1. Fed Switch From QE to Forward Guidance, as China Starts Belated
Deleveraging in 2014
Sean Maher
Strategist
sean.maher@entext.com
+ 44 207 687 2213
Nov 2013

2. Given Scale of Fed Balance Sheet, Delaying Exit Much Longer Dangerous
$3.9trn into GEM Debt and Equities Since Crisis, $2.2trn to Asia
•
•
•
•
•
•
•
Global broad money M2 up $3trn YTD to end September (annualised 6% growth) of which
$2trn in GEM; global CPI inflation index up by only 2% - excess liquidity driving asset prices
Late stage bull market? – watch for frenzied US momentum tech trades on 100-200x PERs
reversing (Tesla, Amazon, Netflix)
PCE inflation well under 2%, real risk of delay is growing market dysfunction, disruptive credit
spread volatility - $4trn balance sheet makes Fed solvency questionable on normalization
- IMF estimates Fed losses in most likely rate normalization scenario would amount to
about 3% of GDP, or $500bn.
2% interest by 2015 on current excess reserves is $44bn annually i.e. slowing down money
velocity will be expensive once inflation expectations rise above 3% - interest payments plus
capital losses on LT bond holdings would require Fed recapitalisation, a huge political problem
One strategy would be to reduce duration of bond portfolio with a ‘reverse Operation Twist’,
using the short-term bonds obtained to mop up excess reserves, much like the BOJ did in
2006 - average maturity on Fed balance sheet about 10 years – versus 6 years for overall
market.
Blurring of lines between central banks and governments, led by Japan – shift globally to
Nominal GDP targeting? ECB and BOJ likely to ease further in 2014, to counter inflation
target undershoot - short JPY/Long Topix trade to resume in Q1
Fed likely to shift to rules based forward guidance from QE as policy focus in early 2014,
to cap LT rate expectations while diminishing near-term asset bubble risks
Sean Maher
Q1 Economic & Strategy Outlook
Market Overview
Almost $2.4trn in Excess Bank Reserves at Fed – Over 60% of Balance Sheet by Year End
2

3. Markets Face Pivotal Moment by Mid 2014 – Does QE Work in Real Economy?
US Credit Spreads at Post Crisis Lows, USD Biggest Loser from Debt Ceiling Scare
Gold Weakness Driven by ETF Liquidation, EM Demand Pressured from India to Turkey
Junk/IG Spread At Lows, Gold Struggles
500
450
400
350
300
250
2
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
22
18
14
10
200
Barclays US Agg Credit Option Adjusted Spread % (lhs)
Gold Spot Price ($) (lhs)
Junk/IG Yield Spread (bps) (rhs)
VIX Index (rhs)
S&P 500 Companies Boosting ROE Via
Buybacks Rather than Capex
Will USD Strength Resume in 2014?
122
118
15
114
(4Q through Q2 13)
20
Macro Overview
1950
1850
1750
1650
1550
1450
1350
1250
1150
1050
VIX Spike Reversed by QE For Longer
10
5
110
0
106
ROE %
Earnings
FCF
Sales Growth
Reinvestment Reinvestment % (annualised)
Rate %
Rate %
JPM Asian Dollar Index
Sean Maher
Q1 Economic & Strategy Outlook
3

4. Investor/Corporate Liquidity Preference Has Peaked –1990s Style Asset Bubbles?
Technology Absorbing CPI Pressures by Suppressing Labour ULC as well as Investment Costs
YTD Equity Inflows Outpacing Bond for first time since 2007 ($350bn versus $170bn)
•
•
•
•
Bubble risks advanced in corporate credit (esp.
Europe), US social networking stocks, prime
Asian real estate – US HY net leverage at 3.8x,
over 10% above LY average
Fed obsession with employment/output gap
framework misguided – structural shifts in
income distribution, demographics and
employment intensity of growth being
ignored
Further equity re-rating above LT CAPE
trend likely if liquidity preference declines
further – US liquid assets rose from 9% to
almost 13% of total household assets, now
declining and flowing into markets, combined
with excess global liquidity
S&P 500 revenue growth running at just 3.5%
annualised – yet consensus 15.4% operating
EPS growth in 2014
Market Cap./GDP at 1.12x, price/sales ratio at
1.6x, EV/sales 2.3x – latter only exceeded in
1999; margin debt over $400bn, testing July
2007 highs
Sean Maher
Buyout Median EBITDA Multiples
Above 2008 Highs
10.7
10.0
9.0
9.1
9.5
8.1
7.7
8.0
6.2
3.4
3.3
8.1
8.5
8.5
4.5
3.8
3.0
3.5
6.0
3.8
3.2
3.9
2.2
4.0
5.1
2.0
5.6
5.8
5.7
4.0
3.9
4.6
4.7
5.3
6.2
Bubble Trouble?
•
0.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
YTD
Debt/EBITDA (x)
Equity/EBITDA (x)
Valuation/EBITDA (x)
Q1 Economic & Strategy Outlook
4

