YMFYP International Portfolio

Young Money for Young
*****

Investment Portfolio
Strategy

TABLE OF CONTENT

I) US & Europe Macroeconomic Outlook And Team Strategy…………………….……p.4

II) Stocks, Mutual Funds, ETF & Bonds………………………………………………...p.41

III) Options………………………………………………………………………………p.129

IV) Futures………………………...…………………………………………………….p.198

V) International Stocks & Hedges……………………………………………………...p.264

3

US & EUROPE

MACROECONOMIC OUTLOOK

AND

TEAM STRATEGY

4

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 the

overall economy by fostering investments. In order to do that, Obama signed the Tax Relief

Unemployment Insurance Reauthorization and Job Creation Act 1. This bill had as a

consequence for the working families to keep their tax cuts, avoiding losing $3000 per

household2. Also the bill helped to foster growth and job creation. The establishment of a full

year emergency unemployment insurance benefits reduced the deterioration of the labor

market. 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 worsen

the medium and long term deficit; because this bill will support the economy by avoiding an

addition of costs for the government in the next 5 years4.

In order to improve this expansionary fiscal policy, the US government

implemented tax cuts in order to improve employees’ tax relief. An important measure was

also to extend the emergency unemployment benefits in order to help people who were

searching jobs and therefore help to stabilize the fragile labor market. The other government

measures had for consequences to improve education, business investments and to create jobs

in order to revitalize the labor market.

In 2011, the US government continued to focus on the labour market in order to boost the

creation of jobs and the hiring. The set up of the WIA (Workforce Investment Act) which

authorizes $10 billion for job training and employment services5, is a clear example of such a

measure. To stabilize the labour market, the government decided to implement automatic

1
http://www.whitehouse.gov/issues/taxes/tax-cuts
2
3
4
http://www.taxalmanac.org/index.php/Tax_Relief,_Unemployment_Insurance_Reauthorization,_and_Job_Creat
ion_Act_of_2010
5
http://www.gpo.gov/fdsys/pkg/BUDGET-2011-BUD/pdf/BUDGET-2011-BUD.pdf

5

workplace pensions and proposed regulatory reforms to give all workers access to retirement

savings opportunities6, measures taken in order to make significant improvements in work

conditions. Furthermore, to revitalize the business investments and the labor market, the US

government 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 Education

Act) 8 and injected $3 billion in education programs in order to improve the quality and the

standards 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 the

reduction of the national debt. To achieve that, the US government cut spending in many

departments and started 120 programs for termination, reduction, or other savings for a total

of approximately $23 billion in 2011, as well as an aggressive effort to reduce the tens of

billions of dollars in improper Government payments made each year9.

Last but not least, the US government set up the TARP (Troubled Asset Relief
10
Program) that guarantees to the American taxpayers their payback from banks and firms :

“to ensure that taxpayers are fully compensated for the extraordinary support they

provided”11, as Obama said in his speech about the American budget for 2011.

For 2012, the US government, following the recommendations of the bipartisan Fiscal

Commission12, proposed to adopt a plan that will help to reduce the deficit by $4 trillion over

12 years13 by decreasing all kinds of spending, the main ones being the annual domestic

6
7
8
9
10
11
12
http://www.whitehouse.gov/the-press-office/2011/04/13/remarks-president-fiscal-policy
13

6

spending, the defense budget and the healthcare spending, without being detrimental to the

middle class, the seniors and the future investments.

By reducing the annual domestic spending, the US government will save $750 billion

over 12 years14 but will continue to keep its core investments in order to maintain the

improvement on the labor market and the US economy. The government also forecasted

investments in medical research, clean energy technology, education and infrastructures.

The cut in the military budget will allow the government to make additional savings without

affecting the ability of the US government to protect the homeland and the American interests

all around the world.15

The last measure taken by the US government will reduce the healthcare spending, not by

limiting the reimbursements and the services but by limiting the cost of the healthcare bills

itself.

2) Monetary policy

Assisted by the Board of Governors of the Federal Reserve System which is

responsible for the discount rate and the reserve requirements, the FOMC (Federal Open

market Committee) is dealing with open market operations. In 2010, the US public debt was

estimated to be about 69.4% of GDP, and in 2011 about 62.9% of GDP; this shows an

improvement 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 maintain

the historical Fed Funds Rate at 0.00% to 0.25% until mid 201317, in order to boost

investments and households’ spending. At the beginning of the year (January 27, 2010), the

FOMC decided to purchase $1.25 trillion of agency mortgage-backed securities and $175

14
15
16
https://www.cia.gov/library/publications/the-world-factbook/geos/us.html
17
http://www.federalreserve.gov/newsevents/press/monetary/20100127a.htm

7

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, the

economy was strengthened throughout the year supported by a less a deteriorated labor

market, households and an expansion in business spending. However, the high unemployment

rate 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 by

purchasing $600 billion of long term securities by the end of the second quarter of 201119 in

order 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 business

spending increased moderately, the FOMC was still concerned about the weak improvement

of 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 to

start QE2 by the end of the second quarter. The FOMC is also worried about inflation

resulting from the first Quantitative Easing begun in 2009 and the increase of commodities

prices. In the second half of 2011, economic growth slowed, mainly due to the dramatic

events in Japan that caused a disruption of the supply chain and an increase in food and

energy prices21. In Europe, “on December 21st the ECB made available an eye-popping €489

billion ($628 billion) in three-year loans to more than 500 banks across Europe. The money

was released in response to an almost total freeze since July in the bond markets that are an

important 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 new

threshold of the European Banking Authority.

18
19
20
21
22
http://www.economist.com/node/21542187

8

In response to the deceleration of the economy and in order to boost employment and

maintain price stability, the FOMC intends to purchase $400 billion of Long Term securities

by the end of June 2012 and sell $400 billion of short term securities23, allowing the reduction

on 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 of

GDP, labor market and inflation rates : “The central tendencies of these longer-run

projections were 2.5 to 2.8 percent for real GDP growth, 5.0 to 6.0 percent for the

unemployment rate, and 1.6 to 2.0 percent for the inflation rate.”24 The Fed remained also

very concerned about expected inflation in 2012, therefore; “another QE program is

unlikely”.25 According to Sifma, “Concerns over fiscal policy, European sovereign debt,

regulatory uncertainties, and high commodity prices remain significant risks to the

outlook”.26 Such expectations are the reasons why the FOMC is unanimous about the

maintaining of its current 0.00% to 0.025% target Fed Funds Rate.27

23
24
http://www.federalreserve.gov/monetarypolicy/mpr_20110301_part1.htm
25
https://www.wellsfargo.com/downloads/pdf/com/research/market_strategy/2012-Economic-
Outlook_12072011.pdf
26
http://www.sifma.org/research/item.aspx?id=8589934676
27
http://www.sifma.org/research/item.aspx?id=8589934676

9

II. Past and Expected Inflation

According to CBS News28 , on May 13 2011, the US met the biggest yearly increase

in prices since 2008, with an inflation of 3.2% driven by fuel and food. One month later, Ben

