Yearly Outlook 2011 - Bancherul
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Yearly Outlook 2011 - Bancherul


– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –IntroductionSaxo Bank, the online trading and investment specialist, tends to be somewhat more pessimistic than the average financial analystand were quite pessimistic on the whole recovery since 2003, assuming the low-rate environment would lead to speculativeexcesses worse than that of the dot-com bubble. Events during 2008, unfortunately, proved the thesis right.As we head into 2011, Saxo Bank’s analysts worry about the quality of the foundation on which the recovery that began in 2009is built. While the global economy has improved, we believe that we’re dealing with a stimulus-induced cyclical recovery withinthe context of a secular deleveraging process. There is still too much debt in the system and the we’re concerned that the failureto properly address the need to reduce private and especially public debt levels will result in a relatively halting recovery withrather weak, if still positive, growth in the developed countries in 2011.The attempts by politicians and central banks to sweep the problems generated by the past credit super-cycle under the rug mayseem to be bearing fruit at present. But these efforts are not addressing the root cause of the entire challenge: the enormousdebt overhang at all levels. In fact, all of the attempts at stimulus, bail-outs and money printing are adding to the developedeconomies’ overall debt burden and are tantamount to treating a drug addict with more drugs. Instead of going through a short,painful withdrawal process and starting afresh, all efforts have so far been a kicking of the can down the road, a process thatminimizes the short term costs, but only maximizes the eventual extent of the final costs.So bulls may continue to find reasons for celebration in the New Year, but the bears will eventually be on the prowl further downthe road as the great public bond bubble moves one year closer to its eventual confrontation with fiscal reality.– 2 –


– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –C O N T E N T SPREMISES FOR 2011: BUBBLES AND BULLS AND BEARS… OH MY! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 5GROWTH PERSPECTIVES IN 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 8EUROZONE: A YEAR TO REMEMBER OR A YEAR TO FORGET? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 11UK: THE SURPRISE STORY OF 2011? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 12JAPAN: ANOTHER DIP IN THE ROAD? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 13POLICY RATES IN 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 15FX OUTLOOK 2011: GREENBACK TO REIGN SUPREME? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 18FX OPTIONS: NAVIGATING IN A SEA OF RISK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 23EQUITIES: BULLS TO CONTINUE TO GET THEIR WAY? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 25COMMODITIES: A STRONG BEGINNING, BUT DANGER LIES AHEAD . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 30WHAT NEEDS TO BE DONE? A 10 STEP PLAN TO FINANCIAL STABILITY AND GROWTH . . . . . . . . . . . . P. 32SPECIAL REPORT: SOLAR ENERGY TO SHINE IN 2011? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 33– 4 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –On the other hand, we cannot deny that the U.S.seems to be in recovery mode, even if that recovery hasin large part been enabled by a government that hasyet to show any credibility in addressing its enormousbudget shortfalls. We do not welcome the approachof solving debt problems with more debt, but we alsorecognise its positive contribution to GDP in the shortrun. Add to that the lean, mean, profit-generatingmachines also known as U.S. companies and you havea case of steadily improving earnings in 2011, barringa commodities price shock. We say steadily improvingrather than surging earnings as we project salesgrowth will remain subdued due to sluggish growthin final demand in the economy. Risks to our call oneconomic growth and prospects for risk assets in 2011are mainly to the downside, but stocks may yet eke outgains on solid company fundamentals.The U.S. dollar is undervalued in our eyes as the“Everything up versus the U.S. dollar-trade” dominatedproceedings in 2010 and simply on a partial unwindof that trade, the U.S. dollar could see a recovery nextyear. Neither Europe nor Japan look like attractive alternativesto the U.S., and the overambitious expectationsfor China and thus emerging market, particularly ifcommodities continue sharply higher into the NewYear could mean a significant pullback in short USD/long EM carry trades.Interest rates have risen strongly in the U.S. and Europefrom pre-QE2 lows in October. The resumption ofquantitative easing must assume its share of the blame,but a rebound in risk appetite as U.S. macro reportscontinued to rule out a double dip also chipped in.Despite the rosier U.S. macro picture, we remain bullishon the bonds of the sovereign debt of major developedeconomies in 2011. Rising fiscal austerity and continuedhousehold deleveraging does not warrant a continuationof the recent surge in yields, even if growthcontinues to stumble higher in 2011. U.S. Treasuries inparticular could be a popular investment in 2011 if thesovereign debt situation in Europe gets ugly.– 7 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –GROWTH PERSPECTIVES IN 2011USA: new normal or the good old days?Looking back at the Great Recession and the stock marketcrash of more than 50 percent, the markets and theU.S. economy have come a long way since the horrorsof 2008-09. The problem is that the U.S. recovery hasfailed to close the output gap with its feeble recoveryof below-trend growth. Unemployment is still hoveringclose to 10 percent 18 months after the official end ofthe recession, weekly initial claims for jobless benefitsare still above the 400,000 mark, and a record 45+ millionAmericans receive food stamps. History tells us thatthe unemployment rate is a lagging indicator, but wehave other worries: mortgage delinquency rates are stillabove 9 percent, private balance sheet deleveraging isongoing with consumer credit contracting at an annualrate of 2.9 percent, and disinflation still rages outside ofthe commodity spectrum.SECULAR HOUSEHOLD DELEVERAGING CONTINUESThe U.S. is suffering a balance sheet recession, anentirely different animal from your garden-variety postWorld War II inventory-led recession. Every recessionbetween 1945 and 2008 was arguably related to theinventory cycle, which is to say that companies investedin the capacity to produce more and more goods –often durable goods – in anticipation of future demandand then a recession sets in when demand falls shortand companies cut back sharply on investment.The private sector has been deleveraging (paying offdebt and/or defaulting on it) for all of 2010 and, whilethis has brought us closer to sustainable levels, thereis much farther to go relative to historic norms (seechart). Consumer credit is in the dumps, especiallywhen we subtract out the sudden inclusion of studentloans in the data. Loans extended for commercial andChart 1: US household financesHousehold dept / Disposable income (left)Savings rate (right)140%14%120%12%100%10%80%8%60%6%40%4%20%2%0%0%19601962196419661968197019721974197619781980198219841986198819901992199419961998200020022004200620082010Source: Bloomberg. Our calculations.Standing on the brink of New Year what can we expectfrom the world’s largest economy in the twelve monthsto come? Will manufacturing continue to contributeto economic activity through an inventory cycle, whichhas run longer than we initially expected? Will theconsumer step up to the plate?industrial purposes are still contracting at a run rateof 8 percent per year and we only look for loans toflatten and possibly increase slightly in 2011. While theU.S. economy will grow in 2011, let us not get carriedaway. The unemployment rate will remain very high,even if it edges lower towards year-end. This will meanmany consumers will continue to look to deleveragetheir balance sheets, even as others increase theirspending. Overall, the rate of deleveraging must– 8 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –decrease next year to see the reasonable growth weproject.lower savings rate amounts to, is about as far ahead asmost policy makers seem to think.The big question for 2011 is whether these are indeednew times for the American consumer or whether oldhabits quickly return. Is this a ‘new normal’ or was2008-2010 simply an intermezzo before the U.S. returnsto the “good ol’ days” of 2-3 percent savings rates andIpads for everyone! The savings rate currently hoversaround 5.7 percent, much higher than the 2 percentobserved in 2006-07, but down somewhat from apost-recession high of 6 percent. While we encourageAmericans to continue this newfound frugality and preferconsumers to cultivate it even more, wishful thinkingand the eventual reality rarely share the same destiny.Given the improved outlook for 2011, aided by theObama package, we expect the savings rate will notmove higher from the current level. Rather, we evensee a possibility of a slightly lower rate, which will bemuch cheered by policy markers. The reason is thata decline in the savings rate feeds into consumerspending and with private consumption accountingfor roughly 70 percent of GDP, any reduction in thesavings rate will provide an immediate boost to GDP.While we prefer higher savings and investment forsustainable growth the lure of a short-term fix, which aSHORT-TERM BOOST FROM MONEY-SQUANDERING GOVERNMENT POLICIESWaning stimulus programs, among them the AmericanRecovery and Reinvestment Act (ARRA), led us in ourYearly Outlook 2010 to predict that the second halfof this year would see fiscal stimulus reverse into adrag. However, no such thing took place. And giventhe expected passage of the Christmas package that isPresident Obama’s extension of former President Bush’stax cuts, jobless benefits and a payroll tax break, weexpect the public sector to be less of a drag in 2011than projected earlier. We look for the initiatives toboost GDP growth by 0.5 percent point in 2011.PRIVATE INVESTMENT SUBDUED AS INVENTORYCYCLE FADESAs panic erupted in the fall of 2008, firms slashedinventories and investment at a ferocious pace, whichdragged growth even deeper into negative territory.Since then an inventory rebuilding cycle set in as itturned out that companies over-reacted to the crisis.We are now back to pre-crisis inventory levels and furtherexpansion in the manufacturing sector thereforerest on consumer spending. We therefore expect theChart 2: US Gross Dometic Product8%Contribution from changes to inventoriesOther contributionsGross Domestic Product (QoQ annualised)6%4%2%0%-2%-4%-6%-8%03/200706/200709/200712/200703/200806/200809/200812/200803/200906/200909/200912/200903/201006/201009/2010Source: Bloomberg. Our calculations.