2014Q1 Investment Strategy Outlook En

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ANNUAL EDITION

December 2013

INVESTMENT STRATEGY2014 OUTLOOK

GREEN LIGHT AHEAD, MIND THE SPEED LIMIT

Most asset prices could shift upward given

current extraordinary conditions, but this is not a

guarantee of extraordinary long-term returns


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TABLE OF CONTENTS

Foreword 3

Global strategy 6

Currency

Fixed income

Equity

Emerging markets

Alternative investments

Major risks

7 Convictions for 2014 18

Conviction # 1- US bond yields back up!

Conviction # 2Value in European short duration high yield

Conviction # 3European banks beauty contest

Conviction # 4Investment cycle gathering speed

Conviction # 5Upside for depressed energy sector

Conviction # 6Emerging pockets of value

Conviction # 7German stocksRocket-borne

Global economic outlook 25

2014: Four seasons of leverage

Regional perspectives

Key economic focus: Womanomics

Forecasts


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This document is provided for information purposes only and does not constitute a recommendation or advice.Socit Gnrale Private Banking does not represent that such information is complete or suitable for you and itshould not be relied on as such or acted on without further discussions with your private banker.

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FOREWORD

GREEN LIGHT AHEAD, MIND THE SPEED LIMIT !

2013 has clearly been a great year for equities and risky assets in general. What we calledthe fall of safe havens early this year fully unfolded when US and German governmentbonds declined and gold dropped as economic improvements materialised. It was also aremarkable year for the financial community as the Nobel Prize in Economics was attributedto Professors Eugene Fama, Lars Peter Hansen and Robert Shiller for their empiricalanalysis on asset prices. According to our records, it has been 23 years since the Nobel

Academy last distinguished a work that relates to investor needs in terms of investments,

asset allocation, or strategy.

2014 appears to be a year of further economic normalisation, which should remainsupportive for cyclical and risky assets especially in advanced economies. The call for bettereconomic prospects in 2014 remains unchanged, but our confidence is now higher. There isclearly better visibility, with fewer identified uncertainties: geopolitical tensions have greatlyeased, Eurozone sovereign stress has waned, the US fiscal dispute is over, etc. In fact,there are even more potential positive surprises ahead: Japans economic policies mayprove a success thanks to innovative initiatives (see our focus on The third arrow of

Abenomics: Womanomics),Eurozone structural reforms on internal competitiveness couldbe decided, and China might surprise the world by succeeding in a smooth transition from itsplanned export-driven economy to a liberalised consumer-driven economy, averting a hardlanding.

International investors increasingly share the sentiment of better visibility, currently drivingasset prices higher. This trend should continue. In a world of low interest rates and abundantliquidity, stocks and high yield bonds still have room to appreciate further.

Yet, we cannot help tempering our optimism for 2014 with some reminders of caution.Improved visibility on what is known should not to be confused with lower risks overall. Theworld is of course, full of uncertainties and surprises! Keeping in mind Robert Shillersimpressive record of tracking investor exuberance by warning for bubbles in 2000 and againin 2005-2007, we have to remember his conclusions:

Long-term asset returns are conditioned by structural equilibrium in economicconditions, such as interest rates, growth rate, corporate profitability, etc. Thisequilibrium prevails over cyclical fluctuations, and over long periods, the main

economic drivers such as unemployment, profits, or inflation, revert to their averagetrends.

Therefore, relevant predictors of long-term returns are not short-term trends butvaluation metrics that show the relationship between asset price and a long-termaverage of an economic indicator such as stock index/GDP, stock prices/tangibleassets, stock prices/profits, bond yields/average inflation. Note that these metrics donot give any valuable information for short-term returns.

Bubbles do exist, and appear when investors fall prey for "irrational exuberance"confusing short-term market trends with long-term expected returns.

In conclusion, beware of possible market exuberance building up in 2014 as global growthaccelerates, thus be ready to reverse positions if needed. Most asset prices could performwell given current economic and financial conditions, but this is not a guarantee ofextraordinary long-term returns, especially if the current conditions are themselvesextraordinary. In non-Nobel wording: tall trees cantgrow to the sky.


Mourtaza Asad-SyedHead of Strategy

[email protected]

Xavier DenisCurrency strategist

[email protected]

Kim MarchEmerging markets strategist

[email protected]

Claudia PanseriEquity strategist

[email protected]


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How to read the table:

Gradings Investments Portfolio(vs. Benchmark) Absolute expectations(vs cash) Relative expectations(vs history)

++ Buy! Strong overweight High capital gain High capital gain

+ Buy on dips Overweight Capital appreciation Above average return

= Hold Neutral Yield return* Average return

- Sell on rebond Underweight Cash return Below average return

-- Sell! Strong underweight Capital loss Capital loss

*Yield return: Money market rate for FX, coupon yield for bonds, and earnings yield for stocks

As of November 27, 2013


Upgrade since previous investment strategy Downgrade since previous investment strategy

GRADINGS

2014Q1 Global

Advanced markets

EMEurozone US UK Japan

Cash -

Fixed-income = = = = = =Government - = - - - =

Corporate = = = = = =

Investment Grade - - - -

High Yield + + = +

Duration = 3-5y 1-3y 3-5y 1-3y

Equities + + + = + -

Alternative +

Commodities =Hedge Funds +

Currencies - + + - -


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CONVICTIONS

2014

# CONVICTIONS Summary Recommendations

1 US bond yieldsback up!

US monetary policy is entering a multi-year tighteningphase and US long-yield will keep rising in line withaccelerating activity.This is a major trend that impacts portfolio structure andinvestments in bonds, currency and diversificationtechniques.

Prefer short-duration bonds Hedge interest rate risk on existing bonds

Focus on USD vs other currencies, especially theones in the Dollar-Zone

2

Value in Europeanshort durationhigh yield

Default rates in European High Yield are set to stay lowwhile short maturity bonds provide protection againstthe risk of rising long-term yields

Structural factors are supporting increased marketliquidity

Focus on short-duration European High Yieldbonds

Switch from Investment Grade to High Yield

3 European banks

beauty contest

Economic turn around and accommodative monetary

policy will further ease funding conditions. Asset QualityRevue performed by the ECB will ease market concernsabout the soundness of the Eurozone banking sectorand will increase investorsappetite. Bond redemptionswill continue to overtake bond issuance providing asupport to the financial bond market.

Positive on Eurozone banking stocks

Positive on banks senior debt and covered bonds Be selective on subordinated banks debt (Tier 1

and Tier 2)

4

Investment cyclegathering speed

Business fixed investment has been relatively week indeveloped markets for several years but we now expecta recovery in the capex in Japan, US and Europe(especially in Germany and in the UK). As financingconditions remain accommodative, companies cashflow is at very high levels and that global growth is nowaccelerating we expect an increase in investments.

Favour Capital Goods related sectors in US,Europe and Japan

Favour stocks in Tech Hardware, Semiconductorand Industrial sectors

5 Upside for theenergy sector

Free cash flow generation is key for avoiding theongoing Big Oil de-rating. Improved visibility on Big-Oilsfuture cash flow, relative valuation to the market nearten year lows and higher cash returns to shareholdersshould attract investor appetite for energy stocks. Inaddition, the oil sectors defensive profile and highdividend yield look attractive for those investors wantingto avoid likely increase in the equity market volatility.

Favour Global Energy stocks

In Europe, prefer Integrated companies rather toOil services

In the US, favour Integrated and Services

6 Emerging pocketsof value

While 2013 has seen high correlation among Emergingmarkets equity, in 2014 EMs that have nurtureddomestic growth drivers, pushed needed reforms andpossibility to cut rates (low inflation) will eventually

outperform those that have relied excessively onexternal and domestic credit as well as fiscal stimulus.

Current valuation levels highlight some valueopportunities, especially when countries are exposed tothe global cycle or exporting to US, Germany andJapan.

Favour markets with current account surplus andlow valuation. Our preference goes to Korea,Taiwan and then to lesser extend Poland,Philippines and Mexico

Among the BRICs, China will outperform Brazil,India and Russia.

We would avoid Brazil, South Africa, Indonesia,Turkey and India.

7 German stocks:rocket-borne

Low interest rate environment, attractive effectiveexchange rate and accelerating economic growth are allthe necessary factors to drive German stocks furtherup. In the Eurozone the DAX remain our preferred indexas valuation is cheap.

Small & Mid caps in Germany are still attractive despitethe 20% premium they show relative to large caps in

the region.

Favour the DAX to the other European indices.

German small and mid caps are set to outperformagain in the coming 12 months

Favour consumer discretionary, technology andcapital goods



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GLOBAL STRATEGY

2014 market catalysts: more of the same with more dispersion

Most diversified portfolios performed well in 2013 thanks to double-digit stock marketperformances in advanced countries. Going forward, we expect the four major 2013 driversto persist, namely:

Very accommodative monetary policiesin advanced economies, with a hint that the USintends to normaliseits policy,

Fiscal policies, which have been restrictive in most advanced countries in 2013, will beless of a drag,

Economic growth that improved steadily across most advanced economies and has

shown signs of weakness in emerging countries, and Dynamic global credit cycle that is still at work, and which allowed US corporate re-

leverage and recovery.