S. Bernanke gave an outlook on the inflation in front of the Federal Reserve board, during the

International Monetary Convention29. He also presented “gasoline and other energy products

and, to a somewhat lesser extent, food, as the major cause for this increase in prices”. In

November 2010, the Federal Reserve planned to purchase $600 billion Treasuries until June

2011. Such a plan worried the markets, as injecting money in the economy is a source of

inflation. In June 2011,Bernanke, saw no evidence to be concerned as inflation did not seem

to be lasting. Indeed, the actual increase was in the price of a single product, inflation at that

time was dependent on the commodities market and not the US economy. It should quickly

drop to a healthy level; moreover, in June the commodities market prices were already

starting to decrease. The two other reasons presented by the chairman were first, the

unemployment rate. According to the Phillip's Curve, unemployment and inflation have a

negative correlation. Therefore, since labor costs were, and still are, too expensive compared

to production costs, and wages are decreasing, inflation should decline. The second reason

was drawn by different measures testing inflation expectation, which forecasted future

inflation as stable. “As long as longer-term inflation expectations are stable, increases in

global commodity prices are unlikely to be built into domestic wage – and price-setting

processes, 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 Index

Summary30 a yearly increase in the food index of 5.9%, but the end of the year showed a

deceleration in increasing prices. In October and November the food index only rose 0.1%,

28
http://www.youtube.com/watch?v=lw0jd6a3-KU
29
http://www.federalreserve.gov/newsevents/speech/bernanke20110607a.htm
30
http://bls.gov/news.release/cpi.nr0.htm

10

this reduction follows Ben Bernanke's forecast. Moreover, the report showed a significant

drop 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 a

yearly decline of 1.30%.

Following Ben Bernanke's speech, Goldman Sachs, in its economic outlook31 did not

believe either that inflation would be a lasting issue. Inflation would remain moderate. The

report explained the 2010 drop in inflation was due to a strong monetary policy. Inflation was

above the Federal Reserve’s long term target in 2011, due to an increasing number of people

entering the rental market, with higher criteria for mortgages, and therefore an increasing

number of foreclosures. The second reason was the vehicle market, which met an increase in

price due to supply chain disruptions during the Japanese earthquake, but it was only

temporary. The last cause for inflation was the increase in apparel prices, due to higher

commodity prices and wages in Asia. Goldman Sachs also projected a drop in inflation in

2012. Indeed, the factors for inflation in 2011 were mostly temporary.

31
http://www2.goldmansachs.com/gsam/docs/fundsgeneral/general_education/economic_and_market_perspectiv
es/wp_economic_outlook.pdf

11

For the year 2012, a decrease in inflation can be expected. At mid-December analysts

projected32 an inflation of 2.8% in January, and a continuing decrease until April 2012 to

1.8%, after-what it should slowly increase again to 3.8% in July.

Concerning Europe's inflation, which is going through its most unstable time since the

creation of the European Union, had an acceleration of 3% this autumn33 due to rising energy

prices, but it decreased in December 2011 to 2%. Moreover, it is expected that the

appreciation of the Euro will slow down the inflation rate in 2012, to below the European

Central Bank's target. There is another possibility, where the inflation rate might continue to

increase, if labor costs and energy costs continue to increase, but this might create a situation

of stagflation, with high unemployment and high inflation, a situation Europe cannot currently

afford to be in.

32
http://forecasts.org/inflation.htm
33
http://www.euroeconomics.eu.com/inflation_variables.htm

12

III. Unemployment

Since May 2009 the unemployment rate is above 9% which is very high. The last

time 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, “the

unemployment rate has declined by 0.6%.”35 In December 2011, it was the lowest rate of the

year. The reason was that 147,000 jobs per month had been added on average over the

previous six months and according to the same report “job gains occurred in transportation

and warehousing, retail trade, manufacturing, health care, and mining.”

34
http://www.ihs.com/products/Global-Insight/industry-economic-report.aspx?ID=1065931873
35
http://www.bls.gov/news.release/empsit.nr0.htm

13

However, some analysts contradict the previous projections, such as Bloomberg. The

company stated that the « Employers in the U.S. added fewer jobs than forecast (8.6%) in

December»36.

If we look at the graph above, the projected annual unemployment shows a

significant decrease in the future years. According to Market News International, « With

continued healthy growth in 2011 and beyond, the unemployment rate is projected to fall, but

it 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-.html
37
http://www.forexlive.com/index.php?s=With+continued+healthy+growth+in+2011+and+beyond%2C+the+une
mployment+rate+is+projected+to+fall%2C+but+it+is+not+projected+to+fall+below+6.0+percent+until+2015+

14

IV. Gross Domestic Product (GDP)

Over the years following the financial market crash in the United States, the GDP of

the US has been on a roller coaster ride. During the 2008 crisis, the GDP had fallen

substantially (almost -10.0% as shown on the graph). Indeed, at that time period,

consumption, business investments and government spending decreased as the credit crunch

touched the entire country. The measures taken by the Federal Reserve with QE1, pushing

inflation higher, led the GDP to rebound in 2009 and 2010.

According to the Bureau of Economic38 Analysis during the 2nd quarter of 2011 GDP

increased 1.3%, and during the 3rd quarter, it increased 1.8%. The end of the year 2011 met an

increase in consumer spending, and in consumption of durable goods, mostly in motor

vehicles and parts. Also, there was acceleration in business investment, mainly investments in

equipment and softwares. Exports increased, according to the BEA there were “decreases in

travel and passenger fares were mostly offset by increases in royalties and license fees and

other private services (which includes items such as business, professional, and technical

38
http://www.bea.gov/newsreleases/national/gdp/gdphighlights.pdf

15

services, insurance services, and financial services). Changes in the other categories of

services exports were small.”39

It is forecasted for the year 2012, that GDP will increase about 2.5% 40. Consumers

are spending again after saving money for the past four years, and the expectations are mainly

in the vehicles sector. Moreover, employment should improve with businesses investing in

new equipment, in order to increase production. Also, according to the department of

commerce, 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 show

that the economy grew at an annual rate of 3% or more in the last quarter of 2011 but that the

pace will slow again early in 2012 and pick up only slightly by the end of the year. A

sustained recovery is still not under way, more than two years after the end of the Great

Recession”.

If we compare the GDP per capita between US and Europe, the US are doing better

than Europe, according to Adam Davidson, «the U.S. GDP per capita is nearly 50 percent

higher than it is in Europe»41. George Irvin, a Research Professor at SOAS in London, said

that, «the main reason the US is richer is, first of all, because a higher proportion of

Americans are in employment and, secondly, they work about 20% more hours per year than

Europeans».

