Summer in the Markets Fixed Income: PIGS Fly Currencies: Risk-On Currencies Special Report: Crisis & Opportunity

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Weekly Market Wrap-Up

Week Ending October 30, 2011

Commodities: Gold on a Comeback Equities: Eurozone Deal Boosts Equities Mergers and Acquisitions: Energy Steals the Limelight

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Analysts: Anshul Kamath a.kamath@warwick.ac.uk Daryl Chia, PRM r.m.d.chia@warwick.ac.uk Karan Shah k.j.shah@warwick.ac.uk Kunal Shah kunal.shah@warwick.ac.uk Vassil Kirtchev v.kirtchev@warwick.ac.uk

October 30, 2011

Weekly Market Wrap -Up

Overview

Summer in the Markets

By Vassil Kirtchev Summer 2011 will be remembered for the exceptional amount of volatility in the equity markets with stocks tumbling in bouts of global sell-offs and perhaps as the start of a new and persistent bear market. A number of factors could explain this declining trend, and the primary ones are economic a stagnant US economy (the absence of a sustainable recovery), the European Debt Crisis and, less prominently, a decline in productivity figures from China. Further contributing to the market rout was Standard & Poors downgrade of U.S. government debt in August. In Europe, Greece has been center stage. Questions have been raised about the viability of the European Monetary Union common currency system, and fears of a default on Greek debt have been wide spread. Particularly concerning is that it could well spark a chain of defaults within the private sector be it partial or complete and is especially a worry for French banks, which have significant exposure to Greeces debt and their counterparties. Overall, fiscal issues in Western economies and fears of a double dip recession worldwide have led to heightened risk aversion, and at times the markets seemed to be driven by fear and uncertainty more than fundamentals. It is such that we have witnessed a transfer of funds from equities to safe-haven type assets such as gold and US Treasuries. The major stock indices in the U.K. and U.S. the FTSE 100 and S&P 500 respectively have between them displayed a similar downward trend over the summer, particularly between July and August. The FTSE 100 lost approximately 1000 index points in that period of time, in stark parallel with the plunge in the German DAX as investor sentiment about future prospects waned and not of help was declining consumer confidence in Germany. Financial stocks in the EU have taken the brunt of the beating, while across the Atlantic, Bank of America received significant attention over the viability of its business. In addition to the weak prospects for economic growth, there is also declining confidence in how policy-makers will deal with the problems, particularly a loss in confidence of central banks and the tools they possess to stimulate economies. All these factors have had a huge impact on investor risk appetite, and hence this summer was a one of flight-to-quality.
Warwick Investment Club Research Team 2

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Fixed Income: PIGS Fly

By Daryl Chia, PRM Amid relatively tepid trading and falling volatility across all markets earlier in the week vis--vis the wide fluctuations seen during summer as economic data and expectations deteriorated risk-on trading and market euphoria was again in vogue as the week came to a close. Yields benefited broadly over the fixed income space after Thursdays release of U.S. GDP data, which confirmed the median Bloomberg survey estimate of a 2.5 per cent annualised rise in third quarter growth, a significant improvement from the 1.3 per cent growth rate posted in the second quarter and a comfortable distance from the 2.0 per cent tipping point which many economists believe draws the line between a U-shaped recovery and a growth recession which could well evoke a vicious spiral into a double dip. Even Fridays U.S. PCE data from the commerce department that consumers only managed to increase purchases by 0.6 per cent over the same period through an unsustainable cut in their savings rate from 5.1 to 4.1 per cent failed to dampen the mood, which was lifted immensely by an eleventh hour resolution at the Euro-Area Summit. EU leaders on Friday agreed at the Euro-Area Summit on a deal to recapitalize European banks to a 9 per cent core tier one capital ratio, make them accept a 50 per cent haircut on holdings of Greek debt and to leverage the 440bn of the EFSF by using it as private debt insurance. Not less supportive was the discussed possibility that China contribute between $50bn to $100bn to the EFSF in both Chinese Yuan and from its $3,200bn of foreign reserves. As a result, U.S. Treasury 30-year bond yields rose for a fifth week, the longest rise in more than two years, while yields on 10-year notes closed the week at 2.31 per cent, rising 8bp and once touching 2.42 per cent, the highest level since August 9 when sharply falling expectations along with the Feds announcement of Operation Twist led to one of the most spectacular bond rallies ever seen, driving 10-year treasury yields

