1 The Global Macro Outlook: Investing In Turbulent Times Peter Berezin Chief Strategist Bank Credit Analyst May 2013

1

The Global Macro Outlook: Investing In Turbulent Times

Peter BerezinChief StrategistBank Credit Analyst

May 2013

2

THE THREE KEY QUESTIONS THAT INVESTORS NEED TO CONSIDER:

© BCA Research 2013

• Will U.S. growth accelerate anytime soon?• Will the euro crisis be resolved?• Will China suffer a hard landing?

3

U.S. GROWTH TO STAY SLUGGISH FOR MOST OF THE YEAR


3.5

3.0

2.5

2.0

2010 2011 2012

3.5

3.0

2.5

2.0

50

0

-50

-100

50

0

-50

-100BLOOMBERG CONSENSUSECONOMIC FORECAST FOR U.S. GDP

FULL-YEAR 2012 FULL-YEAR 2013 FULL-YEAR 2014

Ann%Chg

Ann%Chg

U.S. ECONOMIC SURPRISE INDEX*

SOURCE: CITIGROUP GLOBAL MARKETS INC.

2013* ROLLING 3-MONTH STANDARD DEVIATION OF DATA SURPRISES, SMOOTHED.

4

PLENTY OF PENT-UP DEMAND

3

2

1

0

1950 1960 1970 1980 1990 2000 2010

3

2

1

0

30

26

22

18

30

26

22

18

5-YEAR PERCENT CHANGE, ANNUALIZED:REAL PRIVATE-SECTOR CAPITAL STOCK PER CAPITA

% %

U.S. CYCLICAL SPENDING (PERCENT OF POTENTIAL GDP)% OfGDP

% OfGDP

NOTE: SHADED AREAS REPRESENT NBER-DESIGNATED PERIODS OF RECESSIONS.


5

GROWTH SHOULD ACCELERATE BY THE END OF THE YEAR


5

4

3

2

2000 2002 2004 2006 2008 2010 2012

70

60

50

40

30

20

10

U.S.

RESIDENTIAL CONSTRUCTION (PERCENT OF GDP) (LS)

NAHB* HOMEBUILDERS OPTIMISM (ADVANCED) (RS)

% OfGDP

* NATIONAL ASSOCIATION OF HOMEBUILDERS.

Housing on the mend

6

HOUSEHOLD DEBT HAS COME DOWN

14

13

12

11

10

2000 2002 2004 2006 2008 2010 2012

14

13

12

11

10

130

120

110

100

90

130

120

110

100

90

HOUSEHOLD DEBT-SERVICE PAYMENTS(PERCENT OF DISPOSABLE INCOME)

% %

U.S. HOUSEHOLD DEBT(PERCENT OF DISPOSABLE INCOME)

% %


7

LESS DRAG FROM STATE AND LOCAL GOVERNMENTS


.4

.2

0

-.2

-.4

2000 2002 2004 2006 2008 2010 2012 2014

0

50

100

150

U.S.CONTRIBUTION TO REAL GDP GROWTH FROM STATE & LOCAL GOVERNMENTS (LS)

STATE BUDGET SHORTFALLS* (INVERTED) (RS)

% BnUS$

* REVENUES COLLECTED BY STATES MINUS PROJECTED CURRENT SERVICES SPENDING. SOURCE: CENTER ON BUDGET AND POLICY PRIORITIES.

8

WITH THE EXCEPTION OF GREECE, IRRESPONSIBLE FISCAL POLICIES DID NOT CAUSE THE EURO CRISIS


80

60

40

1995 2000 2005 2010

80

60

40

110

100

90

80

110

100

90

80

SPAIN

% OfGDP

% OfGDP

GOVERNMENT DEBT-TO-GDP RATIO:

GIIPS*

% OfGDP

% OfGDP

* GIIPS = GREECE, IRELAND, ITALY, PORTUGAL AND SPAIN.SOURCE: IMF AND EUROPEAN COMMISSION.

