YMFYP International Portfolio

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International Portfolio management through Stocktrak (US and foreign stocks, US and foreign bonds, futures, options, foreign-exchange-exposure hedging strategies)

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YMFYP International Portfolio

  1. 1. Young Money for Young ***** Investment Portfolio Strategy
  2. 2. 2
  3. 3. TABLE OF CONTENTI) US & Europe Macroeconomic Outlook And Team Strategy…………………….……p.4II) Stocks, Mutual Funds, ETF & Bonds………………………………………………...p.41III) Options………………………………………………………………………………p.129IV) Futures………………………...…………………………………………………….p.198V) International Stocks & Hedges……………………………………………………...p.264 3
  4. 4. US & EUROPEMACROECONOMIC OUTLOOK AND TEAM STRATEGY 4
  5. 5. I. Fiscal and Monetary Policy (2010-2011) 1) Fiscal Policy In 2010, the main concern of the US government was to create jobs and boost theoverall economy by fostering investments. In order to do that, Obama signed the Tax ReliefUnemployment Insurance Reauthorization and Job Creation Act 1. This bill had as aconsequence for the working families to keep their tax cuts, avoiding losing $3000 perhousehold2. Also the bill helped to foster growth and job creation. The establishment of a fullyear emergency unemployment insurance benefits reduced the deterioration of the labormarket. The working families saw an increase of their disposable income due to the 2%payroll tax cut and the continuation of the tax credit3. Finally, the bill will help not to worsenthe medium and long term deficit; because this bill will support the economy by avoiding anaddition of costs for the government in the next 5 years4. In order to improve this expansionary fiscal policy, the US governmentimplemented tax cuts in order to improve employees’ tax relief. An important measure wasalso to extend the emergency unemployment benefits in order to help people who weresearching jobs and therefore help to stabilize the fragile labor market. The other governmentmeasures had for consequences to improve education, business investments and to create jobsin order to revitalize the labor market. In 2011, the US government continued to focus on the labour market in order to boost thecreation of jobs and the hiring. The set up of the WIA (Workforce Investment Act) whichauthorizes $10 billion for job training and employment services5, is a clear example of such ameasure. To stabilize the labour market, the government decided to implement automatic1 http://www.whitehouse.gov/issues/taxes/tax-cuts2 http://www.whitehouse.gov/issues/taxes/tax-cuts3 http://www.whitehouse.gov/issues/taxes/tax-cuts4 http://www.taxalmanac.org/index.php/Tax_Relief,_Unemployment_Insurance_Reauthorization,_and_Job_Creation_Act_of_20105 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf 5
  6. 6. workplace pensions and proposed regulatory reforms to give all workers access to retirementsavings opportunities6, measures taken in order to make significant improvements in workconditions. Furthermore, to revitalize the business investments and the labor market, the USgovernment decided to eliminate capital gains taxes for investments in small firms7,improving their ability to invest and to hire new workers. The US government also reformed the ESEA (Elementary and Secondary EducationAct) 8 and injected $3 billion in education programs in order to improve the quality and thestandards of the American education system. To avoid oil dependence from foreign countries,the US invested in clean energy infrastructures and new nuclear power plants. Nevertheless, the major concern for the US government was the containment and thereduction of the national debt. To achieve that, the US government cut spending in manydepartments and started 120 programs for termination, reduction, or other savings for a totalof approximately $23 billion in 2011, as well as an aggressive effort to reduce the tens ofbillions of dollars in improper Government payments made each year9. Last but not least, the US government set up the TARP (Troubled Asset Relief 10Program) that guarantees to the American taxpayers their payback from banks and firms :“to ensure that taxpayers are fully compensated for the extraordinary support theyprovided”11, as Obama said in his speech about the American budget for 2011. For 2012, the US government, following the recommendations of the bipartisan FiscalCommission12, proposed to adopt a plan that will help to reduce the deficit by $4 trillion over12 years13 by decreasing all kinds of spending, the main ones being the annual domestic6 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf7 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf8 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf9 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf10 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf11 http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf12 http://www.whitehouse.gov/the-press-office/2011/04/13/remarks-president-fiscal-policy13 http://www.whitehouse.gov/the-press-office/2011/04/13/remarks-president-fiscal-policy 6
  7. 7. spending, the defense budget and the healthcare spending, without being detrimental to themiddle class, the seniors and the future investments. By reducing the annual domestic spending, the US government will save $750 billionover 12 years14 but will continue to keep its core investments in order to maintain theimprovement on the labor market and the US economy. The government also forecastedinvestments in medical research, clean energy technology, education and infrastructures.The cut in the military budget will allow the government to make additional savings withoutaffecting the ability of the US government to protect the homeland and the American interestsall around the world.15The last measure taken by the US government will reduce the healthcare spending, not bylimiting the reimbursements and the services but by limiting the cost of the healthcare billsitself. 2) Monetary policy Assisted by the Board of Governors of the Federal Reserve System which isresponsible for the discount rate and the reserve requirements, the FOMC (Federal Openmarket Committee) is dealing with open market operations. In 2010, the US public debt wasestimated to be about 69.4% of GDP, and in 2011 about 62.9% of GDP; this shows animprovement in the situation of the US. Also in 2011 the deficit was about -8.9% of GDP.16 Over 2010, because of the financial crisis, the FOMC decided to continue to maintainthe historical Fed Funds Rate at 0.00% to 0.25% until mid 201317, in order to boostinvestments and households’ spending. At the beginning of the year (January 27, 2010), theFOMC decided to purchase $1.25 trillion of agency mortgage-backed securities and $17514 http://www.whitehouse.gov/the-press-office/2011/04/13/remarks-president-fiscal-policy15 http://www.whitehouse.gov/the-press-office/2011/04/13/remarks-president-fiscal-policy16 https://www.cia.gov/library/publications/the-world-factbook/geos/us.html17 http://www.federalreserve.gov/newsevents/press/monetary/20100127a.htm 7
  8. 8. million of agency debt spread over the year18 in order to improve the overall economy,especially the mortgage lending, the housing and private credit markets. Over 2010, theeconomy was strengthened throughout the year supported by a less a deteriorated labormarket, households and an expansion in business spending. However, the high unemploymentrate and the bank lending in contraction did weaken this fragile economy. This led to the QE2(Quantitative Easing 2) which consisted in expanding the Fed is holding of securities bypurchasing $600 billion of long term securities by the end of the second quarter of 201119 inorder to promote a stronger economic recovery and to have a better control on inflation. Over 2011, the overall economy was in recovery. Even if the households and businessspending increased moderately, the FOMC was still concerned about the weak improvementof the labor market, the high unemployment rate and the deterioration of the housing wealth.Therefore, the FOMC decided to maintain the Fed Funds Rate at 0.00% to 0.25%20 and tostart QE2 by the end of the second quarter. The FOMC is also worried about inflationresulting from the first Quantitative Easing begun in 2009 and the increase of commoditiesprices. In the second half of 2011, economic growth slowed, mainly due to the dramaticevents in Japan that caused a disruption of the supply chain and an increase in food andenergy prices21. In Europe, “on December 21st the ECB made available an eye-popping €489billion ($628 billion) in three-year loans to more than 500 banks across Europe. The moneywas released in response to an almost total freeze since July in the bond markets that are animportant source of long-term funding for banks.”22 Moreover, according to the same article,banks will have to present a plan in order to raise €115 billion in order to meet the newthreshold of the European Banking Authority.18 http://www.federalreserve.gov/newsevents/press/monetary/20100127a.htm19 http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm20 http://www.federalreserve.gov/newsevents/press/monetary/20110126a.htm21 http://www.federalreserve.gov/newsevents/press/monetary/20110622a.htm22 http://www.economist.com/node/21542187 8
  9. 9. In response to the deceleration of the economy and in order to boost employment andmaintain price stability, the FOMC intends to purchase $400 billion of Long Term securitiesby the end of June 2012 and sell $400 billion of short term securities23, allowing the reductionon the pressure of long term securities and therefore, lowering the long term interest rates. The Federal Reserve issued projections for 2012 and 2013 concerning the evolution ofGDP, labor market and inflation rates : “The central tendencies of these longer-runprojections were 2.5 to 2.8 percent for real GDP growth, 5.0 to 6.0 percent for theunemployment rate, and 1.6 to 2.0 percent for the inflation rate.”24 The Fed remained alsovery concerned about expected inflation in 2012, therefore; “another QE program isunlikely”.25 According to Sifma, “Concerns over fiscal policy, European sovereign debt,regulatory uncertainties, and high commodity prices remain significant risks to theoutlook”.26 Such expectations are the reasons why the FOMC is unanimous about themaintaining of its current 0.00% to 0.025% target Fed Funds Rate.2723 http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm24 http://www.federalreserve.gov/monetarypolicy/mpr_20110301_part1.htm25 https://www.wellsfargo.com/downloads/pdf/com/research/market_strategy/2012-Economic-Outlook_12072011.pdf26 http://www.sifma.org/research/item.aspx?id=858993467627 http://www.sifma.org/research/item.aspx?id=8589934676 9