5. How Much of Falling US Participation Rate is Structural?
Full-time employment/population ratio bottomed at 46% in January 2010, 47.7% now
Lower Immigration, Retiree Surge and Later Workforce Entry Supply Side Factors
Weak US Workforce Participation
Rate Complicates Fed Exit Strategy
US Workforce Growth Declining on
Demographics/Slower Immigration
69%
79%
67%
78%
4%
3%
65%
76%
US Labour Market
77%
2%
63%
75%
1%
61%
74%
59%
73%
57%
72%
0%
-1%
Employment-Population Ratio 12mma (lhs)
-2%
Civilian Participation Rate 12mma (lhs)
Civilian Participation Rate of Men Over 20 Years Old
12mma (rhs)
Total Civilian Labour Force (3yr % growth saar)
Total Civilian Employment (3yr % growth saar)
Sean Maher
Q1 Economic & Strategy Outlook
5

6. Fiscal Deficit Sub 2% of GDP in FY2015 – State/Local Hiring Budgets Growing
Inequality Key Structural Theme Globally - Share of US employees earning sub $15k in real terms
at 13% up 2ppts since 2000 - share making less than $35k grew 4ppts to 35.4%
50%
48%
9%
46%
55%
50%
45%
40%
35%
30%
11%
7%
Top 10% Income Share (Excluding capital gains)
Top 10% Income Share (Including capital gains)
Healthcare Inflation Slowing to 1-2%
44%
5%
450
350
250
42%
US Structural Themes
Top 10% Income Share at Record High
Wage Share of GDP at Record Lows
3%
150
50
Wage and Salary Disbursements (% GDP 12mma) (lhs)
Corporate Profits After Tax (% GDP 12mma) (rhs)
Overall Urban CPI Index (1982-84 = 100)
Healthcare CPI Index (1982-84 = 100)
Sean Maher
Q1 Economic & Strategy Outlook
6

7. Korea Vs. ASEAN Bet in Q3 Paid Off, as Did China Banks and AXJ Tech
Global Cyclical/Defensive Mean Reversion as ‘Low Volatility Anomaly’ Sectors Overshot
GEM Investors Rediscover Relative Macro Risks in Portfolio Differentiation – Bet on Capex Rebound?
Defensive Yield to Cyclical Switch
Has Legs, GEM Volatility to Resume
S&P 500 Stretched Vs. Japan, Europe
2.8
115
6%
110
4%
US
0%
100
-2%
95
-4%
90
Price to Book x
2%
105
Australia
World
2
UK
1.6
Eurozone
-6%
GEM
Sing
Japan
HK
85
-8%
80
Sector/Style Rotation
2.4
-10%
1.2
0.8
3
Global Cyclical - Def Spread (RHS)
Emerging Markets (Jan 1 2013 = 100) (LHS)
Sean Maher
Q1 Economic & Strategy Outlook
7
11
Trailing ROE %
15
7