Concerning Europe, in 2011 the European debt crises led the GDP of most of the

European countries to decrease. Governments had to use austerity plans, decreasing their

spending and increasing product prices in their country. “Gross domestic product rose at a 1.8

percent annual rate from January through March after a 3.1 percent pace in the last three

months of 2010, the Commerce Department said today in Washington. Economists projected 2

39
http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm
40
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

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 (and

both 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.html
43
http://www.thenewfederalist.eu/Europe-vs-USA-Whose-Economy-Wins

17

V. The Dollar

USD/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. The

highest peak that we can see on the chart in June 2010 was caused by Hungary and Greece

debt concerns in Europe.45 In November 2010, the Federal Reserve announced its second

quantitative easing (QE2) of $600 billion of US Treasury purchases. This made the Dollar the

victim of the following days; it depreciated against the Yen and the Yuan as this

announcement engendered a growing fear in Asia (China being the biggest investor in US

Treasuries). 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, the

economy was concerned by the US debt crisis, but the Dollar strengthened as investors were

even more worried about the situation in Ireland and some other European countries such as

44
http://www.finance. yahoo.com
45
http://www.reuters.com/article/2010/06/07/markets-forex-idUSN0721338820100607

18

Portugal or Italy. Then, “the dollar depreciated against most currencies through the summer

of 2011.” 46 But the worsening Eurozone of the situation at the end of the summer allowed the

dollar 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 lowering

the reserve requirements for banks led the US dollar to depreciate because the Chinese Banks

could 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 the

death of leader Kim Jong-Il.” 48

Today, the Dollar is still seen as the safe-haven for investors, after serious concerns

about the Eurozone crisis. After S&P’s sovereign downgrades including France, the Dollar

appreciated significantly. As explained by John Kicklighter, Senior Currency Strategist, “To

build serious demand for a currency that exemplifies liquidity and safety, we needed a

catalyst 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 a

report from Scotiabank, “the USD, measured by the trade-weighted DXY index, has increased
50
8% since early September.” As the situation in the Eurozone is worsening after the last

downgrades; we expect the dollar to keep appreciating in the short term. Asian markets will

probably be overvalued due to fewer exports to Europe, leading the US currency to

strengthen.

46
http://www.ihs.com/info/ecc/a/economic-predictions-2012.aspx
47
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=0
50
http://www.scotiacapital.com/English/bns_econ/fxout.pdf

19

VI. The Euro

51
EUR/USD over the past two years

The Euro, just like the US Dollar, has been through challenging years as shown on

the graph. June 2010 was a relatively bad period for the currency, as it hit its lowest level
52
against 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 rose

above $1.41 due to the dollar weakening after the Federal Reserve’s announcement about

QE2.

In May 2011, after a depreciation at the beginning of the year due to the bailout of

Ireland (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 the

single currency.” 53 The Euro then depreciated sharply at the beginning of October, as Greece

default was feared more and more in Europe. It hit $1.318554 its weakest level against the yen

51
http://www.finance.yahoo.com
52
http://www.reuters.com/article/2010/06/07/markets-forex-idUSN0721338820100607
53
http://www.reuters.com/article/2011/05/04/markets-forex-idUSLDE74318220110504
54
http://www.reuters.com/article/2011/10/03/markets-global-idUSN1E7921W020111003

20

since 2001. The currency seemed to recover at the end of October by hitting a peak, but “the

euro slipped after the auction yield on the new 10-year Italian government debt hit a new

euro lifetime high.” 55

Since September 2011, the Eurozone’s currency is suffering from the sovereign debt

crisis which is now spread throughout the entire continent, with less and less countries able to

keep their triple A rating. The Euro remains weak at $1.2680 after France, Austria and ESFS

downgrades from AAA to AA+.

We believe that the Euro will continue to weaken in 2012 as we expect the debt crisis

in 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 the

currency will depreciate.

55
http://www.reuters.com/article/2011/10/28/markets-forex-idUSN1E79R0WH20111028
56
http://www.scotiacapital.com/English/bns_econ/fxout.pdf

21

VII. Treasury Bond and Bond Market

Beginning in the fourth quarter of the year 2008, the US began its economic crisis

and the ensuing recovery plan. Up until this day the US is still working hard to see its

economy recover. Treasury bills, also known as T-Bills, are government traded securities that

are issued by the United States government. They are typically considered to be one of the

safest forms of investment for investors. About twenty years ago Treasury bills were selling

with yields around 8.65%. After events such as the Gulf War and 9/11 Terrorist attacks, T-bill

rates started to decrease to 0%. The recent financial crisis of 2008 accelerated the decline of

22

T-bill rates to nearly 0%.57 Such unusual low rates; in order to fight the inflation the Fed had

to withdraw money from the market. Also, as a fiscal policy the government chose not to

increase tax rates citizens as an incentive to keep spending; this in turn would help to

stimulate economic growth.

Looking at the rates offered for T-bills during the present year we see that they are

still very low. Short term securities ranging from three months to one year are selling at a

coupon of 0% while T-notes are selling at rates just under 1% to 2%. T-bonds are selling at

rates higher than 2% but lower than 3%. That is to be expected since investors would not want

to invest in these securities unless they would have some return.58 The Fed will of course raise

these rates once the economy shows some signs of recovery to fight inflation but as of now

they will stay as is.

If we compare the yield curve of municipal bonds and corporate bonds, we note that

the returns for corporate bonds are higher than that of the municipal bond. In other words, the

corporate 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

From 2010 to 2011, both curves showed a decrease in municipal bonds and corporate

bonds rates. Municipal bond yields fell greater than corporate bond yields due to the decrease

in the total dollar amount of municipal debt between the fourth quarter of 2010 and first

quarter 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 the

decrease in issuance of bonds in 2011 was due to fact that 2010 was a record year for bond

issuance. Corporate bonds decreased quarter to quarter by 8.6%. 59 According to the report of

the US Census, Corporate bonds comprised just under a sixth (15.7%) of the total cash and

security holdings of major public-employee retirement systems for the current quarter.60

59
http://www.bondsonline.com/Search_Quote__Center/Municipal_Bonds/
60
http://www.bondsonline.com/Search_Quote__Center/Corporate_Agency_Bonds/Spreads/

24

The comparison of the yield curves from January 2011 and January 2012 shows that

rates were much higher in the year 2011 in respect to all treasuries sold. 61 The biggest

difference can be seen when looking at treasury rates for 30 years where the difference is

almost 1.5%. In short it seems that recovery slowed down in the year 2011. Hopefully, as we

look towards the coming months these rates will once again increase and investors will have

better 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 to

2011. As investors are worried about unsafe European bonds, they will focus on US

Treasuries. Therefore, an increasing demand in the US bond should decrease the interest rates

for 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%2F2012
62
http://www.marketvector.com/interest-rate/long-term-government-bonds.htm

25

Looking at the European bond market graph above for ten year government bonds

issued by European nations, we see that bond rates have generally been on the rise since early

2010.63 The European crisis started with Greece in December 2009. The downgrade of

Greece’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 debt

concerns.”64 We can expect Greek bond prices to remain low over the next few years and the

country financial situation to improve very little.

In late 2010, we saw the same thing that happened in Greece happening to other

European nations such as Ireland, Spain, and Italy. From 2010 to 2011 we saw that every time

a country was downgraded by rating agencies it affected the bond markets of other European

nations by increasing their market interest rates. There was high risk and investors were not

confident in investing in this volatile market.