  10. 10. II. Past and Expected Inflation According to CBS News28 , on May 13 2011, the US met the biggest yearly increasein prices since 2008, with an inflation of 3.2% driven by fuel and food. One month later, BenS. Bernanke gave an outlook on the inflation in front of the Federal Reserve board, during theInternational Monetary Convention29. He also presented “gasoline and other energy productsand, to a somewhat lesser extent, food, as the major cause for this increase in prices”. InNovember 2010, the Federal Reserve planned to purchase $600 billion Treasuries until June2011. Such a plan worried the markets, as injecting money in the economy is a source ofinflation. In June 2011,Bernanke, saw no evidence to be concerned as inflation did not seemto be lasting. Indeed, the actual increase was in the price of a single product, inflation at thattime was dependent on the commodities market and not the US economy. It should quicklydrop to a healthy level; moreover, in June the commodities market prices were alreadystarting to decrease. The two other reasons presented by the chairman were first, theunemployment rate. According to the Phillips Curve, unemployment and inflation have anegative correlation. Therefore, since labor costs were, and still are, too expensive comparedto production costs, and wages are decreasing, inflation should decline. The second reasonwas drawn by different measures testing inflation expectation, which forecasted futureinflation as stable. “As long as longer-term inflation expectations are stable, increases inglobal commodity prices are unlikely to be built into domestic wage – and price-settingprocesses, and they should therefore have only transitory effects on the rate of inflation.” The Bureau of Labor and Statistics also presented in its Consumer Price IndexSummary30 a yearly increase in the food index of 5.9%, but the end of the year showed adeceleration in increasing prices. In October and November the food index only rose 0.1%,28 http://www.youtube.com/watch?v=lw0jd6a3-KU29 http://www.federalreserve.gov/newsevents/speech/bernanke20110607a.htm30 http://bls.gov/news.release/cpi.nr0.htm 10
  11. 11. this reduction follows Ben Bernankes forecast. Moreover, the report showed a significantdrop in November in the energy products such as, gasoline (-2.40%), household energy (-0.40%) and natural gas (-4.40%). Among all those indexes, only the natural gas one showed ayearly decline of 1.30%. Following Ben Bernankes speech, Goldman Sachs, in its economic outlook31 did notbelieve either that inflation would be a lasting issue. Inflation would remain moderate. Thereport explained the 2010 drop in inflation was due to a strong monetary policy. Inflation wasabove the Federal Reserve’s long term target in 2011, due to an increasing number of peopleentering the rental market, with higher criteria for mortgages, and therefore an increasingnumber of foreclosures. The second reason was the vehicle market, which met an increase inprice due to supply chain disruptions during the Japanese earthquake, but it was onlytemporary. The last cause for inflation was the increase in apparel prices, due to highercommodity prices and wages in Asia. Goldman Sachs also projected a drop in inflation in2012. Indeed, the factors for inflation in 2011 were mostly temporary.31 http://www2.goldmansachs.com/gsam/docs/fundsgeneral/general_education/economic_and_market_perspectives/wp_economic_outlook.pdf 11
  12. 12. For the year 2012, a decrease in inflation can be expected. At mid-December analystsprojected32 an inflation of 2.8% in January, and a continuing decrease until April 2012 to1.8%, after-what it should slowly increase again to 3.8% in July. Concerning Europes inflation, which is going through its most unstable time since thecreation of the European Union, had an acceleration of 3% this autumn33 due to rising energyprices, but it decreased in December 2011 to 2%. Moreover, it is expected that theappreciation of the Euro will slow down the inflation rate in 2012, to below the EuropeanCentral Banks target. There is another possibility, where the inflation rate might continue toincrease, if labor costs and energy costs continue to increase, but this might create a situationof stagflation, with high unemployment and high inflation, a situation Europe cannot currentlyafford to be in.32 http://forecasts.org/inflation.htm33 http://www.euroeconomics.eu.com/inflation_variables.htm 12
  13. 13. III. Unemployment Since May 2009 the unemployment rate is above 9% which is very high. The lasttime the United States faced an elevated unemployment rate was in March 1982. In 2011,“The big news was the sharp drop in the unemployment rate to 8.6% from 9.0%”34. According to the U.S Bureau of Labor Statistics, from August to December, “theunemployment rate has declined by 0.6%.”35 In December 2011, it was the lowest rate of theyear. The reason was that 147,000 jobs per month had been added on average over theprevious six months and according to the same report “job gains occurred in transportationand warehousing, retail trade, manufacturing, health care, and mining.”34 http://www.ihs.com/products/Global-Insight/industry-economic-report.aspx?ID=106593187335 http://www.bls.gov/news.release/empsit.nr0.htm 13
  14. 14. However, some analysts contradict the previous projections, such as Bloomberg. Thecompany stated that the « Employers in the U.S. added fewer jobs than forecast (8.6%) inDecember»36. If we look at the graph above, the projected annual unemployment shows asignificant decrease in the future years. According to Market News International, « Withcontinued healthy growth in 2011 and beyond, the unemployment rate is projected to fall, butit is not projected to fall below 6.0 percent until 2015 »37.36 http://www.bloomberg.com/news/2011-01-07/u-s-adds-fewer-than-estimated-103-000-jobs-unemployment-declines-to-9-4-.html37 http://www.forexlive.com/index.php?s=With+continued+healthy+growth+in+2011+and+beyond%2C+the+unemployment+rate+is+projected+to+fall%2C+but+it+is+not+projected+to+fall+below+6.0+percent+until+2015+ 14
  15. 15. IV. Gross Domestic Product (GDP) Over the years following the financial market crash in the United States, the GDP ofthe US has been on a roller coaster ride. During the 2008 crisis, the GDP had fallensubstantially (almost -10.0% as shown on the graph). Indeed, at that time period,consumption, business investments and government spending decreased as the credit crunchtouched the entire country. The measures taken by the Federal Reserve with QE1, pushinginflation higher, led the GDP to rebound in 2009 and 2010. According to the Bureau of Economic38 Analysis during the 2nd quarter of 2011 GDPincreased 1.3%, and during the 3rd quarter, it increased 1.8%. The end of the year 2011 met anincrease in consumer spending, and in consumption of durable goods, mostly in motorvehicles and parts. Also, there was acceleration in business investment, mainly investments inequipment and softwares. Exports increased, according to the BEA there were “decreases intravel and passenger fares were mostly offset by increases in royalties and license fees andother private services (which includes items such as business, professional, and technical38 http://www.bea.gov/newsreleases/national/gdp/gdphighlights.pdf 15
  16. 16. services, insurance services, and financial services). Changes in the other categories ofservices exports were small.”39 It is forecasted for the year 2012, that GDP will increase about 2.5% 40. Consumersare spending again after saving money for the past four years, and the expectations are mainlyin the vehicles sector. Moreover, employment should improve with businesses investing innew equipment, in order to increase production. Also, according to the department ofcommerce, even though GDP is rising, it is not necessarily showing a strong recovery.“Unfortunately, growth isn’t accelerating as it normally does in a recovery. Data will showthat the economy grew at an annual rate of 3% or more in the last quarter of 2011 but that thepace will slow again early in 2012 and pick up only slightly by the end of the year. Asustained recovery is still not under way, more than two years after the end of the GreatRecession”. If we compare the GDP per capita between US and Europe, the US are doing betterthan Europe, according to Adam Davidson, «the U.S. GDP per capita is nearly 50 percenthigher than it is in Europe»41. George Irvin, a Research Professor at SOAS in London, saidthat, «the main reason the US is richer is, first of all, because a higher proportion ofAmericans are in employment and, secondly, they work about 20% more hours per year thanEuropeans». Concerning Europe, in 2011 the European debt crises led the GDP of most of theEuropean countries to decrease. Governments had to use austerity plans, decreasing theirspending and increasing product prices in their country. “Gross domestic product rose at a 1.8percent annual rate from January through March after a 3.1 percent pace in the last threemonths of 2010, the Commerce Department said today in Washington. Economists projected 239 http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm40 http://www.kiplinger.com/businessresource/economic_outlook/41 http://www.nytimes.com/2012/01/08/magazine/the-other-reason-europe-is-going-broke.html?_r=1&ref=grossdomesticproduct 16
  17. 17. percent growth, according to the median estimate in a Bloomberg News survey.”42 Even the European countries who performing well are poorer than the United States,for example Germany, «is about 20 percent poorer than the U.S. on a per-person basis (andboth countries have roughly 15 percent of their populations living below the poverty line)»43.42 http://www.bloomberg.com/news/2011-04-28/economy-in-u-s-grows-less-than-forecast-1-8-as-consumer-purchases-cool.html43 http://www.thenewfederalist.eu/Europe-vs-USA-Whose-Economy-Wins 17