– 9 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –inventory cycle to have run its course come the secondhalf of the year.unpleasant for baby boomers who are upside down ontheir home equity and are on the brink of retirement.Turning to residential investment, we expect thehousing slump to continue throughout 2011. Indeed,house prices may well fall for most months of the year,enough so that it will likely serve as a drag on theeconomy in general. Our base case for housing is aweak market of slowly falling prices, with the assumptionthat delinquency rates remain fairly stable sincemuch of the mortgage rate reset shock is behind us,though there is still a good deal in the pipeline. Greatefforts have been made by the Fed and the administrationto revive the housing market, including lowmortgage rates and homebuyer tax credits, which haveall failed to stop the cycle of price correcction. In theprocess the problem of low mortgage rates seems tohave been either misunderstood – or worse – ignored.As the herd refinanced in the last decade, little attentionwas given to the fact that not only do youget lower interest expenses when you refinance, youalso re-extend the duration, which will be particularlyDISINFLATION IS STILL THE NAME OF THE GAMEWe expect disinflation to stay with us throughout2011, especially as it pertains to the core index of consumerprices. We view the recent surge in assets as acombination of lower demand for readily available cashand a misguided inference that quantitative easingwill eventually cause money to flow into the economyand push up prices for everything. There is still a hugeoutput gap of excess capacity and unutilized potentiallabor (the unemployed) that must be closed before wesee more any worrisome inflation rates.We like the U.S. economy compared to other majorwestern economies such as the UK, the Euro-Zone, andJapan, and look for growth to accelerate in 2011 andend the year with GDP growth of 2.7 percent with furtherupside potential, but a weak labour market, continueddisinflation, and household deleveraging remainthreats for sustaining the strength of the recovery.Forecasts FY-2010 Q1-2011 Q2-2011 Q3-2011 Q4-2011 FY-2011USAGross Domestic Product YoY (%) 2.8 2.5 2.7 2.8 3 2.7Unemployment Rate % 9.7 10 10 9.8 9.5 9.8Consumer Price Index YoY (%) 1.4 1.2 1.5 1.5 1.5 1.4Source: Saxo Bank Strategy & Research– 10 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –EUROZONE: A YEAR TO REMEMBER OR A YEAR TO FORGET?A quick glance at key economic indicators may give theimpression that the Eurozone has recovered reasonablywell from its deep recession. GDP growth for 2010 wasan estimated 1.7 percent in 2010, but the aggregateEurozone growth figure hides a huge gap in economicperformance among the individual member states.Export-dependent Germany boomed last year whilethe peripheral countries are mired in a sovereign debtcrisis. The best of times and worst of times were seenin Europe in 2010, depending on your focus.FUEL SUPPLY DWINDLES FOR GERMAN LOCOMOTIVEGermany saw the economy collapse by 6.6 percent yearon-yearin the first quarter of 2009 as manufacturingcrashed due to dwindling global demand for Germangoods. In particular, domestic investment in machineryand exports plummeted, bottoming at -23.6 percentand -18 percent, respectively in mid-2009. A quickturnaround soon followed as global demand for Germanproducts flourished despite a strengthening Euro.The German locomotive will lose steam this year as thesupply of fuel declines. Internal Eurozone demand willbe meagre as most members engage in some degreeof austerity. Not much benefit will be derived from theEuro either; the performance of which we expect willbe distinctly average, (and German exports are less Eurosensitive anyway). More than 70 percent of German tradewith foreign countries involves European trading partnersand while German exporters are increasingly turning theireyes in the direction of Asia, the continued weak growthexpected in most Eurozone countries, the peripherals inparticular, will not be kind to the German export machine.THE NEXT PIG TO ROAST…The PIIGS acronym gained much notoriety in 2010 asGreece and then Ireland struggled with skyrocketingyields, and we do expect Portugal and Spain to comeunder similar fire from the credit market over the fundingof its sovereign debt. Italy is the dangerous wildcard. Spain may be different to the other PIIGS in termsof the magnitude of its outstanding debt, but it stillfaces other problems, like as a devastated post-bubblehousing market and looming troubles at the regionalbanks (cajas), not to mention enormous amounts ofdebt that must be rolled and fiscal deficits that must befunded by someone. In addition, Spain has significantexposure to Portuguese debt, meaning that if and whenPortuguese debt is restructured, the potential for contagionis a threat to Spain as well.The problem for the Eurozone is that it is a monetaryunion without an accompanying fiscal union, so monetarypolicy may not be tailored to each specific country’sneeds. While this often results in a cry for a fiscal unionto address trade imbalances, we rather argue that the peripheralcountries have been living beyond their means asthey feasted on interest rates that encouraged credit andhousing bubbles and loss of competitiveness. Over thelast 10 years, the PIIGS have seen poor productivity gains,excessive consumption, and increasingly uncompetitivewages. This must be corrected internally and is not Germany’sfault. Germany does not force its goods on othernations, they choose to buy them, and now they mustrealise that this is something they can no longer afford.2011 is shaping up to be an eventful year for the Eurozone.Either the Euro bloc muddles through withoutanother sovereign casualty or Germany will have toaccept a solution that involves either E-bonds or ECBmonetisation. We look for weak growth in the Eurozoneof 1.4 percent next year, but fear that risks are mainlyto the downside. Inflation should retrace a bit whileunemployment remains disturbingly high.Forecasts FY-2010 Q1-2011 Q2-2011 Q3-2011 Q4-2011 FY-2011EurozoneGross Domestic Product YoY (%) 1.7 1.8 1.5 1.1 1.3 1.4Unemployment Rate % 10 10 10 9.8 9.8 9.9Consumer Price Index YoY (%) 1.6 1.5 1 1 1.5 1.2Source: Saxo Bank Strategy & Research– 11 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –UK: THE SURPRISE STORY OF 2011?The UK economy is in bullish mood as we stand on thebrink of 2011. The latest batch of data have outperformedmarket expectations and suggests an economyin good shape ready to tackle the looming drag thatwill arrive with impressive austerity measures decreedby the new government. Is this a correct description orsimply a case of demand pulled forward as the entirenation is aware of the hammer that will fall at thebeginning of the New Year? While there can be nodoubt that the coming budget cuts will impact shorttermeconomic activity, we believe that the economymay bounce back towards the end of the year and into2012.DOMESTIC DEMAND TAKES A HITThe austerity measures call for a GBP 81 billion reductionover a four-year period, of which 9 percent or 7billion will be in welfare support. In addition, publicsectorjobs will be reduced by almost half a million infive years and the retirement age will also be raised. Allof these will contribute to weaker contributions fromthe public sector to GDP in years to come. Our expectationis, however, that the cuts are so narrow in scopethat consumer sentiment will not be hurt excessivelymeaning that consumption is unlikely to take a big hitin 2011.With that said the recent improvement in retail salesahead of new increases in taxes such as the VAT, whichwill be raised to 20 percent in January 2011 from17.5 percent, suggests that demand has been pulledforward in the short term as consumers made one finalstand before the austerity measures begin in earnest.Hence, we look for a weak first half of the year interms of consumer spending, but expect the greatforce of mean reversion to be a cause for improvementin the second half of the year.GROWING INVESTMENT AMID WEAK HOUSINGMARKETLike many other developed economies, the UK is strugglingwith a housing sector that is in a post bubbleenvironment. The correction that began in 2007-08was temporarily reversed by the tremendous loweringof interest rates, but now prices seem to be falling inearnest again, and could continue to do so in 2011 asprices revert slowly back to their long term mean.Overall, this leads us to conclude that sentiment onthe UK economy is likely too negative at the momentand that a revival will be underway as we exit 2011.We thus look for GDP growth to average 2 percent in2011, but with a early-to-mid slump before reacceleratinginto 2012. Unemployment, hurt by the layoffs inthe public sector, and CPI will both remain high thoughthe latter will come down to 2.3 percent for 2011 froman expected 3.2 percent in 2010.Forecasts FY-2010 Q1-2011 Q2-2011 Q3-2011 Q4-2011 FY-2011UKGross Domestic Product YoY (%) 1.7 2.5 1.8 1.6 2.2 2Unemployment Rate % 7.8 8 8 7.8 7.5 7.8Consumer Price Index YoY (%) 3.2 2.8 2.6 2.1 1.9 2.3Source: Saxo Bank Strategy & Research– 12 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –JAPAN: ANOTHER DIP IN THE ROAD?It would be an understatement to say that Japan couldpossibly see a double dip in 2011. The country is aperennial recession risk and looks set to start the yearon a weak note and should a dip materialise, it will bethe nineteenth dip since 1989 if we look at quarter-onquartergrowth rates and the seventh using year-onyeargrowth rates. Regardless, Japan just cannot seemto escape its flirt with stagnation as the 1.1 percent annualgrowth rate since 1989 can attest to. So what isin store for the underachieving Land of the Rising Sun?DOMESTIC DEMAND TO EASE BACK AT FIRST,THEN EXPAND MODERATELYA quick glance at domestic demand in 2010 showsvigorous growth, but this picture of the domesticeconomy was heavily influenced by a bevy of governmentprogrammes. These have distorted consumptiongrowth by pulling demand forward into 2010, but arenow expiring. Furthermore, the employment pictureremains bleak, which will inhibit growth on the consumerlevel in 2011.Employment has been a rollercoaster ride in the lastten years with unemployment peaking at 5.5 percentin 2002-2003 before it dove to 3.6 percent in mid-2007. A reacceleration then took the rate to its highestrate on record of 5.6 percent in July 2009 and wecurrently stand at 5.1 percent despite solid economicgrowth of no less than 5 percent in the most recentfour quarters. With growth set to decelerate in 2011with the possibility of negative growth in one or morequarters, employment will not receive much supportfrom this front. At the same time, however, growth isset to slow down because unemployment is so widespread,which means that private consumption willhave a difficult time getting traction.IT’S THE TRADE SURPLUS, STUPID!A slight rephrasing of the well-known slogan fromformer U.S. President Bill Clinton’s successful campaignof ’92 makes it apt for the Japanese economy,which has spent the better part of three decades in atrade surplus. Unlike its neighbour, China, Japan hasnot been accused – officially at least – of engaging inactive currency devaluation and out of generosity wewill refrain from pointing out the Bank of Japan’s futileendeavours in this area in mid-September. That shouldnot distract us from the fact that Japan’s economy ebbsand flows with global trade, but perhaps the pictureis a tad more nuanced than often discussed. The netexports-to-GDP ratio currently stands at 1.2 percent,which is a far cry from the heyday of the eighties whenit was routinely above 2 percent with a peak of 4 percentin 1986. Indeed, in the last decade the ratiohas averaged 1.2 percent as Japan has struggled toescape another “lost decade”. The flipside of the coinis of course that domestic demand has averaged justbelow 99 percent of gross domestic production in the2000’s.Is the Japanese export machine damaged for good orwill Japan bounce back in