Looking towards the future we can expect bond rates across the Eurozone to fall, but

not substantially. From the graphs above we already saw that towards the end of 2011 bond

rates have begun to decrease. We can expect that these rates will continue to fall until the

European economy improves. As the European economy improves we can expect bond rates

to flatten out and be less volatile. According to Emilly Knapp, “the success of today’s

63
www.economist.com/blogs/dailychart/2011/08/euro-zone-bond-spreads
64
http://theinvestmentblog.net/2010/12/26/2011-bond-market-outlook-2010-year-end-bond-summary/

26

European bond auctions, and the expectation of continued success, was enough to outweigh a

host 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 bund

yielding 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% higher

than last year. On January 12th, 2011 Portugal, in order to delay its bail out, set a bond

65
http://wallstcheatsheet.com/trading/market-recap-euro-bond-auctions-buoy-markets-despite-negative-
data.html/
66
http://markets.ft.com/research/Markets/Bonds

27

auction. At the end of the day, it was reported by the newspaper The Guardian 67 that “The

country paid 6.7% to raise money – less than the 7% rate that would have been regarded as a

step towards a bailout.” The auction amounted to EUR1.25 billion, with the intervention of

the 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

VIII. Stock Markets

a) Dow Jones

68

During 2011, the Dow Jones has been volatile due to the past financial crisis. At the

beginning of the year, the Dow’s curve rose with a 4% increase in March, resulting from the

recovery 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 hit

Japan69 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 argued

about bills spending and debt ceiling70. At mid-July, the government was forced to find a

68
69
http://www.fool.com/investing/general/2012/01/14/2011-a-crazy-year-for-the-dow.aspx
70

29

solution or risk defautl71; therefore, the Dow jones reacted by falling sharply. Later in July

Congress came to an agreement but the markets remained volatile, the investors being still

anxious and afraid about the overall economic and financial conjecture. On August 5th,

Standard and Poors, (the notation agency) downgraded the US Treasury Securities from AAA

to AA72, causing a wave of panic among the investors. In reaction, the Dow Jones plunged by

15% to reach its trough of the year and remained extremely volatile until October because of

the political uncertainty and unpredictable nature of the markets. From October to mid

November, the Dow Jones rose significantly, due to the speech of Ben Bernanke, the

chairman of the Federal Reserve, who denied any future quantitative easing from the Fed. 73

This reassured the investors in the stock market. Also, the Dow Jones was driven by large

companies which increased their profits. The ECB (European Central Bank) which massively

bought US bonds caused an increase in bonds prices and therefore a decrease of their interest

rates. Referring to Jean Claude Trichet, “the central bank would continue its bond buying

program and extend loans to banks to prevent liquidity problems.”74 Hence, the investors

dropped their bonds and started to invest in the stock market. The Dow Jones ended 5.5% at

the end of the year, which remained the biggest increase in 13 years. Even if the market

became volatile in mid November, this hiccup was due to the fact that European investors

invested 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 to

invest 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
72
73
http://www.thestreet.com/_yahoo/story/11267126/1/stock-market-story-oct-
4.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA
74
http://www.thestreet.com/_yahoo/story/11270268/1/stock-market-story-oct-
75

30

"the U.S. will continue to be the 'least bad' place to invest for a number of years." 76

Moreover, “despite the fears that a large European country such as Italy will default on its

debts, causing a banking crisis there and possible financial contagion around the globe, the

euro zone’s debt crisis doesn't have to end in a worldwide financial crisis” said Stephen

Auth77, 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
79
the 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 economic

and financial conjecture, investors preferred to invest in the Dow Jones, which is the price

weighted average of the thirty significant stocks traded on the NYSE and the Nasdaq, which

76
http://www.usatoday.com/money/perfi/stocks/story/2011-12-30/stock-outlook-2012/52342704/1
77
http://www.usatoday.com/money/perfi/stocks/story/2011-12-30/stock-outlook-2012/52342704/1
78
79
http://www.thestreet.com/_yahoo/story/11360717/1/stock-market-story-dec-
80
http://www.thestreet.com/_yahoo/story/11360717/1/stock-market-story-dec-

31

explain its safe haven connotation, in order to guarantee the preservation of their initial capital

in troubled times and its valorization in better times.

32

IX. Commodities market

a) Gold

During 2011, the gold market has known an amazing increase over the year; first

from January 14th to August 30th with an increase of 40%. The price then fell again to a price

of $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 of

investors who feared a double dip recession following the financial crisis of 2009, gold

proved itself to be a safe place to invest in, a safe haven. According to many analysts, “the

gold sector is undervalued and poised for a comeback”.81However, the main reasons of the

incredible increase in gold were, firstly, China’s growth in GDP of 21% from 2009 to 201182

knowing 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 popular

81
http://www.thestreet.com/_yahoo/story/11166900/1/gold-stocks-ready-for-a-
recovery.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA
82
https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html
83
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

and almost inexpensive securities that investors like to trade in order to take advantage on the

fluctuations of the gold market; and lastly, the US dollar depreciated responding to “the

mixture of Ben Bernanke’s testimony and the Moody’s rating news”85, causing the rise in gold

prices.

Since August 30th, gold started to decline sharply, this drop being a cause of the

strengthening of the dollar. As the dollar rose, the investors dropped gold. This burst of the

gold bubble can also be explained by the fear of nationalization of world gold mines by the

governments. Indeed, as David Christensen said: "[nationalization is] going to play out ... the

pie has gotten bigger and so the perception is that they should take the larger portion of the

pie", meaning that the gold mines profits will be mostly absorbed by the governments which

frightened investors.

On October 3rd, an announcement was made about Kibali’s gold mine. It was stated

that 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 by

Reuters: “The Kibali project is potentially one of Africa's largest gold mines and Bristow said

a 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 to

the 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=43
87
http://www.reuters.com/article/2011/11/16/markets-precious-idUSL5E7MG28J20111116

34

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, high

debt burdens in Europe will continue to hamper growth, and the risk of a U.S. recession is

rising. All of these factors are individually positive for gold. Taken together, they are a

potentially explosive cocktail.” UBS said.89 Referring to Bloomberg, the price of gold is

expected to rise dramatically in the coming year. Even after some disappointment in the

previous year, speculation will cause the price of gold will range between $1900 and

$2000/ounce at the end of 2012.90

88
http://www.forecasts.org/gold.htm
89
http://www.bloomberg.com/news/2011-09-07/ubs-boosts-2012-gold-price-forecast-by-50-to-2-075-an-
ounce.html
90
http://media.bloomberg.com/bb/avfile/News/First_Word/vzp7Z2sK7kjY.mp3

35

b) Oil

At the beginning of 2011, oil rose drastically. The main reason of such an increase

was the riots in Libya and the Arab Spring91. The area which was politically very troubled

added to the risk of disruption in the supply chain of crude oil, knowing that Libya and

countries in the neighborhood are massive oil producers’ countries, caused a sharp increase of

oil prices, which reached their peak in the end of April. Indeed, “this turmoil raised the level

of instability in the Middle East and consequentially made many oil traders anxious as crude

oil price soared mainly at the beginning of last week.”92The massive speculation on the

increase of oil prices amplified the sudden growth of the oil prices.

