Current edition contains:

CAR SALES IN US ON THE MEND

1
If car sales in US normalize, many companies will see record earnings.
EXTERNAL DEBT OF PIGS COUNTRIES
2
Indebted countries sending coupons out of country dig themselves into deeper hole.
WHAT WILL EARNINGS SEASON BRING US NEXT MONTH?
3
Will we see strength in multinationals?
PROXY FOR WEAKNESS IN CHINESE CONSTRUCTION SECTOR
4
Despite sell-off in Australian assets, they still remain bubbly.
ROBUSTNESS OF US SYSTEM
5
Total debt in US is coming down swiftly.

GLOBAL MACRO STRATEGY

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1) CAR SALES IN THE US ON THE MEND

US automakers are in better condition than year earlier. GM showed an amazing recovery from bankruptcy. Ford is
shooting to the moon, with sales being backed up by great line-up of models. Auto parts manufacturers follow the
same path. Many car-related businesses went through bankruptcy last year or worked extremely hard to decrease
their level of overall debt and capacity. Utilization went up and break-even points came down. Therefore most
companies are showing very profitable performance despite the currently very low levels of sales.

US Auto Sales Domestic Vehicles Annualized, SA

index
22

20

18

16

14

12

10

6
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

US Auto Sales, Domestic Vehicles Annualized, SA

US Auto Sales, Total Vehicles Annualized, SA

After Lehman collapsed, credit virtually halted and only individuals with top-notch credit rating were able to finance
purchases of big-ticket items like cars. On the chart above, we can see that average annual vehicle sales in US
reached 16 million, 13 million were domestically produced. If we consider that normalized scrappage rate in US is
probably 13-14 million vehicles annually, today still more cars are actually being scrapped than sold. Cut backs in
vehicle purchases left growing number of drivers behind a wheel of vehicles that have outlived their economic
usefulness. At certain point, it makes no economic sense to keep repairing old car and makes a purchase of new one
a viable option.

According to data from the Conference Board, the intentions to buy a vehicle in next six months have clearly
bottomed and imply rising trend in sales in the upcoming months. The reason is quite simple. As we already stated,
sales at this point are still terrible and cannot remain depressed for much longer. Credit is also more widely available.
According to industry analysts, by 2014 we could see sales near the peak levels again.

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 Conference Board Consumer Confidence, Plans to buy automobile, SA
% of respondents
11

10

3
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Conference Board Consumer Confidence, Plans to buy automobile, SA

Most car companies are making money today despite lousy sales. Think about what they can make when things get
back to historical averages. Globally, cars and trucks sales are estimated to rise from current 57 million units to about
90 million units. At this point, however, we are more interested in auto-part manufacturers as the rise in mergers
and acquisitions across the industry may improve valuation multiples.

After screening the industry, we really like company Dana Holding. After it went through bankruptcy, it dramatically
decreased its debt burden. Currently, it trades at 6x Enterprise Value compared to its 12 month trailing EBITDA,
compared to its historical average of 8-10. We believe there is upside both in valuation multiple and in EBITDA
growth itself.

EBITDA /
Enterprise Value / Debt / Analyst Target Revenue Enterprise Value /
Short Name Ticker Interest
EBITDA T12M EBITDA Upside Growth y/y FCF T12M
Expense
ARVIN MERITOR INC ARM 14,1 1,8 6,5 29% 25% 13,0
FEDERAL MOGUL FDML 7,5 5,9 20% 9,5
TENNECO INC TEN 6,6 3,5 3,3 36% 36% 18,2
DANA HOLDING DAN 6,0 4,3 2,3 50% 24% 7,1
LKQ CORP LKQX 10,7 13,7 2,0 21% 18% 21,6
BORGWARNER INC BWA 11,7 10,1 1,9 20% 57% 32,0
TRW AUTOMOTIVE TRW 4,3 9,5 1,7 37% 50% 10,2
JOHNSON CONTROLS JCI 10,7 12,8 1,6 26% 32% 16,2
AUTOLIV INC ALV 7,8 18,5 1,4 24% 86% 10,0
WABCO HOLDINGS WBC 13,8 1,0 23% 47% 22,4
GENUINE PARTS CO GPC 9,0 27,4 0,7 11% 6% 10,6
CHINA AUTOMOTIVE CAAS 10,2 48,4 0,6 26% 88% 29,2
GENTEX CORP GNTX 13,6 0,0 30% 98% 17,8
AMER AXLE & MFG AXL 3,2 -69,1 35% 30% 3 097,7
LEAR CORP LEA 9,4 24% 0%

