Please refer to page 28 for important disclosures and analyst certification, or on our website

www.macquarie.com/research/disclosures.

GLOBAL

Inside

Dawn of new Era – massive discontinuity 2

Pendulum is swinging back to the State 16

Thematics – uncorrelated strategy 18

Appendices 23

MQ – Global ‘Thematics’ Notional Portfolio performance

Source: Bloomberg; Macquarie Research, June 2016. Refer Fig. 39 for footnotes

MQ – Asia ex JP ‘Thematics’ Portfolio perf

Source: Bloomberg; Macquarie Research, June 2016. Refer Fig.40 for footnotes

Analyst(s) Viktor Shvets +852 3922 3883 viktor.shvets@macquarie.com Chetan Seth, CFA +852 3922 4769 chetan.seth@macquarie.com

7 June 2016 Macquarie Capital Limited

What caught my eye? v.59 In praise of Thematics In this latest issue, we discuss importance of Thematics in structuring portfolios

and how it could add uncorrelated returns that are independent of Central Banks.

Over the last three years we have been arguing that pure Thematics are likely

to become an increasingly important part of investment landscape. Whilst

equity investors have in the past been reluctant to embrace Thematics, or at

least regarded them as separate from traditional strategies, we believe investors

are on the cusp of a significant change, with Thematics playing a far greater role.

There are two forces driving investors towards Thematics. First, realization that

there are powerful structural changes at play altering the key fundamental

assumptions underlying the global economy, key sectoral or stock fundamental

drivers. Second, in an environment dominated by the public sector and central

banks (CBs), there are few opportunities for investment styles that are

uncorrelated to macro cross-currents, with Thematics being the prime example.

However, we believe that it is critical to identify the right themes. In the last

twenty years, investors were looking for positive themes, such as emerging

markets; convergence and hence rising consumption and middle class creation;

generic technology; environmental and conventional demographic themes. We

believe that the next ten years would be time for negative (constraints based)

themes. Investors are likely to inhabit an investment world characterized by

divergence not convergence and declining returns on humans, which is likely to

turn demographic dividends into curses, preventing and reversing middle class

creation while strengthening de-globalization. Also as technologies mature, we

believe that generic technology themes would outlive their usefulness.

We maintain that ‘declining returns on humans’ is the strongest and most

persistent theme shaping most investment strategies. It is driven by fundamental

forces that are altering manufacturing and production value chains; provision of

services and the role that people play in various stages of production or trade.

These forces are destroying conventional perception of labour markets and they

question the value and importance of human inputs. We usually describe it as

the ‘Third Industrial Revolution’ but other investors prefer descriptions as

diverse as ‘robotics and machine age’ to ‘buy robots and sell humans’ era. We

prefer ‘Third Industrial revolution’, which indicates we transited through similar

(though nowhere near as disruptive) periods at least twice before.

As with the First (1750s-1850s) and Second (1880s-1940s), the Third Industrial

revolution (from 1970s) is redefining relationship between people, machines and

societies. Whilst ultimately boosting productivity, each revolution tended to be

highly disruptive and current is no different. In the midst of transition, productivity

& real incomes tend to stagnate whilst income/wealth inequalities rise both within

and between countries, with obvious social and geopolitical consequences. The

latest phase is further aggravated by three decades of overleveraging (a by-

product of contemporary societal response to stagnant productivity & incomes).

Building on prior work (here and here) we identify seven global themes that

benefit from declining ‘return on humans’: human replacement (robotics,

automation & AI); human augmentation (biotech); social upheaval (‘prisons &

bullets’); ‘opium of the people’ (games; 3D; entertainment); education & skilling;

demographics and ‘disrupters & facilitators’. There are other themes that we

eventually plan to add (e.g. impact of minimum income guarantees) which are

not yet mature. We constructed a global portfolio that reflects these themes,

complementing our narrower Asia ex ‘Thematic winners’ portfolio.

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Port. perf rel to MSCI AC World (US$)

Global Thematics (hypothetical perf)

MSCI AC World US$

95

97

99

101

103

105

107

109

111

113

115

Oct

-14

No

v-1

4

De

c-1

4

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Asia ex "Thematics" portfolio (rel to MSCI ASXJ, $ TR basis)

Macquarie Research What caught my eye? v.59

7 June 2016 2

Dawn of new Era – massive discontinuity “Those who cannot remember the past are condemned to repeat it”, George Santayana

We believe that in many ways, we are facing an investment landscape that is unique when

compared to almost any other period in the modern era.

Arguably, 1930s were the closest recent comparable. First, as today, 1930s suffered from a

significant indigestion following collapse of extravagant post World War spending. Second,

the 1930s was a continuation of geopolitical and social dislocation that accompanied the

Second Industrial Revolution (which picked up speed post the 1880s), with higher than

average income and wealth inequalities as well as sharp changes in relative positioning of

different countries. In essence, World War I and II were one war separated by a short

armistice and both wars were fought to reflect changing relative positions of different

countries.

Whilst history does not need to necessarily repeat itself, in Mark Twain words, it “does

rhyme”. The First Industrial Revolution (which commenced in the 1750s-60s and ran through

1840s-50s) also coincided with the revolutions of 1848 (which spread through the entire

European Continent) and culminated in violent creation of new countries (i.e. Italy and

Germany in 1860s-70s), Civil War in the US, Crimean War etc. Second Industrial Revolution

ended with World War I and II.

Each stage becomes more disruptive - starting with the First...