style? The first half of theyear looks tough for the economy in general and theexporters in particular. First, the yen has had a strongyear on a trade weighted basis, which was basicallydue to a weak U.S. dollar. This has had a dampeningeffect on net exports, which have been runningconsistently around JPY 600 billion in the second halfof 2010. Our view on the U.S. dollar, however, may beForecasts FY-2010 Q1-2011 Q2-2011 Q3-2011 Q4-2011 FY-2011JapanGross Domestic Product YoY (%) 4.3 1.6 1.2 0.7 1.6 1.3Unemployment Rate % 5.1 5 4.8 4.5 4.5 4.7Consumer Price Index YoY (%) -0.5 0 -0.5 -1 -1 -0.6Source: Saxo Bank Strategy & Research– 13 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –the lifejacket Japan has been searching for. With USD-JPY set to surge in our base scenario combined witha fairly flat EURJPY, net exports appear to be set for acomeback as we progress through the year.of the year as stimulus wanes before picking up somemomentum as global trade shifts into a higher gear.Prices will stagnate at first before deflation returns asthe temporary drivers of upward price pressure vanish.Overall, our expectations for the Japanese economyare – unsurprisingly – nothing to be excited about. Economicactivity is expected to decelerate in the first half– 14 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –POLICY RATES IN 2011U.S.: The final weeks of 2010 were characterized bywhat might be described as an outbreak of ‘irrationalexuberance’, to borrow Alan Greenspan’s famousphrase.Choosing to ignore continuing downbeat housingmarket reports and the extremely disappointing U.S.Labour report, released on December 3rd, which featureda paltry 50,000 increase in private payrolls anda surprise move higher in the unemployment rate to9.8 percent, the market decided to focus instead uponmarginal improvements in consumer confidence, theInstitute of Supply Managers report on Manufacturing,and a modestly robust Retail Sales report-a notoriouslyvolatile series of data.It may also be that investors were unduly influencedby the apparent agreement between Democrats andRepublicans to extend the Bush-era tax cuts, across theboard, accompanied by cuts in payroll taxes. In fact,the boost to GDP growth is expected to be relativelymuted-of the order of 0.5-1.0 percent- leaving GDPstill only growing at 2.5-3 percent in 2011. There isa famous law of economics, known as Okun’s Law,which states that for every 1 percent by which actualreal growth exceeds trend growth, (the long-termmedian growth potential for the economy), the unemploymentrate will fall by 0.5 percent so, accordingto this tried and tested correlation, one might expectthe incremental impact of the tax cut extensions onthe unemployment rate to be a median reduction ofthe order of 0.375 percent -hardly ‘game-changing’,against a headline unemployment rate of 9.8 percent,(with the wider ‘U6’ measure of unemployment,including discouraged part-time workers, standing at17 percent).with residential activity described as remaining, ‘at alow level’, and the commercial market ‘mixed’.Recent reports for Housing Starts, Building Permits,Existing and New Home Sales and Price Indices have allbeen below expectations, and still mired at historicallydreadful absolute levels.This is why the most recent meeting of the Fed’s interestrate-setting committee, the FOMC, contained onlythe remotest scintilla of improvement in its descriptionof economic conditions. Indeed, one almost needs tobe a code-breaker to even discern any significant improvementin outlook in the post-meeting statement.The words used to describe the recovery in output andemployment became “economic recovery is continuing,though at a rate that has been insufficient to bringdown unemployment” whereas, after the previousmeeting the characterization was simply “slow”. Consumerspending was said to be ‘increasing at a moderatepace’, instead of ‘increasing gradually’. Which isbetter?There were similarly Delphic references to the depressedstate of the housing market and the fact that,“measures of underlying inflation “continued to trenddownward”- if anything more downbeat than theprevious, “have trended lower in recent quarters”.Finally, although the FOMC was silent on this occasionwith regard to its Quantitative Easing programme,Chairman Bernanke recently confirmed in a 60 Minutesinterview that additional bond purchases were “certainlypossible”. This was hardly a ringing endorsementof growth prospects.The Federal Reserve seems to be taking a more cautiousapproach to developments. The most recently released‘Beige Book’, which collates reports from its 12districts, was still distinctly measured in tone. Althoughone could describe it as cautiously optimistic in aggregate,it continued to portray consumers, (70 percent ofthe economy, let us not forget), as price sensitive anddetermined to limit discretionary expenditure, but thereally chilling part remains the housing market story,The decision as to whether to extend QuantitativeEasing has become quite politicized, in light of recentSenatorial moves threatening to change the Fed’s dualmandate to a single, inflation-focussed objective. Thequestion is whether such threats can be realized or ifthey will prove empty in the face of continuing, historicallyhigh unemployment.– 15 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Against this back-drop we expect the Federal Reserveto maintain its current target for the Fed Funds rate of0 to 0.25 percent throughout 2011, and see a 50 percentchance of further purchases of U.S. Treasuries bythe Fed, as unemployment and inflation rates remainstubbornly mandate-inconsistent.Eurozone: When observing the somewhat contorteddeliberations of the ECB, (as in all things ‘Euro’ often adesperate exercise in consensus management), one isvividly reminded of an alcoholic, addicted to monetaryconservatism, suffering from Delirium Tremens hallucinationsin the form of an imaginary inflation demon.If things had gone according to script, the ECB’sheadline overnight interest rate would long ago havebeen raised from the current crisis level of 1 percent tomore ‘normal’ levels and all those tiresome extraordinaryliquidity provision schemes, (or LTRO’s as they areknown), would long ago have been consigned to thewaste bin-where, no doubt, the prevailing orthodoxywhich tends to dominate ECB thinking would believethey belong.Instead of this, all that the inflation warriors havemanaged to achieve is a technically induced stealthtightening of the interbank interest rate market, (with3-month money now costing just over 1.0 percent, asopposed to a low of 0.634 percent in March 2010),and 3-month LTRO’s are set to continue for at leastanother three months, in January, February and March.Eurozone banks in many countries are still dependenton the drip-feed of liquidity from the ECB, sinceinterbank lending remains inaccessible for them. To capit all, the ECB continues to have to buy the sovereignbonds of many weaker, peripheral nations, just to puta floor under prices, in some cases.Meanwhile, although growth in Germany is lookingrelatively robust, the economies of Southern Europeand Ireland seemed doomed to endure anaemicgrowth at best, and in some cases contraction or recession,due to the extraordinarily acute deficit reductionmeasure which have been forced upon them by thesovereign debt crisis, which shows signs of rumblingon throughout 2011. Indeed, the crisis may yet intensify,as a sort of Paradox of Thrift starts to appear at anational level in the weaker economies-although fiscalausterity is both desirable and unavoidable in Portugal,Ireland, Italy, Greece and Spain, it will be difficult, if notimpossible, to avoid the unintended consequence thatthis austerity leads to a decline in economic activity,and hence in tax revenues, in turn exacerbating thevery deficit problems it is meant to address.In light of all of the above, there seems little prospectthat Eurozone interest rates will be rising any timesoon, and we predict that the official Refinancing Ratewill remain at 1 percent throughout 2011.Japan: The predominantly export-driven nature of theJapanese economy should mean that it continues tobe supported by the recovery in global growth that weexpect to see in 2011, although exporters will also continueto face the challenge of a stubbornly strong yen.However, we see little scope for any meaningfulincrease in momentum coming from domestic consumption,with scant opportunity to deploy furthersignificant fiscal stimulus, due to the dangerous debtmountain which Japan has already amassed.Turning to monetary policy, there is no prospect whatsoeverof any increase in policy rates from their currentlevel of 0.1 percent during 2011, indeed one shouldexpect further non-conventional monetary stimulus, inthe form of Bank of Japan purchases, (mostly of JGB’s),beginning possibly as early as the February meeting,and continuing periodically throughout the year tocounter-balance the lack of additional fiscal boost.U.K.: December’s release of CPI for November at 3.3percent, year-on-year, was still stubbornly above theBank of England’s 2 percent target, and slightly aboveexpectations. This continues to present the MonetaryPolicy Committee with an uncomfortable dilemma;their expectation is for CPI to peak at 3.6 percent in Q12011 and, thenceforth, to begin a gradual decline sothat, within 18 months, it will be below target.However, in January the VAT rate will increase from17.5 percent to 20 percent, leading to an increase in– 16 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –CPI-maybe by as much as 0.5 percent, depending onthe ability of businesses to pass on the hike. This isobviously a one-off effect and the MPC continue to‘look through’ this, and the current blip in CPI, (as theysee it).For all of the above reasons, this is a very close call,but we think the MPC will leave rates on hold at 0.5percent throughout 2011, and, very probably have toincrease Quantitative Easing, as fiscal tightening bites.The trouble is that this is a long game and they havebeen ‘looking through’ above target numbers for morethan a year now and the risk is a loss of credibility forthe MPC, leading to an increase in medium-term inflationaryexpectations. The offsetting factor is obviouslythe impending tightening of fiscal policy which is ofunprecedented proportions in living memory.