In May, oil fell due to several reasons. The uncertainty of the previous gold

fluctuations and the unpredictable nature of the oil price evolutions frightened investors who

during those precise times were risk averse and were looking for stability93. Dollar and oil are

negatively correlated. Indeed, “The strengthening of the greenback also helped keep oil prices

91
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

at bay.”94. And last but not least, the demand for oil and gasoline dropped by the United

States due to the IEA’s report which forecasted a cut in oil demand 95. Added to that, the

OPEC had an excess of oil production which caused an increase in the oil supply, directly

leading to a drop in oil prices.

Since the end of September – beginning of October to the end of the year, crude oil

surged caused by the European efforts and agreements to solve the debt crisis 96. Also OPEC’s

production decreased (mainly in Saudi Arabia and Nigeria), decreasing the oil supply and

leading to an increase in crude oil prices.97

98

As the overall economic recovery is dependent on the fluctuations of oil prices, the

political issues in the Middle-East and some African countries can affect and seriously

damage the fragile global economic situation in 2012.

94
http://www.oil-price.net/en/articles/oil-prices-down-for-now.php
95
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-crisis
97
http://www.tradingnrg.com/opec-crude-oil-production-slightly-fell-september-2011-opec-october/
98
http://www.forecasts.org/oil.htm

37

According to the Energy Policy Information Center: “Considering the continued

volatility in Iran and Nigeria, a severe or prolonged oil price spike could dramatically

worsen the situation in 2012”. 99

99
http://energypolicyinfo.com/2012/01/trade-deficit-widens-beyond-expectations-on-oil-imports/

38

X. Team Strategy

During the past few months, Europe has been through the worse crisis since the

creation of the European Union; this will have a significant impact on the market in the short

term as currently the situation does not show any sign of recovery. The US seems to have the

safest economy for now; their economy seems to have recovered from the 2008 crisis, but the

coming elections might also have an impact on the US markets, depending on people’s

confidence. Moreover, inflation is not supposed to increase in 2012; we can therefore wonder

if the Federal Reserve is going to ease the economic recovery again by purchasing US

government bonds in order to boost growth. However, another quantitative easing is not

forecasted by the Fed, which is still concerned by the maintaining of the inflation rates and

prices stability. Concerning European monetary policy, we will also have to pay attention to

the ECB actions. Because of this uncertain future, opinions are staying relatively moderate on

how the markets will progress. Volatility will stay high, forcing investors to stay active and to

follow 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 financial

improvements and still preserving the initial capital and minimizing the losses during

economic contractions and financial troubles.

The bond market in Europe is currently less attractive than the US; due to the

European debt crisis, people are more focused on US bonds in order to have safer

investments. 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 highly

leveraged companies in order to maximize the returns, and in large safe companies.

39

We will allocate our capital as shown in the Pie Chart:

40

Stocks, Mutual Funds, ETF and
Bonds

41

Our Long Position: HALLIBURTON COMPANY (HAL)

Company Profile

Halliburton is a $32.61 billion company created in 1919, and headquartered in

Houston, Texas. It belongs to the oil and gas equipment and services industry. The company

is one of the largest oilfield services corporations, providing exploration, development and

production 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 on

the New York Stock Exchange. It takes part in a highly competitive market. Indeed, energy is

a domain that will always be needed. Moreover, this industry highly depends on oil and gas

prices, 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. We

decided to buy Halliburton’s stocks because we believe that this domain, still volatile, will

never hit the bottom. Moreover, the performance of this industry is forecasted to accelerate in

the 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 to

which we expect to moderate other risky investments. The major competitors of Halliburton

are Schlumberger Limited, Baker Hughes Incorporated, Technip.

42

100

Halliburton is the second largest company of its industry after Schlumberger

Limited, which has a market capitalization three times bigger.

Schlumberger employs two times more people than Halliburton, but Halliburton is

making 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 the

industry, Halliburton retains a higher proportion of revenue after having paid its variable

costs. The company has therefore more to pay its fixed costs which are quiet high in this

industry, 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 less

revenue to invest in other operations than Halliburton.

If we compare the net income of Halliburton ($2.72 billion) with its major

competitor, Schlumberger’s net income is almost the double with $4.78 billion. For each
100

43

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) is

27.6 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 times

lower than the industry and nine times lower than its competitor Technip. Consequently, we

can expect that the stock price will rise in the future, as at the moment it would mean that the

stock is undervalued.

One-Year Stock Moves and Beta Comparison

One-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 higher

101

44

prices for their oilfield services through 2012.”102 Brian Uhmler, analyst, added that: “Oilfield

services companies [had] the power to raise prices more than 16 percent [in 2010]. It may

accelerate consolidation in the industry as companies expand to meet demand”

On July 22nd, oil companies hit highs. “Oil pushed higher, briefly topping US$100 a

barrel, as investors cheered progress on an agreement to aid Greece and the world's largest

oil consumers decided against releasing additional oil stockpiles.”103

Until the end of August, Schlumberger was moving just like the market, meaning a

beta close to 1, whereas Halliburton has always been above, outperforming the market. Its

beta is lower than 1, due to the fact that their stock price is driven by oil prices, which is an

utility, and that it is an international company.

Due to concerns of another recession in September, oil prices dropped leading oil

companies to underperform the market. Since this time period, both companies’ beta rose

above 1 as they became more volatile.

On September 6th, the company announced that “it has entered into a definitive

agreement to acquire Multi-Chem Group, LLC.”104 Multi-Chem is a provider of production

chemicals 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 not

meeting its target of deficit reduction for this year dominated investor sentiment.”106 Both

stocks dropped dramatically, Halliburton hitting -25.0% and Schlumberger -30.0%. S&P500

closed at its lowest level since 2010. The same article stated that: “On the NYSE, for every

102
http://www.bloomberg.com/news/2011-06-24/fracking-gold-rush-lifts-halliburton-prices-as-backlog-
swells.html?cmpid=yhoo
103
http://www.morningstarthailand.com/th/news/articles/99695/Global-Market-Report-22-July-2011.aspx
104
http://www.reuters.com/finance/stocks/HAL/key-developments/article/2396079
105
http://www.reuters.com/finance/stocks/HAL/key-developments/article/2409658
106
http://www.zacks.com/stock/news/62097/Stock+Market+News+for+October+4,+2011

45

one stock that moved up, a total of 10 stocks declined.” Both HAL and SLB are traded on the

NYSE.

Halliburton’s Beta107

HAL changes

β

S&P500
changes

Historical Prices of HAL and S&P500 taken from Yahoo108

Today, Halliburton has a beta of 1.58. On the characteristic line, it is slightly

different (1.70) as we only took the changes in prices over one year. Alpha (α) is equal to

0.0002, meaning that Halliburton is slightly outperforming its benchmark as the return of the

stock when the market does not move is 0.02%. The industry has a beta of 1.25, meaning that

it is a very volatile one. Compared to the industry, Halliburton is more risky than the average

107
http://www.reuters.com
108

46

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 Schlumberger

is more international, less risky, and that it has more market power. The industry being

volatile but not highly risky, it is in line with our strategy.

