FXCstrategy29n06 Dec 0506

Horizon 2007 The market is looking beyond the valley: financial and cyclical stocks in vogue François-Xavier Chevallier 33 1 45 96 79 32 - E-mail : chevalfr@cmcics.com Outlook 2007 1

Valérie Plagnol 33 1 45 96 53 63 - E-mail : plagnova@cmcics.com Stéphane Malvert 33 1 45 96 77 57 - E-mail : malverst@cmcics.com

Overview of our 2006 strategy ► Economy: a protracted deflationary boom…  A structural contradiction: the drop in the capital/labour ratio is offsetting a sustained oil shock  The boom in emerging countries is contrasting with the slowdown in the US  The inversion of the yield curve means a slowdown in US consumption in 2006  In Europe, record profits, a controlled oil shock, the appreciation of the dollar and low 10-year yields

► Markets: advantage Europe, against a good backdrop for equities  The equity markets are getting over the difficulties seen at the start of the decade  2006 earnings: +9% (+18% in 2005) and a positive earnings revision trend  A very attractive risk premium in Europe in relation to the US  Our revised target for the CAC 40 at end of 2006: 5,250

► Sectors: cyclical, dollar stocks and financial euro stocks  Revival of interest in industrial and technical dollar stocks  Good earnings revision momentum for banks and insurance companies  Misgivings about consumption, tourism and airlines 2

Key elements of our 2007 strategy ► Economy: a mid-decade adjustment expected  European trends are clashing with the slowdown in the US  But Europe should peak in early 2007  Conversely, a soft landing in the US would pave the way for a rebound at end-2007

► Markets: the slowdown has already been priced in  Underpinned by the dispelling of inflationary fears  Towards normative earnings growth  Our CAC 40 target for end 2007: 6,000

► Sectors: financial and cyclical stocks in vogue  Preference for financial stocks with the drop in long-rates and mergers and acquisitions: banks, insurance, financial services  Overweighting of cyclical stocks based on anticipated drop in US short rates

3

Economy:

A typical mid-decade adjustment now underway ► Europe being out of sync with the US favours the mid- cycle soft landing scenario we advocate ► The growth differential between Europe and the US is set to invert in 2007 

Europe’s strong trends are likely to start waning as 2007 gets underway − Impact of the slowdown in the US and the planned VAT increase in Germany in January



−

A soft patch at end-2006

−

Inflationary risks are relatively well contained

−

Record corporate profits favour investment

However, the soft landing in the US should pave the way for a gradual rebound as of mid 2007 − The slowdown started in autumn 2005 (via the property sector) −

4

Possible dip in the US cycle in mid-2007 with a soft landing before a gradual rebound as of the summer

Economy: 10-year cycles

A typical mid-decade soft landing underway ISM Manufacturing Index

ISM manufacturier Manufacturing

70

Index 10

Soft landing

65

9

60

8

55

7 6

50

5

45

4

40

3

35 30

Hard landing

2

Hard landing

Hard landing

1

25

0 80

82

84

86

88

90

ISM Manufacturier Manufacturing Sources: Ecowin. CM-CIC Securities

5

92

94

96

ISM Manufacturing

98

00

02

04

06 Source: Reuters

EcoWin

Economy: 3-year cycles

Towards a cycle peak in Europe â–ş Next peak in Europe at end-2006?

65.0 62.5 60.0 57.5 55.0 52.5 50.0 47.5 45.0 42.5 40.0 37.5 90

110.0 107.5 105.0 102.5 100.0 97.5 95.0 92.5 90.0 87.5 85.0 92

94

96

ISM Manufacturier

Sources: Ecowin. CM-CIC Securities

6

98

00

02

IFO

04

06

2000=100

ISM manufacturing and IFO

Economy:

Our macroeconomic forecasts Contribution to GDP growth

Europe

US

Japan

2006e

2007e

2006e

2007e

2006e

2007e

% GDP growth

+2.4%

+2.3%

+3.5%

+2.6%

+2.7%

+2.7%

Of which contribution to growth

Consumption

+1.2%

+1.1%

+1.2%

+0.8%

+0.7%

+0.8%

Investment

+1.0%

+1.0%

+1.5%

+1.2%

+1.5%

+1.4%

Inventories

+0.3%

+0.3%

+0.8%

+0.4%

+0.0%

+0.3%

Foreign trade

+0.2%

+0.2%

0.0%

+0.2%

+0.5%

+0.5%

Budget overrun

-0.3%

-0.3%

0.0%

0.0%

0.0%

-0.3%

3-year yields (year end)

3.50%

3.75%

5.25%

4.75%

0.50%

0.50%

10-year yields (year-end)

3.80%

4.30%

4.60%

4.90%

1.80%

2.25%

Updated 2 November 2006

Source: ESN

7

Economy:

Drop in oil price, a driver in 2007

Double top

a’

D a’’ Double bottom à inscrire

a D. Downward trend towards $54 and $50.25, break with support levels a & a’’

Source: CM-CIC Securities

8

Markets:

Starting to anticipate the rebound ► The markets have priced in the slowdown in the US followed by a slowdown in Europe… ► … and are starting to factor in a rebound in the US ► Strong support: the valuation is reasonable 

Prices only slightly factor in earnings growth



Earnings growth has returned to normative levels and will possibly wane over the medium term



The risk premium offers further upside

► Our index targets are +10-15% at end-2007, i.e. 6,000 for the CAC 40 and 405 for the DJ Stoxx

9

Markets:

Performance of asset classes ► A return to normative performance over the long term

Annualised return on assets (revenues reinvested) 28%

27.6%

Equities vs bonds over 10 years (revenues reinvested) 400 350

23%

20.6%

300

18%

250

8.0% 8%

-2%

7.7% 7.6%

8.3%

150 100

1 year

3 years

5 years Fixed income

Sources: CM-CIC Securities, Factset JCF

10

Monetary

Fr government bond 10y

2006

2005

2004

2003

2002

10 years SBF 120 (capitalised dividends)

Equities (sbf120)

2001

2000

1999

50 1998

3.2%

2.6%

2.4%

1997

2.8% 1.0%

1996

3%

200

11.8%

13%

Markets:

US mid-cycle monetary easing bullish for stocks ► We expect the Fed to start cutting rates shortly

12

70

11

60

10

50

9

40

8

30

7

20

6

10

5

0

4

-10

3

-20

2

-30

1

-40 84

86

88

90

92

94

Fed lead rates Sources: Ecowin. CM-CIC Securities

11

96

98

00

02

04

06

Standard & Poors 500

Percent

Percent

Fed lead rates and 12-month change in S&P500

?

Markets:

Share prices factor in low earnings growth Implied earnings growth over the coming five years in the DJ Stoxx 30 25

Average 1993-2002: +13%

20 15

Zero earnings growth over the next five years to justify current prices on the DJ Stoxx 600 While the consensus forecasts growth of 10% in 2007

10 5 0 -5 -10 -15

Implied earnings growth over the coming five years in the S&P 500

-20 -25 93

94

95

96

97

98

99

00

01

02

03

04

05

06

40

35

Earnings growth of 10% to justify current prices on the S&P 500‌

30

While the consensus forecasts growth of 13% in 2007

20

Average 1994-2002: +17%

25

15

10

5

0

Sources: CM-CIC Securities. Factset JCF

12

-5 94

95

96

97

98

99

00

01

02

03

04

05

06

Markets:

The risk premium is still attractive in Europe 11%

1500

12%

10%

1400

11%

1300

10%

1200

9%

6%

12%

1500

11%

1400

10%

Sell zone

Source : CM-CIC Securities

13

Monetary risk premium

S&P 500 (RH scale)

