Global Financials Update April 13, 2012 Global Market Update After posting a fairly strong and consistent rally over much of the last six months, the global equity markets have changed course over the past several weeks. Many of the same issues that sparked the sell-off last fall are reappearing, including concerns about Europe (it just so happens to be Spain this time around), slowing growth in China, and a potential slowing of the U.S. economy. After peaking in early April, the S&P 500 index has now dropped two weeks in a row but still remains up +9% for the year. Earning season kicked off this week with a handful of companies reporting better than expected earnings. Absent any major news from Europe, earnings announcements over the next several weeks will likely drive U.S. stock markets. Stocks in Europe fell for the fourth straight week after hitting a nine month high in mid-march. Concerns over the European banking sector have been renewed in recent weeks following a surge in borrowing from Italian and Spanish banks. Investors have become increasingly concerned that Spain will become the next Euro member to need a bailout. Pricing on Spanish credit default swaps and yields on government bonds have risen sharply in recent weeks reflecting concerns about the country s debt load. Despite the various warning signals in the market, European leaders and politicians continue to express confidence in the ECB s ability to prevent the crisis from spreading to additional countries. Industry Developments This week Spanish bond yields rose to their highest level since early January, fueling concerns that they may eventually be forced to seek a bailout. Ten year government bond yields rose to 5.94% following a very weak bond auction. The Spanish economy is expected to contract by 1.7% in 2012 and the unemployment rate has risen to 23%. The Spanish stock market, measured by the IBEX 35 Index, has fallen 15% this year, making it the worst performing equity market in Europe. U.S. banks have increased lending to troubled borrowers as they gain confidence in the economic recovery and seek to make-up for a drop in fee income. In December, banks provided 1.1 million credit cards to households with poor credit history, signifying a 12.3% increase over the prior year. Italian and Spanish banks have significantly increased their borrowing from the ECB in recent months. Italian banks have now borrowed 270 billion, while Spanish banks have taken out 152 billion. Both countries had borrowed less than 50 billion a year ago. BlackRock, the world s largest asset management firm, announced plans to launch a trading platform that would allow bond market participants to bypass Wall Street firms and trade directly with one another. The platform would be designed to increase efficiency and reduce the transaction costs associated with trading through investment banks. According to Reuters, Chinese gold demand remains very strong. In February, mainland China imported nearly 40 metric tonnes of gold from Honk Kong alone. Demand over the first few months of the year is up +700% over last year. Yields on U.S. 10 year Treasury bonds have fallen back down to the 2.0% level after hitting 2.37% two weeks ago. Weak economic data and renewed fears about Europe have led investors back to risk-free assets. Global Financials Update 4-13-2012 Page 1
Global Economic Data China s GDP grew 8.1% during the first quarter of 2012, down from 8.9% in Q4. The growth rate fell to its lowest level in nearly three years. Weak demand domestically and from Europe, as well as slowing property sales have contributed to the slowdown. Consumer confidence in the U.S. fell in April for the first time since August. Last month, the University of Michigan confidence index hit a one year high as labor markets continue to improve. The Indian economy appears to be slowing as industrial production rose less than expected in February. January data was also revised lower signaling weaker global demand. China reported a $5.35 billion trade surplus for March. Exports grew at an annualized rate of 8.9%, but imports were only up 5.3% year-over-year. The weak import growth caused concern as economists point to slowing demand and economic activity in China. Following several months of strong employment data, U.S. non-farm payrolls grew by a disappointing 120,000 in March well below the consensus forecast of 203,000. The data marked the smallest increase in new jobs since October. Bank CDS & Sovereign CDS The data below shows CDS pricing for U.S. banks, European banks, and various countries. CDS pricing not only accounts for the chance of technical default, but also for a hyperinflationary revaluation of the currency. As a result, many believe this makes CDS spreads a more accurate