RRR and ERR Calculation

( )
HALLIBURTON SCHLUMBERGER

RRR = 0.1% + (8.7% – 0.1%) * 1.58 RRR = 0.1% + (8.7% - 0.1%) * 1.39
RRR = 0.1369 = 13.69% RRR = 0.1205 = 12.05%

HAL SLB

Data taken from Yahoo109
HALLIBURTON SCHLUMBERGER
ERR = 0.01 + 0.19 ERR = 0.015 + 0.287

109

47

ERR = 0.20 = 20% ERR = 0.3020 = 30.20%

Halliburton's 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 above

the Required Rate of Return. This is therefore a BUY sign. RRR is on the security market

line, this means that if the rate of return was 13.69%, we should hold. The growth rate is

expected 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, the

RRR is lower than Halliburton’s one because SLB is less risky (beta of 1.19), so risk averse

investor will be more willing to buy SLB stocks rather than HAL. However, its ERR is higher

as its growth rate this year is higher than Halliburton’s by 51%.

48

Ratios Analysis

Data taken from Yahoo110

The current P/E is higher than the forward by $5.24, or 68.14%, which is better for

Halliburton. This means that EPS is expected to rise in the future, that the price per share is

expected to decrease, or both. As we can see above, EPS is expected to hit $4.00 in December

2012, 45% more than the current EPS ($2.76). Therefore, we stay confident that the price of

the stock will not fall.

110

49

Data taken from Reuters111

Halliburton is more liquid than most of the companies in the same industry; its quick

ratio 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 its

inventory 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 means

that it aggressively uses its debt to finance its growth. The industry has a ratio greater by

58.32%, 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 we

wanted a company with a high leverage, but financially safe enough to be able to generate

returns.

111
http://reuters.com

50

Data taken from Reuters112

With a ROA 110.26% higher than the industry, Halliburton seems to effectively turn

its invested assets into profit. Indeed, its ROI is also 87.04% higher so the company makes

87.04% 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 by

its shareholder is effectively used in its investments as it represents a quarter (25.25%) of its

net income.

We conclude that Halliburton’s management is more effective in allocating its

resources 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 is

a decrease by 7.92% over 2009. This is due to an increase in account receivables and in

inventory in 2010. This means that the company was waiting for its clients to pay, and that it

could not turn its inventory into cash. Schlumberger, however, generated $5.49 billion of cash

112
http://www.reuters.com
113
http://finance.yahoo.com/q/cf?s=HAL+Cash+Flow&annual
114
http://finance.yahoo.com/q/cf?s=SLB+Cash+Flow&annual

51

from its operating activities, which is an increase by about 3.40%. This was due to an increase

in the net income of 36.15%, to an increase in liabilities and in operating activities (such as

purchase of short term investments). Therefore, the company has more debt but more

liquidity.

Analysts’ Estimates

(Data taken from Yahoo115)

The last price of Halliburton stock (as of January 24th 2012) was $36.36. The mean

target is greater by $16.64, and the low target is greater than the actual price by $6.00; this

means that the stock is undervalued, and this confirm what we noticed before in the ratio

analysis. Therefore, we can expect the price of the stock to increase in the future. If it attains

the mean target, it would increase by 45.76%. If it attains the high target, it would increase by

106.27%. If it attains the low target, it would still increase by 15.51%, which is a signal for a

significant buy.

115

52

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, this

is again a BUY sign.

Hot News

Q4 2011 earnings results have been released on January 23rd. CEO Dave Lesar stated

during the conference call that he is “very proud to say that this was a record year for our

company, 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 has

nearly doubled in size over the last 5 years.”116 They are also confident for 2012 as they

invested in technologies “which not only have made a substantial contribution to our success

in 2011 but will, we believe, underpin our focus areas for growth in unconventional

deepwater mature assets in 2012.”

On January 25th, Halliburton has been said to be smart in their strategies in its quest

to gain loyal customers. “The fourth quarter saw the company spending $23 million in

strategic 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

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 with

customers.”117

Decision and Calculation

We decided to BUY Halliburton Company as it perfectly fit with our strategy. The

stock is volatile due to the risk of the industry, but according to the estimates, and due to the

fact that the stock is underperformed, its price should increase.

Therefore, we bought 2,807 shares at $36.08.

Investment: 2,807 shares * $36.08 = $101,276.56

117
http://www.fool.com/investing/general/2012/01/25/halliburtons-smart-approach.aspx

54

Company Profile

First Solar, Inc. is a manufacturer who sells photovoltaic solar modules using

semiconductor technology that converts sunlight into electricity. First Solar, Inc.’s

activities include project development; engineering, procurement, and construction

services; operating and maintenance services; and project finance. The products are sold

to 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 the

most revenue; it consists in the design, manufacture, and sale of solar modules. In

January 2011, the Company and RayTracker, Inc. announced that First Solar, Inc. had

acquired RayTracker, Inc. In January 2010, First Solar, Inc. acquired assets from the

“Edison Mission Group's solar project development pipeline”. This project was made up

of utility-scale solar projects, set up in California and in the southwestern area of the

United States. In the second half of 2011, revenues fell 5% to $1.10B. Net income

decreased 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

this drop with an increase in expenses related to goods sold. There was also a rise in

research & development expenses, increased selling, general & administration expenses,

higher production start up expenses, lower operating income and a last fall in interest

income. The company operates in the USA, Germany, Canada, Malaysia, Belgium,

Spain, China and Australia. It was originally named First Solar Holdings, Inc., but its

name was changed to First Solar, Inc. in 2006. This firm was created in 1999 and is

based in the city of Tempe in Arizona.

Industry

First Solar, Inc. operates in the segment of semi-conductors. The sector suffered

the 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 industry

represented $298.3 billion in 2010; in other words a 31.8% increase from 2009, very

close 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 watchers

contended that the strength in the first half was more on account of pent-up demand

than the beginning of another growth phase. ”122 The end of the year strongly was

underperformed, due to unemployment's persistence, therefore, the holiday season fell

below the industry's expectations; the holidays being the usually best performing time of

year.

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
122
123

56

disrupted and led to an increase in price. Then, reparation were needed in the factories

and all the equipment, which was very specific to each product, had to be replaced and

this process was long and expensive. Also, of course a strong part of the demand

decreased.

For 2012, it is expected that the semiconductor industry will have a negative

growth 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 capital

equipment market in 2011, but we expect equipment spending to increase 13.7 percent in

2011,” said Klaus Rinnen, managing vice president at Gartner. “However, equipment

providers will not be as lucky in 2012. The impact of the slowing macro economy, high

inventories and a sluggish PC industry — due to both weak demand and the flooding in

Thailand — will temper the outlook for 2012.”124 Gartner forecasts this decrease to

affect the market until the second quarter of 2012. It is predicted that demand and supply

should 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

Competitors

First Solar's market capitalization is about $3.28B. It is almost 3 times lower than its

main competitor Sharp Corporation which has a market capitalization of about $9.31B. This

number is understandable due to Sharp Corporation's seniority on the market; this company

was created in 1912 in Japan. This company already has a century of experience in this

industry, and therefore, a strong reputation; whereas, First Solar, Inc. was created in 1999, and

launched the commercialization of its products in 2002.

