshooting in inflation and yields into H2. In the US dollar, our suggested major wave 5 top is in place as the trigger of a 10 to 12 months bear cycle. We can see a temporary break of correlations on the macro side but from a trend perspective a bearish US dollar is bullish oil and commodities. In crude oil, after the expected tactical Q1 correction, our suggested late March higher bottom is in place, which remains underlying bullish with target $60/63 into later summer. Agricultures are oversold and in a basing process and copper trades in a constructive consolidation pattern, which in our view has a bullish trend continuation character with target $3.00 into summer. Higher oil prices, another bull leg in copper and agricultural commodities expecting to bounce/rally into summer would have a strongly reflationary background. Tactically, in the US dollar, we have seen our suggested late March oversold bounce, which we think is near to complete. The March correction leg in the AUD we see as a corrective wave C (near to complete) and the basis for another significant rally into summer, where we expect the break its obvious key resistance at 0.78. Correlation wise, a bottom and subsequent rally in the AUD would be bullish commodities/gold and we therefore see the AUD as a key indicator for starting a comeback of the 2016 reflation trade via triggering a new rally in commodities, inflation expectations and yields into summer/h2. Conclusion: Tactically, it was one of our 2017 macro key calls to expect a temporary pause in the 2016 reflation trade in Q1. On track with our cyclical model, we saw yields, US cyclicals and inflation expectations pulling back, whereas in defensives we got our favored multi-month rebound. On a very short-term basis we expect the late Q1 pull back in US equities to extend into later April, where we see risk per se moving into an important tactical low/buying opportunity. This potential deeper/late April bottom we would see as an important turning point on the macro side, where we anticipate an important low for yields as the basis for higher yields into H2 and a significant rotation from defensives back into cyclicals. Consequently, any further near-term weakness in cyclicals into later April we would use to buy/add. Chart 11. ) US Dollar Index (inverse) versus US Inflation Expectations Chart 12. ) US Dollar Index (inverse) versus CRB Index UBS 5

Inter Market Update: Chart 13. ) US Dollar Index Daily Chart From the mid-march oversold levels we expected a tactical bounce. Although a touch higher than anticipated we see this bounce nearly compete and expect a new US dollar down leg to start with test of the 2016 trend support at around 99 into deeper/later April Chart 14. ) AUDUSD Daily Chart The March correction leg in the AUD we see as a wave C correction leg, which should complete the February/March corrective structure. In this context we expect renewed US dollar weakness to be led via the commodity complex, which would be aggressively bullish commodities, Emerging Markets, gold and related sector themes. Chart 15. ) AUDUSD versus Gold AUD and gold are normally highly correlated. So a new bull leg in the AUD would be clearly bullish gold. We are sticking to our underlying bull call on gold and gold mines, where tactically it is in our view just a question of time to break its February top at $1264, which would open the door towards $1300 and best case $1375 into summer. UBS 6

Inter Market Update: Chart 16. ) Shanghai Composite versus Copper Emerging Markets and in particularly China were and remain highly correlated to commodities and in particularly copper. We are bullish copper and we are therefore bullish EM and China, where we think it s just a question of time to see the Shanghai Composite breaking its obvious 3288 breakout level into deeper Q2. Chart 17. ) US Inflation Expectation versus US 10-Year Yield Higher inflation expectations in the US into H2 2017 would clearly suggest higher interest rates. Again, tactically we expected US yields to pull back into late Q1, and a low in risk assets in later April should be correlated to a low in yields. In our recent comments on bonds we highlighted the obvious key support in the US 10-year yield at 2.30% where we continue to see the risk of a temporary break. It would suggest the ultimate washout in in the extreme short positioning we had in bonds at the beginning of the year. At the end of the day we would see this washout as a selling opportunity in bond into later April as the set up for another significant up leg in yields where we continue to see minimum a test of the major long-term breakout level at 3.00% into later 2017 Chart 18. ) US 10-Year Yield (inverse) versus US Defensives/S&P-500 It was a key call of our 2016 strategy that a major low in oil and commodities as the starting point of a 1.5 to 2 years lasting reflation cycle should serve as the basis for a major reversal in the long-term leadership where we have seen 17 years of defensives outperformance versus the S&P-500. In December, after the vertical outperformance of the Trump rally in cyclicals, we called a tactical top in cyclicals. In the oversold defensives we expected a tactical several months lasting rebound on the back of our pull back scenario in US yields. However, a comeback of the reflation trade into summer would imply that a potential late April low in risk assets would be the beginning of new major rotation from defensives back into cyclicals where in particularly late cyclical commodity themes should outperform aggressively. UBS 7