As economic conditions normalise and systemic risks fade, investors are shifting their focusand are now able to dig with greater details into each asset class, each country, sector, andeach company individually, opening the door for more fundamental analysis anddifferentiation. By collectively chasing all remaining investment opportunities, investors willmake financial flows increasingly important in market behaviour. In the end, markets arelikely to be driven by:

The sustainability of growth,which will define the length of the current cycle,

Chinas economic transition,which impacts global trade and commodity prices, Profit growth and margins,which will be key to assess fair value of equity markets,

Liquidity and financial flows,which are driving most short-term moves in financialmarkets.

The macro view: green light ahead for advanced economies

We expect the policy-mix in advanced economies to support growth thanks toaccommodative monetary conditions and less restrictive fiscal policies. The four main OECDcentral banks (Fed, ECB, BOJ and BOE) are not concerned about inflation. On the contrary,deflation is still cited as a major risk by authorities. None are willing to increase rates in 2014.The US Federal Reserve has stated that it will reduce its asset purchase program in the

coming months as the economy improves. We see this as healthy rebalancing, not monetarytightening. Fiscal policy uncertainty has been greatly dispelled in the US with the Republicanslifting their blockade on the budget, and in the Eurozone there is a greater acceptance thatausterity is a hard cure that has to be softened to promote growth.

Recent indicators show that growth is already accelerating across major advancedeconomies, at an annual rate now above 1.5% vs 1% on average in 2013 and headingtoward 2% in 2014. The large emerging markets (EM) are running high at 5.5%, but nonotable acceleration is likely in 2014. EM might face accelerating inflation which could bring atighter policy-mix and growth disappointment.

The long-awaited capital expenditure bounce is already visible from business surveys andcapital goods order books in the US, Japan and Germany. This could mean a sustained

growth cycle. Nevertheless, it has yet to be confirmed by faster employment gains in the USand abroad, and greater consumer purchasing power will be needed to foster growth beyond2014 into 2015.



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GLOBAL STRATEGY

China and other emerging market countries will face challenges to correct accumulatedexcesses, but should manage a soft landing that will not disrupt global activity. Global trade isalready rebounding, and the US-led recovery should spread further abroad.

Profits should post satisfactory growth in 2014 and margins remain steady in the absence ofany major changes in commodity prices. Despite US monetary normalisation, financialliquidity should remain abundant as banks take up the relay from central banks as capitalbuffers have been rebuilt.

Tactical allocation: still overweight on risky assets with increased diversification

Our global outlook assumes accelerating growth in 2014, normalising slowly to potential

growth, but low inflation leaving monetary policies accommodative. This economic backdroptranslates into an overweight position in risky assets at the expense of cash and defensiveassets. We maintain a bias towards equities and high yield bonds, and underweightgovernment bonds, gold and cash. We favour equity markets in Japan, the US, and theEurozone which we upgrade at the expense of the UK. In fixed income, as it is increasinglychallenging to capture value at acceptable risk, we focus on European high yield bonds,especially short duration bonds. In moving further away from investment grade bonds,opportunities could be found within alternative investments, especially hedge funds thatshould be favoured at the expense of commodities. Gold remains our least preferred asset;any technical rebound in the first quarter would be an opportunity to reduce any positions.

We maintain our expectations for greater differentiation and performance dispersionexpressed in 2013, which translates into digging into sectors and countries across our seven

key convictions for 2014:

1. US bond yields back up: favour short-duration bonds and hedge long-durationportfolio taking exposure to volatility,

2. Value in European short duration high yield: switch investment grade bonds intoshort-duration high yield bonds,

3. European banks beauty contest:take advantage of increasing visibility on Europeanassets, buying bank stocks and bonds, including senior and subordinated bonds,

4. Investment cycle gathering speed: with capital on the rise, favour Industrials andTechnology sectors in the US, Japan and Eurozone equity markets,

5. Upside for depressed energy sector:invest in undervalued energy stocks that havecompleted their investment plans,

6. Emerging pockets of value:take advantage of a generalised EM asset sell-off duringthe year, by buying stocks in Korea, Taiwan, Mexico, the Philippines and Poland,

7. German stocks: rocket-borne:invest in German stocks, especially those sensitive toexpansionary monetary policy and regional consumption.

Managing risks: beware of market exuberance and excess confidence

Our position biased towards risky assets makes our portfolio vulnerable to growth

disappointments and financial shocks, although in the immediate months, we are moreconcerned about excessive optimism. Our main risks by decreasing importance include: i) amarket sell-off following a period of excessive optimism in the first quarter, ii) an interest rateshock from tighter monetary policy, and iii) slowing economic growth in any major region.



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EUR/USD & Rate differentials

Source: Bloomberg, Socit Gnrale Private Banking

GLOBAL STRATEGY

CURRENCY

EUR/USD: EVENTUALLY A LOWER DRIFT BUTDOWNSIDE TOO SHOULD BE LIMITED

Although US momentum gained traction over 2013 and theEurozone slipped back into recession, the EUR continuedto appreciate in the second part of the year, even brieflytopping 1.38. As the Fed remained at a standstill,preferring to postpone QE, the EUR benefited from

receding tail risks and returning foreign investors wishingto take advantage of low valuations in some hard hitperipheral markets. Also, the Eurozone current accountbalance improved significantly as domestic demand wasdepressed and exports advanced. The growth differential,with US growth expected to exceed 2% in 2014, shouldfeed diverging monetary policy trends. The ECB is set toinfuse additional liquidity to fight ongoing deflationarypressures whereas US real interest rates should continueto rise, mirroring better economic conditions and a gradualshift in the Fedspolicy stance.

I We are keen on maintaining our dovish view on the EUR

although downside is likely to be limited as investors lookmore eager to increase exposure to Eurozone assets and

the ECB is unlikely to be excessively aggressive

(EUR/USD: 1.30 in six months and 1.25 in one year).

GBP/USD: THE BoE EXPECTED TO WIN THE SNAILSRACE AGAINST THE US FED

As the British economy surprised on the strong side, theGBP has rallied against the USD, gaining 10% since thetrough recorded in July. It is true that the UK economy isexpected to continue to do quite well in 2014 (with a

growth rate forecast well above 2% and significant jobcreation) but the BoE is set to remain on hold for a longperiod of time, and probably even longer than the Fed asUK inflation expectations have recently eased. As thehousing market is heating up, the central bank seemsmore inclined to use prudent macro measures to prevent abubble building up rather than tightening its monetarypolicy stance. This should ease market pressure on theBoE to start a hiking cycle earlier than desired.

I Although the GBP may continue to trade on the strong

side ahead of the much-awaited tapering, we think that the

British pound should gradually lose ground vs the USD

(1.60 at six month and 1.55 in one year). As for theEUR/GBP, we do not expect a major move, but the GBP

is likely to trade on the strong side vs the EUR (EUR/GBP:

0.83 at six and 0.81 at twelve months).

Recent GBP appreciation looks overdone



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1.65

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UK 10 yr real yield (LHS)

US 10 yr real yield

GBPUSD (RHS)


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Rising inflation expectations weigh on the JPY


EUR/CHF: NON-DOMESTIC FACTORS SHOULDFAVOUR MODEST DEPRECIATION

Although upward pressure on the CHF has been alleviatedas the Eurozone debt crisis has eased, the CHF has notsignificantly depreciated, trading in a narrow range of 1.23-1.24 for most of 2013. The CHFs strength stems from apersistent current account surplus, lingering capital inflows

seeking a safe haven in the European environment, andrecent speculation on the removal of the 1.20 floor set bythe central bank to counter the overshooting of the Swissfranc. Since financial fragmentation in the Eurozone shouldrecede further and the CHF is about 15% overvalued inreal terms, a normalising environment should pave the wayfor a gradual weakening of the CHF.

I We reiterate our dovish view on the CHF but its softening

is set to be gradual as structural factors are supporting its

strength (EUR/CHF: 1.25 in six months, 1.28 in one year).

USD/JPY: A NEW YEN DROP IN SIGHTJapanese authorities succeeded in massively weakeningthe JPY vs the USD by close to 20% over 2013, the firstarrow of the Abenomics strategy. This greatly helpssustain the economy with inflation steadily drifting upward.

As the BoJ is firmly committed to anchoring inflation at 2%on a sustainable basis, we are pretty confident that anadditional round of quantitative easing lies ahead. TheVAT hike scheduled in spring 2014 should trigger pre-emptive action from the BoJ to mitigate its contractionaryimpact on consumer demand. Certainly the Japaneseeconomy has not fully pulled out of the deflation trap, but

substantial progress has been recorded and a weaker Yenremains a key driver to revive the economy. Also, thedeterioration of the current account balance as well asrenewed capital outflows fostered by domestic institutionalinvestors seeking higher returns overseas will constituteadditional weakening factors.