Sharp Corporation has 9 times more employees than First Solar, which can be put in

relation with the company's seniority; these two competitors do not operate at the same scale.

Also the revenues prove well the difference between the two: the Japanese company accounts

13.5 times more revenue than the American company.

Sharp Corporation has a negative revenue growth rate due to last year's natural

disaster, which led to destruction of equipment, reparations to fund, inventory losses and so

on.

First Solar Inc. retains $0.4256 from each dollar of revenue generated, to be put

towards paying off selling, general and administrative expenses, interest expenses and

distributions to shareholders. This number is very close to the rest of the industry, but 2 times

greater than its main competitor. It shows lower variable costs for First Solar Inc., compared

to its peers.

First Solar Inc. has an operating margin of 23.02%, which is more than 9 times

greater than its Sharp Corporation. It means that First Solar Inc. makes $0.23 (EBIT) for

every dollar of sales. This number is so high considering the size of the company due to its

product specialization, as solar panels are important structures to install and it is an expensive

product. Whereas for Sharp Corporation, solar panels are only a small part of their operating

58

activities, they also sell diverse electronic devices, such as smartphones, printer, LCD

monitors and so on.

The competitor’s net income is negative due the natural disaster which made the

company unable to make most of it sales, knowing that domestic sales are almost half of

Sharp Corporation's net sales.

First Solar Inc.’s shares are almost 15 times greater than the rest of the industry. It

means that FS's 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 dollar

of their earnings. This company's earnings are ensured due to the company's strong

specialization, and the small scale of the company compared to the industry leaders. Suntech

Power's 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 than

Sharp Corporation. The stock is undervalued.

Price to sales is almost 5 times greater than Sharp Corporation; it shows a share price

greater than the revenue per share for First Solar, Inc

59

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 Company's CEO December 15, 2011 : Release
of low 2012 estimates

Over 2011, First Solar Inc. fell dramatically. It started in May 2011 as the market

suffered 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 power

companies lost some of their customers. “As the impact of the economic downturn was felt

across all sectors, enterprises increasingly sought ways to cut energy-related costs, and this

new focus is responsible for turning the tidal flow of investment dollars in the sustainable

sector.”126

In its 2nd quarter First Solar Inc. kept on decreasing, this news was release during a

conference call on August 8, 2011127. It is explained as prices dropped, and a change in

policies in Italy, Germany, and France which lowered demand128. Indeed, limits on permits

were set, and some projects were stopped129.

125
http://www.reuters.com/finance/stocks/FSLR.O/key-developments/article/2305797
126
http://www.renewableenergyworld.com/rea/news/article/2011/09/renewable-industries-predictions-for-the-
second-half-of-2011
127
128
http://investor.firstsolar.com/releasedetail.cfm?ReleaseID=596906
129
http://www.bloomberg.com/news/2011-02-14/china-profits-from-solar-power-strategy-as-europe-backpedals-
on-subsidies.html

60

The third worsened the company's situation, as First Solar Inc. fired its CEO and

replaced him by one of the company founders130. Indeed, during the time Gilette led the

company, it lost 65% of its market value131.

In its last quarter, the firm's stock kept on falling; it showed the biggest drop in the

Standard & Poors 500 Index, with a decrease of 76%. The company released their estimates

for the year 2012; they expect their earnings will continue to fall; their forecast was lower

than the analyst's estimates.132

First Solar's 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 is

explained by a drop in energy prices, lowering revenues. “By the end of Q2 2011, it was clear

that the renewable sector was feeling the effects of depressed economic conditions. During Q2

2011, 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 drop

from Q1 2011 levels.”133

130
131
http://idealab.talkingpointsmemo.com/2011/10/stormy-forecast-first-solar-ceo-fired-stocks-tumble.php
132
133
http://www.renewableenergyworld.com/rea/news/article/2011/09/renewable-industries-predictions-for-the-
second-half-of-2011

61

Ratios134

134
http://www.reuters.com/finance/stocks/financialHighlights?symbol=FSLR.O

62

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 company's 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

company is quite recent, and young companies are always considered riskier. Moreover this is

operating in a risky industry, and over the last year, the company went through a difficult

period, mainly with the loss of 73.6% of its stock value136. A Citibank analyst has even

pointed out that the firm needed to either be taken private, either be acquired by a richer

parent or its future would situation would keep on increasing137. The company's beta is not

forecasted to decrease as none of First Solar Inc.’s attempt to improve its situation so far; even

the firing of their CEO was not enough to stop the rumors of bankruptcy.

Indeed, expectations about First Solar Inc. are quite low. The company's P/E is very

low, which proves that investors are expecting lower earnings growth in the future compared

to industry with a higher P/E. The industry still has a low P/E showing equivalent low

expectations, but it is still 1.2 times greater than FSLR. This low P/E shows pessimistic

forecasts, but it can be expected as this sector is highly dependent on gas prices, being a

commodity whose prices have a tendency to fluctuate a lot. Also, the past year added

volatility and risk to the renewable energy market. But the company and the industry have not

always been high risk, as it can be seen in the P/E high – last 5 years, and the P/E low – last 5

year. First over the past 5 year, was able to reach a P/E of 521.04, which is 4.3 times greater

that the industry's peak. This is explained by the emergence of this market, the fact that the

company is operating in a new market, it makes possible to have a very fast growth as well as

a rapid fall. First Solar Inc., before the economic crisis, used to be a strong performer in its

market, and would quite often beat expectations; for instance in 2007. " uring the fourth
D

quarter of 2007 we benefited from the full capacity and economies of scale of our

Frankfurt/Oder plant. This combined with continued throughput and conversion efficiency

gains afforded us strong operating leverage and decreased our manufacturing cost per watt

by 12% year over year to $1.12 per watt in the fourth quarter of 2007, further solidifying our

136
http://www.cnbc.com/id/45764352
137
http://www.cnbc.com/id/45764352

64

cost leadership position in the industry,"said Michael J. Ahearn, Chief Executive Officer of

First Solar138.

Even though First Solar Inc. has had difficulties over the past year, its quick ratio of

2.62, which is about the double of its industry, shows a good capacity to pay off its short term

debt. In other words it means that for every dollar of current liabilities there are $2.2 dollars

of easily convertible assets. The company's ability to pay off its short-term obligations is also

visible through its current ratio of 3.25, so even though FSLR is currently not in a good

financial health, it is able to pay back its short-term liabilities with its short-term assets, the

company has liquidity. Concerning the long term debt of the company, the LTDebt to equity

of the company is about 14.48. It means that the company has $14.48 of debt for every $1 of

book value. This number is not so high when it is compared to the industry's, which is

enormous with a ratio of $167.48; it 11.6 times higher. It is explained with the several

renewable energy companies who received federal loans over the past over four, of those

many 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 the

industry. It is a positive number as it shows that the company makes more than the industry on

less investment. The investors can see that the company is effective in converting the money

it has to invest into net income.