© ATWEL International, s.r.o. www.atwel.com Page 3

2) EXTERNAL DEBT OF PIGS COUNTRIES

Credit Default Swaps on weak Eurozone countries reversed their rise in last week as a result of direct ECB
intervention. Markets are though still worried that the only solution for long-term survival lies with restructuring or
rescheduling of the debt. One of the main issues besides weak competitiveness of the PIGS countries is that much of
these countries' debt is held by non-residents. That means the governments do not receive tax revenue on the
interest paid, nor does the interest payment itself remain in the country. As it is the non-residents who receive the
interest on respective debt (German, French banks), the paying nation is actually becoming poorer with every
interest payment paid and wealth is exported away from the country. As a matter of fact, think of the PIGS countries
as the exact opposite of Japan. Despite Japan is another debt-struck nation, debt there is 90% domestically owned.

As of the end of General Government Gross General Government Net External Debt Net External Debt Position
2009 Debt (%GDP) (%GDP) (%GDP)
Portugal 77,2% 57,8% 88,6%
Ireland 64,5% 45,5% 75,1%
Greece 113,4% 89,5% 82,5%
Spain 55,2% 26,1% 80,6%
Italy 115,1% 49,4% 37,3%
Germany 72,5% 35,2% -21,7%

The table above shows different dynamics of debt between Greece and Italy. While in both countries gross debt of
general government stands at roughly 115%, the net external debt position of each country is very different. 82% of
Greece‘s GDP is owned to a foreign country. In Italy, most debt is domestically owned and only 37% of debt is to be
repaid to foreigners. Much of Italy’s interest burden is thus paid to Italians.

Another interesting fact is that average PIGS net external debt as % of GDP is about 30 percentage points higher than
average gross external debt to GDP ratio observed in the emerging market external debt crises. In order to reduce
the net external debt-to-GDP ratio, the PIGS countries will need to close their huge current account deficits
substantially.

Current Account Deficit as % GDP

%
0%

-2%

-4%

-6%

-8%

-10%

-12%

-14%

-16%

Italy CA deficit (annualized) / GDP Spain CA deficit (annualized) / GDP

Portugal CA deficit (annualized) / GDP Greece CA deficit (annualized) / GDP

This process will have to occur as a mix of higher national savings rate and also improved exports dynamics, so that
GDP and employment is supported. If we look at individual countries, Spain has made the biggest adjustment so far.
Greece on the other hand seems to be slipping back to 12% current account deficit, which is a tremendous drag on

© ATWEL International, s.r.o. www.atwel.com Page 4

the country's investment position. Let us remind you that yields of Greek debt came hardly down and the
government still has to pay about 8-10% interest on its debt. Liquidity is currently not a problem as the ECB is buying
the debt. It is the interest that has to be paid and that is sucking remaining wealth out of the country.

Despite a lot of action on the fiscal side, we foresee PIGS will be probably unable to significantly reduce their overall
external debt. Some sort of bankruptcy, rescheduling or bank resolution will be needed to avoid a major collapse.
We also fear what happens when Mr. Weber succeeds Mr. Trichet and stops pumping money into the system.

© ATWEL International, s.r.o. www.atwel.com Page 5

3) WHAT WILL EARNINGS SEASON BRING US NEXT MONTH?

th
On July 17 , Alcoa will once again start the earnings season. In the last month, we have been observing leading
indicators roll over which is a sign of slower growth in the second half. We had surprisingly many bad news, ranging
from renewed weakness in the housing market, jobs growth not reaching expectations, optimism in Europe plunging,
and also new measures to pop bubble in the Chinese property market. Generally speaking, we do not expect a
double dip in US. Instead we expect the level of economic activity to gradually move up (generally driven by Asia and
LatAm), but at a slower pace.

We are impatiently looking forward to see how corporations managed to deliver earnings in the current
environment and what kind of guidance they will provide us with. Analysts have raised their S&P500 earnings
guidance for full year up to 80 USD (14xPE), which many people see as too high, pointing out that market estimates
especially for year 2011 are too rosy.

In our view, the origin of earnings is much more interesting and gives some hope for good results. As we wrote
before, the US based companies that outsourced capital intensive production seem to be able to adjust very quickly
to any variation in consumption and thus keep their earnings strong. Neither are multinationals bound by labor as
they constantly look around the world for the best talent at the lowest cost. If multinationals are after all a function
of growth in human knowledge and technological progress, then by nature they are very hard to tax. For knowledge,
contrary to capital, is not physically located in any country and can more from state to very easily. The only solution
for the government to make any profit of multinationals is to be very hospitable to these companies. That means to
tax them with a low rate and instead tax as much as they can the two things that will remain local for obvious
reasons: consumption and real estate.