I We maintain our dovish view on the yen vs. the USD as a

further rise in inflation expectations should continue to

lower Japanese real interest rates, driving the yen lower.

(USD/JPY: 105 in six months, 108 in one year).

OTHER G10 CURRENCIES: COMMODITY PRICES ANDVALUATION METRICS WILL BE THE DRIVERS

The super-commodity cycle has been a powerful engineunderpinning the strengthening of commodity currencies.

Lower commodity prices drag down the AUD



Improving terms of trade combined with domesticeconomic booms and sound financial systems haveattracted foreign inflows looking for yield in a safeenvironment. The wind has now turned, and overvaluationlooks difficult to sustain. From a fundamental viewpoint,the AUD looks the most at risk for further depreciation asChina has embarked on a decelerating growth trend andhard metals or coal, of which Australia is a big exporter,are likely to fall further. We are more confident in the NOKor the CAD, as the oil price should remain broadly flatthroughout the year and since those currencies are lessovervalued from a structural perspective (purchasingpower parity).

GLOBAL STRATEGY

CURRENCY

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AUDUSD (LHS)

Industrial MetalsPrice (S&P)


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GLOBAL STRATEGY

FIXED INCOME

FURTHER YIELD RISE MAKES GOVERNMENT BONDSUNATTRACTIVE

2013 was characterised by a significant yield pick-up at thelong end of the curve (around 100bp between May and

August for the 10Y) as the Fed chairman prematurelysignaled in May the need for tapering. Since the Fedsurprised the market in September by delaying tapering,

the 10Y UST yield has moved sideways. The new FedChairman, Janet Yellen, to succeed Ben Bernanke inJanuary 2014, recently highlighted forward guidance asthe new preferred policy tool for Fed action, so that the UScentral bank is unlikely to hike its policy rate before mid-2016, with the aim of managing the inevitable yield rise in2014.

I As we expect QE3 to be scaled back in Q1 2014 before

coming to an end in September with the US recovery

gaining pace, additional yield pick-up is on the cards in the

70 to 100bp range across 2014.

In the UK, more buoyant growth combined with stabilisinginflation expectations will nevertheless feed into higherlong-term yields as the market will start pricing in a hikingcycle. Forward guidance is also a watchword for the BoEas a way to avert overreaction from the bond market, buthigher interest rates are to be expected there as well. Inthe Eurozone, deflationary forces have pushed downheadline and core inflation well below the 2% target,raising the odds of additional liquidity injections in the formof long-term refinancing operations, a way to mitigatepossible money market tension ahead of the redemption of

the 1st LTRO that is due in late 2014. As US andEuropean bond markets show a high correlation (60% onaverage over the past five years), German bond yields willnot be immune from a rise in US yields, but the magnitudeis likely to be smaller.

I The immediate implication is our negative view for both

US and European government bonds.

Yet there is at least one exception to that: peripheral debt

markets where we still see potential for spread

compression in a more benign economic environment,

warranting a Neutral rating for this specific bucket.

ISM new orders & change in 10-year UST yields


INVESTMENT GRADE (IG): BEWARE OF RETURNINGVOLATILITY ON SPREADS

As already advocated for a while, we are keen onreiterating our negative view on investment grade bonds.

Spreads have significantly tightened across 2013 andthere is probably no more room for spread compression,

and some widening cannot be ruled out.Clearly, volatility is set to bounce back on financial marketsand credit markets will not be an exception as central bankcommunication will be put to the test.

I As maturities have been extended and investors as well

as issuers have come down the ratings ladder, there is no

more value to pursue in the investment grade universe.

Interest rate risk has returned as US monetary policy is set

to gradually move towards a less accommodative stance.



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Annual default rates (%)

Source: Moodys, Socit Gnrale Private Banking

Investment Grade (IG) bond performance has not beenimpressive this year. The year-to-date total return in theEurozone is about 2.5% and -1.5% for the US market, asthe yield curve has markedly steepened. Issuersbalancesheets tend to deteriorate with more debt issued to fundequity buybacks.

I The further acceleration of the capex cycle we expect in

2014 in the US and to a lesser extent in the Eurozone isanother argument to shy away from the investment grade

market as cash positions are set to shrink across the

board.

There are nevertheless some exceptions to this view. Wethink that there is value in European corporate financialbonds in Europe and more specifically in bonds issued bybanks, including covered bonds, in the Eurozone inparticular. An economic turnaround, even modest,underpinned by a more aggressive monetary policy stanceand no negative surprises expected from the ECBsAssetQuality Review should help reduce the risk premium

attached to financial issuers.

I For these reasons, we expect bank bonds to outperform

this year.

HIGH YIELD: VALUE REMAINS FOR THE TAKING

The high yield universe is certainly a segment where westill see value in 2014. First of all, default rates are likely toremain low and certainly below historical averages.Moodys speculative default rate reached 3.3% at end-September 2013 (vs 4.78% for the 13-year average) andthe recovery unfolding in developed markets will helpanchor it below historical averages. Loose monetary

conditions will preserve a favourable funding environmentallowing refinancing at attractive conditions while lingeringinvestor appetites for high-yielding assets will maintaingood liquidity conditions. Also, 2014 should show apositive correlation again between high yield and equities.But expected returns are set to be lower than in previousyears: after an expected total return around 10% in 2013 inthe Eurozone market and 7% in the US, the performancelooks set to be lower in 2014, but should be moreappealing in the Eurozone as there is greater room forspread compression and more positive surprises arepossible.

I In any case, duration risk needs to be closely monitored

against a steepening yield curve backdrop so we strongly

recommend focusing investments on short-duration bonds.

EU investment grade bonds spread and leverage



GLOBAL STRATEGY

FIXED INCOME

30-year average (US)

Forecasts


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FROM LIQUIDITY-DRIVEN MULTIPLES EXPANSION TOAN EARNINGS-DRIVEN CYCLE

2013 has been a year of strong stock market recovery inmost developed countries. The end of the recession in theEurozone and of deflation in Japan, along with postponedFed tapering, are all factors which have helped reduceinvestor risk aversion and drive 20% expansion in

multiples. In our view, there is less room for additionalPrice/Earnings (P/E) re-rating now, so we feel it isimperative that we see a clear rebound in earnings for theequity outlook to remain positive over the medium-termhorizon. Our top-down forecasts point to 10% profit growthin the US and the UK, which is largely in line withconsensus forecasts; 8% for the Eurozone (vs 16% for theconsensus); and Japan remaining in the double digits.Therefore, while valuations appear less attractive than ayear ago, we still see potential for positive returns over thecoming 12 months.

I For next year, our regional preference is again for

developed vs emerging countries. Japan should enjoy thebest upside, followed by the Eurozone with Germany inparticular, and the US.

US STOCKS SLOW BUT TREND IS STILL POSITIVE

Despite an upward shift in US stocks and the rise invaluations, the prospects for US equities remain attractiverelative to other asset classes in the region and in absoluteterms. Returns are likely to slow but remain strong. Wecontinue to believe that the critical time for equities is likelyto be the period around the first Fed funds rate hike (mid-2016). While we forecast a modest P/E expansion, US

stocks should be buoyed by resilient profit growth and highmargins. Low interest rates and low local energy costscontinue to support net profit margins in US margins vsother regions. One additional driver of these high marginsis the low cost of labour which does not seem likely toreverse any time soon. Cyclical peaks in the profit share ofGDP have tended to occur at least ten months after wagegrowth has started to accelerate and have also tended tooccur when hourly wage inflation was running between3.5% and 4%. That said, we are convinced that theS&P500 index may overshoot in the coming months.Sector wise, U.S. mid- and late-cycle sectors (Industrials,

Energy, Technology) and financials are best positioned toexperience an improvement in relative ROE (Return onEquity) and to outperform the rest of the market.

I US stocks may overshoot, driven by positive profit

growth, but returns are expected to be lower next year

than in 2013.