  18. 18. V. The DollarUSD/EUR over the past two years44 The Dollar has been through a lot of declines and rallies within the past two years.As it is seen as the safe-haven, the greenback appreciates during risk-aversion periods. Thehighest peak that we can see on the chart in June 2010 was caused by Hungary and Greecedebt concerns in Europe.45 In November 2010, the Federal Reserve announced its secondquantitative easing (QE2) of $600 billion of US Treasury purchases. This made the Dollar thevictim of the following days; it depreciated against the Yen and the Yuan as thisannouncement engendered a growing fear in Asia (China being the biggest investor in USTreasuries). QE2 being a sign of future inflation, this also led the Dollar to depreciate. 2011 was a challenging year for currencies. At the beginning of the year, theeconomy was concerned by the US debt crisis, but the Dollar strengthened as investors wereeven more worried about the situation in Ireland and some other European countries such as44 http://www.finance. yahoo.com45 http://www.reuters.com/article/2010/06/07/markets-forex-idUSN0721338820100607 18
  19. 19. Portugal or Italy. Then, “the dollar depreciated against most currencies through the summerof 2011.” 46 But the worsening Eurozone of the situation at the end of the summer allowed thedollar to rebound. In December 2011, the dollar was mainly driven by Asian matters, with“the decision of the Bank of China [to] put strong pressure on the US dollar”47 by loweringthe reserve requirements for banks led the US dollar to depreciate because the Chinese Bankscould than sell their USD assets causing supply of the US dollar to rise on the open market.On December 20th, “the US dollar rose against most major currencies on the report of thedeath of leader Kim Jong-Il.” 48 Today, the Dollar is still seen as the safe-haven for investors, after serious concernsabout the Eurozone crisis. After S&P’s sovereign downgrades including France, the Dollarappreciated significantly. As explained by John Kicklighter, Senior Currency Strategist, “Tobuild serious demand for a currency that exemplifies liquidity and safety, we needed acatalyst to tip the tenuous balance between central bank guarantees and impending recession.Rating agency Standard & Poor’s may have provided just that.” 49 For 2012, we expect the dollar to stay the safe-haven for investors. According to areport from Scotiabank, “the USD, measured by the trade-weighted DXY index, has increased 508% since early September.” As the situation in the Eurozone is worsening after the lastdowngrades; we expect the dollar to keep appreciating in the short term. Asian markets willprobably be overvalued due to fewer exports to Europe, leading the US currency tostrengthen.46 http://www.ihs.com/info/ecc/a/economic-predictions-2012.aspx47 http://www.stockmarketsreview.com/forex/the_decision_of_the_bank_of_china_put_strong_pressure_on_the_us_dollar_20111201_209673/48 http://www.stockmarketsreview.com/forex/the_us_dollar_rose_against_most_major_currencies_on_the_report_of_the_death_of_leader_kim_jong_il_the_north_koreas_leader_20111220_226579/49 http://finance.yahoo.com/news/Dollar-Prepared-Fear-Follow-fxcm-788274478.html?x=050 http://www.scotiacapital.com/English/bns_econ/fxout.pdf 19
  20. 20. VI. The Euro 51EUR/USD over the past two years The Euro, just like the US Dollar, has been through challenging years as shown onthe graph. June 2010 was a relatively bad period for the currency, as it hit its lowest level 52against the dollar since 2006 at $1.1876, but also against the yen and the Swiss Franc.However, November 2010 was bullish for the Euro; as we can see on the above chart, it roseabove $1.41 due to the dollar weakening after the Federal Reserve’s announcement aboutQE2. In May 2011, after a depreciation at the beginning of the year due to the bailout ofIreland (end of November 2010) and Portugal (May 2011), “the euro was up 0.3% at 1.4870,with demand from Asian sovereigns as well as European real money interest boosting thesingle currency.” 53 The Euro then depreciated sharply at the beginning of October, as Greecedefault was feared more and more in Europe. It hit $1.318554 its weakest level against the yen51 http://www.finance.yahoo.com52 http://www.reuters.com/article/2010/06/07/markets-forex-idUSN072133882010060753 http://www.reuters.com/article/2011/05/04/markets-forex-idUSLDE7431822011050454 http://www.reuters.com/article/2011/10/03/markets-global-idUSN1E7921W020111003 20
  21. 21. since 2001. The currency seemed to recover at the end of October by hitting a peak, but “theeuro slipped after the auction yield on the new 10-year Italian government debt hit a neweuro lifetime high.” 55 Since September 2011, the Eurozone’s currency is suffering from the sovereign debtcrisis which is now spread throughout the entire continent, with less and less countries able tokeep their triple A rating. The Euro remains weak at $1.2680 after France, Austria and ESFSdowngrades from AAA to AA+. We believe that the Euro will continue to weaken in 2012 as we expect the debt crisisin Europe to worsen. Moreover, the Eurozone’s inflation “remains above the bank’s 2%target” 56 leading to higher yields in the short term. This also enforces our expectation that thecurrency will depreciate.55 http://www.reuters.com/article/2011/10/28/markets-forex-idUSN1E79R0WH2011102856 http://www.scotiacapital.com/English/bns_econ/fxout.pdf 21
  22. 22. VII. Treasury Bond and Bond Market Beginning in the fourth quarter of the year 2008, the US began its economic crisisand the ensuing recovery plan. Up until this day the US is still working hard to see itseconomy recover. Treasury bills, also known as T-Bills, are government traded securities thatare issued by the United States government. They are typically considered to be one of thesafest forms of investment for investors. About twenty years ago Treasury bills were sellingwith yields around 8.65%. After events such as the Gulf War and 9/11 Terrorist attacks, T-billrates started to decrease to 0%. The recent financial crisis of 2008 accelerated the decline of 22
  23. 23. T-bill rates to nearly 0%.57 Such unusual low rates; in order to fight the inflation the Fed hadto withdraw money from the market. Also, as a fiscal policy the government chose not toincrease tax rates citizens as an incentive to keep spending; this in turn would help tostimulate economic growth. Looking at the rates offered for T-bills during the present year we see that they arestill very low. Short term securities ranging from three months to one year are selling at acoupon of 0% while T-notes are selling at rates just under 1% to 2%. T-bonds are selling atrates higher than 2% but lower than 3%. That is to be expected since investors would not wantto invest in these securities unless they would have some return.58 The Fed will of course raisethese rates once the economy shows some signs of recovery to fight inflation but as of nowthey will stay as is. If we compare the yield curve of municipal bonds and corporate bonds, we note thatthe returns for corporate bonds are higher than that of the municipal bond. In other words, thecorporate bonds have higher risk than municipal bonds.57 http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/58 http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/ 23
  24. 24. From 2010 to 2011, both curves showed a decrease in municipal bonds and corporatebonds rates. Municipal bond yields fell greater than corporate bond yields due to the decreasein the total dollar amount of municipal debt between the fourth quarter of 2010 and firstquarter of 2011.Decreases in debt held by individuals, mutual funds, banking institutions,insurance companies, and other entities also attributed to the decrease. Another reason for thedecrease in issuance of bonds in 2011 was due to fact that 2010 was a record year for bondissuance. Corporate bonds decreased quarter to quarter by 8.6%. 59 According to the report ofthe US Census, Corporate bonds comprised just under a sixth (15.7%) of the total cash andsecurity holdings of major public-employee retirement systems for the current quarter.6059 http://www.bondsonline.com/Search_Quote__Center/Municipal_Bonds/60 http://www.bondsonline.com/Search_Quote__Center/Corporate_Agency_Bonds/Spreads/ 24
  25. 25. The comparison of the yield curves from January 2011 and January 2012 shows thatrates were much higher in the year 2011 in respect to all treasuries sold. 61 The biggestdifference can be seen when looking at treasury rates for 30 years where the difference isalmost 1.5%. In short it seems that recovery slowed down in the year 2011. Hopefully, as welook towards the coming months these rates will once again increase and investors will havebetter returns.Long Term U.S Government Bond Yields Past Present and Future62 The forecast for the US government bonds for 2012, show an increase compared to2011. As investors are worried about unsafe European bonds, they will focus on USTreasuries. Therefore, an increasing demand in the US bond should decrease the interest ratesfor those bonds, as shown in the above chart.61 http://www.bondsonline.com/Chart_Center.php?FA=treasury_yieldCurve_double&date1=1%2F16%2F2011&date2=1%2F16%2F201262 http://www.marketvector.com/interest-rate/long-term-government-bonds.htm 25
  26. 26. Looking at the European bond market graph above for ten year government bondsissued by European nations, we see that bond rates have generally been on the rise since early2010.63 The European crisis started with Greece in December 2009. The downgrade ofGreece’s credit rating by one of the world leading rating agencies is what got the ball rolling.Consequently, “Greek bonds as well as European bonds declined steeply as a result of debtconcerns.”64 We can expect Greek bond prices to remain low over the next few years and thecountry financial situation to improve very little. In late 2010, we saw the same thing that happened in Greece happening to otherEuropean nations such as Ireland, Spain, and Italy. From 2010 to 2011 we saw that every timea country was downgraded by rating agencies it affected the bond markets of other Europeannations by increasing their market interest rates. There was high risk and investors were notconfident in investing in this volatile market. Looking towards the future we can expect bond rates across the Eurozone to fall, butnot substantially. From the graphs above we already saw that towards the end of 2011 bondrates have begun to decrease. We can expect that these rates will continue to fall until theEuropean economy improves. As the European economy improves we can expect bond ratesto flatten out and be less volatile. According to Emilly Knapp, “the success of today’s63 www.economist.com/blogs/dailychart/2011/08/euro-zone-bond-spreads64 http://theinvestmentblog.net/2010/12/26/2011-bond-market-outlook-2010-year-end-bond-summary/ 26
