EDRG: In its second LTRO, the ECB loaned EUR 529.5bn to banks

credit channels flowing. The fact that 800 banks were party to the scheme shows that the ECB has attained its goal; less stringent repo conditions have allowed many small banks to leave emergency, more expensive arrangements (ELAs) with their national central banks. Success will be measured by developments in lending data in coming months.
Europe’s economic situation is still stabilising to judge from February’s manufacturing PMI for the eurozone (49 vs. 48.8 in January) even if there are still some pockets of weakness like French consumption.
US data is still upbeat. Manufacturing ISM slipped to 52.4 from 54.1 but that is still coherent with moderate growth. Improving household confidence can be seen in auto sales which hit an annualised 15 million vehicles in February compared to 14.1 million in January. Similarly, like-for-like sales in major retail groups rose by 6.7% over 12 months.
There are more positive indications in the US residential property market: pending home sales rose 10% over a year while inventories contracted at a faster pace, falling to 2005 levels According to the Case/Shiller indices, prices are still falling (-4% over 12 months ) but the key point is that foreclosure sales are being more easily absorbed. A recovery in home sales always marks the end of a price correction and prices themselves are always the last to react. The recent move by the FHFA, the federal mortgage agency regulator, to launch a pilot scheme to sell foreclosed Fannie Mae properties is interesting. Buyers undertake to rent out these properties in areas like Las Vegas and Atlanta where prices have been particularly hard hit. These investors are banking on good returns from rising rents.

EUROPE
Indices were unchanged this week as investors digested the Greek aid programme (EUR 130bn from Europe and debt forgiveness of EUR 107bn) and the ECB’s second LTRO for EUR 530bn (around EUR 320bn net or 65% more than last
December’s operation). S&P then officially downgraded Greece to selective default but the ISDA is not treating this as a credit event.
Most of the company results for 2011 to emerge were in line and even encouraging for cyclicals like CGG Veritas, Ipsos and Havas although guidance for 2012 is cautious. Volkswagen said auto sales in 2011 were 15% higher while net earnings came in higher than EUR 15bn. CRH said higher sales in 2011 would be repeated in 2012 thanks to its strong Polish and German markets.
WPP saw solid organic growth in 2011 and will increase its dividend more than expected while Adecco has decided to
distribute more than 50% of its EPS compared to a third previously, despite results that were only in line with expectations.
In retail, Casino enjoyed strong recovery in France in the second half and robust growth in emerging countries like Brazil and Asia which now represent 45% of sales. This helped the group increase overall sales by 18% in 2011. Ahold expects competition to remain very tough in 2012 but has confidently increased its dividend by 38%. Standard Chartered‟s results were in line and the bank sees double digit EPS growth over the medium term.
Veolia Environnement posted losses of EUR 490m but the share jumped 15% on news that it intended to sell its transport division. This makes CEO Antoine Frérot‟s refocusing plan credible. He has been confirmed as CEO despite recent rumours of manoeuvres.

Bad news was centred on telecoms. After France Telecom, Bouygues and Vivendi said the arrival of a 4th operator (Free) was inevitably eroding their telecom activities. Bouygues says it has lost 134,000 subscribers but has taken the offensive and announced a EUR 300m cost-cutting drive. In contrast, Vivendi is not budging and continues to criticise Free„s arrival.
It has announced an action plan but has not detailed the potential savings that might offset the expected 12/15% fall in EBITDA at its telecom affiliate SFR. The group has also made a radical and unexpected change to its dividend policy. It is offering EUR 1 in cash for FY 2011 plus one new share for every 30 held. This is both astonishing and dilutive. From 2012 onwards, dividend payouts will be revised to “45-55%” which suggests around EUR 1 although Vivendi had in recent months undertaken to stick with EUR 1.40. Ipsen (pharma) disappointed the market by reducing guidance on margins from 17.5% to 15% or significantly lower than market expectations. This is due to a 15% slump in sales of regular drugs in France although speciality pharma was 8% up. Eurotunnel‟s financial situation seems to be improving and the company expects to see its credit rating upgraded in the next few months. Lastly, Hochtief will pass on its dividend for FY 2011 due to losses.