– 17 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –FX OUTLOOK 2011: GREENBACK TO REIGN SUPREME?Last year, our 2010 outlook asked whether the neverending theme of hyper correlation of risk appetite withthe USD- and JPY-funded carry trades would end. Theanswer was “maybe” for the JPY and “definitely not”for the USD, which traded almost the entire year as theflipside of risk appetite. We suspect that 2011, however,could finally see some decoupling of this pattern.Perhaps surprisingly, we wonder if the USD is set for awin-win situation in 2011, even if we dislike the currency’slonger term potential. Elsewhere, the G-10 FXlandscape is littered with extreme valuations as we leave2010. Aussie is in the ionosphere and the Euro, GBPand the USD are in the dumps. We expect some meanreversion in currency valuations in 2011, though thepath to that mean reversion remains cloudy. One thingseems certain: volatility promises to go nowhere but up,especially considering the tense dynamics of the globalmacroeconomic picture as we head into the New Year.THE CUSP OF 2011: SETTING THE SCENEAs we head into the New Year, the macro-economicdynamics are very different from those we saw as weheaded into 2010. Recovery or not, the major developedcountries are in a woefully vulnerable statefor one reason or another, and, outside of (Fed- andstimulus-enabled) reasonable growth expectations inthe U.S., growth projections aren’t particularly inspiringfor the world’s largest developed economies. Whatgrowth there is and will be in the New Year has beenenabled by over-active central banks that have droppedall talk of exit strategies (all the rage last December, wemust recall) and are engaged in the fight of their livesto get their economies’ growth rates back to trend.Meanwhile, too much of the easy money from themajor developed countries seems to be winding upas capital flows to emerging markets, where assetmarkets and domestic economies are on fire onceagain and the threat is more one of overheating thananything else. Also, the developed world’s centralbanks have been so ready to reach after the printingpress as the solution to all problems, that the theme ofthe demise of fiat currencies has gripped the market’sattention and sent hard asset prices rocketing higher.Central bank policies are heightening global trade tensionsand already, a number of EM countries like SouthKorea and Brazil have already moved to stem strengthin their currencies with capital controls and punitivetaxes on foreign owned assets within their countries.In 2011, the ECB, Fed, BoJ and BoE will all remain in easymoney mode, while major emerging market economies– China, in particular – are in the fight of their lives toput down potential asset and credit bubbles and overwhelmingcapital flows from the virtually non-yieldingdeveloped. This mismatch of policy needs could provean explosive cocktail and promises plenty of volatility; inparticular if the various participants dig in with furtherpunitive measures aimed at curbing currency movements.The irony of all attempts to control a currency isthat they often prolong imbalances and make the eventualfall-out from misguided policy that much worse.A couple of potential scenarios in 2011: commoditiescontinue to march higher until growth is reduced bycollapsing corporate margins and a higher percentageof global workers’ pay dedicated to the bare essentialsrather than discretionary spending. Another scenario:China slams on the brakes and the country lurches intoa hard landing that sees a profound reassessment ofglobal growth potential, particularly since China andits satellites have been such a significant global growthdriver since the dark days of early 2009. Neitherscenario is particularly emerging market positive norpositive for risk appetite.Whether one of these two scenarios proves the correctone, we have a hard time imagining an extension of thecurrent environment of a simultaneous rise of interestrates, commodities prices and equity prices for any appreciablelength of time in the New Year. Something’sgot to give eventually: while all three can eventually fallif growth projections prove overoptimistic, not all threecan continue the upward spiral we’ve seen since earlyNovember. Eventually, risk would have to consolidate ifinterest rates or commodity prices continue to rise fromtheir late 2010 levels. The only way we get the Goldilocksscenario is if growth continues while interest ratesand commodities remain range-bound, a scenario thatwould continue to favour risk assets. Our FX forecast for2011 assumes a less sanguine outcome for risk – as youcan see below in our outlook for the G-10 currencies.– 18 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Another important factor to consider in the comingyear is the possibility that the Fed’s star has peakedand that it could come under increasing pressure fromthe obstreperous new Congress that will take office inJanuary. It is clear that Bernanke wouldn’t hesitate tolaunch further rounds of QE to address the mountingdebt crisis at the municipal and state level if he felt theneed was there. But will the Congress move to blockfurther Fed activism? Certainly, resistance to the Fed isgrowing on both the political and even popular fronts.EUR: WHERE’S THE BOTTOM?It is clear that the Eurozone is headed for a very criticaltest for its survival – a test we believe it will eventuallyfail in the longer run beyond the horizon of thisoutlook, but not before EU politicians and ECB make asignificant effort to keep the motley crew of nations inpolitical and monetary union. Any effort, regardless ofthe form it takes (enlargement of the rescue fund and/or some new powers granted to the ECB that makepossible new, unsterilized quantitative easing), it hasEuro-negative implications. There are also reasonableodds that one or more of the nations at the Eurozoneperiphery actually defaults, considering how obviouslyin their best interest such a move would be. An example:why should Irish taxpayers be put on the hookand make foreign banks 100 percent whole for unwisedecisions made in commercial real estate market inthe bubble days? Any default would clearly throw thealready highly leveraged European banking systeminto disarray, with a massive need for public backingof banks and all of the negative implications a bankingcrisis would have on the currency and economicgrowth. Such a move would also see an explosion indebt spreads on contagion fears – fears that the ECBand EU political leadership would have a very hard timeputting a lid on. The EU is headed for the fight of its life.JPY: DR. JEKYLL OR MR. HYDE?The outlook for Japan in 2011 clearly hinges on theinterest rate outlook, as it nearly always does. As longas interest rates head higher in an environment of positiverisk appetite, the JPY will remain relatively weak asdomestic investors look to foreign shores for superioryield and the JPY could even become a favoured fundingcurrency for carry. This is the Dr. Jekyll side of theJPY’s potential in 2011.A more dramatic Mr. Hyde scenario for the JPY is this:if interest rates go into a tailspin once again as riskappetite contracts at some point during the year andthe commodities rally fades, the JPY could see an aggravatedrally as domestic investors bring their fundshome and carry trades are unwound. The BoJ wouldinevitably crank up the printing presses in response tosuch a development, and it could finally succeed in settingoff a JPY devaluation if the Japanese bondholders(almost all JGB’s are held by domestic savers) revolt asthey consider the implications of the eventual QE strawthat will break the Japanese Yen’s back on an impossiblyhigh public debt burden. The domestic markethas reached the saturation point on its JGB holdingsand can’t absorb any more and foreign buyers woulddemand a higher yield. Even with rates at almost zeroand at no more than 125 bps for 10-year bonds, morethan a quarter of the Japanese budget is used oninterest payments for the public debt. Any further risein already stupefying debt levels could see an amazinglurch from deflation to high inflation in the blink of aneye if the least crisis in confidence triggers any kind of“run on the bank”. That run becomes an eventualitywhether the route to such a run is via higher interestrates or via the printing press. So 2011 is a year oftwo-way risks for the currency, but all scenarios pointto eventual JPY weakness.While the year may be one of win-win for the USD, itcould be one of lose-lose for the Euro in the short tomedium term. The only solace some investors mightfind is that the world is already very pessimistic on theEurozone’s prospects and that the currency might be asafer harbour than some of the most pro-risk currenciesin 2011.GBP: SURPRISING STRENGTH?The pound sterling and the USD saw a similar trajectoryin 2010, as their fundamentals were largelysimilar: two countries overwhelmed by dysfunctionalbanks, massive twin deficits, and central banks moreor less in continued QE mode. Where the two currenciesdramatically diverge going into the New Year ison the political front. While the U.S. administration– 20 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –and Congress have connived to bloat the short termdeficit further in the coming year with what amountsto a new stimulus bill, the freshly minted UK governmenthas gone on an “austerity spree” if there issuch a thing. The new government’s measures willinclude a rise in the VAT, public wage freezes and otherspending cuts. While not a harbinger of super stronggrowth rates, these new measures do show a kind ofdynamism and political willpower not at all evident inthe U.S. – a good sign for the longer term potentialfor the UK economy to return to proper health andbalance, especially if a good solution is found to thehobbled UK banking dinosaurs. To boot, the UK cancongratulate itself that it never chose not to join thecontinent’s currency union, a decision that could bringplenty of strength versus the single currency in 2011.As an alternative to mounting problems and unrealisticexpectations elsewhere and due to its very cheapvaluation, the pound could be a surprisingly strongperformer next year.CHF: A CONUNDRUMSomething structural has happened over the last yearto the Swiss franc: the currency has entirely decoupledfrom the kind of safe haven behaviour it exhibited forthe last 10-12 years, in which it more or less movedin negative correlation with risk appetite. Instead,the franc is incredibly strong considering its virtuallynon-existent yield and the resurgence in risk appetitein the second half of the last year. The newfoundCHF strength has come on the back of the Europeansovereign debt debacle (Switzerland has very modestpublic debt to GDP ratio relative to most of the otherdeveloped economies) and perhaps as well due to apositive feedback loop from hedging due to its appreciationas so many loans abroad were financed in Swissfranc during the boom years. In 2011, the franc mayappreciate further as the Eurozone crisis wends its wayto a climax of one kind or another, but at some point,the franc’s very strength becomes a self-correctingphenomenon, damaging competitiveness and brakingSwiss economic activity, which may have gottenan artificial boost in 2010 from the monetary stimulusprovided by the SNB’s misguided and failed efforts tointervene against the currency’s strength. The country’senormous financial sector (with assets more thansix times GDP) is also a risk, considering our negativeview on risk appetite and the likelihood for a tougherregulatory environment going forward. Once EURCHFbottoms out in the New Year, the currency could gofrom strength to pronounced weakness for a time.AUD: ONE TRICK PONY TO STUMBLE?The Australian dollar hit its stride in 2010 again as ifthe global financial crisis never happened. After all,here is a country with little public debt, a relativelyhigh interest rate, and an economy fully leveragedto piggyback the Chinese growth juggernaut withits commodity export complex of coal, metals, andother materials. But looking at the currency and theAustralian economy as we head into 2011, we seeseveral warning lights flashing. The economy is almostexclusively reliant on its resource extraction industriesfor continued strength, meaning any hiccup in Chinesedemand as the regime there potentially launches amore determined effort to bring the country’s propertybubble and inflation under control could see a dramaticfallout for the Australian economy. As well, onthe domestic front, a number of worries include weakeconomic activity surveys outside of the mining sector,and the combination of an overleveraged consumerand a housing bubble that appears on the cusp ofunwinding. AUD is overvalued and