9

SPANISH GOVERNMENT DEBT HAS INCREASED DESPITE FISCAL AUSTERITY


60

55

50

45

2007 2008 2009 2010 2011 2012 2013

60

55

50

45

130

125

120

115

110

105

130

125

120

115

110

105

GOVERNMENT SPENDING ON GOODS AND SERVICES

€Bn

€Bn

PUBLIC-SECTOR EMPLOYEE COMPENSATION

IMF ESTIMATES AND PROJECTIONS FOR SPAIN MADE IN 2008

MADE IN 2012

Bn€ Bn

€

NOTE: BASED ON IMF STAFF REPORTS FOR ARTICLE IV CONSULTATIONS WITH SPAIN.

6%

23%

10

THE MAIN REASON DEBT HAS INCREASEDIS BECAUSE GROWTH HAS COLLAPSED


1400

1300

1200

1100

1000

900

2005 2006 2007 2008 2009 2010 2011 2012 2013

1400

1300

1200

1100

1000

900

NOMINAL GDP:IMF ESTIMATES AND PROJECTIONS FOR SPAIN

MADE IN 2007

MADE IN 2012

€Bn

€Bn

NOTE: BASED ON IMF STAFF REPORTS FOR ARTICLE IV CONSULTATIONS WITH SPAIN. THE PROJECTION FOR NOMINAL GDP IN 2013 IS BASED ON THE EXPECTED GROWTH RATE IN THAT YEAR, AS PUBLISHED IN THE IMF'S 2008 ARTICLE IV CONSULTATION. All OTHER DATAPOINTS IN THIS SERIES ARE BASED ON THE 2007 ARTICLE IV CONSULTATION.

26%

11

THE CREATION OF THE EURO SOWED THE SEEDS OF ITS OWN DEMISE


6

4

2

0

-2

1999 2000 2001 2002 2003 2004 2005 2006

6

4

2

0

-2

8

6

4

2

8

6

4

2

REAL INTEREST RATES**% %

2-YEAR GOVERNMENT BOND YIELD* GREECEIRELANDPORTUGALSPAINITALYFRANCEGERMANY

% %

* SOURCE: THOMSON REUTERS.** 2-YEAR GOVERNMENT BOND YIELD DEFLATED BY CPI.

12

THE EVOLUTION OF EURO AREA UNIT LABOR COSTS


130

120

110

100

1996 2000 2004 2008 2012

130

120

110

100

UNIT LABOR COSTS

GIIPS*

EURO AREA EXCLUDING GIIPS*

* GDP-WEIGHTED AVERAGE OF GREECE, IRELAND, ITALY, SPAIN AND PORTUGAL.NOTE: ALL SERIES SHOWN REBASED TO 2000 = 100.SOURCE: EUROPEAN COMMISSION.

13

FISCAL ADJUSTMENT IN THE PERIPHERY: MISSION ACCOMPLISHED?


1

0

-1

-2

2008 2010 2012 2014

1

0

-1

-2

2

0

-2

-4

2

0

-2

-4

FISCAL IMPULSE***

% OfGDP

% OfGDP

GIIPS*CYCLICALLY-ADJUSTED

PRIMARY BALANCE**

% OfGDP

% OfGDP

* GDP-WEIGHTED AVERAGE OF GREECE, IRELAND, ITALY, PORTUGAL AND SPAIN.** AS A SHARE OF POTENTIAL GDP. *** CHANGE IN THE PRIMARY STRUCTURAL BUDGET BALANCE AS A SHARE OF POTENTIAL GDP.

2009 2011 2013 2015

SOURCE: IMF, INCLUDES ESTIMATES AND PROJECTIONS.

14

WILL CHINA SUFFER A HARD LANDING?

1000

800

600

400

200

2002 2004 2006 2008 2010 2012

1000

800

600

400

200

NUMBER OF ARTICLES MENTIONING CHINESE HARD LANDING*

* SOURCE: FACTIVA.