This is what Singapore, HK, Canada, Switzerland, and Sweden are doing, which puts incredible pressure on the rest to
lower taxes to avoid losing their companies and the employment that still goes with them.

© ATWEL International, s.r.o. www.atwel.com Page 6

4) PROXY FOR WEAKNESS IN CHINESE CONSTRUCTION SECTOR
According to Soufun, a Chinese real estate portal, property sales in 30 largest Chinese cities fell 44% in May over
April. It certainly looks like expectations of price falls are gathering momentum. At this point it is hard to judge
whether the Chinese real estate market will slip into an outright panic as in 2008, but this time, Beijing seems to be
more focused on specific targets such as luxury properties where bubbles reached the largest scope. In order to
prevent nationwide slump, Beijing hopes to shore up construction volume by instructing state-owned developers to
build more public and low-cost housing.

One thing seems to be clear though. Construction volume is set to slow down dramatically, as first four months of
construction activity showed breath-taking +32% y/y growth. As the proposed floor space under construction
remains at solid +10% y/y, the front-loaded activity implies -27%% y/y construction growth in May through the rest
of the year.

Commercial Floor Under Construction (mil.sq.m)

Commercial Floor Under Construction (mil.sq.m)

Total Floor Under Construction (mil.sq.m)

So how should one play the slowing in Chinese construction? As Chinese equities are vastly not accessible for
shorting and Chinese property builders are already down a lot, one has to look outside China. Steel is the first
candidate that should reflect slowdown in construction volume. As Chinese steel producers will not be able to find
enough demand at home, they will look at export markets to sell their product into. That could put a pressure on
global steel prices like Arcelor Mittal, Nippon Steel, or Gerdau SA. Later in time, we could see a spillover into the
upstream market and iron ore producers could feel the pain as well (Brazilian Vale is the purest play on iron ore as it
gets 90% of revenues from iron ore).

Another way to play the theme could be through shorting Aussie Dollar or Australian equities. Australia is running
vast current account deficit and its property market is one of the most overheated ones. Very high leverage, rising
interest rates, and less demand from China are a recipe for a fall in domestic demand in Australia. Thus betting on
further downside in Australia might be the best way to play the theme of potential policy overshoot in China.

© ATWEL International, s.r.o. www.atwel.com Page 7

5) ROBUSTNESS OF US SYSTEM

Nassim Nicholas Taleb often speaks of the so called robustness, which could be described by how much shock the
system can absorb. And it is without doubt that the more debt resides in the economic system, the more the system
is prone to break down under a shock. With the recent data from Fed Funds Flows, we can observe that the overall
level of debt is rapidly decreasing. That means households and financial corporations are deleveraging faster than
the government is leveraging.

USA, Debt as percentage of GDP

%
360%

340%

320%

300%

280%

260%

240%

Overall debt level as % of GDP

At current speed of deleveraging, it would take roughly another 2.5 years before the overall debt level settles at
reasonable 300% of GDP. In the past year, the overall debt/GDP ratio dropped from 360% to 343%. Two thirds of this
drop is due to rise in nominal GDP (real GDP was actually very strong so the debt was not eaten away by inflation, we
would rather say it was socialized). The remaining one third is a result of actual debt repayment.

US, borrowing by sector

bn USD
6 000 12%
5 000 10%
4 000
8%
3 000
2 000 6%

1 000 4%
0 2%
-1 000
0%
-2 000
-3 000 -2%

-4 000 -4%

Financial sector Public sector Households Corporations Y/Y change in debt

On the chart above, one can clearly see that most of deleveraging is being done in the financial sector. This may be a
result of a lot double-counting and unwinding of securitized assets. Strategic household defaults on mortgages also
play an important role. Households have not freaked up and repay their debt only slowly. The fastest pace of
repayment is seen in the credit cards as the interest of carrying over credit card debt is the highest. But the very

© ATWEL International, s.r.o. www.atwel.com Page 8

important piece of data from the Fed Flow of Funds report is that corporations actually started to take some new
debt on their balance sheets.
In case of Japan debt crisis of 1990s, corporate sector needed to run huge financial surpluses (savings) to repay the
outsized debts they had accumulated in the bubble period. But Western companies today have no such need to pile
up cash. If corporate managements in the US, Europe and Britain become convinced that interest rates would remain
at rock-bottom levels for many years ahead, they would stop hoarding cash and reduce the IRR demands for new
projects for new investments. Only by using low interest rates to stimulate a strong recovery in corporate investment
and thus reduction of their corporate financial surpluses can the advance economies hope to create financial
conditions for sustainable reduction of government debts.

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