November 24, 2009


1) S&P 500 -0.3% after the EU close - closing +1.4% at 1106. US equities spurred by global strength, an unexpected surge in Existing Home Sales and some dovish Fedspeak, albeit on light volumes, NASDAQ and NYSE volumes are tracking -20% below 30-day averages. Telecom Services (+2.6%) outperforming. Consumer Discretionary (+0.9%) and Retail (+0.9%) underperforming.
2) Quarterly Hedge Fund Trend Monitor - net exposure has increased to 40%, highest since 4Q07 - hedge funds long/overweight Materials, Tech, Consumer Discretionary - underweight Financials & Industrials. David Kostin: (i) This report focuses on hedge fund positions at the start of 4Q and the meaningful changes from the previous quarter. The report is based on an analysis of 684 hedge funds with $604 billion of long stock-specific equity assets and an estimated $363 billion of short positions. (ii) Hedge funds net exposure climbed to 40% in 3Q, from 31% in 2Q09 and 17% in 3Q08, the highest since 4Q07. During 3Q, hedge fund long portfolios increased by 21% and short assets rose by 5%. The equity market appreciated 16% during the quarter, suggesting that hedge fund net exposure increased as a result of active equity buying as well as short covering. (iii) As of September 30, hedge funds owned 3.8% of the Russell 3000, up from 3.6% last quarter and 2.8% in 4Q 2008. Hedge fund ownership of small caps is more pronounced, totaling 7.0% of the Russell 2000, up from 5.8% as of 4Q 2008. (iv) From a sector point of view, hedge funds have got the largest net exposure to Tech (21% of total net exposure), Healthcare (14%) and Consumer Discretionary (13%), and the smallest net exposure to Utilities (2%), Consumer Staples (6%) and Industrials (6%). From a market-relative point of view, hedge funds are net overweight Materials (560 bp), Consumer Discretionary (320 bp) and Telecom Services (290 bp), and net underweight Financials (-500 bp), Industrials (-440 bp) and Consumer Staples (-360 bp). (v) Our hedge fund VIP list (Bloomberg: GSTHHVIP) consists of stocks that appear most frequently among the top ten holdings within hedge fund portfolios (see first attachment, p. 7, Exhibit 9). This basket lagged the S&P 500 by 1,147 bp during 4Q 2008 (-41% vs. -30%). Since then, the VIP basket performance has reversed, outperforming the S&P 500 by 1,368 bp year-to-date (39% vs. 26%). (vi) Our “most concentrated” hedge fund basket (Bloomberg: GSTHHFHI) consists of the 20 most concentrated stocks in terms of the share of market cap owned in aggregate by hedge funds (see first attachment, p. 9, Exhibit 11). This basket outperformed the market by 713 bp in 3Q 2009 (+23% vs. +16%) and 4,744 bp YTD (+73% vs. +26%). Since November 2008, when hedge fund redemption pressures began subsiding, our basket of “High Concentration” stocks has outperformed the market by 7,773 bp (+129% vs. +51%).
3) Large increase in existing home sales in October - but largely due to deadline for the expiration of the homebuyer tax credit. Existing home sales increased +10.1% mom in October (+23.5% yoy) vs consensus +2.3%. Sales of existing homes were bound to increase as the deadline for the expiration of the homebuyer tax credit approached. Although the homebuyer credit has subsequently been extended, we expect home sales to give back some of the extraordinary increases posted in recent months -- almost 20% in the past two months alone and almost 30% since May. The surge in sales, combined with an unusual drop in number of units on the market, cut the months supply of unsold units on the market to 7 months in October from 8 in September.
4) Small gain in Euroland Flash PMI - but still upside risk to our 4Q GDP growth forecast. The Euroland Flash Manufacturing PMI increased slightly to 51.0 in November from 50.7 in October, consensus was for 51.2. The PMI data are now consistent with GDP rising by about 0.5%qoq in Q4 -- an upside risk to our forecast of +0.2%.
5) Spot iron ore price into China have recouped August/September losses and are now printing new 2009 highs - but largely driven by freight costs. Seaborne spot iron ore prices into China have recouped all of the losses that occurred during the August/September sell-off and are now trading just above the previous 2009 peak (see second attachment, p. 1, top-right chart). We estimate that higher Capesize freight costs account for ~70% of the rise in CFR values into China since late September. If we strip out freight, the implied spot FOB price ex-WA is still well below levels seen in early August.
Global FX Strategy 2010: New year, new lows
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Global FX Outlook 2010: New year, new lows (John Normand)
The dollar will turn in 2010, but not before marking new lows versus the euro (1.62), Swiss franc (0.91) and possibly the yen (82). This move is more than a carry trade, given broad weakness in the balance of payments.

