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The magnificent 7 and equity markets - Review 5 (end of the year)

We are now 10 month up after the trough reached on 9th March 2009. Following extremely
oversold conditions in March, the marked forged ahead with a vengeance the MSCI World Free
index having surged 76% (less in the Western world and more in the developing world). The
magnificent 7 are telling us that there is no reason for the markets to pause beyond short term
overstretched valuations (I recommend the reader to go to the GTI web site
(http://www.global-thematic.com/ - if you want to subscribe, mention Markets & Beyond and
you will get a rebate) for their monthly newsletter, one of the best available).

S&P 500 Banks index: For 5 month the index has traded in a narrow 120-140 band. The
index and the 200 days moving average are converging after the latter turned up in July and is
now positive. The index is still 70% below the nadir reached in February 2007. The 120 support
is holding very well. Positive.

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Global 1200 financial index: The world financial sector broke multiplied its value 2.5 times
since it trough in March this year, to trade between 930-1040 since July. As for the S&P Banks
index the 200 days moving average turned positive and is converging with the index. Positive.

TED spread (LIBOR USD 3 mth - US 3 mth T-bills): The spread is back to normal - no
stress showing at +/- 20 basis points (0.20%). The interbank market shows no stress.
Positive.

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USD bank BBB 10 yr - US 10 yr yield: Whilst still high and above historical average, the
spread has steadily decreased since July and is nearly 3% below the highest point reached in
March standing at 4.5%. Positive.

OEX volatility: OEX volatility has continued it downward trend and is now hovering around
20% well below the stress times of Q4 2008 and Q1 2009, and at the level I wanted to see
during my lats review in October. We need this indicator to stay at or below 20%. Positive.

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S&P Case Shiller house price index: The latest data (October) published 29th December
(see my comment yesterday) showed a picture at best flat, stopping a series of solid gains.
There is a clear dichotomy appearing between existing homes where the market improves and
new homes that is still very weak:

Composite-10: October 2009: +0.01%, y/y: -6,4%

Composite-20: October 2009: -0.05%, y/y: -7,3%

Signs are becoming more positive but still ambivalent. Slightly positive.

Oil price: The oil prices seems to be capped at +/- $80/b. Higher oil prices can be absorbed
by economies it if the pace of increase is not sharp. For example, the doubing of prices since
the low reached in March has not impaired the "recovery". If the economy gains impetus things
may however look different however: beware of a sudden and sharp rally. Positive for the time
being.

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Conclusion: All these indicators are positive. I have been dead wrong to get out of equity
markets in July but jeopardizing 20-25% gain between early April and late June for a possible
15% additional profit did not appeal to me. I still believe that there are strong headwinds
ahead: unemployment not going down as fast as wished (and its psychological effect on
consumers), the private sector unable to take the relay from the public sector leading to a
second package in the US (and as a slump in the USD as collateral damage), additional
delinquencies on residential, commercial and credit cards damaging the recovering (but still
weak) bank's balance sheets, etc.

I am not (yet) in the camp of the commentators that see the current rally being a bear market
rally. Liquidity is still huge and on the sideline: this should continue to spur equity markets. I
however expect a 20-25% correction in equity markets by 2010 H1 but a real and
fundamental improvement in company results.

Source:

Global Thematic Investors

http://www.global-thematic.com/

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