8. Favour GEM to DM Exporters Over Domestic Consumer , Strong USD Beneficiaries
Japan and Europe Equities Over US, GEM Inflow/FX Volatility to Resume
Low Volatility Has Hit Macro Hedge Funds, Particularly in Commodities/Bonds – Volatility Looks Cheap
•
•
•
•
•
Citi US surprise index rolling over, but truck
tonnage in September hit all-time high, up
8.4% y/y - US corporate credit option adjusted
spread at post-crisis lows
Large portion of EM portfolio flows this cycle
from dedicated global EM funds and large
‘Total Return’ style global bond strategies,
rather than banks – total inflows 5% of EM
GDP
Risks highly correlated ‘risk off’ episode when
Fed finally tightens - EMD has recouped about
half summer losses – EM feedback to Fed
policy via S&P earnings/exports complicates
monetary policy further
Underweight commodity terms of trade
losers – deteriorating external balances
combined with consumption/real estate booms
a risk from Brazil to Indonesia and Australia,
potential banking sector funding cost if inflows
reverse
Trend strengthening in USD will draw capital
out of Asia, Japanese AXJ reallocation
sufficient to offset?
Scale and timing of RMB convertibility key
factor – early opening of capital account could
add further excess liquidity to regional markets
Sean Maher
Excess Returns by Asset Class
20%
15%
10%
Asset Allocation
•
5%
0%
-5%
-10%
-15%
1 year
Q1 Economic & Strategy Outlook
3 years
5 years
8

9. Weak US Corporate Investment a Drag on Recovery, But Acceleration Looms
High Correlation With Employment Growth – Surveys/Replacement Cycle Positive
Capex 53% of NIPA Profits in 2012, 68% Average Since 2002 – Mean Reversion on Replacement Cycle?
US Corporate Net Cash Flow as % GDP
Has Surged, Led by Tech Sector
US Corporate Investment Intentions and Job
Openings Turn Higher
14
30
25
12
20
20
10
15
8
10
But Corporate Investment Still Weak…
16%
8%
0
5
-10
0
-5
-20
% GDP
7%
-10
14%
6%
-30
-15
12%
5%
4%
10%
3%
US Capex
Corporate Net Cash Flow as % GDP 12mma
Index
% y/y
10
-40
-20
8%
2%
Non-Residential Fixed Investment (% y/y SAAR)
Total Nonfarm Job Openings % y/y 3mma
Private Residential Fixed Investment
Government Fixed Investment
Private Nonresidential Fixed Investment - rhs
Sean Maher
Philly Fed Future Corporate Capex Diffusion Index (6mma)
Q1 Economic & Strategy Outlook
9

10. US/Europe Fiscal Drag Eases in 2014, Boosting Global Trade
GEM Underperformance on loss of GDP and Earnings/Margin Momentum, Reform Paralysis
FX Reserve Growth Just 5% in 2012 - BOP Focus as Terms of Trade for Commodity Exporters Slump
•
•
•
•
GEM EBITDA margin at 16% now sub DM - 3
and 6mth GEM earnings revisions still
negative as is revision breadth, but improving
at margin – P/B at 1.4x and CAPE at 16.5 x
(versus US at 23x) offers support – Europe
cheaper but limited LT growth
Historically high return on EM labour vs.
capital undermined productivity growth,
which has been falling everywhere, while
earnings driven by top-line growth rather than
by expanding margins has created poor capital
discipline.
Resources account for 40% of GEM equity
earnings – secular bull market now over, driving
soft earnings momentum
Sustained QE destabilising EM economies with
pegs to the USD, BOJ action hasn’t added to
portfolio inflows yet – bank credit quality
deteriorating
Net $28bn in EM debt outflows since May,
resumed in recent weeks – 5% correction in
GEM real exchange YTD only beginning of
trend
Sean Maher
DM Structural Budget Balance
Adjustment Easing in 2014 ex Japan
(% GDP)
2.3%
1.8%
GEM Debt & Equities
•
1.3%
0.8%
0.3%
-0.2%
-0.7%
Q1 Economic & Strategy Outlook
2013
2014
2015
10