Five global macro themes and top trades (Paul Meggyesi, John Normand)
The dollar will undershoot (worst-of basket on CHF, AUD, JPY); recover is discounted but exit strategies are mispriced (GBP/CHF, AUD/NZD); the end of inflation targeting? (NZD/NOK); a CNY revaluation’s impact on G-10 FX is overstated (EUR/JPY); and long-term valuation gaps to close in 2010 (EUR/SEK).

FX Derivatives: A macro model for vol and strategy implications (Arindam Sandilya, Talis Bauer)
A macro model for implied volatility suggests that VXY (3-mo implieds) should range between 10% and 14% in 2010, with spike risk more likely in Q3/Q4. Focus on vol carry for trading returns.

Long-term Technicals: Major transition ahead (Niall O’Connor,Thomas Anthonj)
The dollar will undergo a major consolidation phase over the next two months before resuming its bear trend.

Yen: What would push USD/JPY to all-time lows? (Tohru Sasaki, Junya Tanase, Yoonyi Kim)
USD/JPY can decline to 82 this year before rebounding. Even that level would not prompt BoJ intervention.

Euro: Few obstacles to new highs (Paul Meggyesi)
The euro’s drivers are less idiosyncratic than other currencies, but it will still rise in an environment of broad dollar weakness. Most counterarguments – export impact, China revaluation, euro break-up – are overstated.

Sterling: Funding currency or investment vehicle? (Paul Meggyesi)
Sterling’s undervaluation limits the scope for further weakness, but it is premature to expect a rebound. The trinity of deleveraging in the household, banking and public sectors remains a powerful obstacle.

Swiss franc: Franc to rally as SNB steps off the brake (Paul Meggyesi)
Like the yen, the franc is transforming into a pro-cyclical currency in this post-crisis world of low global yields. The currency will rally in 2010 as the SNB end its intervention (EUR/CHF to 1.46, USD/CHF to 0.91.)

Swedish krona: The myth of krona undervaluaton (Kamal Sharma)
The krona is not as undervalued as most think, but it can still rally 7% in 2010.

Commodity currencies: Where's the gold? (Gabriel de Kock, Matthew Franklin-Lyons)
NOK and AUD will lead the advance in 2010, driven by valuations and policy tightening. NOK is the valuation champ, while AUD benefits from Asian growth. Policy disappointment and valuations hobble CAD and NZD.

Risk scenarios and hedging strategies (Ken Landon)
An inflation surprise, a US funding crisis and US mid-term elections are three to hedge.

FX Alpha Strategies in 2010 (John Normand, Matthew Franklin-Lyons)
Carry should deliver roughly 8% returns as volatility ranges but central banks tighten. Forward Carry returns will moderate from 2009’s 10%. Simple price momentum will struggle in Q3/Q4 when the dollar turns.

Global FX Carry Trade Monitor (Yoonyi Kim)
The carry trade has returned as it always does post-recession, but it is half as large as it seems. Currency managers, global macro funds, CTAs and Japanese retail have moderate exposure. US and European have little.

Post-mortem on 2009 forecasts and trade recommendations (John Normand, Kamal Sharma)
Forecasts were correct on direction but too conservative on magnitude. 60% of trades were profitable.

FX Forecasts
EUR/USD targets raised to 1.62 by Q2 and 1.50 by Q4. USD/JPY should reach 82 by Q2 before rebounding to 89 at year-end. EUR/GBP should peak at 0.94 and AUD/USD at 1.02.