15

CHINA: GROWTH HAS SURPRISED TO THE DOWNSIDE


100

50

0

-50

2010 2011 2012

100

50

0

-50

CHINESE ECONOMIC SURPRISE INDEX*

*SHOWN AS A 5-DAY MOVING AVERAGE; SOURCE: CITIGROUP GLOBAL MARKETS INC.

16

MONETARY EASING SHOULD HELP BOOST GROWTH LATER THIS YEAR

36

32

28

24

20

16

2006 2008 2010 2012

36

32

28

24

20

16

CHINA:TOTAL SOCIAL FINANCING

Ann%Chg

Ann%Chg

NOTE: SUM OF TOTAL FUNDRAISING BY CHINESE NON-STATE ENTITIES, INCLUDING INDIVIDUALS AND NON-FINANCIAL CORPORATES.

17

LITTLE EVIDENCE OF A CREDIT BUBBLE


80

60

40

20

2000 2002 2004 2006 2008 2010 2012

80

60

40

20

8

6

4

2

115

110

105

100

95

HOUSEHOLD DEBT-TO-GDP RATIO:

U.S. CHINA

% ofGDP

% ofGDP

CHINESE

NEW RMB LOANS* (LS) DOMESTIC BANK CREDIT (RS)

TnRMB

% ofGDP

* SHOWN AS A 12-MONTH MOVING TOTAL.

18

CHINA: MANY YEARS OF RAPID GROWTH AHEAD


12

8

4

0

-4

1990 2000 2010 2020 2030 2040 2050

12

8

4

0

-4

100

80

60

40

20

100

80

60

40

20

GDP GROWTH

SOUTH KOREA

CHINA

Ann%Chg

Ann%Chg

GDP PER EMPLOYED WORKER IN CHINA RELATIVE TO SOUTH KOREA% %

SOURCE: THE CONFERENCE BOARD TOTAL ECONOMY DATABASE, BCA ESTIMATES AND PROJECTIONS.

Average growth of 8% in China between 2013 and 2030

19

INVESTMENT STRATEGY

• Risk assets are vulnerable to a near-term correction. Investors should remain tactically cautious, but use any correction in prices to increase risk exposure.

• U.S. equities will outperform bonds over a two-to-five year horizon.• Long-term Treasurys are significantly overvalued. A 1994-style bond riot

cannot be ruled out.• Corporate credit is less attractive than equities, but pockets of value

remain.• Despite recent strength, the dollar has not yet bottomed.• Globally, emerging markets are poised to do very well over the next few

years. Japan is also likely to outperform.• Commodity prices will find some support later this year, but a major bust

is coming later this decade.

20

EQUITIES ARE CHEAP COMPARED TO BONDS…


8

6

4

2

0

1985 1990 1995 2000 2005 2010

8

6

4

2

0

U.S. S&P 500 TRAILING EARNINGS YIELDMINUS REAL* 10-YEAR TREASURY YIELD

% %

* DEFLATED BY 10-YEAR INFLATION EXPECTATIONS.

21

…BUT NOT ESPECIALLY CHEAP IN ABSOLUTE TERMS


6

4

2

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

6

4

2

2.0

1.5

1.0

.5

2.0

1.5

1.0

.5

40

30

20

10

40

30

20

10

PRICE-TO-BOOK RATIO

PRICE-TO-SALES RATIO

S&P 500:SHILLER P/E RATIO*

* SOURCE: ROBERT SHILLER.** EXCLUDING FINANCIALS, UTILITIES AND TRANSPORTS.

16% above median

40% above median

30% above median

Median

Median

Median

S&P 500**:

22

U.S. HOUSEHOLDS ARE NOT PARTICULARLY UNDERWEIGHT STOCKS

50

40

30

20

1950 1960 1970 1980 1990 2000 2010

50

40

30

20

40

30

20

10

40

30

20

10

AS A PERCENT OF FINANCIAL ASSETS

% %

AS A PERCENT OF TOTAL ASSETS

U.S. HOUSEHOLD ASSETS:DIRECTLY AND INDIRECTLYHELD EQUITIES

% %

SOURCE: FEDERAL RESERVE FLOW OF FUNDS. LATEST QUARTERLY DATAPOINT REPRESENTS BCA ESTIMATE.