11. BOJ Injecting 16% of Annual GDP into Asset Markets, 3x More than Fed
Wage Inflation Critical or ‘Abenomics’ Will Backfire – Cash Wages Down 0.6% y/y
LT MSCI World Relative PER Premium on Topix Normalised at 16-17k – 110 JPY Target end Q1
• Cash Wage Growth of +0.5% y/y Probably Requires Unemployment Sub 3.5%
• Female Participation Rate Rising, Still Sub 49% – Key To Reducing Demographic Drag
• Bank lending at 4-year high but limited credit demand; key measure of success is whether private
investment accelerates into 2014
Households Invested for Deflation
7.0%
900
Euro Area
(€19.3trn)
35.8%
600
9.5%
14.4%
3.2%
32.8%
Japan
(JPY 1,547trn)
-300
-600
55.2%
0%
20%
28.1%
4.0%
2.1%
0
31.7%
11.8%
United States
14.6%
($54.4trn
300
3.9%
7.2%
6.8%
40%
60%
4.2%
27.7%
80%
Currency and Deposits
Stocks Net Flow 12 Week MA - JPY Bn
Bonds Net Flow 12 Week MA - JPY Bn
Sean Maher
Japan
Will Japanese Investors Return to
Foreign Markets?
Bonds
Investment Trusts
Shares and Equities
Insurance and Pension Reserves
100%
Others
Q1 Economic & Strategy Outlook
11

12. Modest 1-1.5% Recovery in 2014 – Credible Stress Tests Crucial, New LTRO?
Loan to Deposit Ratios Unsustainable – Credit Contracting at 4% y/y
Bank Assets 375% of GDP Vs. 160% in Japan, 75% in US, Bad Debts 8% of Loans in Italy, 12% in Spain
•
•
•
Bank Loan to Deposit Ratios 120% in Italy/Spain, vs. 70% in Asia/US – Eurozone GDP Almost 3% Below
Pre-Crisis Peak, but 1-1.25% Growth in 2014
German ‘Grand Coalition’ Unlikely to See Austerity Relaxation, But Fiscal Drag Peaking; Bundesbank
wants removal of zero risk weighting on sovereign debt
Political Risks Receding – Backlash versus Golden Dawn in Greece/Berlusconi in Italy
French Spreads Over Bunds to Widen by 50-100bps in 2014?
German Trade Surplus Near Record
11
750
650
550
450
350
250
150
50
-50
-150
-250
-350
-450
9
Current Account % GDP
Spanish Eurosystem Liabilities Down
Over €160bn Since mid-2012
7
5
3
1
-1
-3
-5
Europe
•
-7
China
Sean Maher
US
Germany
Finland
Greece
Netherlands
Q1 Economic & Strategy Outlook
France
Ireland
Portugal
Germany
Italy
Spain
12

13. Plenum Marked Decisive Shift in Pro-Market Direction, RMB Overvalued?
Pressure to Accelerate Convertibility – But Needs Deeper Bond Markets (only 45% of GDP)
Investment 56% of GDP Growth in Q3 as House Prices Accelerated in Tier 1 Cities
• Average Price/income ratios from 12x (Shenzhen) to 15x (Shanghai) and 22x (Beijing) versus 5x in Singapore, 7x in
London/NY and 9x in Sydney - real estate 25% of fixed investment
• Leverage heading toward 250% of GDP by 2016/17 on current trend, pace of domestic investment growth must slow 57ppts to mid-teens; external demand pick-up key to deliver even 6-7% growth during the transition
20% RMB Real Appreciation Since
2010 a Drag on Growth
120
Property Price Boom Destabilizing
24
21
18
112
15
108
104
China
REER (Jan-2010 = 100)
116
12
100
9
96
92
6
88
3
84
80
0
-3
China
Indonesia
India
Korea
Malaysia
Singapore
Thailand
Brazil
Russia
Tianjin
Guangzhou
Shenzhen
Sean Maher
Big 5 Average
Beijing
Shanghai
Q1 Economic & Strategy Outlook
13