As long as US wages keep falling, US margins not at risk

Source: Datastream, Socit Gnrale Private Banking

P/E expansion may continue even when bond yields rise


R = 0.59

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Trailing P/E (x)

GLOBAL STRATEGY

EQUITY


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Wages % GDP (lhs) Profits % GDP (rhs, inverted)


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PROFIT GROWTH AT A TURNING POINT

Since July 24, 2012 when European Central BankPresident Mario Draghi promised to do whateverit takesto save the EUR, Eurozone stocks have performed well(+30%). Lowering the probability of systemic risk and aEUR break-up, Mr Draghisspeech was the catalyst for themarket re-rating over the past year and a half. As interest

rates were driven down in peripheral countries by thecomeback of investor appetite, this also gave somecountries the time to move forward with reforms (i.e.Spain). Since deflation risk remains a threat and theeconomys recovery is still fragile, we believe that anyadditional positive market performance would only befostered by favourable surprises on the corporate side.With the ECB expected to act if there is no recovery, andconsidering that for the first time in three years, Eurozoneprofits will see high single-digit growth in 2014 (about 8%),we upgrade the Eurozone to Overweight from Neutral.In terms of allocation in the Eurozone, we tend to

prefer German stocks to French names. Indeed withinthe core countries of the Eurozone, valuations are fully inline however potential for a rebound is stronger forGermany than France due to the higher risk of deflation inthe latter. In the peripheral countries, we prefer Spanishstocks to Italians as Spainsrecovery is one step ahead. Inaddition Spanish stocks offer an impressive high yield(5%) one of the highest in the world equity markets.Sector wise, we tend to Overweight Financials which areexpected to benefit from better visibility after the ECBs

Asset Quality Review; Energy thanks to its extremely lowvaluation and high dividend yield; and Pharmaceuticals forthe sectorsgrowth appeal.

IWith profit growth now expected to turn positive, we

move to Overweight on Eurozone stocks.

AMONG UK STOCKS WE STILL PREFER SMALL & MIDTO LARGE CAPS

UK stocks enjoy one of the best economic climates: a solidrecovery in the housing market, the strongestmanufacturing expansion, cheap valuations, andaccommodative monetary policy. In this context we tend toprefer the most cyclical part of the market, namelyfinancials and small & mid caps. This is the reason why wecontinue to reiterate our preference for the FTSE 250rather than the large cap benchmark (the FTSE 100).

IWe continue to Overweight Industrial stocks exposed toUS capex; we move to Overweight on Energy at the

expense of Consumer Staples. We also Overweight

Financials as they find additional support in the steepening

of the yield curve.

END OF DEFLATION IN JAPAN PLAYS A MAJOR ROLEIN P/E EXPANSION

Thanks to the governments efforts to boost corporateinvestment, the investment cycle is likely to show a strongupward trend by 2014. In this kind of climate, companyprecautionary savings are likely to decline, and capexshould generate strong demand. In addition, further

depreciation of the yen relative to the dollar should keepexports growing, supporting another year of double-digitprofit growth in Japan (according to our calculations, EPSshould grow by 18% in 2014 estimate). As valuations arestill very attractive and deflation is coming to an end, P/Eexpansion is set to continue next year, keeping thestructural re-rating of Japanese stocks alive. We thereforeremain positive and maintain our Overweight stance.

Sector wise, we continue to Overweight Financials andConsumer Staples. We upgrade Consumer Cyclicals fromNeutral to Overweight as potential wage hikes shouldeasily offset the expected increase in VAT. We downgrade

both Technology and Telecoms stocks after the impressiveperformance.

I Additional monetary policy easing, strengthening

domestic demand, and expectations of a capex recovery

are the ingredients for a strong stock performance in the

coming 12 months.

Restocking should sustain Eurozone profit growth nextyear


-70

-60

-50

-40

-30

-20

-10

0

10

20

30

40

Q21986 Q41988 Q21991 Q41993 Q21996 Q41998 Q22001 Q42003 Q22006 Q42008 Q22011 Q42013

Euro Area profits growth (%)

New Order minus Inventories (%)

GLOBAL STRATEGY

EQUITY



14/3614

A YEAR OF HOPE AND FEAR

Emerging Markets (EM) assets are entering 2014 less

overpriced than they were at the start of 2013, though

probably not as cheap as they will yet become.

EM citizens may approach 2014 and the elections with hopeof structural reforms to reignite the EM growth story, EMinvestors with hope that the waning tide of global liquidityand less supportive financial conditions will be mitigated bytrue Developed Markets (DM) recovery, and global demand.

However, side by side with this, we expect 2014 to also becharacterized by fear. Notably, fear of the unknown fallout ofFed tapering, particularly if policymakers react to win votes(taking a pro-growth stance which could further weakenfundamentals) rather than to appease financial markets(tightening policy to address persistent externalimbalances).

Less dynamic growth across EM and receding globalliquidity as the US Fed gears up to end asset purchases(QE) imply that the recent era of artificially low long-termrates is coming to an end. In this scenario, upward pressureon borrowing costs will likely further dent EM growth, which

has been largely supported by domestic demand amidstrong credit growth. Furthermore, China has become lesssupportive for EM, weighing in turn on global commodities.This, at a time when developed markets are finally pickingup pace. EM are simply less attractive relative to DM thanthey used to be. While a global recovery (US growth nearing3%, Eurozone exiting recession, trade picking up) would bea good thing for EM - particularly manufacturing export EM(Mexico, Korea, Poland) the simultaneous withdrawal ofliquidity, and retrenchment of capital flows to EM are likelyto offset this boost.

EMERGING MARKETS RATES & CURRENCIES

Local markets have seen their worst selloff since 2008,driven by the May Fed taper talk. EM yields rose sharply thissummer, later gaining back some of their losses. Yet, weexpect more downside into 2014 as the shift to a lessaccommodative US monetary policy puts further upwardpressure on global policy rates, EM included. The samedynamic is expected for EM currencies, which weakenedeven despite persistent USD weakness, which we expect toreverse in 2014 as the USD strengthens. Furthermore,given the risks to EM growth from higher borrowing costs,FX remains the key channel for macro adjustment. This ismost true in countries which have the greatest external

imbalancesBrazil, South Africa, Turkey, India, Indonesia(BRL, ZAR, TRY, INR, IDR)but may also play out acrossmost EM. The argument for carry-based FX upside willremain subject to risk given the likely volatility which could

EM FX and USD Index


EM Bank Lending Conditions (Index, 50 = Neutral)

Source: IIF, Socit Gnrale Private Banking

accompany the change in global monetary conditions.Some select currenciesMXN, PLN, PHP, CNYappearless likely to come under such pressure given animproving economic outlook and still supportive externalaccounts, though upside is likely to be bumpy.

I Currencies and interest rate risk is coming under

additional pressure in 2014 as the US shifts away from

asset purchases. Some select FX (MXN, PHP, PLN) may

outperform given more supportive growth and externalaccount dynamics.

44,7

48,6 48,6

49,950,5 50,6

48,3

49,549,1

41

42

43

44

45

46

47

48

49

50

51

52

Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13

*Values above 50 (improving conditions); below 50 (deteriorating conditions)

80

85

90

95

100

105

110

115

10 11 12 13

70

72

7476

78

80

82

84

86EM FX Index USD Index (DXY, rhs)

FX depreciation


GLOBAL STRATEGY

EMERGING MARKETS


15/3615

-150

-100

-50

050

100

150

200

10 11 12 13

0,0

0,5

1,0

1,5

2,02,5

3,0

3,5

4,0

4,5EM BBB Svgn - US corp BBB

EM BBB Corp - US corp BBB

UST 10y (rhs)

EMERGING MARKET CREDIT

Higher US bond yields and moderate EM growthexpectations paint a challenged backdrop for EM credit in2014, although the year is not likely to be a completewashout either. Attractive carry in EM corporate HY andmodest spread tightening potential in both sovereign andcorporate EM as macro fundamentals stabilize mean thatopportunities will remain (particularly for long-terminvestors).

Despite the sharp selloff in 2013, we see only selectpotential for sovereign spread tightening in 2014. Theseinclude Indonesia, given signs that policymakers areaddressing imbalances, Mexico due to structural reforms,and CEE on stronger regional growth prospects. The themeof avoiding current account deficit sovereigns otherwiseremains, many of which are also holding elections (Brazil,Indonesia, Turkey, South Africa), risking policy missteps onthe back of lower global liquidity. Corporate credit providesgreater potential upside but will also remain highly sensitiveto global rates. High yield could outperform in this regardgiven its shorter duration and lower interest rate sensitivity.

Regionally speaking, Asia appears buffered by its relativelystronger external accounts (India and Indonesianotwithstanding) and strong local investor base. Latam waspunished in 2013 by higher default rates, which could face areprieve in 2014; select opportunities in IG and HY Latamcredits are possible.

I Sovereign EM bonds will likely perform better than EM

corporate taken together, but opportunities in EM corporate

(HY Asia, Latam) may offer decent upside potential, on a

selective basis.

EMERGING MARKET EQUITIESThe recovery of DM growth stands to provide some supportto EM in 2014, albeit less across the board than haspreviously been witnessed. As stated above, Chinasslowergrowth outlook implies less demand for global commodities,upon which many EM are largely dependent. As such, andgiven the removal of support to domestic demand from easyfinancial conditions, EM as a groupare less likely to rally inthe coming year than has historically been the case.

