The magnificent 7 and ...                     (USD -411 bn during the 25 mont...                     Europe, the picture is getting ...                    500 Banks index: for over two y...                   spread (LIBOR USD 3 mth - US 3 m...                   bank BBB 10 yr - US 10 yr yield:...                     Case Shiller house price index...                    price: The WTI oil reached a pe...                    The indicators on the b...                   & Beyond: The magnif...
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The magnificent 7 and equity markets review 11


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2011 was a bumby year for financial markets and 2012 will be no less hectic. However the US economic picture is improving and as written in early 2011 no double dip to be expected but for FED policy folly.

Global imbalances remain, but the eurozone is where lies the deepest problems which have not been properly addressed.

Remain invested in high yielding equities / net cash companies with a strong franchise and look at strong brands in fast growing economies; stay clear from the bond market and financials.

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The magnificent 7 and equity markets review 11

  1. 1. The magnificent 7 and equity markets - Review 11Since I last wrote about the magnificent 7 in February 2011, a lot has happened and it israther appropriate to review where do we stand at the beginning of 2012.Despite all discussions about recession/double dip in the US for most of 2011, it did notoccur and growth looks to carry on, whilst at a moderate pace; this is strikingly differentfrom what we have been witnessing in Europe since the summer and the inability ofEuropean policy makers to put the eurozone (“EZ”) house in order.In 2011, the DJ increased 5.5% (the S&P 500 was flat) which is not so bad given whathappened in the world, and in Europe in particular. If one picked up dividend aristocrats itwas a reasonable year in the US.In Februray 2011 I wrote: “Economic news from the US continue to point towards acontinued GDP growth and a (slowly) improving situation in unemployment;Commercial and Industrial Loans at All Commercial Banks in the US havedefinitely passed the trough and now seems to be well entrenched in an upward move”. .The latter indicator has displayed the 12th positive number in a row for a total of USD +114 1
  2. 2. (USD -411 bn during the 25 months starting in November 2008) and this pointstowards a continued growth in the US 6 months ahead.Friday’s employment numbers were rather positive at +200k bringing the unemploymentrate down to 8.5%.Things indeed went in the right direction and 2012 starts under the same auspice bearingthat: • The FED continues with its low interest rate policy along the yield curve, which is most likely during a Presidential election year and in the current economic environment. • International investors continue to buy the US debt, which they should in my opinion by the lack of other choice, continuing to believe that the US will tackle one for all its deficit and inflation will be kept in check. 2
  3. 3. Europe, the picture is getting worse by the month, even the German engine isslowing down markedly. There are more and more voices calling for custom tariffs to fendoff imports from low costs producing countries and added regulation: Europe has beennaïve with its strong euro policy (well, it was Germany’s call to get the euro) and is battlingthe last war with increasing regulation, taxation and bureaucracy. Until the EZ sorts out itsmess (both banks and over indebted countries) growth will be sub-par. This being said,like in the US, there are world class companies, which are more affected bywhat happens in the fast developing world, and very profitable niche playersthat we like to find at P&C.Fast growing economies in the rest of the world keeps up forging ahead whilst inflationcontinues to be a real issue (food prices remain very high in China and India, albeit goingdown recently). However, this is more a consequence of a growing population and a fasterdeveloping middle class: a strong engine to growth. In addition, some countries like Indiaare going 2 steps forward and one backwards in terms of liberalization of their markets(for example opening up the country to foreign supermarket companies).The graph below is self-explaining… 3
  4. 4. 500 Banks index: for over two years, the index has traded range boundand has yet to decisively to breach the 165 level; there is no sign this happening any timesoon and, conversely, there is no sign of a deterioration either, US banks continuing torecapitalize thanks to an unabated FED QE. In my opinion, the level comes from acontinuing reappraisal of the future profitability of banks (less leverage + more controls =lower ROE) versus their ability to pass on additional costs to customers. Neutral.Global 1200 financial index: The index broke its 200 MA in May 2011 andseveral support levels, reflecting the deepening crisis in the EZ and the needto recapitalize European banks beyond the official numbers (not talking aboutOTC derivatives where nobody knows what the global risk is, even banks on an individualbasis probably do not know their real risk); the solid 800 floor was penetrated without awhisper and now represents a resistance. The outlook for a number of Europeans banks isbleak and the introduction of Basle III rules ahead of the 2019 deadline is adding pressure.Negative. 4
  5. 5. spread (LIBOR USD 3 mth - US 3 mth T-bills): since July, the spread hasdeteriorated but in an orderly manner (the OIS displays the same pattern) and isnowhere near the 2008 crisis levels, with central banks reacting very quickly by openingUSD swap lines and the ECB offering 3 years lines of credit (LTRO) in the tune of EUR 426bn. Neutral 5
  6. 6. bank BBB 10 yr - US 10 yr yield: In July the spread started to widenmarkedly, whilst well below the extraordinary stress of 2008-2009, to pause for thepast 2 months. Neutral.OEX volatility: OEX volatility had a spike during the summer but did not break the highof 2010 and has since come back to the low 20s. Positive. 6
  7. 7. Case Shiller house price index: The latest data for US home values (October)published 27th December have continued to go down for the 5th consecutive month, onlytwo cities showing positive numbers.The unadjusted data are negative (-4% since July, the recent high); adjusted data displaythe same pattern:Composite-10: Oct 2011: m/m -1.1%; y/y -3.0%Composite-20: Oct 2011: m/m -1.2%; y/y -3.4%As the report comments:“Some of the other housing statistics posted relatively healthy figures for November, but itseems that most of the good news was confined to the multi-family sector. Existing homesales rose in November, but are still at a low annual rate of about 4.0 million. Single familyhousing starts also rose, but remain close to record lows and are still down about 1.5%versus October 2010.”The recovery did not materialize. Negative. 7
  8. 8. price: The WTI oil reached a peak of $115 to settle down in a $80 - $110range. In 2011, the story was he spread between the WTI and Brent which reached $25 inAugust reflecting the glut of crude at refineries in the US and the Arab world revolutionswith oil disruptions in Libya. In the US, unconventional oil & gas recovery is a gamechanger which explains low prices for natural gas at below $4/btu: Neutral. 8
  9. 9. The indicators on the banking situation deteriorated, whilst otherindicators are mostly neutral. The macro-economic situation between Europe and the USis diverging to the advantage of the latter, even if in both cases public finances are indisarray. The magnificent 7 are telling us that nibbling equity markets will provide aninteresting return.2011 was bumpy and 2012 will be no less hectic.Continue investing in high yielding equities / net cash companies with astrong franchise and look at strong brands in fast growing economies.09/01/2011 9
  10. 10. & Beyond: The magnificent 7 and equity markets - Review 10 Department of the Treasury: Monitoring the economy Home Price Indices (via Business Insiders): Manufacturing PMI indices by country 10