14. Productivity Growth Falls to 7-8% as Investment/Output Ratio Soars
Boosting Productivity From 17% of US Levels Key - SOE Capex/Sales Ratio at 10% Peaking
45% of Debt ST Vs. 33% in non China AXJ – 50% of Listed Stocks Have Sub IG Credit Profile
6
5.2
5
3.9 4
3.2
3
2.7
3.2
2
1
0
2009-2012 1961-1970 1981-1990 1981-1990 1991-2012
China
Japan
S. Korea Taiwan
Investment Ratio (%GDP)
GDP Growth %
Investment/Output Ratio x
China
5
Industrials
4
Materials
3
Real Estate Median NonFinancial
2
1
Energy
Consumer
Discretionary
0
0
5
10
15
EBITDA Interest Cover (x)
20
China FCF/Debt Cover A Third of AXJ
China GDP Drivers (% Growth)
25
30%
3.0
1997-2002
Capital
Labour (Quality
Adjusted)
2003-7
2008-11
3.5
4.3
3.9
2.5 - 3
25%
2.5
20%
2012-17
1.6
1.3
1
0 - 0.5
2.0
2.5
6.6
4.8
2.5 - 3
GDP
7.6
12.1
11.5
6 - 7.5
TFP as % of GDP
Growth
33
54
51
35 - 40
Sean Maher
15%
10%
1.5
TFP
China - Productivity
60
50
40
30
20
10
0
Cyclicals Remain Vulnerable to Reform Led
Slowdown in 2014/15
Gross Debt/EBITDA (x)
Collapsing Investment Returns Force
Growth Model Shift
5%
1.0
0%
China
AxJ ex China
Europe
US
Median Gross Leverage (x, lhs) Median FCF/Total Debt (%, rhs)
Q1 Economic & Strategy Outlook
14

15. External Balances and ‘Stickiness’ of Capital Flows Matter Again for GEM
$3.9trn in GEM Inflows Since 2009, Largely in Debt – EM FX Volatility to Resume in Q1
Indian and Indonesian Current Account Rebalancing in 2014?
•
•
•
•
Since 2008 bank inventories of EM assets
have shrunk more than 70% to about one
day’s trading volume - combined with ‘one
click’ ETF flows, makes risk-off episodes
inherently more violent and correlated
Markets with trend credit/GDP ratio rising,
inflation above trend are going to face
sustained volatility i.e. Turkey, India, South
Africa, Indonesia, and Brazil
Thailand, Malaysia adjustment to be
absorbed
mostly
by
currency
depreciation rather than by broader
economic and asset market disruption.
Negative feedback loop focuses on
currency weakness driving inflation
dynamics and challenging the credibility of
central banks – stagflation environment
persists from India to Indonesia and Brazil
Moderate improvement in EM PMIs in
recent months, but level remains relatively
low and China has disappointed - watch for
improving Indian/Indonesian trade data to
offer INR/IDR support in Q1
Sean Maher
FX Investors Fled Funding Vulnerability
6
30
20
4
10
2
0
0
-10
-2
-20
-30
-4
-40
-6
GEM FX
•
-50
-8
-60
Current Account Q213 (%GDP, 4Q sum)
Net International Position % GDP
Q1 Economic & Strategy Outlook
15

16. US Biggest Non-OPEC Oil/NGL Producer by mid-2014 at 11m bpd
Over Past Decade, 50% of US Trade Deficit Was Energy Imports – Long Term Trend USD Positive
China Now Biggest Importer - Needs Urgent Energy Pricing Reforms To Curb Pollution
• US Oil Production at 8.2m bpd next year – Rising Auto Fuel Efficiency Reducing Consumption
• China consumes about 35-40% more energy than Korea, 2x Brazil at comparable income levels
• Iranian crude exports halved after the EU/US sanctions in mid-2012, cutting revenues by over $35bn a
year – return to market by mid-2014?
China's Energy Intensity Unsustainable
Net Oil Imports Halve Since 2007
3100
13000
2800
12000
2500
11000
2200
10000
1900
9000
1600
8000
7000
250
200
150
100
50
1300
6000
300
Energy
14000
350
3400
Exports (ths bl/d, 4wk avg)
Imports, Balance (ths bl/d, 4wk avg)
15000
1000
Energy Intensity (mt oil equivalent/$m GDP)
Balance (lhs)
Sean Maher
Imports (lhs)
Exports (rhs)
Q1 Economic & Strategy Outlook
16