Average

Average

23

TREASURYS REMAIN OVERVALUED

2

1

0

-1

1990 1995 2000 2005 2010

2

1

0

-1

8

6

4

2

8

6

4

2

TERM PREMIUM**% %

U.S.

10-YEAR TREASURY YIELD, 5 YEARS FORWARD*

10-YEAR TREASURY YIELD*

% %

* SHOWN SMO0THED EXCEPT FOR LATEST DATAPOINT.** SOURCE: KIM AND WRIGHT, FEDERAL RESERVE FINANCE AND ECONOMICS DISCUSSION SERIES, 2005-33.

24

HIGHER INFLATION AHEAD


3.0

2.0

1.0

2011 2012 2013 2014 2015 2016 2017 2018 2019

3.0

2.0

1.0

2.8

2.4

2.0

1.6

2.8

2.4

2.0

1.6

9

8

7

6

9

8

7

6

FED FUNDS RATE

% %

PCE INFLATION*

% %

THREE POLICY PATHS

BASELINE (MARKET EXPECTATIONS)

JANET YELLEN'S 'OPTIMAL POLICY' RULE

MODIFIED TAYLOR RULE

U.S.UNEMPLOYMENT RATE

% %

* 4-QUARTER PERCENT CHANGE.SOURCE: THREE POLICY PATHS: AN ILLUSTRATIVE EXERCISE (PERSPECTIVES ON MONETARY POLICY), JANET L. YELLEN, JUNE 6, 2012.BASELINE FROM THE FEDERAL RESERVE BANK OF NEW YORK, SURVEY OF PRIMARY DEALERS. LATEST UPDATE: NOVEMBER 2012.

25

STILL SCOPE FOR SPREAD COMPRESSION


12

8

4

2006 2008 2010 2012

12

8

4

1200

800

400

0

1200

800

400

012-MONTH TRAILING DEFAULT RATE**BCA FORECASTDEFAULT LOSS***BCA FORECAST

% %

U.S. HIGH-YIELD INDEX:DEFAULT-ADJUSTED SPREAD*PESSIMISTIC RECESSION SCENARIO

BPs BPs

** SOURCE: MOODY'S INVESTORS SERVICE.

*** CALCULATED AS: DEFAULT RATE × (1 - RECOVERY RATE).

* OPTION-ADJUSTED SPREAD LESS EXPECTED DEFAULT LOSSES, SOURCE: BARCLAYS.

26

DOLLAR SENTIMENT IS STRETCHED


80

60

40

20

2008 2010 2012

80

60

40

20

60

40

20

0

-20

80

40

0

-40

BULLISH SENTIMENT ON THE DOLLAR**% %

U.S. DOLLAR SPECULATIVE POSITIONS* NET LONG (LS) NET LONG (PERCENT OF OPEN INTEREST) (RS)

%

* SOURCE: CFTC.** SOURCE: MARKETVANET.NET.

Bn

27

CYCLICAL FACTORS HAVE FLATTERED THE U.S. CURRENT ACCOUNT


1.2

.8

.4

1990 1995 2000 2005 2010

1.2

.8

.4

1.0

.5

0

-.5

1.0

.5

0

-.5

EXTERNAL INVESTMENT INCOME BALANCE% OfGDP

% OfGDP

BCA MODEL ESTIMATE* OFTHE CYCLICAL IMPACT ONTHE U.S. NON-OIL TRADE BALANCE

% OfGDP

% OfGDP

* BASED ON A REGRESSION OF THE NON-PETROLEUM GOODS TRADE BALANCE ON THE FEDERAL RESERVE'S BROAD REAL EFFECTIVE EXCHANGE RATE, THE U.S. OUTPUT GAP, THE EXPORT-WEIGHTED GLOBAL (EX. U.S.) OUTPUT GAP AND A LINEAR TIME TREND.NOTE: SHADED AREAS DENOTE NBER-DESIGNATED RECESSIONS.