could end 2011significantly lower.CAD: MIDDLE OF THE ROADThe Canadian dollar had its ups and downs over thecourse of the 2010, at first strong on the generalresurgence in risk appetite during the first quarter ofthe year and sharply higher expectations for the Bankof Canada’s interest rate, but later weaker as the U.S.economic outlook deteriorated and as energy prices– the most important commodity prices for Canada’sresource mix – underperformed much of the rest ofthe commodities complex. With USDCAD threateningparity for much of the year, the Bank of Canada hasbeen quick to slam the lid on further interest rate hikeexpectations. And, while economic strength in the U.S.could serve as a boon for Canada’s export industries in2011, there are other worries for the Canadian economy,including a housing bubble that risks unwindingand a consumer that is even more overleveraged than– 21 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –the U.S. consumer ever was during the credit bubblepreceding the global financial crisis. USDCAD couldhead much higher in 2011. On the more CAD-positiveside, however, Canada’s finances and banking sectorare in tip-top shape and can weather a considerablestorm and the currency looks ridiculously undervaluedagainst the other commodity currencies, especially theAustralian dollar.NZD: OVERVALUEDThe kiwi rose to new highs versus the rest of the G-10currencies during 2010, but by the end of the year sawits strength fading despite a generally positive environmentfor risk appetite and virtually all commodities.A relatively weak domestic economy was partially toblame, particularly as drought conditions seemed to betaking hold by the end of the year, which threaten thecountry’s important agricultural exports. A lacklustreoutlook from the RBNZ was no boost to the currencyeither. In 2011, we see risk appetite becoming a twowaystreet again, with significant risk for downside,and the kiwi, while much weaker than it was at itshighs, could have much farther to fall relative to therest of the G-10. Against, the Aussie, however, thecurrency is beginning to look underpriced, particularlyif weather conditions for New Zealand’s key food commodityexports improve.SEK: NEITHER HERE NOR THEREThe Swedish krona enjoyed a strong resurgence in2010 as it began the year at undervalued levels and asits export economy enjoyed a huge boom on generallystrong external demand. The Swedish krona isgenerally a pro-cyclical currency, so it enjoyed strengthwhenever risk appetite was on the rise in 2010, andalso looked like an attractive alternative to the Eurodue to the single currency’s special challenges. In 2011,the krona could enjoy some further strength on theexpectation of a continued economic recovery, buttrouble in asset markets could mean that the currencyfinds a ceiling relatively quickly.NOK: TOO CHEAPNOK receives the 2010 blue ribbon for “Quietest G-10currency” after a year of very little volatility versus thebroader market. Norges Bank was the first of the G-10banks to hike all the way back in 2009, but quickly puton the brakes as its domestic economy (housing pricepressure notwithstanding) saw anaemic growth and ascrude oil prices were relatively flat for most of the year.Going into 2011, expectations for the Norges Bankare very weak, but the currency looks rather undervaluedversus the commodity currencies in particular andcould look especially attractive at any time the focusshifts to countries’ public balance sheets, as Norway isa paragon of financial solidity. NOK is a buy against abasket of riskier currencies in 2011.G10 FX TRADING THEMES FOR 2011Long GBPAUD – the market positioning at the endof 2011 suggests that the UK’s prospects are in thedumps where the belief for Down Under seems to bethat trees can grow into the sky. This trade is a wayto express the belief that the UK is at the vanguard inaddressing its fiscal challenges and could see a betterthan expected trajectory in the new year while theAUD is at nosebleed levels and too dependent on amining sector that could falter in 2011.Short EURUSD – The Eurozone sovereign debt situationwill take some time to sort through and policyefforts by the ECB can only mean easing monetaryconditions and uncertainty at a time when the U.S. Fedmay find itself increasingly sidelined by reasonable U.S.fundamentals and a hamstrung Fed. EURUSD couldhead toward 1.10-1.15 during the course of the year.Long CADJPY – If the focus shifts to credibility onsovereign debt, here is your trade. Japan’s problemswill quickly accelerate and require a devaluation ofthe yen if interest rates head much higher in the NewYear, while Canada is one of the best positioned majorcountries in terms of banking sector and sovereigndebt credibility.Short NZDNOK – this is a valuation play more thananything else. The Norwegian krone has been neglectedwhile the kiwi’s rise has been at least partially builton lazy assumptions and its exposure to Asia. Also, ifrisk appetite faces challenges in the New Year, NZDwould likely suffer more than NOK.– 22 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –FX OPTIONS: NAVIGATING IN A SEA OF RISKOverall we see 2011 as a key period for FX, witheconomies across the globe still facing serious risks:unprecedented levels of quantitative easing, sovereigncredibility, and European tensions (politically andeconomically). All those, and many more, might wellprove to be non-issues in 12 month time and all mightbe well in the world. However, whilst hoping for thebest, we need to be prepared for the worst. An optionThe UK government, having put forward some toughmeasures from the start, now seems to be in a betterposition to withstand further shocks. In particular, thepound seems a better tool than EUR to hedge a bullishUSD view, with continuing concerns in the EUR zoneand if one wants to play the angle of the UK gainingmore credibility than the U.S. on the fiscal austerityfront. In addition, the risk reversal still favours GBP putsChart 4: 6 mth implied volatilities40EUR JPY ZAR3530252015105010/200601/200704/200707/200710/200701/200804/200807/200810/200801/200904/200907/200910/200901/201004/201007/201010/201001/2011Source: Bloomberg. Our calculations.portfolio presents a unique opportunity to do so as itcan provide great leverage in extreme market conditions.We would therefore be on the lookout for cheapoptions to purchase and be keen to maintain an overalllong implied volatility position.heavily, making upside strikes trade at an implied volatilitydiscount. Note long EUR Puts / GBP calls might bechosen instead.Long 1-year emerging market volatilitiesThe attached chart displays six month implied volatilitiesin EURUSD, USDJPY and USDZAR over the lastfour years. Volatilities are not back to their pre-crisislevel, but we clearly see the explosive nature of optionvolatility under stress conditions.With this in mind, we would favour the followingthemes for the year ahead:Long 1-year GBP Calls / USD PutsAny market shock as the potential to unnerve emergingmarkets: as such we believe being long a basket ofemerging market options could provide some interestingleverage should FX see the active year we expect.We would choose EURPLN and USDZAR straddles to tryto diversify somewhat, but more currency pairs couldbe added to the mix. This theme provides positiveexposure to implied volatilities and could also providemany opportunities for delta hedging and active management.– 23 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Long 1-year USD Calls / JPY PutsShort 1-year XAU Puts / USD CallsLow delta JPY puts have been a very crowded tradeever since USDJPY spot fell firmly below 95-100… Asalways with options (and trading), timing is everything.It might sound strange to look for a bullish USD themedespite relentless QE, but we feel the situation in Japandoes not warrant going long JPY. As with the GBPtheme, this benefits from a discount for upside optionsdue to the volatility skew.Our only short volatility view is in Metals. We believeGold (and other precious metals) will retain their safehaven status for the coming year (whereas you canprint USD, the transmutation of base metals into goldis proving slightly more challenging!). With this inmind, we would be happy to sell downside options inGold to benefit from the high level of implied volatility.– 24 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –EQUITIES: BULLS TO CONTINUE TO GET THEIR WAY?We look for reasonable returns from equity marketsin 2011 as we enter the mature phase of the earningscycle in 2011. A period of cyclical strength in the USeconomy in particular could have the market projectingfurther reason to continue to bid up risk assets,though earnings growth could prove more sluggishthan the consensus expects. We have a year-end targetfor MSCI World of 1,400, roughly a 10 percent gain onthe end of 2010 level around 1,275.Normally at this stage of the earnings cycle, marginsare peaking while sales have yet to really get going.We do not expect a strong pick-up in sales this timearound, however, as final demand will only grow slowlyin developed economies. Hence we expect continualmargin improvement, but at a slower rate comparedto previous years and we therefore doubt that the bottom-upconsensus of earnings growth will be achieved.The current forecast is for 15 percent globally, but weonly target 7 percent. With a revenue growth forecastof only 6 percent globally, it is left to margin expansionto deliver growth in earnings. The last time marginspeaked was back in 2006, but this was under unusuallystrong macroeconomic conditions. These are notaround to support such an overshoot in margin expansionnow, so margins will grow at a slower pace.THE DRIVERSWe expect economic growth in 2011, especially in theU.S. and emerging markets. The increased confidenceof investors and corporate executives in the sustainabilityof the economic recovery is the very foundationof our belief that solid returns in equity markets willmaterialize in 2011. As corporate executives gain confidencein the recovery they will start to re-leverage theirbalance sheets, spend more on hiring and increase capitalexpenditures (capex), which will support earningsgrowth and increase risk appetite for equities. Investorswill applaud these actions to improve profitability fromcompanies and lead to higher valuations as uncertaintyabout future free cash flow is reduced. Higher valuationsin particular will drive returns in equity markets in2011.One of the main drivers of return in equity marketsnext year will be corporate re-leveraging. Return onEquity (RoE) will remain under pressure as cash balancesare currently very high while profit margins arepeaking. In order to protect profitability companies willstart to increase their leverage through hiring, buybackshare programs, dividend payouts and M&A to improveRoE. This will lead to P/E multiple expansions, whichwill in our view be the main driver of returns in 2011.And there is plenty of room for P/E multiple expansion;currently the 1-year forward P/E of MSCI World is 30percent below the long-term historical average andeven with modest earnings growth assumptions of 7percent the implied global P/E would be 12.8; leavingsufficient headroom for further P/E multiple expansionoffsetting slower growth in earnings.OUR REGIONAL PREFERENCESIn terms of regional preferences our first preference arestill emerging markets, as this is in our view is wherewe will experience the highest earnings growth led byGDP growth. The BRIC countries will as such not be insweet-spot as prior, but rather single countries in bothAsia, Latin America and to lesser extent Central- andSaxo Bank Forecasts world indices: Year-end 2011 level forecasts.Index S&P500 DJSTOXX600 Nikkei225 MSCI EMYear-end forecast 1,420 315 11,400 1,350Implied price return 13.6% 12.5% 10.2% 19.4%Source: Bloomberg and Saxo Bank Strategy & Research.Closing prices at 29th of December used forcalculating price returns.