However, we see some standouts among EM in 2014. Tostart, not all EM are so commodity dependent. EM exportmanufacturers, particularly those with open economies, willlikely gain from the pickup in US and Eurozone growth. Inthis regard, Korea, Taiwan, Mexico and some CEEcountries may enjoy support in the coming year. A few EMhave also taken reform measures to improve theirfundamental backdrop (Mexico, Philippines), which argue

EM Policy Buffers and Equity Performance


Sovereign and Corporate BBB Spreads to US Corps (bps)


for a more constructive view in the coming year despite theglobal pressure of weaker currenciesand higher rates. In amore general sense, EM with current account surpluses,low inflation and possible room for manoeuvre in terms ofpolicy support (rate cuts, fiscal strength) may exhibitupside. Furthermore, despite Chinas less helpful outlookto EM, the Chinese equity market itself stands to re-rate tosome degree given the policy clarity provided by the ThirdPlenum in November.

I Pockets of EM Equity upside are likely in 2014, namely

from those countries best positioned to benefit from the US

recovery and least exposed to external financing risk.

Brazil

China

Czech Rep

Hungary

India

Indonesia

Korea

Malaysia

MexicoPhilippines

Poland

RussiaSouth Africa

Taiwan

TurkeyR = 0,40

0

2

4

6

8

10

12

-10 -5 0 5 10 15

2013e Inflation (%)

2013e Current

Account (% GDP)

Bubble sizeis 2013 profitgrowth


GLOBAL STRATEGY

EMERGING MARKETS


16/3616

Oil prices: WTI and Brent


Gold still in downward trend with short-term exaggeration


COMMODITIES : NEUTRAL

Energy (WTI oil): Neutral (Spot: $94, 3m: $101, 6m:$95). Our oil outlook is for a broadly balanced physicalmarket in 2014. Projected global demand growth next yearis unchanged at 1.2 Mb/d, led by emerging markets. Non-OPEC production growth has been increased, driven bythe US and Canada. We expect Saudi Arabia to continue

to take the lead in balancing the physical markets. Ourforecast is for OPEC crude output to be cut by 0.3 Mb/dnext year. We slightly revised down our forecast on oilprices for 2014, due to slightly weaker fundamentals thanpreviously expected, and less of an upward bias fromgeopolitical risk, due to Iran normalisation.

I Oil prices continue to be driven by fundamentals, and our

outlook is for a broadly balanced physical market in 2014.

Gold:Negative (Spot: 1254, 3m: $1250, 6m: $1100). Ona tactical basis, downward pressures on gold might easeas sentiment has turned excessively negative lately, butbeyond February, gold should again be heading lower,very likely below $1200. Indeed, ongoing US monetarynormalisation will drive real yields higher reducing theattractiveness of holding gold.

I Gold still faces serious headwinds, because the trend in

real yields is upward, and with growth accelerating

throughout the year, 2014 is unlikely to be positive for gold

investments.

HEDGE FUND : POSITIVE

The economic and investing backdrop presents a fertileopportunity for hedge fund managers to generate

performance. Equities remain a core favoured strategyand Special Situations also provide good opportunities.However, Long/Short credit strategy and CommodityTrading Advisory (CTA) funds are still challenging and arenot likely to provide very strong returns in the next quarter.

I Hedge Funds as a whole remain an attractive asset class

on the basis of risk-adjusted returns especially compared

to investment grade positions. They are likely to continue

to generate positive returns as financial normalization

takes place and economic data recovers.


GLOBAL STRATEGY

ALTERNATIVE INVESTMENTS

Source: SG Cross Asset Research, Lyxor


17/3617

GLOBAL STRATEGY

MAJOR RISKS TO OUR SCENARIO

DOWNSIDE RISKS:

Market sell-off following a period of euphoria! A major brutal pullback on all risk

assets during the first quarter, after excessive optimism in December-January. Mostrisky assets suffer a 5-10% decline, returning to early November levels.

Increase exposure to volatility by buying short-term protection. Takeprofits whenever equity markets rally by 10% in Q1.

Interest rate shock.US 10-year rates overshoot towards 4%. US housing recovery ishalted, firms stop re-leveraging. Stock markets drop by 10%-15%, EM assets bleedfurther.

Remain long USD, underweight EM assets (FX), and underweight interest-sensitive US stocks.

Slowing economic growth. Eurozone relapses into recession, US economy misses

consensus estimates and Prime Minister Abe fails to drive Japan out of deflation.Defensive assets perform well (US, German government bonds and gold) while equitiesdrop. The USD depreciates.

Increase exposure to volatility by buying medium-term protection.

UPSIDE RISKS:

China economic growth surprises to the upside. EM markets and commodities startoutperforming.

No hedge. A portfolios with risky assets will benefit directly but it wouldprobably underperform if under-invested in EM.


We envision three main downside risks and one upside risk. Some risks could hurt ourpositions, but most of our current tactical bias mitigates downside risks.


18/3618

CONVICTION # 1

US BOND YIELDS BACK UP!

INVESTMENT CONCLUSIONS

Prefer short-duration bonds

Hedge interest rate risk on existing bonds

Underweight/sell US government USD bonds

Focus on USD vs other currencies, especially theones in the Dollar-Zone

US Treasury yields drivers


The Federal Reserve was very clear in its policy guidance:it will now focus on normalising its monetary policy. First,by reducing direct asset purchases, then by increasingshort-term interest rates. We expect purchase reductionsto begin in the first quarter and the rate hikes to occur byearly 2016.

There is still great uncertainty on the exact timing andpotential additional delays if the Fed is still concernedabout the persistent unemployment rate. But higher ratesseem quite certain. The Federal Reserve is determined toact and the recent run-up in asset prices will put pressureon the board to prevent any new asset bubbles.

It is unlikely that bond markets and long-term yields willwait for 2016 to adjust upward. In just two months, US 10-year bond yields increased by a full 100bp, followed byGerman bonds and most OECD bond markets.

We expect long-term yields to continue their journeyupward for two reasons:

The bond market should revert to its natural driver,nominal GDP growth, once asset purchases dissipates.The US nominal growth trend is heading to 5% by 2016bringing the 10-year equilibrium yield to about 4.5-5.5%, along way to go from the current 2.8%. We think 3.5% isreachable in 2014.

The government bond market has now started tobehave pro-cyclically, thus reducing its diversificationbenefits for institutional investors. Structural fixed incomepositions for long-term investors should declinecontinuously in 2014 pushing prices down and yields up.

Rising yields generate opportunities and risks for investors.

First, after selling US government bonds, especially theones with 5-year maturities, it is wise to reduce theportfolios duration (interest rate sensitivity) either bypreferring short-duration bonds, or by hedging existingbonds. Second, opportunities could be found amongcurrencies by buying USD versus other currencies, namelythe CAD, AUD, NZD, JPY and other Asian and Latin

American currencies.

HIGHLIGHTS

I US monetary policy is entering a multi-year tighteningphase

I US long-term yields will keep rising in line withaccelerating activity

I This is a major trend that impacts currency trends andoptimal portfolio structure

The USD tends to experience multi-year appreciationcycles when its yields are rising with stable to declininginflation. Third, we believe investors with multi-assetportfolios should diversify with assets uncorrelated to theeconomic cycle, such as volatility indices that still behave

contra-cyclically as opposed to stocks, commodities andbonds.


Forecasts


19/3619

0

50 000

100 000

150 000

200 000

250 000

9/30

/199

9

6/30

/200

0

3/31

/200

1

12/31/20

01

9/30

/200

2

6/30

/200

3

3/31

/200

4

12/31/20

04

9/30

/200

5

6/30

/200

6

3/31

/200

7

12/31/20

07

9/30

/200

8

6/30

/200

9

3/31

/201

0

12/31/20

10

9/30

/201

1

6/30

/201

2

3/31

/201

3

0

50

100

150

200

250

300

350

400

450

500

Number of issues (RS) Nominal Value (m)

Global Corporate High Yield (HY) has widely outperformedother fixed income instruments over the past decade,particularly in terms of risk adjusted return. The asset classis supported by structural factors, but the attractiveness ofEuropean HY is also due to fundamental and cyclicalreasons. In the current macroeconomic environment, weparticularly like the short maturity bucket of this assetclass, as it offers greater protection against rising long-

term yields. This short-duration performance should,become increasingly relevant as global rates rise whileshort rates are held steady by forward guidance or, in theEurozonescase, by the potential even of additional policyeasing.

Some key factors should be taken into account wheninvesting in HY corporate bonds:

1) Credit fundamentals. Todays accommodativemonetary environment remains a positive backdrop forCorporate HY. The significant liquidity in the system allowscomfortable refinancing possibilities for the private sectorand, as such, offers good protection against rising defaultrates. Cash flows and profitability likewise benefit fromreduced refinancing costs. The most defensive part of theasset class (BB-rated issuers) is particularly attractivebecause it is made up of well-known and soundcorporations.