indication of the real risk in government bond markets. CDS pricing is quoted in basis points and refers to the annual payment required to insure a specific amount of debt. For example, 50 bps equates to a $50,000 per year payment to insure $10 million of debt. Pricing on sovereign CDS has dropped significantly year-to-date, particularly on non-european countries. Spain has been the major outlier of the countries tracked on the graph with its price rising 27.8% as it has been forced to increase its borrowings from the ECB. Bank CDS has also fallen year-to-date amid signs of stabilization in Europe and a general improving of the U.S. economy. European banks have seen their CDS prices rise over recent weeks as mounting concerns over Spain gain attention. Credit Suisse is the only bank we track that has seen pricing on its CDS contracts rise year-to-date. Global Financials Update 4-13-2012 Page 2
Current CDS Prices - Sovereigns 1200 1100 1000 900 800 700 600 500 400 300 200 100 0 30 63 70 100 113 180 481 425 572 1087 20% YTD CDS Price Changes - Banks 16% 10% 0% -10% -1% -10% -12% -16% -13% -20% -15% -20% -30% -29% -40% -36% -36% 30.0% 20.0% 10.0% YTD CDS Price Changes - Sovereigns 27.8% 0.0% -10.0% -20.0% -30.0% -24.5% -26.7% -26.7% -19.5% -1.1% -8.3% -12.8% -14.2% -40.0% -34.4% Global Financials Update 4-13-2012 Page 3
Equity Market Performance Despite a recent pullback, bank stocks in the U.S. and Europe have generated positive returns in 2012. Banks in the U.S., which are in much better shape financially than their counterparts in Europe, have significantly outperformed this year. In Europe, bank stocks surged during the first two months of the year following the LTRO program. Much of those earlier gains have been given back in the past month as Italy and Spain have become the focus of investor attention. As a result, Italian, Spanish, and French banks have suffered the sharpest losses while others have seen more modest pullbacks. U.S. banks have benefitted from an improving economy and the short-term stabilization of Europe. Bank of America and others that suffered the largest losses in 2011 have experienced the largest gains in 2012. 58.6% U.S. Banks Monthly Change YTD Change 45.0% 25.0% 27.3% 32.1% 20.8% 28.2% 5.0% -15.0% -1.5% -1.5% -10.0% -8.7% -5.7% BAC C JPM WFC GS European Banks 40.0% Monthly Change YTD Change 24.7% 20.0% 0.0% 7.3% 1.1% 19.1% 9.6% -20.0% -40.0% -12.8% -15.2% -13.1% -22.4% -28.9% Soc Gen BNP DB Barclays Credit Suisse Global Financials Update 4-13-2012 Page 4
Bank Lending Euro LIBOR rates have fallen significantly in 2012 on the back of LTRO and ECB lending. U.S. rates have also fallen but remain elevated above levels seen for most of 2010 and 2011. U.S. bank lending activity has increased year-to-date, particularly in terms of bank-to-bank lending (interbank loans) which are up 13.5%. Additionally, the amount of cash held on bank s balance sheets is down over 15% since the height of the European debt crisis. Bank Lending / Assets Cha nge (%) 3 mo Cha nge (%) 6 mo Current 3 months Ago Commercial and Industrial Loans Consumer Loans Interbank Loans Cash Assets 1.2% 3.1% USD 3-mo LIBOR interest rate 0.47% 0.56% -0.4% 0.4% EUR 3-mo LIBOR interest rate 0.66% 1.13% 13.5% 3.8% -1.6% -15.3% Source: Federal Reserve Disclosure The information contained in this summary is for informational purposes only and contains confidential and proprietary information that is subject to change without notice. Any opinions expressed are current only as of the time made and are subject to change without notice. This report may include estimates, projections or other forward looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. While we believe this information to be reliable, Convergent bears no responsibility whatsoever for any errors or omissions. Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, caution must be used in inferring that these results are indicative of the future performance of any strategy. Index results assume the re-investment of all dividends and interest. Moreover, the information provided is not intended to be, and should not be construed as, investment, legal or tax advice. Nothing contained herein should be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. Any investment advice provided by Convergent is client specific based on each clients' risk tolerance and investment objectives. Please consult your Convergent Advisor directly for investment advice related to your specific investment portfolio. Non-deposit investment products are not FDIC insured, are not deposits or other obligations of Convergent Wealth Advisors, are not guaranteed by Convergent Wealth Advisors and involve investment risks, including the possible loss of principal. Global Financials Update 4-13-2012 Page 5