US
Indices once again edged higher amid much fuss over tech stocks ahead of the Facebook listing and due to the Mobile World Congress in Barcelona. The second estimate of Q4 GDP growth was 3%. Generally speaking, signals are somewhat mixed. Manufacturing data from the Richmond and Dallas Fed were very encouraging but manufacturing ISM was slightly disappointing and durable goods orders missed expectations by falling 4%. However, weekly jobless claims returned to levels preceding Lehman‟s collapse.
In company news, auto sales rose 16% and Ford did particularly well. Bombardier (aeronautics) and Staples (office
supplies) sold off heavily after lacklustre results. Elsewhere, the FDIC released encouraging bank data for the 4th quarter: asset quality continued to improve, lending was enjoying regular growth, capital bases were solid and revenues were only down slightly.
Over the last 5 trading sessions, IT and consumer discretionary rose sharply. Industrials and commodities fell.

JAPAN
During the week, the Topix rose 1.3%, buoyed by large caps and domestic demand-related stocks. On February 28, Elpida, the world‟s 3rd largest DRAM maker, filed for bankruptcy. This seemed to weigh on Japanese stocks in the morning session. But the negative impact of the news, however, was eventually limited to the Elpida share price itself as the Topix soon rebounded. TSE1 trading volume continued to increase amid a mix of profit taking and buying interest in undervalued stocks.
The Yen continued to slide against the dollar and euro by 0.5% and 2.2% respectively, though the pace of its decline
slowed.
Monetary easing and the weak Yen, which stayed at around JPY 80 to the dollar helped lift most Topix 33 sectors. This was especially true for domestic demand sectors, such as real estate and financials which had lagged during last week‟s rally focused on economically sensitive stocks. Sumitomo Realty, Mitsui Fudosan, and Mitsubishi Estate jumped more than 4%. Among insurance companies, T&D Holdings climbed 5.8% and Dai-ichi Life rose 4.4%. Mega banks also enjoyed some respite: Mizuho advanced 4%, and both MUFG and SMBC were up by 2%. Busier trading pushed up Daiwa by 4.6% and Nomura by 3.8%. Large cap stocks led the Topix higher. Ricoh surged by 9.8%, consumer electric giants such as Panasonic, Toshiba, and Sharp gained more than 4%.Fanuc reached a year high, and Fast Retailing posted a two-year high. In contrast, mining, oil, and marine transportation declined as profit taking set in.

ASIA
China‟s manufacturing index for February beat expectations by coming in at 51 vs. 50.5 in the previous month. This is the third month in a row with a reading above 50 and Q1 GDP should be well above 8.5% compared to 8.9% in Q4 2011. This mean no brutal fall is on the cards. But that might also mean, as in the US after Ben Bernanke’s comments, that China is not set to ease monetary policy as quickly as expected, especially as the ECB now seems to be in charge of potentially inflationary liquidity injections. Action from China‟s government might also be affected by this weekend‟s National People‟s Congress which will decide on major economic and social issues. Social housing, consumption, commodities and new energy sources will be top of the agenda.
Indonesia‟s inflation continues to slow. It was only 3.56% in February, a remarkably tame figure given strong GDP growth in the fourth quarter. However, such low inflation could be about to change as the government is expected to unveil a series of price increases in coming weeks for electricity and (heavily subsidised) petrol along with wage rises for certain public sector categories. How much prices will increase is not yet clear but, as commodity prices are rebounding, we could be moving towards 6.5% or even 7% in inflation by the summer. That would be higher than the central bank‟s comfort zone of 4/4.5%. Consequently, the recent interest rate cut looks more and more misguided to us and will have to be quickly reversed. The Indonesian market will be choppy in coming months but looking further out, changes like the reform of the subsidised petrol scheme are a necessary evil.
There is a very interesting trend in South Korea, a pioneer in internet and electronic goods consumption. Smartphone penetration is already 45% and related sales for mobile internet companies have soared. The Korean internet portal leader, NHN, expects income in this segment to triple to 5% of its forecast EUR 1.6bn in sales in 2012. The launch of LTE 4G phones will further boost traffic while internet access via mobiles rather than a computer at home will make ad targeting more efficient and more profitable. Mobiles establish geographical location and are also much more personal than a shared home computer. This will make it easier to target habits and preferences. The potential is huge in large cities where people are switching much more quickly to smartphones and high-speed infrastructure is already in place.
US auto sales in February were surprisingly robust, rising 15.8% compared to February 2010. The data is even more impressive for Korean makes Hyundai and Kia which saw sales jump 17.5% and 37.3% respectively.