Jul-06

Jul-05

Jan-06

Jan-05

Jul-04

Jul-03

Jan-04

Jan-03

Jul-02

Jul-01

Jan-02

Jan-01

Jul-00

Jul-99

Jan-00

200

4%

Buy zone

Sell zone

Long term risk premium

Jul-06

Jan-06

Jul-05

Jan-05

Jul-04

Jan-04

2%

Jul-03

3% Jan-03

jul-06

janv-06

jul-05

janv-05

jul-04

janv-04

jul-03

janv-03

jul-02

janv-02

jul-01

janv-01

jul-00

janv-00

jul-99

janv-99

jul-98

janv-98

jul-97

janv-97

600 jul-96

700

0% janv-96

1%

5%

Jul-02

800

6%

Jan-02

900

2%

7%

Jul-01

1000

300

Jan-01

3%

8%

Jul-00

1100

Jan-00

4%

DJ Stoxx (RH scale)

9%

Jul-99

1200

Monetary risk premium

400

Jan-99

1300

5%

Sell zone

100

Bond risk premium Europe

1600

Jul-96

6%

Jul-98

Buy zone

Jan-96

7%

Buy zone

150

S&P 500 (RH scale)

Bond risk premium US

8%

4%

Jul-98

Jul-06

Jul-05

Jan-06

Jan-05

Jul-04

Jul-03

Monetary risk premium

Jan-04

Jul-02

Jan-03

Jul-01

Jan-02

Jan-01

Jan-97

Jan-99

Sell zone

Jul-00

2%

Jul-99

600

Jan-00

1%

Jul-98

3%

Jan-98

700 Jul-97

2% Jul-96

800

Jan-96

3%

Buy zone

200

5%

Jan-99

900

4%

Jan-98

5%

250

7%

Jul-97

1000

8%

Jan-98

1100

6%

Jul-97

7%

300

Jan-97

8%

400 350

Jul-96

9%

Monetary risk premium Europe

13%

Jan-97

1600

Jan-96

Monetary risk premium US

12%

DJ Stoxx (RH scale)

100

Markets:

Equity yields are at their highest level Net yield on the DJ Stoxx 600 4.0%

High level of dividend distribution:

3.5%

Net yield of 3.2% in 2007 on the DJ Stoxx

3.0%

2.5%

2.0%

P/E over 12 months on the DJ Stoxx

1.5% 1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

24

22

P/E at lowest level despite the market increases 13x in 2007 for the DJ Stoxx Sources: CM-CIC Securities. Factset JCF

14

20

18

16

14

12

10 1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Markets:

Earnings growth on the DJ Stoxx back to normative ► Waning of earnings momentum and return to normative growth of 10-12%

Earnings growth on the DJ Stoxx

Earnings revisions on the DJ Stoxx

5%

2004

2005

4%

16

2006

14 12

2007

10 8

2008

Exercice 2004

Exercice 2005

Exercice 2006

Exercice 2007

Exercice 2008

1% 0%

Revisions to recurrents earnings:1 month (%) 2007 Revisions to recurrents earnings: 3 month (%) 2007

sept-06

août-06

juil-06

juin-06

mai-06

avr-06

mars-06

févr-06

janv-06

déc-05

nov-05

sept-06

juin-06

mars-06

déc-05

sept-05

juin-05

mars-05

déc-04

sept-04

mars-04

déc-03

sept-03

juin-03

mars-03

déc-02

sept-02

juin-02

mars-02

déc-01

2%

-1%

Exercice 2003

Sources: CM-CIC Securities. Factset JCF

15

juin-04

2003

6

3%

oct-05

18

sept-05

20

4

DJ Stoxx 600

6%

%

Markets:

Earnings growth on the DJ Stoxx: the good and the bad ► Widely dispersed growth of sector earnings Unfavourable earnings growth

Automobiles 23%

20%

Travel & Leisure

Var. in 2007 earnings

Industry

Technology

15%

P & H Goods

10%

Favourable earnings growth

Media Food

Telecom

5%

Financial Services Retail Utilities Healthcare Construction Banks Chemicals Insurance Basic Resources 40% Energy

0%

-5% -5% Sources: CM-CIC Securities. Factset JCF

16

0%

5%

10%

2007 earnings revisions over last six months

15%

Markets:

Upside of 10-15% in 2007 Valuation assumption trends since the trough in 2003 Stability of yields (between Q2-03 and Q3-05)

Increase in yields (since Q4-05)