  27. 27. European bond auctions, and the expectation of continued success, was enough to outweigh ahost of negative economic data today, allowing markets to close slightly up”.65 According to FT66 German bunds stay the safest in Europe, the 10-year bundyielding at 1.78%. Compared to last year, the Greek 2-year note yield reflects its riskiness,increased by 91.80%.Also, Portuguese 2-year note yields at 15.80%, which is 11.44% higherthan last year. On January 12th, 2011 Portugal, in order to delay its bail out, set a bond65 http://wallstcheatsheet.com/trading/market-recap-euro-bond-auctions-buoy-markets-despite-negative-data.html/66 http://markets.ft.com/research/Markets/Bonds 27
  28. 28. auction. At the end of the day, it was reported by the newspaper The Guardian 67 that “Thecountry paid 6.7% to raise money – less than the 7% rate that would have been regarded as astep towards a bailout.” The auction amounted to EUR1.25 billion, with the intervention ofthe ECB, who had to buy some bonds to limit the cost of borrowing.67 http://www.guardian.co.uk/business/2011/may/04/portugal-bailout-euro-rises-bond-markets 28
  29. 29. VIII. Stock Markets a) Dow Jones 68 During 2011, the Dow Jones has been volatile due to the past financial crisis. At thebeginning of the year, the Dow’s curve rose with a 4% increase in March, resulting from therecovery of the overall economy and the improvements of financial and economic indexes.However, in March 11th, the Dow plunged following the earthquake and tsunami that hitJapan69 which provoked a wave of panic among investors in the stock market. Nevertheless,the Dow quickly recovered from this event and started to rise until the end of April –beginning of May, where it reached its peak of the year (12 876). From May to July, the Dow started to slightly decrease as the government arguedabout bills spending and debt ceiling70. At mid-July, the government was forced to find a68 http://www.finance. yahoo.com69 http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx70 http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx 29
  30. 30. solution or risk defautl71; therefore, the Dow jones reacted by falling sharply. Later in JulyCongress came to an agreement but the markets remained volatile, the investors being stillanxious and afraid about the overall economic and financial conjecture. On August 5th,Standard and Poors, (the notation agency) downgraded the US Treasury Securities from AAAto AA72, causing a wave of panic among the investors. In reaction, the Dow Jones plunged by15% to reach its trough of the year and remained extremely volatile until October because ofthe political uncertainty and unpredictable nature of the markets. From October to midNovember, the Dow Jones rose significantly, due to the speech of Ben Bernanke, thechairman of the Federal Reserve, who denied any future quantitative easing from the Fed. 73This reassured the investors in the stock market. Also, the Dow Jones was driven by largecompanies which increased their profits. The ECB (European Central Bank) which massivelybought US bonds caused an increase in bonds prices and therefore a decrease of their interestrates. Referring to Jean Claude Trichet, “the central bank would continue its bond buyingprogram and extend loans to banks to prevent liquidity problems.”74 Hence, the investorsdropped their bonds and started to invest in the stock market. The Dow Jones ended 5.5% atthe end of the year, which remained the biggest increase in 13 years. Even if the marketbecame volatile in mid November, this hiccup was due to the fact that European investorsinvested massively in US bond market, causing momentarily a V shape in the stock markets.75 In 2012, the US stock market will continue to be considered the “safest” market toinvest in, as the situation of the rest of the world becomes more uncertain (e.g.: Europe).Indeed, according to George Feiger the CEO Contango, a major US oil and gas corporation:71 http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx72 http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx73 http://www.thestreet.com/_yahoo/story/11267126/1/stock-market-story-oct-4.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA74 http://www.thestreet.com/_yahoo/story/11270268/1/stock-market-story-oct-6.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA75 http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx 30
  31. 31. "the U.S. will continue to be the least bad place to invest for a number of years." 76Moreover, “despite the fears that a large European country such as Italy will default on itsdebts, causing a banking crisis there and possible financial contagion around the globe, theeuro zone’s debt crisis doesnt have to end in a worldwide financial crisis” said StephenAuth77, the Chief Investment Officer of Federated Investors. b) Nasdaq and S&P500 78 In 2011, Nasdaq and S&P500 indexes had the same curves trends as the Dow Jones,implying a similar correlation between the three indexes. Nevertheless, the Dow Jones was 79the only index which rose 5.5%. The S&P 500 remained almost the same (0.4% decrease)and the Nasdaq decreased by 1.8%80, due to the fact that in such a fragile, troubled economicand financial conjecture, investors preferred to invest in the Dow Jones, which is the priceweighted average of the thirty significant stocks traded on the NYSE and the Nasdaq, which76 http://www.usatoday.com/money/perfi/stocks/story/2011-12-30/stock-outlook-2012/52342704/177 http://www.usatoday.com/money/perfi/stocks/story/2011-12-30/stock-outlook-2012/52342704/178 http://www.finance. yahoo.com79 http://www.thestreet.com/_yahoo/story/11360717/1/stock-market-story-dec-30.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA80 http://www.thestreet.com/_yahoo/story/11360717/1/stock-market-story-dec-30.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA 31
  32. 32. explain its safe haven connotation, in order to guarantee the preservation of their initial capitalin troubled times and its valorization in better times. 32
  33. 33. IX. Commodities market a) Gold During 2011, the gold market has known an amazing increase over the year; firstfrom January 14th to August 30th with an increase of 40%. The price then fell again to a priceof $1650 per ounce of gold, but still having an increase of 22% at January 13 th the next year.At this time, because of the high volatility of the markets, the incertitude and the anxiety ofinvestors who feared a double dip recession following the financial crisis of 2009, goldproved itself to be a safe place to invest in, a safe haven. According to many analysts, “thegold sector is undervalued and poised for a comeback”.81However, the main reasons of theincredible increase in gold were, firstly, China’s growth in GDP of 21% from 2009 to 201182knowing that China is “among the leading countries in importing gold and silver”83;secondly, the emergence of physically backed ETFs (Exchange-Traded Funds)84, very popular81 http://www.thestreet.com/_yahoo/story/11166900/1/gold-stocks-ready-for-a-recovery.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA82 https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html83 http://www.tradingnrg.com/gold-prices-outlook-silver-price-forecast-july-14-2011/84 http://www.reuters.com/article/2011/04/28/etfs-gold-idUSN2828061020110428 33
  34. 34. and almost inexpensive securities that investors like to trade in order to take advantage on thefluctuations of the gold market; and lastly, the US dollar depreciated responding to “themixture of Ben Bernanke’s testimony and the Moody’s rating news”85, causing the rise in goldprices. Since August 30th, gold started to decline sharply, this drop being a cause of thestrengthening of the dollar. As the dollar rose, the investors dropped gold. This burst of thegold bubble can also be explained by the fear of nationalization of world gold mines by thegovernments. Indeed, as David Christensen said: "[nationalization is] going to play out ... thepie has gotten bigger and so the perception is that they should take the larger portion of thepie", meaning that the gold mines profits will be mostly absorbed by the governments whichfrightened investors. On October 3rd, an announcement was made about Kibali’s gold mine. It was statedthat it would be running at full capacity by 2013; which supported the speculation on gold.This caused a good increase until mid-November, a movement that was forecasted byReuters: “The Kibali project is potentially one of Africas largest gold mines and Bristow saida processing plant with a 4-6 million tonne-a-year capacity will be installed. “86 Since mid-November until the end of the year, the decrease in gold is mainly due tothe appreciation of the dollar versus the other major currencies (principally Euro)87; therefore,investors dropped gold and started to invest in the dollar.85 http://www.tradingnrg.com/gold-prices-outlook-silver-price-forecast-july-14-2011/86 http://www.reuters.com/article/2011/10/03/congo-democractic-gold-idUSL5E7L343N20111003?feedType=RSS&feedName=basicMaterialsSector&rpc=4387 http://www.reuters.com/article/2011/11/16/markets-precious-idUSL5E7MG28J20111116 34
  35. 35. 88 According to the preceding chart, the value of the gold is expected to rise by 9.09%during the year 2012. Indeed, “Economic growth expectations globally are declining, highdebt burdens in Europe will continue to hamper growth, and the risk of a U.S. recession isrising. All of these factors are individually positive for gold. Taken together, they are apotentially explosive cocktail.” UBS said.89 Referring to Bloomberg, the price of gold isexpected to rise dramatically in the coming year. Even after some disappointment in theprevious year, speculation will cause the price of gold will range between $1900 and$2000/ounce at the end of 2012.9088 http://www.forecasts.org/gold.htm89 http://www.bloomberg.com/news/2011-09-07/ubs-boosts-2012-gold-price-forecast-by-50-to-2-075-an-ounce.html90 http://media.bloomberg.com/bb/avfile/News/First_Word/vzp7Z2sK7kjY.mp3 35