– 25 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Eastern Europe will be amongst our favorites. The lessenthusiasm surrounding countries in Central- and EasternEurope is due to the dependency of the Eurozone,which in our view will be the region where the leastgrowth is – both in terms of earnings and GDP.The U.S. is coming in as a strong second in the regionhierarchy and here payrolls holds the key to equitymarket performance and the Eurozone will be in lastas we still expect the sovereign debt problems emergefrom time to time putting pressure on equity markets.Japan is clearly the joker here and we cannot stopthinking that we will see a rebound here.USA: more to come from equitiesValuation metrics for the U.S. S&P500 indicate thatU.S. equities are attractive as earnings have recoveredfaster than prices. For 2011-12 we forecast earningsper share of USD 92 and 99, respectively, which implyearnings growth of 9.5 percent and 7.6 percent. Thisis below bottom-up consensus, which forecasts USD96 per share for 2011 and USD 108 per share for2012. Our year-end forecast for S&P500 is 1,420, a13+ percent return for the year. If we decompose it,two-thirds comes from earnings growth and one-thirdoriginates from P/E expansion. However, it is clear fromthe multiple expansions that we could see a surprise tothe upside in our year-end estimate.The macroeconomic background for earnings developmentin the U.S. is supportive. The cost of borrowingmoney is very low – the Fed Funds rate is virtually zeroand we do not expect any change to the rate in 2011.Our inflation expectations are also low as we forecastheadline inflation to average 1.4 percent, which isclearly below the Fed’s target range of 2 percent. Andfinally GDP growth is expected to grow by 2.7 percentyear-over-year. In total this is a supportive macroeconomicenvironment for equities.SALES GROWTH, PROFIT MARGINS, AND EARNINGSIn 2010, we expected very little in terms of salesgrowth, but foresaw increases in margin expansion;this year it the other way around. The main driverbehind sales growth over the long term is GDP growth,which we forecast to average 2.7 percent this year.This will drive domestic demand and hence help salesgrowth in S&P500. We forecast sales growth of 6.5percent, while bottom-up consensus is expecting 6.8percent.What surprised us in 2010 was the strength of thecomeback in profit margins. The corporate reaction tothe setback in the economy in the last few years hastruly been amazing. We have seen accelerating marginimprovements in this recovery and standing on theverge of 2011 the question is: can it continue? Theshort answer is no.Chart 5: Net Profit Margin (S&P500)10%Net Profit Margin8%6%4%2%200020012002200320042005200620072008200920102011Source: Thomson-Reuters Data-Stream and Saxo Bank Strategy & Research.– 26 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –The low interest rate regime and the possibility ofrefinancing debt at lower costs combined with higherGDP growth will be supportive of further increasesin margins, but we look for smaller improvements in2011. This is partly due to our expectation of higher inputcosts. Commodity prices are expected to increase,especially industrial metals, which will inhibit growth inmargins. Add to this that further increases in productivitywill translate into demands for higher salaries andyou have our case for why the growth in margins observedin the last few years will not continue in 2011.Bottom-up consensus for S&P500 ex. financials is for aprofit margin at 9 percent, but we look for 8.6 percent.Besides sales growth and continued high profit marginsthere is an additional reason for solid earningsgrowth in 2011. The cash/asset balance for S&P500ex. financials is now at 10.8 percent, which is a recordhigh. We look for the ratio to come down this year asfuture earnings growth will be bought through sharerepurchases, M&A, and spending on capex.of the world increased the cost of equity and this putdownward pressure on valuations as investors werereluctant to hold risky assets. These are still present,but expect the economic recovery to overshadow themand give investors more confidence of a robust longertermexpansion.SECTOR PREFERENCESIn terms of sector preferences we prefer in the first halfof year to ride along with the pro-cyclical wave and getexposure to companies within energy, technology andbasic materials as these sectors are the ones who willbenefit the most from further signs of the economic recovery.Besides this sector we look for companies witha part of their sales outside the U.S. and preferablywithin emerging markets. In the second half of 2011we expect a rotation in equity markets towards a moremidterm earnings cycle portfolio so we look to increaseexposure to healthcare and industrials.Saxo Bank Forecasts for S&P500 ex. financialsIndex Sales Growth (YoY) EBIT Margin (level) Earnings Growth (YoY)S&P500 6.5% 8.6% 9.5%Source: Thomson-Reuters Data-Stream and Saxo Bank Strategy & Research.P/E EXPANSION IS KEY IN 2011If we assume no expansion in P/E during 2011 thiswould leave us with a year-end target of S&P500 at1,370. However as S&P500 is currently trading at a P/Emultiple of 13.6 of our 2011 estimated EPS and giventhe current low interest rate this implies a P/E multiplein the range of 14 to 16. This leaves considerableheadroom for P/E multiple expansion pushing priceshigher. The major driver of P/E multiple expansions isthe cost of equity, which is directly linked to investors’willingness to carry risk. The macro risks that werepresent in 2010, especially the fear of contagion ofthe sovereign debt crisis from Europe and to the restEurope: subdued earnings growthThe major difference compared with the equity marketoutlook for the U.S. is the expected weaker growthwithin the Eurozone and U.K. For the companies inDJSTOXX600, around 62 percent of their sales arewithin the Eurozone or the U.K. and given the weakoutlook for economic growth in Europe, earningsgrowth will be hurt by slow sales growth. In termsof valuation, Europe should follow the U.S. and seehigher stock prices on the back of P/E expansion. For2011 we forecast earnings in DJSTOXX600 at EUR23.9 per share and for 2012 earnings at EUR 25.9 per– 27 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –share, which imply earnings growth of 7.2 percent and8 percent, respectively. This is way below bottom-upconsensus, which forecasts earnings at EUR 25.7 pershare for 2011 and EUR 28.8 per share for 2012.Our year-end forecast for DJSTOXX600 is 315, a returnof about 12.5 percent for the year and if we decomposethis, roughly half comes from earnings growthand the other half from P/E expansion. Compared withthe U.S. more weight is put on P/E expansion as thedriver for European partly due to more rigid labor markets in Europe. Weforecast growth in margins of 12.9 percent for 2011while bottom-up consensus is looking for 16 percent.This leaves us with an estimated margin of 8.8 percentfor DJSTOXX600 companies – somewhat higher thanthe margin of 8.6 percent expected for S&P500 companies,but still not passing the all-time high back from2007. Despite stronger profit margin development inEurope the lack of sales growth weighs heavily leavingearnings growth of 7.2 percent for DJSTOXX600compared to an expected earnings growth rate of 9.5percent in S&P500.Chart 6: Net Profit Margin (DJSTOXX600)10%Net Profit Margin8%6%4%2%200020012002200320042005200620072008200920102011Source: Thomson-Reuters Data-Stream and Saxo Bank Strategy & Research.SALES GROWTH, PROFIT MARGINS, AND EARNINGSThe macroeconomic environment in the Eurozone isnot supportive for earnings growth as 62 percent ofrevenues of DJSTOXX600 companies is from the Eurozoneor U.K. Given our GDP estimates of 1.4 percentand 2 percent for the Eurozone and the U.K., respectively,earnings for these companies are not going tobe supported as much by improving macroeconomicconditions compared to the U.S. We forecast a salesgrowth of 5.0 percent compared to an expected U.S.sales growth rate of 6.5 percent.The margin expansion outlook is, however, somewhatbetter in Europe than in the U.S. European companieshave not been as efficient in their efforts to streamlinetheir operations as their American counterparts, whichAs in the US besides sales growth and continued highprofit margins there is an additional reason for reasonablesolid earnings growth in 2011. The cash/assetbalance for DJSTOXX600 ex. financials is at roughly10% though somewhat away from breaking all timehigh, but like in the U.S. case we look for the ratio tocome down this year as future earnings growth will bebought through share repurchases, M&A, and spendingon capex.P/E EXPANSION IS KEY IN 2011European equities will need to get more help from P/Eexpansion in order to reach the expected target forDJSTOXX600 compared to the S&P500. If we assumeno expansion in P/E during 2011 this would leaveus with a yearend target of 300. However given our– 28 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Saxo Bank Forecasts for DJSTOXX600 ex. financialsIndex Sales Growth (YoY) EBIT Margin (level) Earnings Growth (YoY)DJSTOXX600 5.0% 8.8% 7.2%Source: Thomson-Reuters Data-Stream and Saxo Bank Strategy & Research.2011 EPS estimate the 1-year forward P/E multipleis trading at 11.7 whereas the P/E multiple in thesemarket conditions might be expected to reach 13-14,which leaves potential upside for stocks. The trigger forfurther upside is higher investor confidence in the economicrecovery – though less so in Europe comparedto the other major developed countries. However thisis expected to lower the cost of equity and boost valuations.EUROPE: WEAKER OUTLOOK COMPARED WITHOTHER MARKETSIn a global setting, European equities look weaker thanother markets, mainly due to the weaker expectedGDP growth, which affect sales growth as analyzed beforein this section. The main beneficiaries of the relativelystronger growth in the U.S. and strong growth inemerging markets are exporters who have their majorpart of their sales outside the Eurozone or the U.K.SECTOR PREFERENCESIn terms of sector preferences Europe is aligned withthe U.S. case where we prefer to ride along thepro-cyclical wave in the first half of the year and getexposure to companies within energy, technology andbasic materials as these sectors are the ones who willbenefit the most from further signs of the economicrecovery. Unlike the U.S. case we are only looking forcompanies with major part of their sales outside theEurozone and U.K. as these regions will experiencelow sales growth. Our preference is getting exposureto emerging markets, but exposure to the US will alsosuffice. We expect a rotation in equity markets towardsa more midterm earnings cycle portfolio so we look toincrease exposure to healthcare and industrials.