Its return on equity is also lower than the industry: 14.46%, 1.5 times lower than the

industry. It shows that managers are not effective and do not succeed in generating high

returns on investors' capital. Considering the difficult economic conditions, FSLR has

difficulties with growing return on its equity. It suggests that the specialization of the

company in one type of product is weakening it.

The company's return on investment is higher than the industry. It is about 12.15%,

138
http://investor.firstsolar.com/releasedetail.cfm?ReleaseID=294090
139

65

which is 1.5 times higher than the industry. It shows that the FSLR, even though is going

through 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 much

riskier; investors require a return of 14.29% from the industry; whereas, FSLR has a Required

Rate 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 are

lowering their spending in the semi-conductor products, and especially solar power

technology. FSLR products are not diversified; they only offer two types of modules, limiting

their ability to sustain growth during an economic downturn, as the current one.

There is no Annual Dividend Yield available; therefore to discuss the Expected Rate

of Return, I will use this year and next year's growth estimate. As it is shown in the table

above, both growth estimates are negative. They show how the company has been losing its

market value, and the rumors of bankruptcy or of a takeover have influenced estimations140.

This year EPS (Dec 2011): $5.85

140
http://www.thestreet.com/story/11315284/1/first-solar-takeover-chatter-is-overdone.html

66

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: 9.11

Trailing P/E = 6.25 = P0/ EPS past = $37.94/ EPS past EPS past = $6.07

Forward 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 and

its competitors over the year 2010. On the 4th quarter of 2010 the company's fall has already

started, 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 time

at which sales were operated, and also the preparation of 2011 pricing. Until then First Solar

Inc. was the leader in photovoltaic products revenue, but in first two quarters of 2010 it was

passed over by its main competitor, a young Chinese company, Suntech Power Holdings

Company Ltd142. For the company's net income, on a year-over-year basis, FSLR was still

seeing increase. From the third to fourth quarter the company's net income started to drop:

“Fourth quarter net income per fully diluted share was $1.80, down from $2.04 in the third

quarter of 2010 and up from $1.65 in the fourth quarter of 2009.”143 This fall was mainly due

to the fall in sales, and an increase in raw material prices. The increase from 2009 to 2010

here was led by an increase production, and lower production costs. But this increase was less

visible because of selling prices lowered and an increase in expenses. Over 2010 the company

141
http://www.solarserver.com/solar-magazine/solar-news/current/2011/kw08/first-solar-net-sales-decline-236-
in-4q-2010-to-usd-610-million.html
142
http://www.solarserver.com/solar-magazine/solar-news/current/2011/kw08/first-solar-net-sales-decline-236-
in-4q-2010-to-usd-610-million.html
143
http://www.thestreet.com/story/11022165/1/first-solar-inc-announces-fourth-quarter-and-year-end-2010-
financial-results.html

67

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 an

increase in fixed costs due to an increase in the number of employees, therefore the amount of

wage expenses. But to accompany the increase in operating cash flow, the company realized

an excess on tax benefits “from share-based compensation arrangements”145 These benefits

were 14.2 times greater in 2010 compared to 2009. Moreover, the company received more

cash from its customers, due to supply contracts that were extended. “The increase in

accounts receivable was primarily due to the amendment of certain of our customers’ Supply

Contracts to extend their payment terms from net 10 days to net 45 days primarily to increase

liquidity in our sales channel and to reflect longer module shipment times from our

144
http://www.thestreet.com/story/11022165/1/first-solar-inc-announces-fourth-quarter-and-year-end-2010-
financial-results.html
145
First Solar Inc., 2010 Annual Report, p.62

68

manufacturing plants in Malaysia and due to additional volume shipped during 2009.”146

Concerning its competitors such as Sharp Corporation and Suntech Power Holdings Co., Ltd,

numbers from the year 2010 will also be discussed. Sharp Corporation, at the end of 2010

could observe an increase in net sales. This increase was accomplishment due to a difficult

economic environment in Japan at that time; it was mainly due to the launch of new products

as well as a governmental stimulus called Eco Point Program.147 FSLR other main competitor

is Suntech Power Holdings Co. Ltd, a Chinese company which was created in 2001. 2010 was

the year when the renewable energy industry started to discuss this company as it took First

Solar Inc.’s as the leader in photovoltaic products. In the fourth quarter of 2010, FSLR

realized an increase in the number of shipments of 87% from the same period in 2009. “Net

income per American Depository Share (ADS) was $2.02, more than eight times the $0.24

recorded in the fourth quarter of 2009. Revenue in the quarter was $945.1m, well ahead of

the analyst consensus, and up 62% from the year earlier period on an 87% increase in

shipments”148

Concerning these competitors' operating cash flows, Sharp Corporation are decreased

by ¥136,121 million in 2010. The company explains that it is due to a drop in inventories as

well in payables. For Suntech Power, operating cash flow in the third quarter of 2010 was 14

times greater than the second quarter149.This is mainly explained by an increase in inventory,

which increased 17.3%; in other words, the company was waiting for its clients to pay, and it

could not turn its inventory into cash.

146
First Solar Inc., 2010 Annual Report, p.62
147
Sharp Corporation, 2011 Annual Report, p.6
148
http://www.rechargenews.com/business_area/finance/article247568.ece
149
http://online.wsj.com/article/PR-CO-20111122-902134.html

69

Analysts Opinion150

At closing on January 25h 2010, First Solar Inc.’s price was $36.81. Therefore, the

mean target is 1.15 times greater than the actual price, which shows an undervaluation of the

actual, but this is probably due to the year long drop in stock price.

If the price of FSLR were to reach its mean target, it would increase 15% (42.27-

36.81/36.81). If it reached the High target, it would increase 172%. (100.00 – 36.81/36.81).

And if it reached its low target, the actual price would fall 45%.

150
http://finance.yahoo.com/q/ao?s=FSLR+Analyst+Opinion

70

119/43 = 2.7674 111/42 = 2.6429 110/43 = 2.5581 102/44 = 2.3182

The recommendation for this month is 2.8. This is closer to 3, so we would BUY, but

it is very close to HOLD. So we need to pay a lot of attention to this stock.

Hot News

January 4, 2012

First Solar Sinks: CEO Announcement Soon? : Stock price decreased about 5%, and

no announcement was made by the interim CEO. There are rumors about a meeting with a

candidate as the company’s head.

http://blogs.barrons.com/techtraderdaily/2012/01/04/first-solar-sinks-ceo-

announcement-soon/?mod=yahoobarrons

First Solar shares retreat after days of gains: After a few days of gain, FSLR’s stock

dropped again, the company is trying to change its strategy, but its does seem effective so far.

http://finance.yahoo.com/news/First-Solar-shares-retreat-apf-3953045069.html?x=0

71

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