  36. 36. b) Oil At the beginning of 2011, oil rose drastically. The main reason of such an increasewas the riots in Libya and the Arab Spring91. The area which was politically very troubledadded to the risk of disruption in the supply chain of crude oil, knowing that Libya andcountries in the neighborhood are massive oil producers’ countries, caused a sharp increase ofoil prices, which reached their peak in the end of April. Indeed, “this turmoil raised the levelof instability in the Middle East and consequentially made many oil traders anxious as crudeoil price soared mainly at the beginning of last week.”92The massive speculation on theincrease of oil prices amplified the sudden growth of the oil prices. In May, oil fell due to several reasons. The uncertainty of the previous goldfluctuations and the unpredictable nature of the oil price evolutions frightened investors whoduring those precise times were risk averse and were looking for stability93. Dollar and oil arenegatively correlated. Indeed, “The strengthening of the greenback also helped keep oil prices91 http://www.tradingnrg.com/how-does-the-middle-east-turmoil-affecting-the-brent-oil-wti-spread/92 http://www.tradingnrg.com/oil-prices-soared-as-libyan-riots-continued-weekly-recap-21-25-february/93 http://www.oil-price.net/en/articles/oil-prices-down-for-now.php 36
  37. 37. at bay.”94. And last but not least, the demand for oil and gasoline dropped by the UnitedStates due to the IEA’s report which forecasted a cut in oil demand 95. Added to that, theOPEC had an excess of oil production which caused an increase in the oil supply, directlyleading to a drop in oil prices. Since the end of September – beginning of October to the end of the year, crude oilsurged caused by the European efforts and agreements to solve the debt crisis 96. Also OPEC’sproduction decreased (mainly in Saudi Arabia and Nigeria), decreasing the oil supply andleading to an increase in crude oil prices.97 98 As the overall economic recovery is dependent on the fluctuations of oil prices, thepolitical issues in the Middle-East and some African countries can affect and seriouslydamage the fragile global economic situation in 2012.94 http://www.oil-price.net/en/articles/oil-prices-down-for-now.php95 http://www.tradingnrg.com/oil-prices-moderately-inclined-last-week-weekly-recap-2-6-may/96 http://mobile.bloomberg.com/news/2011-09-27/crude-oil-rises-a-second-day-amid-european-efforts-to-solve-debt-crisis97 http://www.tradingnrg.com/opec-crude-oil-production-slightly-fell-september-2011-opec-october/98 http://www.forecasts.org/oil.htm 37
  38. 38. According to the Energy Policy Information Center: “Considering the continuedvolatility in Iran and Nigeria, a severe or prolonged oil price spike could dramaticallyworsen the situation in 2012”. 9999 http://energypolicyinfo.com/2012/01/trade-deficit-widens-beyond-expectations-on-oil-imports/ 38
  39. 39. X. Team Strategy During the past few months, Europe has been through the worse crisis since thecreation of the European Union; this will have a significant impact on the market in the shortterm as currently the situation does not show any sign of recovery. The US seems to have thesafest economy for now; their economy seems to have recovered from the 2008 crisis, but thecoming elections might also have an impact on the US markets, depending on people’sconfidence. Moreover, inflation is not supposed to increase in 2012; we can therefore wonderif the Federal Reserve is going to ease the economic recovery again by purchasing USgovernment bonds in order to boost growth. However, another quantitative easing is notforecasted by the Fed, which is still concerned by the maintaining of the inflation rates andprices stability. Concerning European monetary policy, we will also have to pay attention tothe ECB actions. Because of this uncertain future, opinions are staying relatively moderate onhow the markets will progress. Volatility will stay high, forcing investors to stay active and tofollow the markets cautiously. Therefore, Young Money for Young ***** has decided to adopt a controlled,measured and aggressive investment strategy in order to have greater returns in the short-term, giving value to the invested capital during economic growth and financialimprovements and still preserving the initial capital and minimizing the losses duringeconomic contractions and financial troubles. The bond market in Europe is currently less attractive than the US; due to theEuropean debt crisis, people are more focused on US bonds in order to have saferinvestments. To be in line with our aggressive strategy, we will invest in European bonds.Concerning our investment in equities, we will invest at the same time in volatile and highlyleveraged companies in order to maximize the returns, and in large safe companies. 39
  40. 40. We will allocate our capital as shown in the Pie Chart: 40
  41. 41. Stocks, Mutual Funds, ETF and Bonds 41
  42. 42. Our Long Position: HALLIBURTON COMPANY (HAL)Company Profile Halliburton is a $32.61 billion company created in 1919, and headquartered inHouston, Texas. It belongs to the oil and gas equipment and services industry. The companyis one of the largest oilfield services corporations, providing exploration, development andproduction of oil and gas worldwide, in 80 countries. It operates in the following segments:completion and production (sperry drilling, wireline and perforating, testing and subsea…),drilling and evaluation (cementing, production enhancement, multi-chem…). It is traded onthe New York Stock Exchange. It takes part in a highly competitive market. Indeed, energy isa domain that will always be needed. Moreover, this industry highly depends on oil and gasprices, which are very volatile as they are easily impacted by economic events. For example,if the government of a country producer of oil collapses, oil price will be impacted. Wedecided to buy Halliburton’s stocks because we believe that this domain, still volatile, willnever hit the bottom. Moreover, the performance of this industry is forecasted to accelerate inthe future. Thus, oil and gas prices are expected to increase as well as our company’s stock.We are in line with our moderate-aggressive strategy, Halliburton being the stock thanks towhich we expect to moderate other risky investments. The major competitors of Halliburtonare Schlumberger Limited, Baker Hughes Incorporated, Technip. 42
  43. 43. 100 Halliburton is the second largest company of its industry after SchlumbergerLimited, which has a market capitalization three times bigger. Schlumberger employs two times more people than Halliburton, but Halliburton ismaking more revenue with less people, as the revenue per employee is higher for Halliburton($382,000) than for Schlumberger ($349,912). With the highest operating margin (18.66%) compared to its competitors and theindustry, Halliburton retains a higher proportion of revenue after having paid its variablecosts. The company has therefore more to pay its fixed costs which are quiet high in thisindustry, in particular because of wages as it is a labor intensive industry. Schlumberger,having a lower operating margin (16.90%) and a greater number of employees, will have lessrevenue to invest in other operations than Halliburton. If we compare the net income of Halliburton ($2.72 billion) with its majorcompetitor, Schlumberger’s net income is almost the double with $4.78 billion. For each100 http://www.finance.yahoo.com 43
  44. 44. dollar of net income generated, Schlumberger’s investors are paying $19.95, which is 64%more than Halliburton’s which has a Price to Earnings ratio of 12.76. Looking at the Earnings per Share ratio, we notice that Halliburton’s EPS ($2.76) is27.6 times higher than the industry’s EPS ($0.10) This means that most of the companies’earnings are not growing as much as Halliburton. Halliburton has the lower Price to Earnings Growth with 0.33, more than two timeslower than the industry and nine times lower than its competitor Technip. Consequently, wecan expect that the stock price will rise in the future, as at the moment it would mean that thestock is undervalued.One-Year Stock Moves and Beta ComparisonOne-year Comparison between Halliburton Company, Schlumberger Limited and S&P500.101 Both stocks started to rise after a good statement on June 24th, saying that“Halliburton Co. (HAL) and Schlumberger Ltd. (SLB) may have the power to charge higher101 http://www.finance.yahoo.com 44
  45. 45. prices for their oilfield services through 2012.”102 Brian Uhmler, analyst, added that: “Oilfieldservices companies [had] the power to raise prices more than 16 percent [in 2010]. It mayaccelerate consolidation in the industry as companies expand to meet demand” On July 22nd, oil companies hit highs. “Oil pushed higher, briefly topping US$100 abarrel, as investors cheered progress on an agreement to aid Greece and the worlds largestoil consumers decided against releasing additional oil stockpiles.”103 Until the end of August, Schlumberger was moving just like the market, meaning abeta close to 1, whereas Halliburton has always been above, outperforming the market. Itsbeta is lower than 1, due to the fact that their stock price is driven by oil prices, which is anutility, and that it is an international company. Due to concerns of another recession in September, oil prices dropped leading oilcompanies to underperform the market. Since this time period, both companies’ beta roseabove 1 as they became more volatile. On September 6th, the company announced that “it has entered into a definitiveagreement to acquire Multi-Chem Group, LLC.”104 Multi-Chem is a provider of productionchemicals in North America, helping oil and gas companies to develop their resources. On October 3rd, the company announced the completion of the acquisition of Multi-Chem105. The day after, on the 4th of October, “Greece’s acknowledgement of possibly notmeeting its target of deficit reduction for this year dominated investor sentiment.”106 Bothstocks dropped dramatically, Halliburton hitting -25.0% and Schlumberger -30.0%. S&P500closed at its lowest level since 2010. The same article stated that: “On the NYSE, for every102 http://www.bloomberg.com/news/2011-06-24/fracking-gold-rush-lifts-halliburton-prices-as-backlog-swells.html?cmpid=yhoo103 http://www.morningstarthailand.com/th/news/articles/99695/Global-Market-Report-22-July-2011.aspx104 http://www.reuters.com/finance/stocks/HAL/key-developments/article/2396079105 http://www.reuters.com/finance/stocks/HAL/key-developments/article/2409658106 http://www.zacks.com/stock/news/62097/Stock+Market+News+for+October+4,+2011 45