– 29 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –COMMODITIES: A STRONG BEGINNING, BUT DANGER LIES AHEADThe commodity sector had a strong finish to 2010 ascheap money combined with an improved economicoutlook supported cyclical commodities such as basemetals and energy products. The weather shocksthroughout the year left global supplies of agriculturalproducts struggling to keep up with demand, leaving itvulnerable to additional price appreciations.Commodity prices look set to continue to the movehigher during H1 of 2011 with the potential for anotherdouble digit return on the TR Jefferies CRB index.Demand from emerging markets like China, Brazil andIndia is expected to remain strong while emergingsigns of a U.S. recovery will increase the competitionfor basic resources.Chart 7: WTI Crude front month200 day MA Last Price15012090603012/200703/200806/200809/200812/200803/200906/200909/200912/200903/201006/201009/2010the U.S., the world’s largest oil consumer, have beenan important catalyst for this move.We do, however, see a risk of commodity prices overshootingdue to high growth expectations for Chinaand the U.S. When this last occurred in 2008 commoditiesspiked higher before tumbling as the globaleconomy went into reverse gear.Other factors that could have an adverse impact oncommodity prices is the continued risk of sovereigndebt defaults, which twice led to corrections during2010, China applying the economic brakes even harderand, as we forecast, a stronger dollar.The phenomenal growth in exchange traded funds andcommodity index funds continues, after investor holdingsreached a new record during 2010. Very low realrates will continue to support investments in alternatives,such as commodities. Tight physical supplies havelead to several commodities going into backwardationwith the price of the near term contract trading higherthan the price for later deliveries. This is benefittingpassive investments through ETFs and index funds asthe cost of rolling forward positions on these has beenremoved.Towards the end of 2010 global inventories of energybegan to shrink fast. This helped WTI crude oil risetowards levels not seen during the previous two yearsand this is the main reason for raising the price estimatesfor 2011. Improved economic indicators fromDuring December, the spot price moved above the forwardprice for the first time in two years as tighteninginventory levels from increased demand helped changethe shape of the forward curve. This again will improvethe return that investors receive on passive investmentsin ETFs and index funds and help to support prices.With global oil demand expected to mirror the recordfrom 2010 we see the potential for WTI crude tradingin a range between 80 and 100 dollars during 2011with the outside chance of overshooting through 100dollars before correcting. OPEC, with a spare capacityof six million barrels per day, has indicated that 90 dollarsis the top of their comfort zone with any sustainedmove above likely to trigger a response. The speculativelong position in crude oil is at an all time high andthat will probably be one of the biggest worries aheadas it can lead to major corrections along the way.We believe that gold still has some way to go and seea potential for reaching 1,600 dollars over the next 12months.The investment space for gold has become very crowdedover the past few years and that combined with ourforecast of a stronger dollar poses the biggest risks fora further price appreciation. It will therefore at times bevolatile, experiencing corrections of 5-10 percent, butthe overall direction will be higher.– 30 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Chart 8: Gold spotChart 9: CBOT Corn front month200 day MA Last Price200 day MA Last Price14008001200650100050080035060020012/200703/200806/200809/200812/200803/200906/200909/200912/200903/201006/201009/201012/200703/200806/200809/200812/200803/200906/200909/200912/200903/201006/201009/2010The factors that drove Gold to a new all time nominalhigh in 2010 look set to continue and a positive returnfor the 11th year in a row can be expected. CentralBanks became net buyers of gold for the first time intwo decades in 2010, especially those in emergingeconomies such as China and India. At the same time,mining companies have stopped forward selling theirproduction.It is a popular belief that gold should be a hedgeagainst inflation. We believe that to be inaccurate, itis a hedge against instability. The quantitative easingintroduced by the U.S. Federal Reserve increasedthe demand for hedges against the possible threat ofdeflation or subsequent inflation due to the growthin money supply. The sovereign debt crisis in Europeremains unresolved and it continues to attract safehavenbuyers.Investments in gold have become much easier forretail investors to access over the last couple of years,so much so that total holdings of gold by exchangetraded funds stands above 2,000 tons, more thantwice the amount in China’s national gold reserves.These types of investments are non-leveraged and assuch will be held by investors as long-term investmentslike stocks thereby removing some of the volatility andrisks that normally accompanies investments in leveragedgold futures.The crop most supported by fundamentals is corn withinventory levels at a 15-year low due to reduced yieldand robust demand, especially from increased ethanolproduction and feed demand. In 2010 more than 35percent of U.S. corn production went towards producingethanol and with the forecast for higher gasolineprices over the next year, this will support ethanol/corn prices. Demand for corn feed has also shown anincrease, especially from China where the increasedwealth has shifted people’s dietary behaviour towardsmeat products (and corn is a popular feed grain forlivestock and poultry).Grain and soybean prices increased dramatically in2010 driven by exceptional weather shocks across theglobe that limited supplies and drew down stocks ata time when demand was growing strongly. Chinaincreased its imports of soybeans and became a netimporter of corn for the first time in years. Tight suppliesare also expected in 2011, but higher prices areexpected to trigger increased production which shouldleave prices at elevated but stable levels barring anyadditional weather shocks.– 31 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –WHAT NEEDS TO BE DONE? A 10 STEP PLAN TO FINANCIAL STABILITY AND GROWTHWhile we forecast that the odds favour the continuationof the relatively feeble recovery in 2011 for themajor economies, we are concerned that this recoverycontinues to rest on a very unhealthy foundation ofendless public sector debt and artificial life supportprovided by central bank printing presses and accountinggimmicks. Here we suggest the 10 steps necessaryto truly get the major developed economies back on ahealthy trajectory. And yes, we are fully cognizant thatthese steps will not be carried out, but even a movein their general direction in the New Year would be agreat victory for the economy and a remarkable signthat sanity is gaining a foothold among the powersthat be.• All bank assets need to be marked to market. Ifsome assets are illiquid, a tenth of the positionshould be sold in the market and the resultant priceshould be used to mark the rest of the position onmarket on the balance sheet. This step will help toregain trust in the financial system.• Banks revealed to be insolvent by marking to marketshould either be closed down via a normal, oldschoolbankruptcy process or – assuming they areToo Big To Fail – be taken over by government,which should erase all shareholder equity, let thebondholders suffer a loss and convert the bonds toequity and then let the bank float again with newequity. If the last step is not enough, depositorsshould take a hit and their cash should then be convertedto equity. This step will help to reduce moralhazardand let reckless speculators take responsibilityfor their actions rather than letting tax payers pay.• All government guarantees on behalf of the financialsector should be discontinued. This includes depositorinsurance and bond issues. It should be madeperfectly clear that any failing bank will be left on itsown. No bank should be Too Big To Fail and everybank should be subject to the tough discipline of the(interbank) market.• The board of banks should be made personally liableif the bank they control is becoming insolvent (aswas the case with the previous partnerships in thefinancial sector). This step will help make boards actin a responsible and risk-averse way.• All government budgets should as a minimum bebalanced immediately via spending cuts. While nota pleasant exercise, it should be done in order tostabilize government debt markets. The cuts shouldconcentrate on social welfare and pension schemes,which are grossly underfunded and unrealisticrelative to the future tax base. This step will helpreduce government borrowing costs and make themserviceable.• Governments should set out to cut taxes (especiallyincome taxes and capital gains taxes) dramaticallywithin a two-year horizon. This step will makecapital available to small and mid-sized companies,which deliver most of the growth in GDP and labourutilization. It will at the same time make it moreattractive to work rather than receive governmentwelfare.• Central banks should tighten monetary policy in orderto stimulate savings and discourage debt financing.This will help to clear the market for savings andinvestments.• Interest rate expenses should not be tax-deductibleso as to not encourage excess debt financing.• Any resulting deflation should be welcomed as away to achieve cheaper products and restore competitivenessin export markets.• Wages should be allowed to drop as well, since theunit labour costs (adjusted for PPP) are way too highin the Western world.– 32 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –SPECIAL REPORT: SOLAR ENERGY TO SHINE IN 2011?Despite the failure to make “progress” on climatechange issues at the Cancun climate change conferencein Mexico, climate change and energy policy arestill hot international topics. We expect the sun willshine on solar stocks in 2011 with a potential upside ofat least 30 percent from current levels. The main driversare strong demand, expansion of valuation multiples, astable political outlook and lower production costs.2011 quarterly earnings are released, we expect themarket will change its mind on solar stocks and sendP/E valuations much higher from current levels fortrailing 12-month earnings of around 9.6. An industryfor which demand is projected to grow 9.6 percentannually until 2030 should not be valued at 9.6 timesearnings because earnings growth normally exceedsgrowth in volume (demand) due to higher operatingChart 10: Share price development Solar an wind Industry (2008-2010)120GUGGENHEIM SOLAR ETFFIRST TRUST GLOBAL WIND10080604020007/200810/200801/200904/200907/200910/200901/201004/201007/201010/2010Source: Bloomberg. Our calculations.SOLAR STOCKS WILL RISE LIKE A PHOENIX FROMTHE ASHESThe latest years have been brutal for the solar andwind industry, as seen in the performance of the GuggenheimSolar ETF and First Trust Global Wind EnergyETF that track the solar and wind industries. Theindices are still trading 60-70 percent lower comparedto the summer of 2008 and even had a lousy performancefor 2010.Valuations on solar stocks have been held back by concernsthat excess supply relative to demand will crushthe industry’s profits.We believe the market is far too pessimistic and thelatest outlook for 2011 demand from the leadingsolar companies First Solar and Trina Solar indicatehigher demand in 2011 – even in Europe despiteconcern over subsidies and tighter budgets. As theefficiency and share buy-back programs later in anindustry’s growth cycle.WHY DO WE LIKE SOLAR MORE THAN WIND?Let us look at market