Gazprom (Buy, TP=RUB236.0) - Corporate news - Gazprom could take GDF Suez's 5% stake in VNG Verbundnetz Gas (3p)

Please find below our latest publication:

Gazprom (Buy, TP=RUB236.0) - Corporate news - Gazprom could take GDF Suez's 5% stake in VNG Verbundnetz Gas (3p)
Intriguingly, in a letter to the WSJ on 18 November Nord Stream acknowledged that a ‘major French energy company is also negotiating to join the consortium' – which we think is highly likely to be GDF Suez (Hold, TP €28). In our 5 November report Nord Stream: a strategic pipe for Gazprom...could be part paid by GDF Suez!, we explored the advantages for Gazprom of diverting capex from a low return project, i.e., Nord Stream, and reallocating it to more lucrative E&P projects. We also concluded that Gazprom could achieve an additional advantage by increasing its stake in the German gas market, potentially via an increased stake in VNG.
VNG and Gazprom already have several joint projects: 1) VNG has a 12bcm/year Long Term Take or Pay contract with Gazprom; 2) VNG and Gazprom have a joint storage project in Germany near Bernburg (Saxonia-Anhalt, Germany) that should have a maximum working capacity of 0.5bcm by 2025e. By taking GDF's 5.3% stake in VNG, Gazprom would expand its position in the German gas market. But what could Gazprom give in return for the VNG stake? In addition to a stake in Nord Stream, we believe GDF Suez could seek a long term contract for deliveries via Nord Stream to Greifswald, Germany, mitigating the Ukrainian transit risks.
Target price & rating
We reiterate our Buy rating on Gazprom and RUB236/$8 target price, based on a blend of a SOTP (RUB269) and a DCF (RUB203, beta 1.4 vs 1.5, WACC 9.8%, 1% perpetuity growth, normalised EBITDA margin at 37.5% vs 35.7%e in 09e).
Next events & catalysts
The Nord Stream pipeline will pass through the territorial waters or Exclusive Economic Zones of Russia, Finland, Sweden, Denmark and Germany. So far Denmark, Finland and Sweden have approved construction. With permits pending from Russia and Germany, we believe the permit process should be finalised by end 09 and construction should start in April 10e. For us, the probability of construction is close to 100%, so the longer it takes for GDF Suez to clinch a deal for a stake in Nord Stream, the more expensive it is likely to be… Time is on Gazprom's side.

Lloyds Banking Group (Buy, TP=160.0p) - Corporate news Now for the rights issue (2p)

Please find below our latest publication:

Lloyds Banking Group (Buy, TP=160.0p) - Corporate news Now for the rights issue (2p)
Having announced a successful debt exchange offer yesterday, Lloyds published details of the rights issue this morning to be submitted to the co's shareholders meeting on Thursday.
The capital raising plan –
The innovative £22bn capital raising plan has two stages. First, a £7.5-9bn debt exchange offer to convert into contingent convertibles (CoCos), and, second, a £13.5bn equity rights issue. The debt conversion was a success – attracting demand for conversion of £12.5bn, significantly above the £7.5bn target.
Terms of the rights issue –
Lloyds is raising £13.5bn at a subscription price of 37p, an exchange ratio of 1.34, or c. 4 new shares for every 3 held. Based on a closing price of 91.5p yesterday, this represents a 39% discount to a theoretical ex-rights price of 60p. The discount is deep compared to recent deals, but Lloyds specified a discount range of 38%-42% in the prospectus so this is at the lower end, indicating a decent level of management confidence.
Operating trends –
The prospectus shows key operating trends are all improving: Q3 group impairment charge was 22% below the H1 run-rate, with Lloyds reiterating that H1 09 was the peak; margin is stabilising in a ‘vastly improved wholesale funding market; EU is imposing relatively lenient measures and any revenues foregone should be more than offset by cost synergies of £1.5bn, which Lloyds flagged are currently running ahead of its initial target.
Investment case and valuation –
In conclusion, in view of the rights issue terms and operating trends, we estimate pro-forma normalised earnings of £7.5bn, EPS of c. 12p and NAV per share of 75p is achievable by 2013 (assuming 66bn shares in issue post rights). The announcement this morning removed the last piece of uncertainty for Lloyds, in our view. Implicit multiples of 5x earnings and 0.8x tangible book against the TERP (2013e) look undemanding for a bank showing improving trends and decreasing reliance on the UK government. Our current pre-rights TP is 160p; arithmetically implying 100-105p post rights.

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