  46. 46. one stock that moved up, a total of 10 stocks declined.” Both HAL and SLB are traded on theNYSE.Halliburton’s Beta107 HAL changes β S&P500 changesHistorical Prices of HAL and S&P500 taken from Yahoo108 Today, Halliburton has a beta of 1.58. On the characteristic line, it is slightlydifferent (1.70) as we only took the changes in prices over one year. Alpha (α) is equal to0.0002, meaning that Halliburton is slightly outperforming its benchmark as the return of thestock when the market does not move is 0.02%. The industry has a beta of 1.25, meaning thatit is a very volatile one. Compared to the industry, Halliburton is more risky than the average107 http://www.reuters.com108 http://www.finance.yahoo.com 46
  47. 47. of the companies within it. According to Reuters, the beta of Schlumberger is equal to 1.39,which is still above the industry. But compared to Halliburton, this means that Schlumbergeris more international, less risky, and that it has more market power. The industry beingvolatile but not highly risky, it is in line with our strategy.RRR and ERR Calculation ( )HALLIBURTON SCHLUMBERGERRRR = 0.1% + (8.7% – 0.1%) * 1.58 RRR = 0.1% + (8.7% - 0.1%) * 1.39RRR = 0.1369 = 13.69% RRR = 0.1205 = 12.05% HAL SLBData taken from Yahoo109HALLIBURTON SCHLUMBERGERERR = 0.01 + 0.19 ERR = 0.015 + 0.287109 http://www.finance.yahoo.com 47
  48. 48. ERR = 0.20 = 20% ERR = 0.3020 = 30.20% Halliburtons Capital Asset Pricing Model Return 20,00% ERR = 20,00% 18,00% 16,00% 14,00% RRR = 13,69% Security Market Line 12,00% RRR 10,00% ERR 8,00% Km = 8,70% 6,00% 4,00% 2,00% Krf = 0,10% 0,00% Beta 0 1 2 3 As we can see on the Halliburton’s CAPM, the Expected Rates of Return is abovethe Required Rate of Return. This is therefore a BUY sign. RRR is on the security marketline, this means that if the rate of return was 13.69%, we should hold. The growth rate isexpected to be lower next year as the growth is not expected to be as high as this year;consequently, it is better to buy this year. If we compare those rates with Schlumberger, theRRR is lower than Halliburton’s one because SLB is less risky (beta of 1.19), so risk averseinvestor will be more willing to buy SLB stocks rather than HAL. However, its ERR is higheras its growth rate this year is higher than Halliburton’s by 51%. 48
  49. 49. Ratios AnalysisData taken from Yahoo110 The current P/E is higher than the forward by $5.24, or 68.14%, which is better forHalliburton. This means that EPS is expected to rise in the future, that the price per share isexpected to decrease, or both. As we can see above, EPS is expected to hit $4.00 in December2012, 45% more than the current EPS ($2.76). Therefore, we stay confident that the price ofthe stock will not fall.110 http://www.finance.yahoo.com 49
  50. 50. Data taken from Reuters111 Halliburton is more liquid than most of the companies in the same industry; its quickratio is more than the double compared to the industry, and the current ratio is 62.43% higher.However, Halliburton’s current ratio being higher than the quick, the company easily turns itsinventory into cash, so it is able to use all of its short term assets to pay its short term debts. The company is highly leveraged as its debt to equity ratio is 36.52%. This meansthat it aggressively uses its debt to finance its growth. The industry has a ratio greater by58.32%, meaning that Halliburton is less risky than most of the companies in that industry. The interest coverage ratio is higher than the one of the industry by almost 2 points.It generates more easily sufficient revenues to cover its interest expenses. Halliburton has a strong financial structure. This perfectly fit with our strategy as wewanted a company with a high leverage, but financially safe enough to be able to generatereturns.111 http://reuters.com 50
  51. 51. Data taken from Reuters112 With a ROA 110.26% higher than the industry, Halliburton seems to effectively turnits invested assets into profit. Indeed, its ROI is also 87.04% higher so the company makes87.04% more returns from its investing activities than the overall industry. Finally,Halliburton’s ROE is higher by 93.47% compared to the industry, so the capital invested byits shareholder is effectively used in its investments as it represents a quarter (25.25%) of itsnet income. We conclude that Halliburton’s management is more effective in allocating itsresources than the companies in the same industry.Operating Cash Flow 113 114 In 2010, Halliburton generated $2.2 billion of cash from operating activities, whis isa decrease by 7.92% over 2009. This is due to an increase in account receivables and ininventory in 2010. This means that the company was waiting for its clients to pay, and that itcould not turn its inventory into cash. Schlumberger, however, generated $5.49 billion of cash112 http://www.reuters.com113 http://finance.yahoo.com/q/cf?s=HAL+Cash+Flow&annual114 http://finance.yahoo.com/q/cf?s=SLB+Cash+Flow&annual 51
  52. 52. from its operating activities, which is an increase by about 3.40%. This was due to an increasein the net income of 36.15%, to an increase in liabilities and in operating activities (such aspurchase of short term investments). Therefore, the company has more debt but moreliquidity.Analysts’ Estimates(Data taken from Yahoo115) The last price of Halliburton stock (as of January 24th 2012) was $36.36. The meantarget is greater by $16.64, and the low target is greater than the actual price by $6.00; thismeans that the stock is undervalued, and this confirm what we noticed before in the ratioanalysis. Therefore, we can expect the price of the stock to increase in the future. If it attainsthe mean target, it would increase by 45.76%. If it attains the high target, it would increase by106.27%. If it attains the low target, it would still increase by 15.51%, which is a signal for asignificant buy.115 http://www.finance.yahoo.com 52
  53. 53. Recommendation 55/35 = 1.57 55/35 = 1.57 52/33 = 1.58 55/33 = 1.67 According to analysts, the mean recommendation is between 1 and 2; therefore, thisis again a BUY sign.Hot News Q4 2011 earnings results have been released on January 23rd. CEO Dave Lesar statedduring the conference call that he is “very proud to say that this was a record year for ourcompany, with revenues of $24.8 billion, operating income of $4.7 billion and with growth,margins and returns that led our peer group. To put this in perspective, our business hasnearly doubled in size over the last 5 years.”116 They are also confident for 2012 as theyinvested in technologies “which not only have made a substantial contribution to our successin 2011 but will, we believe, underpin our focus areas for growth in unconventionaldeepwater mature assets in 2012.” On January 25th, Halliburton has been said to be smart in their strategies in its questto gain loyal customers. “The fourth quarter saw the company spending $23 million instrategic projects just to beef up its North American service delivery and supply chain.116 http://seekingalpha.com/article/321309-halliburton-s-ceo-discusses-q4-2011-results-earnings-call-transcript 53
  54. 54. Management calls it a hyper-efficient business model which goes beyond 24-hour operations.This is where the company provides intangible benefits, strengthening existing relations withcustomers.”117Decision and Calculation We decided to BUY Halliburton Company as it perfectly fit with our strategy. Thestock is volatile due to the risk of the industry, but according to the estimates, and due to thefact that the stock is underperformed, its price should increase.Therefore, we bought 2,807 shares at $36.08.Investment: 2,807 shares * $36.08 = $101,276.56117 http://www.fool.com/investing/general/2012/01/25/halliburtons-smart-approach.aspx 54
  55. 55. Company Profile First Solar, Inc. is a manufacturer who sells photovoltaic solar modules usingsemiconductor technology that converts sunlight into electricity. First Solar, Inc.’sactivities include project development; engineering, procurement, and constructionservices; operating and maintenance services; and project finance. The products are soldto project developers, system integrators, and operators of renewable energy. 118 According to Reuters, the firm operates on two segments of the market:components segment and systems segment. "Components" is the segment generating themost revenue; it consists in the design, manufacture, and sale of solar modules. InJanuary 2011, the Company and RayTracker, Inc. announced that First Solar, Inc. hadacquired RayTracker, Inc. In January 2010, First Solar, Inc. acquired assets from the“Edison Mission Groups solar project development pipeline”. This project was made upof utility-scale solar projects, set up in California and in the southwestern area of theUnited States. In the second half of 2011, revenues fell 5% to $1.10B. Net incomedecreased 47% to $117.1M; revenues reflected a drop in sales. Net income also reflects 118 http://finance.yahoo.com/q/pr?s=FSLR+Profile 55
  56. 56. this drop with an increase in expenses related to goods sold. There was also a rise inresearch & development expenses, increased selling, general & administration expenses,higher production start up expenses, lower operating income and a last fall in interestincome. The company operates in the USA, Germany, Canada, Malaysia, Belgium,Spain, China and Australia. It was originally named First Solar Holdings, Inc., but itsname was changed to First Solar, Inc. in 2006. This firm was created in 1999 and isbased in the city of Tempe in Arizona. Industry First Solar, Inc. operates in the segment of semi-conductors. The sector sufferedthe recession between 2008 and 2009, with a drop of 12.2%119; but recovered in 2010,with better than expected earnings120. Global sales for the semi-conductor industryrepresented $298.3 billion in 2010; in other words a 31.8% increase from 2009, veryclose to the Semiconductor Industry Association’s (SIA) forecast: 32.8% increase 121.