2) The interest rate environment.The Eurozone is onlyslowly moving out of recession, and credit channels arestill not working properly. For this reason, we do not thinkpolicymakers will risk removing liquidity. This is asupportive element for the long end of the EUR yieldcurve. Also, HY credit spreads are wide enough to offerdecent protection against rising yields. At the short endwhich is the favorite maturity bucket for HY corporateissuancethe greater likelihood of the ECB cutting, ratherthan raising, rates is a further positive.

3) Liquidity risk.With Basel 3, banking disintermediationis well underway. Eurozone High Yield is only 20%financed on bond markets (vs. 80% in the US), but withmore and more issuance in the pipeline, liquidity is rapidlyimproving (250bn outstanding, five times the level seen in2009). The investor base, especially insurance companiesand pension funds, likes it.

CONVICTION # 2

VALUE IN EUROPEAN SHORT DURATION HIGH YIELD

HIGHLIGHTS

The economic backdrop supports the case for HY credit,which furthermore offers elements of comfort, such as pre-set maturity and coupon

Short-maturity bonds provide buffer against the risk ofrising long-term yields

Default rates in European High Yield are set to stay lowgiven comfortable liquidity conditions

European HY number of issuers & market size

Source: BofA ML, Socit Gnrale Private Banking



Current Eurozone market conditions - low growth, lowinflation, high artificial albeit stable liquidity in thesystem - support the case for investment in EuropeanHY.

We prefer Integrated Companies vs. Services.


20/3620


We suggest:

Increasing exposure to core and non-core Eurozonebank equities that are already in line with Basel IIIratios for capital and funding.

Favouring senior and subordinated debt of thesesame banks.

Staying away from small peripheral banks that will

continue to struggle in a challenging environment andmay require capital injections.

As the Eurozone is heading towards a more supportiveeconomic environment and a sounder financial framework,the financial sector and more specifically banks areset to outperform in both the equity and the creditspheres.

First of all, most Eurozone banks have made majorprogress in building capital, securing safer funding profiles,and standing well ahead of Basel III requirements. Whilestill ongoing, their deleveraging is advancing well asreflected in a significant reduction of their leverage. Inshort, there should be much less regulatory uncertainty in2014.

They have significantly reduced their risk profiles byde-risking their investment bank portfolios and closelymonitoring the cost of risk in their lending activities inspite of a still sluggish macro environment. Clearly,peripheral banks may remain in the spotlight as fast-risingnon-performing loans and further recapitalisation needsloom ahead, but the more robust peripheral banks alsooffer the biggest potential upside.

Receding tail risks in the Eurozone helped reduce fundingcosts, and bank CDS have tightened meaningfully over2012 and 2013. Also, we think that the ECB will be inclinedto offer new long-term refinancing operations in 2014 tocontain deflationary forces and mitigate the impact onmoney market conditions for the redemption of the firstLTRO due late 2014. Consequently, we expect fundingconditions to thaw further for the banking sector as awhole.

Before taking on its overarching supervisory role of thebanking system, the ECB will perform an Asset Quality

Review (AQR) to shed light on the soundness of individualbanks, before new stress tests will be carried out later inthe year by the European Banking Association. No realnegative surprises are expected on this side, and whilesome banks will be asked to strengthen their capital base,the amount at stake - roughly estimated between 50bnand 70bn at the aggregate level - remains manageablefrom a macro angle. As the ECB will set the playing field,we can even expect some positive confidence boosts withno more hidden losses impairing bank valuations that stilltrade below book value in spite of the recent equity rally.

From a supply and demand perspective, redemptions will

continue to outpace new issuance with about 250bn ofredemptions vs100bn of new issuance for senior funding.


CONVICTION # 3

EUROPEAN BANKS BEAUTY CONTEST

HIGHLIGHTS

Economic turnaround and accommodative monetary policywill further ease funding conditions

The ECBsAQR should ease market concerns about thesoundness of the Eurozone banking sector

Redemptions will continue to overtake bond issuanceproviding a support to the financial bond market

US and European banks - Tier 1 ratio

Sources: Bloomberg, Socit Gnrale Private Banking

The outcome should be similar for covered bonds withmuch more redemptions than issuance, as the bankingsector is focusing on capital. Although there is stilluncertainty regarding the regulatory treatment ofsubordinated debt, subordinated debt issuance couldexpand a bit depending on the type of instrument andinvestor appetite.


21/3621

2

3

4

5

6

7

8

9

94 96 98 00 02 04 06 08 10 12

Europe US Japan


Focus on capex-related sectors as they are well-positioned to expand earnings at an above-marketrate, given ample margin upside and revenue growthpotential.

Favour Global Tech Hardware, Semiconductorsand Industrial sectors. Software earnings growthhas scope to accelerate further, but at a moremodest pace in our view than the more operationally-levered cyclicals.

Corporate de-leveraging and low risk-taking had been themain causes of weak corporate investments over the pastsix years.

While 2013 was supposed to be a year of capex recoveryin the US, companies have been more cautious thanexpected. Despite low interest rates and strong balancesheets, US companies have preferred share buybacksover increased investments. Lack of visibility on the debtdebate and fragile growth in the Eurozone and someemerging markets have held back spending.

Now that the US fiscal drag has come to an end andfinancing rates are still low, we expect an acceleration inbusiness investment. The trend should be the same inother regions, especially Japan where companies willenjoy fiscal incentives to strengthen technologicalinnovation, and this along with other factors shouldincrease productivity and revitalise Japanese industry.

Why should we expect a recovery now?

Companies have pent-up needs for investment, aftercutting spending more than necessary to cover equipmentdepreciation. In Japan, the gap between capex anddepreciation as a percentage of sales has turned positive,implying that not only are investments necessary forimproving equipment capacity but also those needed tomaintain current capacity had been suppressed.

The combination of fixed investment obsolescence,normalised capacity utilisation, and a stillaccommodative monetary policy should support theglobal recovery cycle.

The sectors benefitting the most from an increase incorporate spending are semiconductors, software,hardware, and some businesses in the Industrial sector.On the other hand, we expect Energy to cut capitalexpenditure and start returning more capital toshareholders.


HIGHLIGHTS

Business fixed investment has been relatively weak indeveloped markets for several years, but we now expecta recovery in capex in Japan, the US and Europe(especially Germany and the UK)

As financing conditions remain accommodative, companycash flows are at very high levels, and global growth is

now accelerating, we expect an increase in investments

CONVICTION # 4

INVESTMENT CYCLE GATHERING SPEED

Investment intentions in the coming six months

Index equal to 5 means no changes in future investmentsSource: Datastream, Socit Gnrale Private Banking


22/3622


Overweight the Global Energy sector. The oil sectorscheap valuation along with attractive and now safehigh dividend yield give the sector an appealing valueprofile.

Prefer Integrated Companies vs Services in Europe.

Favour both Integrated and Services in the US.

Despite the upside trend enjoyed by oil prices over thepast few years, the largest energy companies have tendedto underperform the broader market. Volume weakness,rising capital intensity and consequent lack of free cashflow have restricted dividend growth and steered investorsaway from the sector. Indeed, the sharp rise in capexplans has made generating free cash flow more difficultduring the past 10 years and resulted in the sectors de-

rating. Consequently, the oil sector has consistentlyunderperformed the equity market and de-correlated fromthe rising oil price.

While earnings growth expectations have been fallingsince early 2012, 2014 and 2015 consensus profitforecasts have been revised upwards. We expect Big-Oilspositive earnings momentum to drive future cashflow, generating higher return-on-equity and potentiallyincreasing shareholder returns. In addition, as valuationrelative to the market is nearing a 10-year low the sectormay also whet value investor appetites and re-rate in anow expensively priced market. With bond yields belowdividend yields, the sectors ability to finance dividends,launch share buybacks remains key for globalshareholders willing to have exposure to the equity marketwhile keeping a limited risk profile.

Across region, European oil integrated companiestrade at important discounts to US peers and offerhigher dividend yields. Therefore, from a valuationstandpoint we tend to prefer European companies to USnames even though overall we are buyers of the sector.

Among global oil services, while US multi-servicescompanies remain a must-have in a global equity portfolio,European names are suffering from additional projectdelays.


HIGHLIGHTS

Free cash flow generation is key for avoiding the ongoingBig Oil de-rating

Improved visibility on big-oils future cash flow, relativevaluation to the market near 10-year lows and higher cashreturns to shareholders should whet investor appetite forenergy stocks

The oil sectors defensive profile and high dividend yieldlook attractive for those investors wanting to avoid a likelyincrease in equity market volatility

CONVICTION # 5

UPSIDE FOR DEPRESSED ENERGY SECTOR

Global Energy relative valuation* at 10-year lows

*relative valuation is calculated using sector P/E vs market P/ESource: Datastream , Socit Gnrale Private Banking

0.5

0.7

0.9

1.1

1.3

1.5

1.7

81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

10-year lows


23/3623


Favour emerging markets with current accountsurpluses and low valuations, with a preference forKorea, Taiwan and then to a lesser extend Poland,the Philippines and Mexico.