European Equity Market Update: Increasing Selectivity Watch OMX The selectivity in Europe is further increasing, with the IBEX and small and mid-caps continuing to outperform/ and hitting new reaction highs, whereas we see losing momentum in the Euro STOXX, DAX, SMI and FTSE MIB as well as we have potentially toppish patterns forming in the FTSE-100 and the OMX sitting on key support. Our last week s call is unchanged. With the outperformer markets being overbought, the Euro Stoxx reaching the upper end of its 2016 bull trend, mid-caps and the DAX facing key resistance (all-time highs), we expect some more near-term consolidation into ideally next week as the next tactical buying setup. Support in the Euro Stoxx is at 3450/3400 and worst case 3342. Our deeper/later summer target is unchanged between 3600 and 3700. Chart 19. ) Euro Stoxx 50 Daily Chart Euro Stoxx 50: Last week saw a relatively resilient European market and no significant change in terms of price on the index front. Europe furthermore maintained its current outperformance mode versus US equities, and breadth remained slightly positive despite a rather mixed picture on the sector side. In terms of price, the situation is absolutely unchanged with the steep shortterm uptrend intact and the Euro Stoxx 50 trading below its next medium-term resistance at 3524. With an intact daily MACD sell signal in place, there remains risk of more consolidation, particularly if we were to see a break of the steep short-term up trend. In that context, last Thursday's intraday low at 3446 represents a new short-term key support. A break would trigger a short-lived pullback towards 3400, if not even 3342 before starting the real breakout attempt at 3524. Chart 20. ) OMXS-30 Daily Chart OMXS-30: The Swedish market has been one of the laggards in recent weeks and the February/March sideways range has a potentially toppish character if we take into account the risk of another down leg in risk into later April. Last week, the short-term key support at 1550 was confirmed, which confirmed the trading range. However, while trading below the mid-march reaction high, and if the index is unable to produce fresh upside momentum, the risk of breaking 1550 remains latently on the agenda. This does not means we cannot see renewed strength into summer but a break of the June/July 2016 bull trend would imply mini um that the market will very likely remain capped on the upside, which would also indicate latently increasing selectivity in Europe, which would be a sign of a maturing bull cycle. UBS 8

European Equity Market Update: Chart 21. ) FTSE-100 Daily Chart FTSE-100: After the second consecutive doji candle on a weekly chart basis, the short-term setup has not changed in terms of price. Short-term key support at 7256 has been confirmed and remains intact. Given the intact momentum divergence, which has been developing during the mid- March reaction high, the index remains in a latently toppish situation and where a break of 7256 would trigger a pullback towards 7100/7000 as part of an anticipated April trading low. Chart 22. ) DAX-30 Daily Chart DAX-30: The overhead resistance at 12388, which is defined by the April 2014 all-time high, represents the big and obvious key level for the DAX-30. With last week s initial reversal, our daily trend work has turned short, which suggests more near-term weakness before we expect the real and ultimate breakout attempt starting into summer. Last week's low at 12119 defines a new minor support, whereas the first bigger price support and a potential pullback target is unchanged at 11850. At least one more pullback leg would be required to complete a classic a-b-c corrective pattern before a new test to clear 12388 comes on the agenda into deeper Q2. Chart 23. ) Swiss Market Index Daily Chart Swiss Market Index: While trading between 8728 and 8519, the market is short-term in a neutral position and in consolidation mode. Within Europe, the SMI has been losing ground in recent weeks relative to the broader European market, so that short-term surprises to the upside in the Swiss blue chip camp are not expected. Further consolidation remains favored with supports at 8519 and 8400. UBS 9

STOXX Europe 600 Index Sector Overview: UBS 10

Weekly Technical Indicators: (Source: Pinnacle Data, Datastream) Charts: Metastock S&P 500 with AAII Bullish Consensus (%) S&P 500 with AAII Bearish Consensus (%) S&P 500 with INVI Advisors Sentiment Bullish (%) S&P 500 with NAAIM Exposure Index S&P 500 with CBOE Equity Put/Call Ratio S&P 500 with CBOE SKEW/VIX Ratio UBS 11

Weekly Technical Indicators: (Source: Pinnacle Data, Datastream) Charts: Metastock S&P 500 Stocks above 20 day moving average S&P 500 Stocks above 200 day moving average STOXX Europe 600 Stocks above 20 day moving average STOXX Europe 600 Stocks above 200 day moving average MSCI World and MSCI World Markets with Golden Cross (%) MSCI World Markets New 52-Week Highs UBS 12

Weekly Technical Indicators: (Source: Pinnacle Data, Datastream) Charts: Metastock S&P 500 with Break-Even Inflation Rate Gold with Break-Even Inflation Rate US Yield Curve versus US Bank Index (BKX)/S&P 500 Yield Difference Germany vs USA and EURUSD Relative Chart STOXX Europe 600 versus S&P 500 Relative Chart Nikkei 225 versus S&P 500 UBS 13

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