But the second half of the year did not show the same trend: “Industry watcherscontended that the strength in the first half was more on account of pent-up demandthan the beginning of another growth phase.
”122 The end of the year strongly wasunderperformed, due to unemployments persistence, therefore, the holiday season fellbelow the industrys expectations; the holidays being the usually best performing time ofyear. Moreover, this sector in 2011 was weakened due to the Japanese earthquake123.Indeed Japan is one of the largest producers and consumers of semi-conductor devices.So, the first issues during the crisis were on the production side, the supply was 119 Global Semiconductors © Datamonitor. Reference Code: 0199-0682 Publication Date: November 2011 120 http://www.zacks.com/stock/news/51665/Semiconductor+Industry+Outlook 121 http://www.zacks.com/stock/news/51665/Semiconductor+Industry+Outlook 122 http://www.zacks.com/stock/news/51665/Semiconductor+Industry+Outlook 123 http://www.zacks.com/stock/news/51665/Semiconductor+Industry+Outlook 56
  57. 57. disrupted and led to an increase in price. Then, reparation were needed in the factoriesand all the equipment, which was very specific to each product, had to be replaced andthis process was long and expensive. Also, of course a strong part of the demanddecreased. For 2012, it is expected that the semiconductor industry will have a negativegrowth of -19.5%, and semi-conductor capital spending will decrease 19.5% to $51.7B.“Natural disasters and the economy have certainly impacted the semiconductor capitalequipment market in 2011, but we expect equipment spending to increase 13.7 percent in2011,” said Klaus Rinnen, managing vice president at Gartner. “However, equipmentproviders will not be as lucky in 2012. The impact of the slowing macro economy, highinventories and a sluggish PC industry — due to both weak demand and the flooding inThailand — will temper the outlook for 2012.”124 Gartner forecasts this decrease toaffect the market until the second quarter of 2012. It is predicted that demand and supplyshould balance, and then capital spending should increase with the increased demand.Therefore, 2013 is the year when growth in this industry should rise again. 124 http://semimd.com/blog/tag/gartner/ 57
  58. 58. Competitors First Solars market capitalization is about $3.28B. It is almost 3 times lower than itsmain competitor Sharp Corporation which has a market capitalization of about $9.31B. Thisnumber is understandable due to Sharp Corporations seniority on the market; this companywas created in 1912 in Japan. This company already has a century of experience in thisindustry, and therefore, a strong reputation; whereas, First Solar, Inc. was created in 1999, andlaunched the commercialization of its products in 2002. Sharp Corporation has 9 times more employees than First Solar, which can be put inrelation with the companys seniority; these two competitors do not operate at the same scale.Also the revenues prove well the difference between the two: the Japanese company accounts13.5 times more revenue than the American company. Sharp Corporation has a negative revenue growth rate due to last years naturaldisaster, which led to destruction of equipment, reparations to fund, inventory losses and soon. First Solar Inc. retains $0.4256 from each dollar of revenue generated, to be puttowards paying off selling, general and administrative expenses, interest expenses anddistributions to shareholders. This number is very close to the rest of the industry, but 2 timesgreater than its main competitor. It shows lower variable costs for First Solar Inc., comparedto its peers. First Solar Inc. has an operating margin of 23.02%, which is more than 9 timesgreater than its Sharp Corporation. It means that First Solar Inc. makes $0.23 (EBIT) forevery dollar of sales. This number is so high considering the size of the company due to itsproduct specialization, as solar panels are important structures to install and it is an expensiveproduct. Whereas for Sharp Corporation, solar panels are only a small part of their operating 58
  59. 59. activities, they also sell diverse electronic devices, such as smartphones, printer, LCDmonitors and so on. The competitor’s net income is negative due the natural disaster which made thecompany unable to make most of it sales, knowing that domestic sales are almost half ofSharp Corporations net sales. First Solar Inc.’s shares are almost 15 times greater than the rest of the industry. Itmeans that FSs earnings are growing faster than its peers. First Solar Inc. has a low P/E; investors are willing to spend only $6.09 for one dollarof their earnings. This companys earnings are ensured due to the companys strongspecialization, and the small scale of the company compared to the industry leaders. SuntechPowers P/E is about 6.5 times greater. First Solar Inc.s PEG is 2 times lower than the industry and 1.5 times lower thanSharp Corporation. The stock is undervalued. Price to sales is almost 5 times greater than Sharp Corporation; it shows a share pricegreater than the revenue per share for First Solar, Inc 59
  60. 60. Historical Prices May 3, 2011 : Earnings expectation decrease August 8, 2011 : Forecast for the rest of the year lowered again October 25, 2011 : Firing and replacement of the Companys CEO December 15, 2011 : Release of low 2012 estimates Over 2011, First Solar Inc. fell dramatically. It started in May 2011 as the marketsuffered the effects of the economic downturn and earnings expectations decreased 125. Indeed,in this difficult period companies tried to find ways to cut energy costs, therefore solar powercompanies lost some of their customers. “As the impact of the economic downturn was feltacross all sectors, enterprises increasingly sought ways to cut energy-related costs, and thisnew focus is responsible for turning the tidal flow of investment dollars in the sustainablesector.”126 In its 2nd quarter First Solar Inc. kept on decreasing, this news was release during aconference call on August 8, 2011127. It is explained as prices dropped, and a change inpolicies in Italy, Germany, and France which lowered demand128. Indeed, limits on permitswere set, and some projects were stopped129.125 http://www.reuters.com/finance/stocks/FSLR.O/key-developments/article/2305797126 http://www.renewableenergyworld.com/rea/news/article/2011/09/renewable-industries-predictions-for-the- second-half-of-2011127 http://www.reuters.com/finance/stocks/FSLR.O/key-developments/article/2379432128 http://investor.firstsolar.com/releasedetail.cfm?ReleaseID=596906129 http://www.bloomberg.com/news/2011-02-14/china-profits-from-solar-power-strategy-as-europe-backpedals- on-subsidies.html 60
  61. 61. The third worsened the companys situation, as First Solar Inc. fired its CEO andreplaced him by one of the company founders130. Indeed, during the time Gilette led thecompany, it lost 65% of its market value131. In its last quarter, the firms stock kept on falling; it showed the biggest drop in theStandard & Poors 500 Index, with a decrease of 76%. The company released their estimatesfor the year 2012; they expect their earnings will continue to fall; their forecast was lowerthan the analysts estimates.132 First Solars competitor Sharp Corporation, even though it suffered a natural disaster,it was able to keep its stock stable, following the market. The slight decrease over the year isexplained by a drop in energy prices, lowering revenues. “By the end of Q2 2011, it was clearthat the renewable sector was feeling the effects of depressed economic conditions. During Q22011, North American cleantech investments totaled $1.42 billion over 113 deals, a year-over-year decrease of total invested capital of 10 percent from Q2 2010, and significant dropfrom Q1 2011 levels.”133130 http://www.reuters.com/finance/stocks/FSLR.O/key-developments/article/2420880131 http://idealab.talkingpointsmemo.com/2011/10/stormy-forecast-first-solar-ceo-fired-stocks-tumble.php132 http://www.reuters.com/finance/stocks/FSLR.O/key-developments/article/2450094133 http://www.renewableenergyworld.com/rea/news/article/2011/09/renewable-industries-predictions-for-the- second-half-of-2011 61
  62. 62. Ratios134134 http://www.reuters.com/finance/stocks/financialHighlights?symbol=FSLR.O 62
  63. 63. Characteristic Line 20,00% 15,00% 10,00% 5,00% 0,00%-8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% Colonne C -5,00% Linéaire (Colonne C) -10,00% -15,00% -20,00% -25,00% -30,00% The companys Beta is about 1.35, which is 1.2 times lower than the industry, which shows that First Solar is slightly less volatile than the rest of the industry. The industry itself is considered risky with a beta of 1.65; the industry represented by Reuters is renewable energy which is still an emerging market made up of a great number of new companies, creating a sort of pool of volatility. Moreover, as the price of crude oil leads renewable energy prices 135, the industry has increased its prices in the past year due to the different conflicts in petroleum areas; such as the Arab Spring. Also, the current dispute with Iran has increased prices lately. This industry can with difficulty sustain strong price peaks as it is still emerging, and it is a type of utility enterprises stop using during economic downturns, due to its high costs. Furthermore, First Solar with its beta of 1.35 presents volatility as well, firstly because the 135 http://www.stockbloghub.com/2011/03/08/fslr-alternative-energy-industry-outlook-march-2011-industry- outlook/68290 63