OTHER EMERGING MARKETS
Higher oil prices put the brake on the Indian market‟s upward march. Oil represents 30-40% of imports so high prices make financing the trade balance complicated. Petrol benefits from heavy subsidies which represent around 2% of GDP.
This means more expensive oil increases the fiscal deficit and it explains why the government is selling 5% in the State company ONGC. There are also rumours that petrol and diesel fuel prices will increase after the Uttar Pradesh elections.
That would automatically push inflation higher. GDP growth for Q3 of fiscal 2012 is still slowing and is now at 6.1% compared to expectations of 6.3%. The coming weeks will determine by how much the Reserve Bank of India might cut
rates. It is struggling to enact two contradictory measures: halting the economic slowdown while putting a lid on inflation which is being fuelled by a rise of more than 20% in oil prices since January 1st 2012.

The Brazilian market gained 2% this week, driven by better economic figures in the US, China and Europe. Confirmation of the LRTO was also a relief. PMI data came in at 51.4. Some retail companies (Arezzo, Hering and Lojas Americanas) reported results that were slightly below expectations. Oil companies took a breather. Attention will now be focused on the Central Bank‟s monetary policy meeting next Wednesday. In Latin America, the Central Bank of Colombia increased interest rates by 25bp to 5.25%. The bank said its decision was warranted partly because of persistently high loan growth and data suggesting households have significantly increased their debt levels. The bank also noted that the most recent economic data on Q4 2011 still pointed to growth momentum. Colombia was the second best performing market after Brazil during the week.

CONVERTIBLES
It was another eventful week on the convertible bond market with macroeconomic news, company results and new issues.
On Wednesday, the ECB loaned EUR 529.5bn to 800 European banks. This extended the positive impact of the first LTRO but managed to avoid giving the impression that borrowers were fragile. Moreover, this week‟s government bond auctions in Europe went off without a hitch. Of note was ISDA‟s decision that the Greek debt swap did not constitute a credit event as understood in CDS contracts (total CDS outstandings: USD 3.25bn). There were also numerous company results in Europe. Abengoa, WPP, Polarcus, Standard Chartered Bank, Adecco, all of which have convertibles, beat expectations. Air France reassured investors over its credit rating by selling Amadeus. Russia‟s Lukoil posted record cash flow and lower net debt but had worrying writedowns due to inaccurate geological estimates of reserves. The group intends to raise money in Asia. The official announcement of the Peugeot-GM alliance also focused attention. GM will buy a 7% stake in Peugeot and the alliance will be based on two main pillars: platform sharing and the creation of a global procurement joint venture. Moody‟s downgraded Peugeot’s senior unsecured debt by one notch due to over-capacity in Europe and lower-than-expected free cash flow. On the new convertible issues front, Golar (Norway, martime transport) raised USD 250m. We decided not to subscribe. Sovereign and corporate yields eased further this week. Portugal‟s 10-year yields fell 100bp while the Xover shed around 20bp over the week.
In the US, Ben Bernanke has for the time being ruled out more QE but there were some disappointing economic data. Durable goods orders fell 4%, the largest drop in 3 years. On the US primary market, DealerTrack (software for car dealers) issued USD 175m in convertibles with a 5-year maturity. We subscribed due to the deal‟s attractive pricing and technical characteristics. All in all, Ares Capital posted results that took the market by surprise. The company is doing very well in its origination business.
Asia was also in upbeat mood. China‟s Manufacturing PMI came in at 51, slightly higher than expected. Elsewhere, property is still hogging the press headlines. Shanghai‟s government has made it clear that only permanent residents can buy a second home. There was lots of news on companies with outstanding convertibles. In short: Hidili reassured investors by refinancing its convertible with China Construction Bank; Country Garden is about to raise USD 400m; Shangri-La and YTL were both up sharply after posting good results; Elpida‟s bankruptcy in Japan boosted its Korean rival, Hynix. In Japan, Yaskawa Electric (auto industry automation) issued JPY 15bn (USD 186m) in convertibles to finance investment in China. We subscribed.