DJ stoxx : +70%

400

350

+30%

3.6

Risk premium: 13.4-10%

7.6%

Annualised EPS growth: +27%

+11%

3.4 3.2

Target at end-2007 Risk free rate: 3.75% Risk premium: 6.5% Variation in earnings: +10%

3.0 300

2.8 2.6

250

2.4 2.2

200

DJ Stoxx 600 (LHS) Source: CM-CIC Securities

17

3-month yields (EUL) (RHS)

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

1.8 Mar-05

Dec-04

Sep-04

Jun-04

Mar-04

Sep-03

Jun-03

Mar-03

Dec-02

150

Dec-03

2.0

DJ Stoxx : 405 CAC 40 : 6 000

Sectors:

Drivers and investment themes in 2007 ► Factors that will drive the markets in 2007  Positive: low yields on long rates and good equity market valuations. Drop in oil price and pick-up in US cycle  Negative: weak US (and German?) consumption. Risk related to the dollar and high level of confidence as regards corporate margins

► Investment themes  Precautionary takeover bids, notably among banks, utilities, construction and industrial groups  Capacity to generate international growth: consumer goods and cyclical export groups exposed to the dollar

18

Sectors:

The two pillars of our sector strategy ► Financial stocks 

Change of status in the eyes of investors: expertise in ALM, high value added in finance



Preference for financial stocks given low level in long rates



Mergers & acquisitions: banks, insurance, financial services

► Cyclical stocks 

Avoid sectors with low pricing power and favour sectors exposed to growth



Overweight cyclical stocks based on anticipations of a drop in short rates in the US in mid-2007 and the subsequent rebound of the US economy



Our preferred cyclical sectors: industrial, chemical, consumer goods, IT services, luxury, mining and construction



Uncertainty surrounding commodities and oil?

19

Sectors:

Theme of pre-emptive takeover bids ► Surge in takeover bids, and race for global champions 

Observation: the volume of takeovers, which have more than tripled over the last three years, reflects a quest for national, regional and global champions



Contradictions: firstly between liberalisation and the race for monopolies, then between the opening of borders and the local bias

► An ecosystem of global champions 

A matrix in which the rows are territories and the columns are centres of excellence



The race for decision-making, research, training centres and outsourcing contacts is giving rise to a groundswell of takeover bids, hostile or otherwise

► The answer to hostile takeover bids 

Legal arsenals are not very effective



Pre-emptive takeover bids: Suez-GDF, Endesa-Acciona, Intesa-San Paolo

20

Sectors:

Thematic rotation and business cycle: the defensive/cyclical match Performance by sector over 2 and 12 months

Basic Resources

10%

Basic Resources

+30%

Utilities

Energy

8%

+20%

Financial Services

Construction

6%

DJ Stoxx Retail Banks Insurance Chemicals Healthcare Industrial G&S

4% 2% Technology

0%

Financial Services

Food & Beverage Personal & Household Goods Travel & Leisure

Telecom

-2%

Insurance Perf. relative 12 mois

Earnings revisions over 6 months

Earnings revisions expected in 2007 over 3 and 6 months

Utilities

+10%

Construction Banks Personal & Industrial G&S Chemicals Retail Household Goods Healthcare Food & Beverage

+0%

Automobiles Travel & Leisure Technology

-10%

Media

Media Automobiles

-4% -8%

Energy -20%

-6%

-4%

-2%

0%

2%

4%

6%

8% Telecom

Earnings revisions over 3 months -30% -10%

Sources: CM-CIC Securities

21

-8%

-6%

-4%

-2%

+0%

+2%

+4%

+6%

Relative performance over 2 months

Sectors:

Financial stocks confirm their popularity DJ Stoxx Banks

1.50

DJ Stoxx Financial services

1.25 1.20

1.45

1.151.50

1.40

1.101.45

1.35

1.00

DJ Stoxx Banks

1.05 1.40

0.951.35

1.30

0.90

1.30

0.85

1.45 1.40

0.75

1.35

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

T4 2006

T3 2006 T4 2006

T3 2006

T2 2006

T2 2006

T1 2006

T1 2006

T4 2005

T4 2005

T3 2005

T3 2005

T2 2005 T2 2005

T1 2005 T1 2005

T4 2004 T4 2004

T3 2004 T3 2004

T2 2004

T2 2004

T1 2004

T1 2004

T4 2003

22

T4 2003

0.701.30

Price relative to DJ Stoxx 600

Source: CM-CIC Securities

T4 2006

T3 2006 T4 2006

T3 2006

T2 2006

T2 2006

T1 2006

T1 2006

T4 2005

T4 2005

T3 2005

T3 2005

1-year average price relative to DJ Stoxx 600

0.80

0.651.25

T2 2005

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

DJ Stoxx Banks

0.851.50

T2 2005

Price relative to DJ Stoxx 600

DJ Stoxx Insurance

0.90

T1 2005 T1 2005

T4 2004 T4 2004

T2 2004

T1 2004

T4 2003

T3 2004 T3 2004

1-year average price relative to DJ Stoxx 600

T2 2004

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

T1 2004

Price relative to DJ Stoxx 600

1.25

0.80

T4 2003

T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

T1 2004

T4 2003

1.25

Sectors:

Return to cyclicals DJ Stoxx Industry

0.90

DJ Stoxx Construction

1.10 1.05

0.85

1.00 0.95

0.80

0.90 0.85

0.75

0.80 0.75

0.70

0.70 T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

T4 2003

T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

T1 2004

T4 2003

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T4 2004

T3 2004

T2 2004

T1 2004

T4 2003

T4 2006

T3 2006

T2 2006

T1 2006

0.80 T4 2005

0.90 T3 2005

0.85

T2 2005

0.95

T1 2005

0.90

T4 2004

1.00

T3 2004

0.95

T2 2004

1.05

T1 2004

1.00

T4 2003

1.10

Sources: CM-CIC Securities

DJ Stoxx Retail

1.05

T1 2005

DJ Stoxx Chemicals

1.15

23

T1 2004

0.65

0.65

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

Sectors:

Some sectors are still being avoided DJ Stoxx Telecom

1.20

DJ Stoxx Media

0.90

1.15 0.85

1.10 1.05

0.80

1.00 0.95

0.75

0.90 0.85

0.70

0.80 T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

1-month average price relative to DJ Stoxx 600

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

Sources: CM-CIC Securities

Price relative to DJ Stoxx 600

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

1-year average price relative to DJ Stoxx 600

T4 2006

T3 2006 T4 2006

T2 2006 T3 2006

T2 2006

T1 2006

T1 2006

T4 2005

T4 2005

T3 2005

T3 2005

T2 2005

T2 2005

1-year average price relative to DJ Stoxx 600

T1 2005 T1 2005

1-month average price relative to DJ Stoxx 600

3-month average price relative to DJ Stoxx 600

T4 2004 T4 2004

Price relative to DJ Stoxx 600

T3 2004 T3 2004

T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

T1 2004

1.25

T2 2004

1.30

T2 2004

1.35

T1 2004

1.40

DJ Stoxx Banks

T1 2004

1.45

DJ Stoxx Technology

T4 2003

1.50

1.30 1.25 1.201.50 1.15 1.101.45 1.05 1.40 1.00 0.951.35 0.90 0.851.30 0.80 0.751.25 T4 2003

DJ Stoxx Healthcare

T4 2003

T1 2004

T4 2006

T3 2006

T2 2006

T1 2006

T4 2005

T3 2005

T2 2005

T1 2005

T4 2004

T3 2004

T2 2004

T4 2003

T1 2004

Price relative to DJ Stoxx 600

1.55

24

T4 2003

0.65

0.75

Sectors:

Preferred sectors â–ş Priority to financial and cyclical stocks Opinion

Negative

Neutral

Positive

Energy

Telecoms Utilities

Banks Insurance Financial services

Aerospace/defence Tourism & leisure Automotive

Chemicals Industry Retail Construction

Style Defensive Value

Cyclical Value

Defensive Growth

Cyclical Growth

25

Healthcare Household products Food

Cosmetics

Technology

Media

Luxury Mining