  64. 64. company is quite recent, and young companies are always considered riskier. Moreover this isoperating in a risky industry, and over the last year, the company went through a difficultperiod, mainly with the loss of 73.6% of its stock value136. A Citibank analyst has evenpointed out that the firm needed to either be taken private, either be acquired by a richerparent or its future would situation would keep on increasing137. The companys beta is notforecasted to decrease as none of First Solar Inc.’s attempt to improve its situation so far; eventhe firing of their CEO was not enough to stop the rumors of bankruptcy. Indeed, expectations about First Solar Inc. are quite low. The companys P/E is verylow, which proves that investors are expecting lower earnings growth in the future comparedto industry with a higher P/E. The industry still has a low P/E showing equivalent lowexpectations, but it is still 1.2 times greater than FSLR. This low P/E shows pessimisticforecasts, but it can be expected as this sector is highly dependent on gas prices, being acommodity whose prices have a tendency to fluctuate a lot. Also, the past year addedvolatility and risk to the renewable energy market. But the company and the industry have notalways been high risk, as it can be seen in the P/E high – last 5 years, and the P/E low – last 5year. First over the past 5 year, was able to reach a P/E of 521.04, which is 4.3 times greaterthat the industrys peak. This is explained by the emergence of this market, the fact that thecompany is operating in a new market, it makes possible to have a very fast growth as well asa rapid fall. First Solar Inc., before the economic crisis, used to be a strong performer in itsmarket, and would quite often beat expectations; for instance in 2007. " uring the fourth Dquarter of 2007 we benefited from the full capacity and economies of scale of ourFrankfurt/Oder plant. This combined with continued throughput and conversion efficiencygains afforded us strong operating leverage and decreased our manufacturing cost per wattby 12% year over year to $1.12 per watt in the fourth quarter of 2007, further solidifying our136 http://www.cnbc.com/id/45764352137 http://www.cnbc.com/id/45764352 64
  65. 65. cost leadership position in the industry,"said Michael J. Ahearn, Chief Executive Officer ofFirst Solar138. Even though First Solar Inc. has had difficulties over the past year, its quick ratio of2.62, which is about the double of its industry, shows a good capacity to pay off its short termdebt. In other words it means that for every dollar of current liabilities there are $2.2 dollarsof easily convertible assets. The companys ability to pay off its short-term obligations is alsovisible through its current ratio of 3.25, so even though FSLR is currently not in a goodfinancial health, it is able to pay back its short-term liabilities with its short-term assets, thecompany has liquidity. Concerning the long term debt of the company, the LTDebt to equityof the company is about 14.48. It means that the company has $14.48 of debt for every $1 ofbook value. This number is not so high when it is compared to the industrys, which isenormous with a ratio of $167.48; it 11.6 times higher. It is explained with the severalrenewable energy companies who received federal loans over the past over four, of thosemany filed eventually for bankruptcy139, such as Solyndra or Evergreen Solar Inc. First Solar Inc.s return on asset is about 10.67%, which is twice the ROA of theindustry. It is a positive number as it shows that the company makes more than the industry onless investment. The investors can see that the company is effective in converting the moneyit has to invest into net income. Its return on equity is also lower than the industry: 14.46%, 1.5 times lower than theindustry. It shows that managers are not effective and do not succeed in generating highreturns on investors capital. Considering the difficult economic conditions, FSLR hasdifficulties with growing return on its equity. It suggests that the specialization of thecompany in one type of product is weakening it. The companys return on investment is higher than the industry. It is about 12.15%,138 http://investor.firstsolar.com/releasedetail.cfm?ReleaseID=294090139 65
  66. 66. which is 1.5 times higher than the industry. It shows that the FSLR, even though is goingthrough a difficult period, they choose their investment well in order to maximize their return. RRRFSLR = 0.1+ (8.7-0.1)1.35 = 11.71% RRRIndustry = 0.1+ (8.7-0.1)1.65 = 14.29% RRRFSLR is 1.25 times lower than RRRIndustry, it shows that the industry is muchriskier; investors require a return of 14.29% from the industry; whereas, FSLR has a RequiredRate of Return of 11.71%. This number is also high, even though it is less than the industry,represents the fact that the company is operating during a difficult economic, when people arelowering their spending in the semi-conductor products, and especially solar powertechnology. FSLR products are not diversified; they only offer two types of modules, limitingtheir ability to sustain growth during an economic downturn, as the current one. There is no Annual Dividend Yield available; therefore to discuss the Expected Rateof Return, I will use this year and next years growth estimate. As it is shown in the tableabove, both growth estimates are negative. They show how the company has been losing itsmarket value, and the rumors of bankruptcy or of a takeover have influenced estimations140.This year EPS (Dec 2011): $5.85140 http://www.thestreet.com/story/11315284/1/first-solar-takeover-chatter-is-overdone.html 66
  67. 67. Next year EPS (Dec 2012): $4.18 EPS growth rate = ($4.18 - $5.85)/$5.85 = -28.5% Trailing P/E: 6.25 Shows that EPS is expected to fall Forward P/E: 9.11Trailing P/E = 6.25 = P0/ EPS past = $37.94/ EPS past EPS past = $6.07Forward P/E = 9.11 = P0/ EPS projected = $37.94/ EPS projected EPS projected= $4.16 Growth rate = ($4.16 – $6.07)/$6.07 = -31.5% Sales/Net Income/ Operating Cash Flow As First Solar Inc. has not released its earnings yet, I will discuss the company andits competitors over the year 2010. On the 4th quarter of 2010 the companys fall has alreadystarted, with “a 23.6% decrease in quarterly sales to USD 610 million, set against a 23.7%increase in annual sales to USD$2.56 billion.”141 The company attributed this loss to the timeat which sales were operated, and also the preparation of 2011 pricing. Until then First SolarInc. was the leader in photovoltaic products revenue, but in first two quarters of 2010 it waspassed over by its main competitor, a young Chinese company, Suntech Power HoldingsCompany Ltd142. For the companys net income, on a year-over-year basis, FSLR was stillseeing increase. From the third to fourth quarter the companys net income started to drop:“Fourth quarter net income per fully diluted share was $1.80, down from $2.04 in the thirdquarter of 2010 and up from $1.65 in the fourth quarter of 2009.”143 This fall was mainly dueto the fall in sales, and an increase in raw material prices. The increase from 2009 to 2010here was led by an increase production, and lower production costs. But this increase was lessvisible because of selling prices lowered and an increase in expenses. Over 2010 the company141 http://www.solarserver.com/solar-magazine/solar-news/current/2011/kw08/first-solar-net-sales-decline-236- in-4q-2010-to-usd-610-million.html142 http://www.solarserver.com/solar-magazine/solar-news/current/2011/kw08/first-solar-net-sales-decline-236- in-4q-2010-to-usd-610-million.html143 http://www.thestreet.com/story/11022165/1/first-solar-inc-announces-fourth-quarter-and-year-end-2010- financial-results.html 67
  68. 68. performed great accomplishments, before its financial health suffered in 2011: “First Solar achieved several milestones in 2010: - Module manufacturing cost for the fourth quarter was reduced to $0.75/watt, down 11% year over year - Line throughput was up 17% year over year to 62.6 MW; increasing operating and announced capacity to 2.9 GW by 2012 - Module conversion efficiency rose 0.5% year over year to 11.6% - Exceeded 3 GW of cumulative production, and produced 1.4 GW in 2010 - Built the largest operational solar PV plant in the world, Sarnia (Canada, 80 MW) and the largest in the U.S., Copper Mountain (Nevada, 48 MW) - Pending Agua Caliente (290 MW) sale to NRG; will be the largest PV facility in the world when completed in 2013 - Acquired NextLight and Edison Mission Group to expand our North American captive project pipeline to 2.4 GW”144 In 2010, First Solar Inc.’s operating cash flow increased 4.5%. There was anincrease in fixed costs due to an increase in the number of employees, therefore the amount ofwage expenses. But to accompany the increase in operating cash flow, the company realizedan excess on tax benefits “from share-based compensation arrangements”145 These benefitswere 14.2 times greater in 2010 compared to 2009. Moreover, the company received morecash from its customers, due to supply contracts that were extended. “The increase inaccounts receivable was primarily due to the amendment of certain of our customers’ SupplyContracts to extend their payment terms from net 10 days to net 45 days primarily to increaseliquidity in our sales channel and to reflect longer module shipment times from our144 http://www.thestreet.com/story/11022165/1/first-solar-inc-announces-fourth-quarter-and-year-end-2010- financial-results.html145 First Solar Inc., 2010 Annual Report, p.62 68

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