COMMODITIES
Brent crude and WTI prices have risen 10% and 14% respectively since February 1st amid geopolitical tensions in Iran but also production stoppages in the Yemen, Syria, Sudan and the North Sea. Inevitably, this has raised questions about the economic impact. Historic data shows that oil represents 5/6% of GDP in the US so any price rise will usually cause the economy to contract even if today‟s figure is 4.5%. And all US recessions bar one since 1945 have been preceded by an oil shock.
We need, of course, to be attentive but things also have to be put into perspective. First, an oil shock occurs when prices rise sharply and very quickly. However, the average year-to-date price is only 4% higher than for 2011 as a whole. Thereafter, everything hinges on what kind of shock take place. If prices rise due to heavy demand, the impact is less severe as it reflects a buoyant economy than if the surge results from lower supply as in the 1970s. For that to reoccur, Iran would have to block the straits of Hormuz which sees 35% of tanker-borne oil. That has not yet happened. At the same time, note that US oil consumption has been relatively low since the 2008 crisis. Energy intensity has fallen which means the economy is less dependent on oil. In any case, oil is 70% used in transport and only 20% in industry. A much
more favourable factor is that US industry is benefiting from falling gas prices which concern mainly electricity generation and heating. Due to intensive development of shale gas resources, prices are now 35% cheaper than the average for 2011 and 66% lower than over the last 5 years. The impact is such that US industry is bringing jobs back home. Perhaps one day, European countries led by France will be tempted to do the same and allow underground assets to be mined. At any rate, the US economy seems to be on the mend so much so that Fed chairman Ben Bernanke is no longer talking about a further dose of quantitative easing (QE3). This is an astonishing volte face after saying only a few weeks ago that QE3 might be necessary. One of the consequences of this new stance, which is relatively positive for the US dollar, was a USD 90 drop in gold or close to 5%. But this move back to the USD 1,700/oz level could end up reviving traditional demand which has been rather soft year to date. Moreover, this retreat coincides with a traditionally favourable period for consumption in China (restocking after the Chinese New Year) and India (the April-May wedding season). Note, too, that central banks in Belarus, Kazakhstan and Turkey have recently increased gold reserves. The CEO of Barrick Gold, which is the sector‟s biggest capitalisation (USD 49bn or one tenth of Apple), says the company could aggressively increase its dividend given the favourable environment for gold. Costs are rising but so are margins and shareholder returns are on the up.

ASSET ALLOCATION
Declining tensions and stabilisation in European economic indicators continued to support risk assets and equities in particular. Between February 22 and 29, the major indices performed as follows in local currency:
– Standard&Poor‟s 500 +0.6%
– Euro Stoxx 50 -0.3%
– TOPIX +1.3%
– MSCI Emerging markets +0.5% (in EUR)

The ECB‟s second LTRO largely benefited Spanish and Italian yields which are now below 5% on 10-year government debt. French 10-year government bonds also eased with the yield falling to 2.8%. Shorter dated maturities also fell sharply: yields on Italy‟s 2-year debt lost more than 100bp in 2 weeks, moving from 3.1% to 1.82%. After falling and then partially reversing the move, yields on the US 10-year Treasury and the German Bund ended the period at 2.04% and 1.86% respectively.
On forex markets, the yen overcame initial hesitation and fell further to 81.6 vs. the dollar but the euro‟s rally petered out (1.33 compared to 1.34). The RMB was unchanged at around 6.30 against the dollar. Last month, we reduced euro equities as the rally was very quick and important deadlines were looming in February. But we have now started to rebuild weightings gradually due to (i) the Greek debt agreement (even if deep-seated problems are still far from over), (ii) the arrival of the second LTRO, (iii) the economic upswing in the US and (iv) monetary easing in emerging countries. At the same time, we have gradually been reinforcing dollar positions. Its recent fall, which was driven by massive euro short covering, looked like an interesting hedge against our risk asset positions, especially on emerging markets after the sharp rise there in both equities and currencies.
We remain positive on emerging equities, particularly in Asia. They are attractively valued insofar as inflation has started to turn down and most countries have embarked on monetary easing. Edmond de Rothschild Europe Flexible: equity exposure has risen to 44% vs. 40% last week. The fallback early on in the week allowed us to raise exposure in favourable conditions.