pricing relative to expectations. Thesolar industry’s revenue is expected to grow 22.5 percentin 2011 compared to 15.4 percent for wind. Profits inthe solar industry are expected to grow at 28.7 percentcompared to 71 percent for wind. The high growth rateexpectations for wind are due to the decline in 2010profits. With 2011 forward P/E for the solar industry at7.5 compared to 15 for wind, the margin of safety is waylarger in solar stocks. The current forward P/E for solarstocks indicates that investors doubt the earnings growthrate in solar stocks and this is where the upside lies. If thesolar industry even gets close to 28.7 percent growth inearnings (anything over 15 percent might even suffice),this could send solar stock valuations way higher. On theother hand, the current forward P/E of 15 for wind on a– 33 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –Chart 11: EBITDA margin (%) (2005-2011E)30%Solar industryWind industry25%20%15%10%5%0%200520062007200820092010E2011ESource: Bloomberg. Our calculations.71 percent expected earnings growth makes wind stocksunattractive compared to solar stocks. If the wind industrydoes not deliver there will be pressure on wind stocksthroughout 2011 unless expectations for 2012 earningsare revised significantly higher.With bullish expectations for 2011 from all solarcompanies, low valuations, increasing asset utilizationand stable EBITDA margins, we expect solar stocks arepositioned to go much higher in 2011 when valuationsmultiples are expanding on strong earnings.From the perspective of industry profitability, solarenergy is also more attractive than wind energy. Solarcompanies have historically produced slightly lowerreturns on equity compared to the wind industry withthe drag coming from lower leverage and asset utilization.This is about to change and the solar industry isexpected to deliver higher return on equity in 2010and 2011 compared to wind driven by increasing assetutilization and significantly higher profit margin.Generally, the solar industry has higher operating(EBITDA) margins and less leverage compared to wind.This signals a healthier competitive situation, and ifthe solar industry is able to increase asset utilization,return on equity could easily pass the 15 percent markin 2012.The extended tax grant program (1603) in the U.S. willsupport solar demand in 2011 and into 2012 and webelieve it will compensate the expected slowdown inSpain and Germany due to cutbacks on subsidies there.HOW TO INVEST IN SOLAR STOCKSOne way to gain basic equity exposure to solar energyis through the Guggenheim Solar ETF, which is a broadbasket of solar stocks – from pure producers of wafersand PV solar panels, to producers of the new solar thinfilms and end-sellers across the U.S., Europe and Asia.It gives you diversification, but not necessarily the highestreturn.Another way to play solar stocks is through individualstocks. Taking into account expectations aboutrevenue, margin and profit growth for 2011 followingstocks look attractive with low forward P/E ratiosand expected EBITDA margins expansions above theindustry; JA Solar Holdings Co. (4.62), Solarfun PowerHoldings Co. (4.90), LDK Solar Co. (5.44), Trina Solar(6.39) and GCL Poly Energy Holdings Ltd. (9.90).RISK ASSESSMENTInvesting in solar stocks provides huge upside but itobviously comes with a couple of risk factors such aspolitical, currency, demand and supply risk.– 34 –

– OUTLOOK 2011 BUBBLES AND BULLS AND BEARS… OH MY! –The political risk in solar investments is high becausethe industry is still heavily dependent on governmentsubsidies. Germany is talking about cutting the feed-intariffs for PV solar systems by 16 percent on July 1,2011; political decisions are obviously an important riskfactor. As the industry moves closer to grid parity thepolitical risk will, however, slowly decrease which willlower the risk premium on solar stocks. With Obama’sextension of the tax grant program (1603) politicalstability in the U.S. is secured in the short-term andthe road to strong growth in U.S. renewable energy in2011 is paved.With Europe’s 75 percent share of new installed solarcapacity in 2009, the Euro remain an important riskfactor because most of the revenue is settled in Euroand most of production costs are denominated in Chineseyuan, which lead to strong correlation betweenearnings and the Euro. According to Bloomberg, thetwo most respected and accurate currency forecasters,Standard Chartered and Westpac Banking, are bothshort-term bearish on the Euro and expect it to declineto around $1.20-1.25 by mid-2011. Third quarterstatements from solar companies indicate the industrybelieves U.S. demand will compensate the falling Euroand demand in the Eurozone.Concerns over low demand in 2011 (particularly inEurope due to declining feed-in tariff environment andtighter budgets) and excess production of solar panelshave previously prevented multiples to expand despiteincreasing aggregate earnings in the solar industry. Thelatest outlook for orders in 2011 somewhat contradictthis concern. The extended tax cuts in the U.S. will alsoadd support for solar demand.SOLAR ENERGY IS THE FUTUREThe solar industry has evolved from infancy into arapidly growing industry with increasingly economics ofscale. According to Exxon Mobil’s “Outlook for Energy– A View to 2030” renewable energy including solar isset to grow at 9.6 percent annually until 2030.General Electric’s chief engineer, Jim Lyons, is predictinggrid parity in sunny parts of the United States byaround 2015 and that solar will eventually be biggerthan wind. The biggest driver in achieving grid parityis production costs on solar panels. Renewable EnergyCorporation and Q-Cells, the two biggest makers ofsolar cells expect to continue lowering costs for solarpanels next year.Life insurance companies are also a supporting driverfor solar demand because they have entered themarket as owners and are providing financing becausesolar parks provide a relatively stable income streamthat is also independent of other assets classes. Withinternal rates of return on solar projects runningaround 8-10 percent with fairly low risk, this is a greatopportunity for insurance companies to diversify theirinvestment income.The growth potential is enormous. The largest PV marketin Europe is currently Germany and here solar onlysupplies around 0.3-0.5 percent of the total powerproduction so there is plenty of room for growth on aglobal basis.DROP THE IDEOLOGY AND GO FORPERFORMANCEWhether global warming is a true trend or not renewableenergy is here to stay because governmentsaround the world want a cleaner and more fossil fuelindependent energy source.What we have learned through the financial crisis isthat when governments and central banks intervenein the markets it tends to do it forcefully and investorsshould not underestimate its impact on investmentopportunities.Our message is this; do not underestimate the willof governments to support the solar industry goingforward. We do not prefer subsidies to certain sectors,but we have to be realistic. Solar is rapidly movingtowards grid parity, demand is soaring, governmentswant this energy source, the solar industry will eventuallybecome competitive without subsidies and its sizewill eventually dwarf the wind industry. In 2011, thesun may shine on solar energy.– 35 –

NON-INDEPENDENT INVESTMENT RESEARCH DISCLAIMERThis investment research has not been prepared in accordancewith legal requirements designed to promotethe independence of investment research. Further it isnot subject to any prohibition on dealing ahead of thedissemination of investment research. Saxo Bank, itsaffiliates or staff, may perform services for, solicit businessfrom, hold long or short positions in, or otherwisebe interested in the investments (including derivatives),of any issuer mentioned herein.None of the information contained herein constitutesan offer (or solicitation of an offer) to buy or sell anycurrency, product or financial instrument, to make anyinvestment, or to participate in any particular tradingstrategy. This material is produced for marketing and/or informational purposes only and Saxo Bank A/S andits owners, subsidiaries and affiliates whether actingdirectly or through branch offices (“Saxo Bank”) makeno representation or warranty, and assume no liability,for the accuracy or completeness of the informationprovided herein. In providing this material Saxo Bankhas not taken into account any particular recipient’s investmentobjectives, special investment goals, financialsituation, and specific needs and demands and nothingherein is intended as a recommendation for anyrecipient to invest or divest in a particular manner andSaxo Bank assumes no liability for any recipient sustaininga loss from trading in accordance with a perceivedrecommendation. All investments entail a riskand may result in both profits and losses. In particularinvestments in leveraged products, such as but notlimited to foreign exchange, derivates and commoditiescan be very speculative and profits and losses mayfluctuate both violently and rapidly. Speculative tradingis not suitable for all investors and all recipients shouldcarefully consider their financial situation and consultfinancial advisor(s) in order to understand the risksinvolved and ensure the suitability of their situationprior to making any investment, divestment or enteringinto any transaction. Any mentioning herein, if any,of any risk may not be, and should not be consideredto be, neither a comprehensive disclosure or risks nora comprehensive description such risks. Any expressionof opinion may be personal to the author and may notreflect the opinion of Saxo Bank and all expressions ofopinion are subject to change without notice (neitherprior nor subsequent).This communication refers to past performance. Pastperformance is not a reliable indicator of future performance.Indications of past performance displayedon this communication will not necessarily be repeatedin the future. No representation is being made thatany investment will or is likely to achieve profits orlosses similar to those achieved in the past, or thatsignificant losses will be avoided.Statements contained on this communication that arenot historical facts and which may be simulated pastperformance or future performance data are based oncurrent expectations, estimates, projections, opinionsand beliefs of the Saxo Bank Group. Such statementsinvolve known and unknown risks, uncertainties andother factors, and undue reliance should not be placedthereon. Additionally, this communication may contain‘forward-looking statements’. Actual events or resultsor actual performance may differ materially from thosereflected or contemplated in such forward-lookingstatements.This material is confidential and should not be copied,distributed, published or reproduced in whole or inpart or disclosed by recipients to any other person.Any information or opinions in this material are notintended for distribution to, or use by, any person inany jurisdiction or country where such distribution oruse would be unlawful. The information in this documentis not directed at or intended for “US Persons”within the meaning of the United States Securities Actof 1993, as amended and the United States SecuritiesExchange Act of 1934, as amended.This disclaimer is subject to Saxo Bank’s Full Disclaimeravailable at Bank A/S · Philip Heymans Allé 15 · 2900 Hellerup · Denmark · Telephone: +45 39 77 40 00 ·

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