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up Macro

Global

Fixed Income (Continued)

below 2 per cent for the first time in 60 years. In line with rising yields, U.S. corporate credit risk recorded its biggest weekly decline since June 2009, as measured by the Markit CDX North America Investment Grade Index. Furthermore, just as one would expect, the flight from quality also meant lower prices and higher yields in other major benchmark 10-year government bonds: Gilts ended the week 2.63% (+10bp), Bunds 2.17% (+8bp) and JGBs 1.04%(+0.03). In the peripheral Eurozone, government bonds were mostly trading higher largely expected given the inverse correlation between PIGS debt prices and that of core government bonds, or more generally, risk appetite. 10 year yields on Greek debt ended the week at 24.24% (-85bp), Spanish debt 5.52% (-5bp) and Portuguese debt 11.95% (-24bp), narrowing their spread and hence perceived risk premium between their issues and that of Germanys benchmark Bunds. An outlier of note was Italian debt yields initially fell 20bp on news of the EU resolution, but ended the week at a euro-era high of 6.03% (+5bp) after an auction of March 2022 bonds was covered less than 1.3 times. Market participants see Italy an entity that is too big to save as the linchpin for the health of the Eurozone, and with Italy required to roll over approximately 300bn of its 1,900 debt burden in 2012, how it performs could very well shape how the debt crisis plays out.

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Currencies: Risk-On
By Kunal Shah Overview This week has proved quite an eventful week for currency movements with global investor sentiment improving after finally seeing what looks for now a comprehensive solution to the Eurozone Debt crisis leading to more risk appetite globally. The US Dollar has been in free fall in the last two weeks as capital from the safe haven assets has begun to be deployed to riskier assets and currencies. Emerging Market and Commodity currencies such as the Canadian and Australian Dollar have been main beneficiaries of this phenomenon. However the Eurozone crisis is not yet over, credible structural solutions still need to be implemented for likes of Italy and Spain. The US Debt problem has not gone away and uncertainty with Washington & Brussels dealing with political issues we advise caution since we are still not out of the woods and in an environment of deleveraging and fiscal tightening global growth is still likely to slow in the foreseeable future. Europe The British Pound has been gaining ground significantly in the last few days against the dollar. Sentiment towards the pound has been earlier dampened by the BoE's decision earlier this month to implement another round of quantitative easing to aid a fragile economic recovery. Optimism that the EUs plan to resolve the debt crisis will stop the contagion spurred demand for both the euro and pound against the safe havens of Japan and the US.

British Pound U.S. Dollar

Euro U.S. Dollar

Warwick Investment Club Research Team 5

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Currencies (Continued)
Asia Pacific The Japanese Yen The yen strengthened even after the Bank of Japan expanded its credit and assetpurchase programs to a total of 55 trillion yen ($724 billion) from 50 trillion yen to damp the currencys appreciation, which harms exporters. It also kept the overnight lending rate at zero to 0.1%. The Bank of Japan is the only central bank in the world whose currency appreciates in the wake of more monetary stimulus because of its safe haven status and expectation of the need for further more easing. Aiding Europe may be Japans best bet for weakening the yen after an expansion of central-bank stimulus yesterday failed to stop the currency from advancing to another post war high. Prime Minister Yoshihiko Nodas cabinet last week approved a 12.1 trillion yen spending plan to rebuild after the March disaster and to help companies cope with the currency. Politicians are spending 2 trillion yen to spur investment and hiring and are also setting aside foreign-exchange reserves to aid exports and bolster overseas acquisitions. The central bank increased its asset-purchase fund to 20 trillion yen from 15 trillion yen and kept its fixed-rate lending program unchanged at 35 trillion yen. All of the additional funds will be used to buy Japanese Government Bonds. All of these measures coupled with lower investor risk aversion should mean a greater supply of yen in the market as companies are persuaded to make acquisitions abroad, re-building accelerates demand for imported raw materials and the Bank of Japans increasing willingness to intervene in the currency markets, we see the Yen weakening gradually.

U.S. Dollar Japanese Yen

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Currencies (Continued)
Americas Improving industrial production and faster than expected GDP growth of 2.5% in the last quarter is calming investor fears of a full-blown recession. With another round of quantitative easing in the mix, and the Fed guaranteeing near-zero interest rates till 2013, the dollar is indeed likely to be the first currency sold off, with investors using the low interest rates available on US denominated securities to finance carry trades for riskier assets. Liquidity concerns that had been mounting all over the world that a second credit crunch is on the way have been dispelling with extension of central bank swap agreements and Eurozone agreement. In light of the above we expect the dollar to continue a gradual downward spiral.