1% of GDP

1% of GDPswing

28

EMERGING MARKETS ARE NOW SOMEWHAT CHEAPER THAN DEVELOPED MARKETS


1

0

-1

-2

-3

-4

1996 1998 2000 2002 2004 2006 2008 2010 2012

1

0

-1

-2

-3

-4

VALUATION GAP BETWEEN EMERGING MARKETSAND DEVELOPED MARKETS*

* STANDARDIZED AVERAGE OF PRICE-TO-SALES, PRICE-TO-CASH FLOW, PRICE-TO-BOOK, PRICE-TO-TRAILING EARNINGS, PRICE-TO-FORWARD EARNINGS AND DIVIDEND YIELD.

SOURCE: IBES, BLOOMBERG AND MSCI INC. (SEE LAST PAGE).

EM more expensive

EM cheaper

29

JAPAN’S STOCK MARKET BUST: MAINLY A STORY ABOUT MULTIPLE CONTRACTION


1.0

.8

.6

.4

1990 1995 2000 2005 2010

1.0

.8

.6

.4

.6

.5

.4

.3

.2

.1

.6

.5

.4

.3

.2

.1

RELATIVE EARNINGS-PER-SHARE**

RELATIVESTOCK PRICE*

U.S. RELATIVE TO JAPAN:

* IN U.S. DOLLAR TERMS. SOURCE: MSCI INC. (SEE LAST PAGE).** IN U.S. DOLLAR TERMS, BASED ON 12-MONTHS FORWARD EARNINGS. SOURCE IBES AND MSCI INC. (SEE LAST PAGE).

Up 419%

No change

30

COMMODITIES: THE LONG-TERM TREND IS DOWN


2.2

1.8

1.4

1.0

.6

1875 1900 1925 1950 1975 2000

2.2

1.8

1.4

1.0

.6

2.52.01.5

1.0

.5

2.52.01.5

1.0

.5

RAW MATERIALS PRICES(DEVIATION FROM 25-YEAR TREND)

REAL* INDUSTRIALS PRICES

* DEFLATED BY U.S. CONSUMER PRICE INDEX.

U.S. Civil War

World War I

Korean War Yom Kippur War/ OPEC embargo

This time is different?

31

CHINA IS ALREADY THE WORLD’S DOMINANT CONSUMER OF BASE METALS

ThTonnes

20000

15000

10000

5000

CHINA G-3

U.S.EUROPEJAPAN

ALUMINUM CONSUMPTIONTh

Tonnes

CHINA G-3

8000

6000

4000

2000

COPPER CONSUMPTION

U.S.EUROPEJAPAN

© BCA Research 2013 © BCA Research 2013

32

THE SHARE OF OIL IN GLOBAL ENERGY USAGE SHOULD CONTINUE TO TREND LOWER


40

30

20

10

0

1970 1980 1990 2000 2010 2020 2030

40

30

20

10

0

% OF TOTAL ENERGY CONSUMPTION OIL COAL NATURAL GAS HYDROELECTRICITY

NUCLEAR ENERGY RENEWABLES

% %

NOTE: MILLION TONS OF OIL EQUIVALENT. SOURCE BP ENERGY OUTLOOK 2030.

33

PLENTY OF DOWNSIDE RISKS FOR PRECIOUS METALS


150

100

50

0

-50

1875 1900 1925 1950 1975 2000

150

100

50

0

-50

80

60

40

20

0

80

60

40

20

0

AS A PERCENTAGE DEVIATIONFROM CPI "TRENDLINE":

PRICE OF GOLDPRICE OF SILVER

% %

GOLD PRICESILVER PRICE

CPI

NOTE: TOP PANEL REBASED TO 1900 = 1.

Documents

1 The Global Macro Outlook: Investing In Turbulent Times Peter Berezin Chief Strategist Bank Credit Analyst May 2013