17. Stagflation Trend Until Post Election - INR Fair Value 60 on Productivity Adjusted Basis
Key is Private Investment Rebound and Current Account – Gold Imports Have Collapsed Since May
Corporate Capex 11% of GDP from 17% in 2008 – Modest Growth Rebound to 5% in FY2014
•
•
•
•
Chronic Supply Side Inflation Bottlenecks Remain – Vulnerable to renewed USD Rally
State banks Risk 15% Peak NPLs – Restructured Debt Over 6% of Loans
Rajan Strategy Cheered by Markets But Will Backfire if Capital Goods Output Trend Remains Dire
After 15% rally, Sensex at 10-yr avg. 15x forward PER – ROE under pressure; Corporate Debt Better Bet
Low Indian FX Reserves Underline
Funding Risks
Industrial Output Growth Weak,
and Inflation Persistent
0
130%
-50
120%
62.0
11%
60.0
9%
58.0
7%
56.0
5%
54.0
3%
-300
52.0
1%
-350
50.0
-1%
48.0
-3%
-100
IIP 3mma (% y/y) (RHS)
Sean Maher
WPI (% y/y) (RHS)
100%
-250
Manufacturing PMI (LHS)
-200
90%
India
110%
-150
80%
-400
70%
-450
60%
Total External Debt (USDbn)
Current Account (USDbn)
Reserves as % of Debt + CA (RHS)
Q1 Economic & Strategy Outlook
17

18. Structural Investment Themes
Intelligent Machines, Mobile Web, Safe Food, and Chinese Wealth Dispersal
•
•
•
•
•
‘Internet of Things’ boom – Smartphone market
maturing (c2bn globally by end 2013), but smartphone
technology embedded in consumer durables and
industrial machines, MEMS (micro engineered
machines) – Samsung and TSMC– chip prices rising
on supply discipline (DRAM, NAND)
ASEAN Investment over Consumption exposure –
flipside of China rebalancing is higher fixed investment
share of GDP in Philippines/Indonesia/Thailand
Global Internet Traffic Shift to Mobile – Currently
only 15% - e.g. Baidu’s mobile search app downloads
up 50% q/q, Facebook ad revenue
Chinese Food Safety - Baby Formula panic likely to
widen as middle class favour imported/local organic
food over domestic, after spate of scandals – a third of
arable land contaminated with heavy metals/pesticides
China Pollution Crisis – PV solar cycle is turning
after overcapacity price crash as alternative share of
China/Japan energy mix surges – wind and solar 3-4%
of China energy mix by 2020, global PV glut easing
and prices stabilising. Global PV industry to install 42
GW this year, up 40% y/y
Sean Maher
•
•
•
•
•
Long China Asset Gatherers/Wealth Management
– capital market deepening (bonds), opening of
capital account as liquidity is redirected from real
estate
China R&D spend – target to add 1% of GDP by
2015 or $60-70bn - recent weak manufacturing
investment trend should reverse, suppliers of
instrumentation, testing, laboratory equipment etc.
China Industrial Automation/Robotics – driven by
rapid decline in school leavers entering factory
workforce, 15% compound wage growth and
weakening productivity ex FDI sectors
US Consumer Revival – record low debt service
costs and rising net worth will offset still weak real
income growth, pockets of skill shortages from
industry to IT already driving a wage pick-up
Short Asian Petrochem Industry - impact from US
energy boom – gas 5-8x more expensive in Asia,
feedstock margins far higher for US processing –
excess capacity in Asia?
Q1 Economic & Strategy Outlook
Investment Themes
Cost of capital to Rise Globally as GEM Reserve Accumulation Peaks at $9trn on Demographics
18