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Currencies Special Report: Crisis & Opportunity

By Kunal Shah

Down south in Argentina, the Peso has depreciated over 7% & President Kirchners election promises seem to be in doubt as runaway inflation estimated by economists to be running as high as 24% have led to a capital flight. Argentinas problems include ultra-lax monetary and fiscal policies, galloping public spending, vast subsidies on energy and transport, a blind eye to high inflation, and a determination to shore up the peso currency at the expense of running down central bank reserves The country has been losing competitiveness as the economy of Brazil its top trading partner and a key market for its manufacturing exports has slowed. Argentina stepped up its efforts to stem capital flight and shore up the peso by tightening restrictions on foreign-exchange purchases. Capital flight prompted the central bank to sell $2.7 billion of reserves in August and September to curb a slump in the peso, which has weakened 6.1 % this year to 4.2358 per dollar, the worst performance among six major Latin American currencies tracked by Bloomberg. Reserves have fallen to $47.6 billion this year from a record $52.6 billion in January while central banks in Brazil, Mexico and Chile build up savings. Argentina, which has been blocked from international debt markets since its 2001 default on $95 billion of bonds, depends on its trade surplus as a primary source of dollars. The government estimates that surplus will shrink to $8.6 billion next year from $12.1 billion in 2010. Risks of more interventionist policies over structural reform like subsidies in the energy and transportation sectors are causes for concern. Public spending is growing at over 30 per cent; the trade surplus and central bank reserves are shrinking and capital flight has accelerated to nearly $10bn in the first half of this year. Look for signs of potential problems as the currency might plummet truly if structural reforms are not carried out and indeed demand from the rest of the world starts waning.

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Commodities: Gold on a Comeback

by Daryl Chia, PRM

In the commodities complex, U.S. GDP data and the Euro-Area Summit (mentioned earlier) were the highlights of the week, and their resultant positive tone overwhelmed earlier negative news of Chinas GDP. China expanded 9.1 per cent in the third quarter from a year earlier, the slowest pace in more than two years. A lynchpin in the global economy and a massive consumer of industrial commodities, especially copper, it expanded 9.5 per cent in the second quarter. At its BRIC counterpart India, industrial production expanded less than expected in August, lagging a Reuters poll forecast for 5 per cent growth. On a brighter note, industrial production in Europe unexpectedly rose for a second month in August. Production in the euro area advanced 1.2 percent from July, when it rose 1.1 percent the biggest gain since November 2010. All said, energy and metals ended the week broadly higher, with front-month WTI closing at $93.32 (+2.32%), Brent1 $109.910 (-1.32%), Natural Gas $3.923 (+8.85%), LME Copper $8,040 (+10.73%), Gold $1,747.20 (+5.75%) and Silver $35.288 (+11.32%). Of special note are crude oil and gold. The West Texas Intermediate (WTI) blend hit US$93/b on Tuesday, 25 October its highest level in 12 weeks on the back of perceived tightness in the U.S. market, as oil and distillate inventories drew down to below their five-year average. Conversely, Brent crude1 suffered ahead of the EuroArea Summit, as summit representatives were not expected to come to a conclusive deal on Greece. The two blends soon rose along with general market sentiment late in the week, but the front month WTI-Brent spread still closed significantly higher at -$16.59, its highest since civil strife in Libya cut Libyan production of 1 million barrels per day and threatened oil production in other politically volatile Middle Eastern states, leading to a hugely unexpected spike in the price of Brent vis--vis WTI, and large hedging losses amongst many refiners and airlines. On the weather front, the threat posed to oil

Warwick Investment Club Research Team

October 30, 2011

Weekly Market Wrap -Up

Global Macro

Commodities (Continued)
production in the Gulf of Mexico by Hurricane Rina is also exerting upwards pressure on prices. As for gold, following its meteoric rise to a record of above $1,900 in September and subsequent savage fall of more than 15% within a month, it closed this week at $1,743.40, a reprieve from the lows seen earlier in the week when it threatened to plunge through the $1,600 mark and test its 200-day simple moving average support in the $1,500 region, a feat which gold to the delight of its bulls has failed to perform since the early days of its decade long rally. For some investors and analysts this indicator of technical strength and golds reduced correlation with equities its correlation with the S&P500 index has reduced from positive during the previous five weeks to zero this week was a signal that gold was resuming its role as a haven asset.

Brent crude is a lower grade of crude oil versus WTI (i.e. Brent is more viscous and

has a higher Sulfur content than WTIs Light Sweet Crude). Brent hence costs more to refine and, ceteris paribus, should cost less than WTI usually $2/barrel less (i.e. a WTIBrent premium of +$2). However, it is trading at a premium to WTI this year (a historical abnormally) due to oversupply in landlocked Cushing, Oklahoma, and the ability of Brent to be transported by supertanker (which WTI lacks, since its storage is landlocked). The premium in the front-month futures contract has in fact hit a low of $26 earlier this year. This has called into question the status-quo of having the WTI contract, which trades on the NYMEX, as a globally recognised benchmark for crude oil prices.