Within the BRICs, China should, in our view,outperform Brazil, India and Russia.

We would avoid Brazil, South Africa, Indonesia,Turkey and India.

2013 has been a difficult year for emerging marketequities. Summer fears of Fed tapering, slowing economicgrowth and tightening monetary policy have all contributedto negative emerging market performance. Despite thesell-off and interesting valuations, we remain rathercautious on the segment and we tend to be veryselective. However we recognize that the generalized sell-off among emerging stocks has also impacted the most

resilient countries.

Heading into 2014, we believe that emerging marketdispersion will increase. Indeed, some central banksface a less challenging inflation environment (thanks tolower oil and commodities prices) and may stop tighteningmonetary policy conditions. Secondly, with developedmarket growth accelerating (especially in the US, in Japanand Germany), exporting emerging countries may see anincrease in global demand.

While valuations are now more attractive than a year ago,we suggest being selective as valuation is not the onlycriteria to consider. We avoid any exposure to emergingmarkets characterized by the combination of currentaccount deficit and high inflation, namely Turkey, South

Africa, Brazil, India and Indonesia.

We also suggest avoiding exposure to emerging marketswith high levels of government debt coupled with largeforeign debt service (i.e. Hungary). Despite extremelycheap valuations we tend to limit exposure to Russianstocks to just the energy sector.

On the contrary, our preference goes for emergingmarkets strongly exposed to the global capex cycle such as Korea and Taiwan as well as to countriesexporting to the US (i.e. Mexico), Japan (i.e. thePhilippines) and Germany (i.e. Poland). Although theglobal emerging market de-rating is expected to continuenext year, we believe that in the above-mentioned buycases (Korea, Taiwan, Mexico, Poland and Philippines)attractive valuations make for an appealing entry point.


HIGHLIGHTS

2013 has seen high correlation among emerging marketequities

In 2014, EMs that have nurtured domestic growth drivers,pushed through needed reforms and the possibility to cutrates (low inflation) will potentially outperform those thathave relied excessively on external and domestic credit aswell as fiscal stimulus

Current valuation levels highlight some valueopportunities, especially when countries are exposed tothe global cycle or export to the US, Germany or Japan

CONVICTION # 6

EMERGING POCKETS OF VALUE

Dispersion among Emerging Markets is set to increase (%)



24/3624


Within the Eurozone, we continue to prefer the DAXto other local indices.

German small and mid capsare set to outperformagain in the coming 12 months.

While German consumer discretionary will benefit themost from the rise in minimum wages, Germantechnology and capital goodsshould benefit fromthe capex recovery cycle in the region and

worldwide.

With Germany definitely closing the door to the old-fashioned Schroders public deleveraging program andopting for growth policies, we expectasset reflation (i.e.real estate, equities) to characterize the next Germaneconomic cycle.

In this context of strong growth, extremely low interestrates (the chart below shows that Eurozone interest ratesare too low in the German economic context and probablytoo high for Spain and Italy) and attractive effectiveexchange rates, the German ground is fertile enough tofeed a strong asset appreciation. Indeed, with the recentpolitical agreement (between the Social Democrat andChristian Democratic Union parties), Chancellor AngelaMerkel is now ready to add23bn in government spendingover the next three years and introduce a minimum wagein a job market which already enjoys a very lowunemployment rate. Furthermore, other fiscal measures,such as tax incentives, will be introduced for companiesspending on R&D.

In this context of growth, low effective exchange rates andlow interest rates, German equities are set to stronglyoutperform the rest of the Eurozone. Indeed, with theECB busy to fight deflation risk in the periphery, Germanywill continue to benefit from an extremely accommodativemonetary policy. Valuations are still attractive despite thisyearsstrong stock market performance, profits are set togrow by 15% in 2014 after this yearscontraction, and thehigh cyclical profile of the local index should support therelative re-rating of German stocks versus Europeanpeers. Overall our scenario points towards a further DAXappreciation to 11,000 in the coming 12 months.

In Germany, we would suggest being exposed to smalland mid caps which represent the biggest leverage toGerman consumers.

Among sectors, we believe that German consumerdiscretionary (Autos and General Retailers) will benefit themost from the rise in minimum wage, German technologyand capital goodsshould benefit from the capex recoverycycle in the region and worldwide.


HIGHLIGHTS

Low interest rate environment, attractive effectiveexchange rates and accelerating economic growth are allthat is needed to drive German stocks up further

In the Eurozone, the DAX remains our preferred index

Small & Mid caps in Germany are still attractive despitethe 20% premium they show relative to large caps in theregion

CONVICTION # 7

GERMAN STOCKS: ROCKET-BORNE

Current monetary policy is too easy for Germany and tootight for Spain

Taylor rule: monetary-policy rule that stipulates how much the centralbank should change the nominal interest rate in response to changes ininflation, output, or other economic conditionsSource: Socit Gnrale Private Banking, Bloomberg

-10

-5

0

5

10

15

00 01 02 03 04 05 06 07 08 09 10 11 12 13

Taylor Rule for German rate (%)

ECB Rate (%)

Taylor Rule for Spain (%)

Taylor rul e for Italy (%)


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Like the four seasons, leverage follows well-known patterns. However, just as seasonalchange can be tricky, so too can the leverage cycle. For policymakers and investors alike,understanding where economies are in the leverage cycle holds the key to success in 2014.In the US, spring is just around the corner as fiscal tightening eases and the housingrecovery gains traction. For the Fed, this will be a particularly challenging time, managing thetransition from QE to forward guidance. Our expectation is to see yield curves steepen to

new historic highs. Moreover, as the cycle matures, we believe the Fed will be willing toaccept higher inflation. The mechanics of our UK outlook hold many similarities to the US,albeit with a less dynamic recovery. For the BoE too, 2014 will see the first test of the forwardguidance policy. In Japan, the ultimate success of Abenomics will be judged on its ability togenerate private sector investment and, with that, credit expansion. Of the major centralbanks, we believe the BoJ will be the most aggressive when it comes to easing and, if thereis a G4 currency battle to be fought, Japan will win. The Eurozone continues to battle theheadwinds of deflationary pressures and financial fragmentation. 2014 will be a critical yearfor European Banking Union; our view remains that the repair will only come slowly. In theEurozone, it is still winter. Turning to the major emerging economies of China, Brazil, andIndia, autumn is creeping in as these economies embark on a process of deleveraging. Theright structural reform mix however, could significantly alleviate the process. In aggregate,however, the emerging market growth engine is clearly losing steam.

1. Bumpy growth relay from emerging to advanced: For the first time post-crisis, weexpect advanced economies in 2014 to see a marked increase in their contribution to globalgrowth. Emerging economies have over the past few years offered a welcome support toglobal growth, but this relied in part on a build-up of credit that now needs to be paid down.The hope is for advanced economies to take the baton from the emerging economies as themain driver of global growth. The US is now poised for sustainable recovery and in Japan,hopes remain that Abenomics will work. The Eurozone, however, continues to lag. As such,the growth relay from emerging to advanced is likely to prove a bumpy process. Commoditymarkets will sit at the heart of this dynamic our analysts look for range-bound markets in2014.

2. From QE to forward guidance 2014 isnt1994:Spring 2013 saw US 10-year bondyields gain over 100bp as expectations of a turning point in US monetary policy gainedtraction in line with the recovery of the real economy. Given our growth forecast of 2.9% for2014, tapering is no longer a question of if, but when. Our forecast is for tapering to start inMarch 2014 and be completed in July 2014. The Fed has, however, already clearly indicatedits willingness to keep rates well below levels implied by traditional policy rules for muchlonger. We expect the first rate hike only in mid-2016. Ultimately, inflationary pressures willbuild and we forecast the Fed will act more aggressively and tighten too much too late in thecycle. This is a question for 2018/2019. For 2014, expect US yield curves to steepen furtherand pressure to mount on the more vulnerable emerging economies. Adjustable exchangerates and overall stronger economic balances should prevent a broad-based emerging

market crisis.

GLOBAL ECONOMIC OUTLOOK

2014FOUR SEASONS OF LEVERAGE



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2014FOUR SEASONS OF LEVERAGE

3. Cross-Atlantic uncertainty gap:All eyes will be back on Washington in early 2014. Whilea new shutdown and/or debt-ceiling stand-off are risks, we believe the odds favour a morebenign scenario. This, in turn, should allow policy uncertainty in the US to resume thedownward trend established over the course of 2013. In the Eurozone on the other hand,policy uncertainty is set to ease only very slowly, reflecting a still-challenging politicalprocess. Policy uncertainty is a key driver of investment and hiring decisions and is an

important factor in explaining the gap between our US and Eurozone growth forecasts.