19. Lower US/Europe Fiscal Drag in 2014, Low US Energy Costs Underpin Growth
•
•
•
•
•
•
•
•
A global resynchronization in growth plausible in 2014: the easing in fiscal drag next year alone will
add 0.6 ppts to growth for G7, including more than 1.5% in the US (IMF). Business surveys suggest that
‘animal spirits’ are gradually returning from depressed levels. From the Tankan survey, to the IFO, to the
Philly Fed survey, capital spending plans are being revised up.
Repeated central-bank intervention has repressed market volatility, lowered correlations and given
the illusion of systemic stability – but can’t tackle structural trends including technology shifts
driving inequality/weak aggregate demand - ‘Financial Repression’ via QE driving asset bubbles from
Asian real estate to US high yield corporate debt – but inflation still well contained globally
China’s growth transition implies huge wealth transfer from state/SOEs and opening capital
account - liberalising interest rates and deepening domestic bond markets key reforms – 7% GDP trend
growth with downside if reforms delayed
US GDP and productivity growth look set to accelerate versus Europe/Japan as share of global
economy generated online soars - energy competiveness/low unit labour costs boost ‘on shoring’ trend –
positive for USD on current account
Japan taking huge risk with belated monetary stimulus – will ultimately backfire unless wage
growth/productivity and lending also accelerate
Global online economy growing 5-8x faster than offline – but China productivity can benefit in telecom,
finance, retail, and education from domestic internet giants
Cost of capital globally likely to rise structurally from mid-decade, as demographic dividend from
China reverses, shortage of domestic deposits
USD looks very cheap on LT fundamentals – test of 100 on DXY in 2014? Both ECB and particularly
BOJ likely to be expanding stimulus to pre-empt disinflationary risks
Sean Maher
Q1 Economic & Strategy Outlook
Summary
Global Growth to Accelerate Toward 3.5%, 3% in US if Capex Recovers
EM Export Pick-Up, But Domestic Demand Constrained by Slowing Credit Growth
19

20. Macro Summary
Recommendations as Tilt Versus Strategic Benchmark/Single Class Limits or Long/Short
For Absolute Return Investors
Investment View
Asset class
Equities
Trading View
(3-6 months)
(1-3 months)
Rationale
Bullish
US
Neutral
Neutral
Tes ting 1800 ERP bas ed fair value target des pite earnings downgrades - cyclical top in Q1?
Europe
Bullis h
Bullis h
Reces s ion eas ing, Target 2 balances im proving
expens ive
UK
Neutral
Neutral
Dom es tic earnings expos ure preferred, res ource weighting a drag on valuation and m om entum
Japan
Bullis h
Neutral
110 JPY/$ by end Q1 on portfolio rebalancing, s tructural reform s key for equity break out on ROE boos t
Asia Pacific
Bearis h
Neutral
O/W late-cycle s ectors (e.g. Indus trials ), Chines e banks , Korea, Taiwan - clos e Thailand/Ppns s hort
GEM Equities
Neutral
Bullis h
Valuations dis count negative earnings m om entum , particularly GEM m aterials - O/W China, Korea, CEE
Fixed Income
Bearish
Governm ent
Bearis h
Bearis h
10yr Treas ury in 2.5-3% range until Fed tim etable clear
Investm ent Grade
Bearis h
Bearis h
Prefer HY to IG. US Financial bonds within IG.
High Yield
Bullis h
Neutral
Default rate at record lows offers s upport
EM deb t
Neutral
Neutral
EMBI tapering led correction was overdue, value in Indones ia, India as CA deficits peak in com ing m onths
Commodities
Neutral
Energy
Neutral
Bearis h
Brent fair value $90-95/bbl on overs upply, geopolitical prem ium s hould revers e in Q4
Industrial Metals
Neutral
Neutral
Copper near m arginal cos t s upport, China data and low inventories s upporting iron ore at $100/m t
Precious Metals
Neutral
Neutral
Gold in $1100 - $1400 range - ETF adjus tm ent over but India likely to turn net s eller s o re-tes t of lows
feas ible
Agriculture
Bearis h
Neutral
Overs upply near term (es p. rice on Thailand) - LT bull cas e intact on China food quality cris is
USD
Bullis h
Bullis h
Bearis h s entim ent prevails on tapering delay but breakout to 100 on DXY in 2014 feas ible - cheap on LT
fundam entals
GBP
Bearis h
Neutral
New hous ing boom underway and GDP likely to grow 1.5% this year, but UK fis cal outlook challenging
JPY
Bearis h
Neutral
Cons olidating as expected s ub 100, target productivity adjus ted fair value 110 vs USD
Europe
Bearis h
Neutral
Reces s ion eas ing, but ECB will eas e in 2014 as Fed exits - target 1.25
Neutral
Neutral
Long pes o, INR fair value at 60, IDR s till high ris k but cheap - KRW, SGD LT bets
Summary Asset View
- prefer European large caps over US but getting
FX
Asia Pacific
Sean Maher
Q1 Economic & Strategy Outlook
20