Warwick Investment Club Research Team

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October 30, 2011

Weekly Market Wrap -Up

Equities

Eurozone Deal Boosts Equities But Only Temporarily

By Vassil Kirtchev

The Eurozone deal to contain the European debt crisis gave equities a temporary boost across the worlds indices. The FTSE 100 peaked at close to 5750 points, while the German DAX rose 3.5% upon announcement of the plan. This also had an effect on US equity markets. The S&P 500 rose 3.4% and the Dow Jones Industrial Average gained 2.9%. Financials in general saw an increase in investor support (however, this receded on Friday, particularly in the UK market), most notably benefiting Bank of America and Citigroup. However, on Friday the rally wore off and the FTSE, for instance, saw a decrease, as investors grew wary of the lack of detail in the implementation of the Eurozone deal. Much of the implementation details remain unclear and more of a concern was that it may only patch the system up and not deal with the real problems in a more permanent manner. In order for the worlds equity markets to see pre-2008 levels at a more consistent basis, there has to be a sustained economic recovery in Europe. This is painful in the short run, and given the short-term nature of politics, such policies are unlikely to be implemented. Going forward, the package needs to be scrutinized and worked on further in order for investors to establish that it is a viable solution to Europes problems, but that is assuming that nothing else goes wrong and disrupts market calm in the interim (think: Italy). Only time will tell.

Warwick Investment Club Research Team

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October 30, 2011

Weekly Market Wrap -Up

Capital Markets

Mergers and Acquisitions: Energy Steals the Limelight

by Anshul Kamath Sector in Focus Oil and Gas In the biggest week for oil and gas sector M&A since the peak of the economic cycle in 2007, Kinder Morgans $38.5 billion of which $21.5 billion comprises of equity purchase of El Paso Corp took center stage. Barclays Capital advised Kinder Morgan and retains the top spot for oil and gas M&A. Evercore Partners, which advised El Paso, have secured yet another large deal this year after an impressive performance in the first half of 2011 with 25 deals totaling $83 billion. So far this month, oil and gas M&A totals $55.4 billion, accounting for 45% of monthly volume. Year-to-date, deals total $412 billion, an increase of approximately 7% over 2010.

Deal in Focus: Heiwa Corps Acquisition of PGM Holdings Overview and Rationale Heiwa Corp, a Japan-listed pachinko machinery manufacturer, made a conditional tender offer to acquire PGM Holdings KK, a Japan-listed golf club operator in an all cash deal. Heiwa is a manufacturer of pachinko machines in the Japanese leisure market and it has considered a priority to build a new profitable business to diversify its business. The firm believes the inclusion of PGM into its business portfolio will enable the group to transform itself into a full-scale leisure business. Deal Fundamentals Deal value: $2,190 million

Warwick Investment Club Research Team

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October 30, 2011

Weekly Market Wrap -Up

Capital Markets

Mergers and Acquisitions (Continued)

Equity: The final valuation resulted in an offer of JPY 52000 cash per PGM share valuing the entire share capital at JPY 61.5bn (USD 806.3m). The offer price represents a 28.6% premium over the last closed price of JPY 40,450 (normally friendly takeovers have premiums of approximately 35%.) Debt: Heiwa made an offer to acquire each PGM Euro Yen Convertible Bonds for JPY 1,523,281 per bond. The Euro Yen CB was issued in the amount of JPY 10.05bn with a maturity date of May 1 2012. The firm also made an offer to cancel all the outstanding options of PGM in the series of 4,5,7 & 8 for JPY 1 each (PGM has 5476 stock options outstanding.)

Other Noteworthy Deals Sony Corporation, the Japan-based consumer electronics company, has agreed to acquire the remaining 50% stake in Sony Ericsson Mobile Communications AB (Sony Ericsson) from Telefonaktiebolaget LM Ericsson (Ericsson) for a cash consideration of $1,460 million. In a North American cross-border deal, MOSAID Technologies Inc, a Canadian intellectual property company has signed an agreement to be acquired by Sterling Partners, a Massachusetts based private equity firm with approximately $5 billion of assets under management. The total deal was agreed at a value of $589 million. Cigna Corp, the fifth-largest U.S. insurer agreed to buy Healthspring Inc, a Tennesse based health-maintenance organization, for $3,827 million in cash. The synergies resulting from the deal include tripling the number of Medicare customers Cigna serves.

Warwick Investment Club Research Team

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October 30, 2011

Weekly Market Wrap -Up

Note from the Team

We are always looking to improve; our team of analysts is dedicated not only to producing exceptional research but also to tailoring information to what best suits our readers. We would appreciate any helpful feedback you may have as we strive to grow the quality and usefulness of our weekly market wrap-ups. Please send this feedback to WIC@WFSocieties.com and the subject as Weekly Wrapup Feedback. Many thanks.

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Warwick Investment Club Research Team

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