4.Eurozones lost decade:Summer optimism on a Eurozone recovery has faded to greywinter skies. Looking ahead we see continued weak growth in the region with only a verygradual recovery. For 2007 to 2018, we expect GDP per capita to be flat, marking a lostdecade of growth for the region. We blame much of this weak performance on slow policyresponse in tackling both the sovereign and banking crisis, and the still too slow pace ofstructural reform. The fear is now that the Eurozone is on the verge of deflation. The ECBtoolbox is not empty, but in our central scenario of low inflation (and not outright deflation) wesee an additional LTRO and the extension of unlimited liquidity. The risk is that the EUR willstay stronger for longer, adding to deflationary pressures.

5. Reform of Asian giants to deliver slowly: Each has its own specific challenges, butAsias three giants (China, India, and Japan) are at a crossroads where structural reformholds the key to the future economic outlook. In China, reform in a nutshell is about removingthe 100% implicit state guarantee and reining in excess supply capacity. In Japan, we believeWomanomics holds much of the key to sustainable long-term growth. In India, the challengefor the new government due to be elected in May is to embrace supply-side reforms.Monetary policy will play a unique role in each case; we see further tightening from the RBI totame inflation and support the INR, further easing from the BoJ to keep the yen weak, andPBOC intervention to prevent the CNY from appreciating too much.

Risks to our central scenario remain tilted to the downside. Turning points in US monetary

policy are delicate operations to manage and the fear is set to be a replay of 1994. The aimof forward guidance is clearly to manage such risks. A disorderly market move holds thegreatest risk for the most vulnerable emerging economies. Further risks in the US centre onthe fiscal decisions to be taken in Washington in early 2014. In the Eurozone, risks appearmore balanced relative to our below-consensus central scenario. Fast-track political solutions

including full delivery of banking unionhold the greatest upside potential. Chinasreformtransformation will create short-term uncertainty; the danger is a hard landing thetemptation then being to adopt further credit stimulus.

Michala Marcussen

Chief economistSG Cross Asset Research



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REGIONAL PERSPECTIVES

Eurozone

Disinflation is now gaining traction, owing to the strength ofthe EUR and intense price pressure in peripheral countries.We see downside risks to our scenario, but no deflation. Aweaker inflation outlook would trigger ECB action.

The Eurozone is exiting the recession. One of the growthforecasts for the Eurozone in 2014 (0.6%) is based oncorporate investment behaviour. Political decisions are keyto the growth outlook. Policy uncertainty remains high.Austerity is set to ease in 2014-2015, but remains significant.The ECB asset quality review (Oct. 2014) is a potential gamechanger in the broader context of building a EuropeanBanking Union. But, we think that achieving financialconsistency will not be easy and that the deleveragingprocess will weigh on economic growth.

.

US

We believe that structural headwinds to growth are slowlydissipating. Specifically, we assume that:

Housing is now a tailwind to growth, both via residentialinvestment and knock-on effects from rising home prices;The effects of fiscal consolidation on growth have already

peaked and will diminish going forward; andBusiness investment will be supported by reduceduncertainty on fiscal policy. If our assumptions prove correct,GDP growth should accelerate significantly at the turn of theyear, marking the beginning of a multi-year period of above-trend growth.

Europe excl. Eurozone

UK: MPC not ready to hike: The BOEs latest (November

nflation Report) projections show the unemployment ratealling to 7% in Q4 2014. Even if the economy is still firing onall cylinders at that time, we do not think the MPC will beanywhere near ready to contemplate initial tightening ofpolicy that soon. While we predict a higher inflation rateprofile than the MPC, it would still not be high enough towarrant a rate increase in 2014. So how does the BOEconvey the message that a rate rise is not yet warranted?Very simple it lowers the threshold, as has already beendiscussed by Deputy Governor Charlie Bean and others. Itwill justify this by lowering its estimate of the NAIRU from6.5% to 6.0%. It looks as though the Fed plans to announcea lower threshold in 2014, a helpful precedent.

China

Reforming China in highly challenging times. The globaleconomy is expected to grow more slowly than in previousdecades, for a prolonged period of time. Against thischallenging backdrop, Chinese policymakers have to deftlypush through economic reform in order to avoid an economichard landing and/or devastating social instability. As weexpected, Chinas new leaders have shown a great deal ofawareness of the fact that the sensible goal is to steer forrelatively less painful deceleration, rather than to sustain fastgrowth rates at the cost of deteriorating economic efficiency.However, given the ingrained structural weaknesses of highcorporate leverage and large-scale excess capacity,downside risk will persist and a bumpy landing remains our

central scenario.

Other advanced

Japan: Thanks to Abenomics, we believe that Japan will

gradually exit deflation. Recent economic indicators highlightstrength in the Japanese economy. So far Abenomics is onthe right track, but for the Japanese economy to movefurther towards a lasting exit from deflation, recovery incorporate activities is essential, as this leads to strongexpansion in aggregate wages. Flexible fiscal policy (thesecondarrow ofAbenomics)as well as a long-term growthstrategy (the thirdarrow) and further yen depreciation willdetermine the success of Abenomics. We predict thatcorporate deleveraging which had been the cause ofdeflationis likely to end in 2017.

EM excl. China

Brazil: Inflation, monetary tightening and fiscal challengeswill kill off the investment revival seen in H1, dragging growthsignificantly below trend in H2 and 2014. Yet the economyshould grow modestly on the back of consumption andexternal demand. The low investment ratio and the highshare of government in GDP are key structural challengesconstraining capacity, productivity and growth and, in theprocess, increasing inflationary pressure.

Russia: Faced with weak external demand as well asstagnating investment and decelerating consumer activity,the Russian economy performed very poorly during Q1-Q313. Due to persistent headwinds, we are downgrading our

full-year growth forecast to 1.3% yoy from 1.7% yoy. Thestagnating environment has increased pressure on thegovernment and the CBR to adopt pro-growth policies.

2012 GDP Breakdown


Source: SG Cross Asset Research/Economics


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Japans recovery is on the right track so far, boosted bythe fiscal and monetary policies of Abenomics (first andsecond arrow). However, for the current cyclical economicrecovery to turn into sustainable higher growth (thirdarrow), the governments long-term growth policies mustsucceed. There is a multitude of policy areas that meritattention, but in our view promoting a more active role forwomen in the economy is of key importance. It wouldaddress the labour shortage in Japan, and it could alsoraise productivity given the high level of education attainedby many Japanese women. PM Abe has fully grasped this,as illustrated in a speech in April 2013 where he saidwomenare Japansmost underutilised resource. The PMoutlined some measures aimed at closing the gender gapin the Japanese workforce, and stressed thatwomanomics* is one of the most important elements in hislong-term growth strategy.

Data produced by the OECD suggests that the overallfemale participation rate in Japan is actually higher than

the OECD average (see table below). However, the OECDfigures are influenced by some member states with verylow rates (Turkey, Mexico, Chile, etc). Compared to other(western) advanced economies, the rate is indeed low.What is striking about Japan is that the labour forceparticipation rates of women with tertiary education areparticularly low compared with other nations: compared tothe OECD average, it is an astonishing 13.8pp lower(again, see table below) This means that there are manyhighly educated Japanese women who are not working either due to a lack of childcare facilities or other reasonssuch as a lack of flexible working conditions. If theseobstacles were removed, Japanese women could

substantially bolster the labour force and hence potentialeconomic growth.

Abesgrowth strategy focuses on this point (womanomics)as a measure to boost economic growth in the long term. Itis important to accurately address what the obstacles arefor parenting-age women to continue working, and howthese obstacles can be removed. The problem needs to besolved from two points of view. One is to increase thenumber of childcare places, which means increasing thenumber of nurseries and nursery staff this is a jobprimarily for the public sector. The other is to change the

working environment so as to make it easier to balancework with childcare primarily a responsibility of theprivate sector. And, more importantly, to narrow theequality gap in pay, which is particularly large in Japan(30.2% vs 20.1% in the US), according to the PM.

KEY ECONOMIC ISSUES

THE THIRD ARROW OF ABENOMICS: WOMANOMICS

Source: SG Cross Asset Research/Economics

So far, Abe has promised to increase the number ofchildcare places as a matter of urgency. The total number

of children accepted into childcare institutions will increaseby 200k by FY14 and by 200k by FY17 (vs 130k in the fiveyears from 2007 to end-2011). Creating a better workingenvironment for working mothers is also a necessity.

According to studies by the Ministry of Health, Labour andWelfare, about 26.1% of female workers who had to leavea job during pregnancy or after childbirth cited the difficultyof balancing work and childcare. Another 9% citeddismissal or suggestion to leave work by the employer,and about 2.6% cited change in job duties..

Abe has already set out some goals to be achieved by2020: to increase womenslabour force participation rates(for women between 25-44 years old) to 73% from 68% in2012; support women continuing to work after the birth oftheir first child so that 55% of such women can continue towork vs only 38% in 2010; increase the share of men whotake parental leave to 13% from a negligible 2.6% in 2011;and push up the percen

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