As discussed in our previous notes (refer), prior to the First Industrial Revolution, productivity

rates remained at a fairly constant 0.1% per annum for over 1,000 years (from collapse of the

Western Roman Empire until 18th century). In the 1600s and early 1700s, there was not much

difference in the standard of living in Europe vs. China, India, and Japan or for that matter

most other geographies. Indeed, strong arguments were made by Gregory Clark1 and many

other academics that English worker in the 1600s were no better off (and most likely worse

off) than hunter gatherers in pre-historic times or citizens of Mesopotamia in 3000 BC.

The First Industrial Revolution, which traditionally dated to around the 1750s until 1850s

represented a significant watershed, as it for the first time ushered in the area of

mechanisation, factories and a high degree of reliance on non-human/animal muscle power.

It centred on steam engines, cotton and textiles industries, steel and railways. The revolution

was led by Britain and later spilled-over to other European countries (such as France,

Belgium, Netherlands and much later Germany) and Western offshoots (such as the US).

This caused a significant divergence of relative income levels both within and between

countries. Whereas in 1600-1700, China had an estimated GDP/Capita (1990GK$) of ~60%-

70% of the British, French or German levels and was broadly equal to Japan, by 1860-70,

China’s relative position was down to only 17% when compared to Britain and not much more

than 25%-30% of France or Germany whilst Japan had by 1870 pulled away from China.2

The First Industrial Revolution was relatively narrow in scope and left a considerable part of

the economy largely unchanged. Nevertheless, the arrival of machinery and looms caused a

significant dislocation in what essentially was agriculture and craft based economies. The

picture of Luddites (unemployed textile craftsmen) smashing looms in 1811-16 Britain was the

classic manifestation of severity of labour displacement. Most investors believe that

technology does not destroy jobs but rather results in creation of new jobs that enhances

overall growth and value proposition. Indeed, over the longer term, this was true. However for

long periods (stretching out for years, sometimes decades), the job replacement and job

creation has been far from a smooth process but rather tended to create significant

discontinuities. In the case of the First Industrial Revolution, real wages did not show much

rise until the 1830s-40s (around 50-60 years after commencement) and income and wealth

inequalities increased significantly.

1 Gregory Clark, “Farewell to Alms”, Princeton University Press, 2007; Ian Morris, “War! What is

good for?”, 2015 2 Maddison data base, 2013

The new Era, but

there are parallels

with First & Second

Industrial

Revolutions

First Industrial

revolution (1750-

1850), caused

significant

dislocation,

including...

...stagnating income

and rising wealth

inequality within

and between

countries

Macquarie Research What caught my eye? v.59

7 June 2016 3

As can be seen below, most academics argue that British GDP/capita growth rates stagnated

at not much more than 0.1%-0.3% per annum until the 1820s-30s. Similarly consumption of

luxury products (sugar, tea and coffee, as the key signs of increased well-being) remained

subdued well into 1840s-50s whilst TFP (Total Factor Productivity) growth rates did not

accelerate to ~1% until after 1860s. At the same time, income inequality rates have risen

dramatically into 1860s-70s.

Fig 1 Britain – GDP/Capita Growth Rates (%) Fig 2 Britain – TFP Growth Rates (%)

Source: Alessandro Nuvolari & Mattia Ricci ‘Economic growth in England’, 1250-1850, LEM, Sep 2012; Macquarie Research, June 2016

Source: Joel Mokyr, ‘The New Economic History of industrial revolution’, 1988; Macquarie Research, June 2016

Fig 3 Britain–Consumption of luxury products/capita Fig 4 Britain – Income & wealth Inequality

Source: Hans-Joachim Voth, ‘Living Standards and Urban Environment’, Cambridge Economic History of Industrial Revolution, 1989; Macquarie Research, June 2016

Source: Daren Acemoglu & James Robinson, ‘The political Economy of Kuznets curve’, Review of Development Economics, 2002; Macquarie Research, June 2016

In other words, whilst most investors currently (correctly) believe that the First Industrial

Revolution allowed the world economy to escape centuries of stagnation and that new

technologies have created jobs, the process was generally far more complex and tortuous.

The preponderance of evidence suggests that it took almost one hundred years of stagnating

income, rising unemployment and political changes before finally achieving the outcome of

aligning machines and people, rising aggregate demand and accelerating growth rates.

....and then Second Industrial Revolution

In many ways, the Second Industrial Revolution was far more disruptive and transformative

than the First and ushered in the modern world of domestic convenience, lifestyle and

medicine; rise in longevity as well as bringing forward new sources of energy and means of

communications.

Broadberry Clark Ricci Maddison Crafts

1250-1580 0.12 (0.01) (0.02)

1500-1700 0.19 (0.11) 0.05 0.28

1580-1780 0.29 0.03 0.22

1700-1780 0.26 0.09 0.25 0.24

1700-1820 0.25 0.21 0.21 0.26

1780-1820 0.24 0.46 0.12

1780-1830 0.32 0.46 0.33 0.45

1830-1850 0.91 0.57 0.68 1.05

Harley Antras & Voth Clark

1250-1770 0.1 - -

1770-1800 0.2 0.3 0.0

1800-1830 0.5 0.6 0.6

1830-1860 1.0 0.5 0.2

(Pounds/weight) Borda

Sugar Tea Tobacco ranking

1794-96 16.0 1.6 1.1 6

1804-06 22.9 1.7 1.1 2

1814-16 17.4 1.6 1.0 7

1824-26 21.6 1.6 0.9 6

1834-36 20.7 1.9 1.0 4

1844-46 22.3 1.9 1.0 3

1854-56 33.1 2.4 1.2 1

Share of top 10% Gini

1823 47.50 0.400

1830 49.95 0.451

1871 62.29 0.627

It took almost a

century to see

productivity and

income accelerating

Macquarie Research What caught my eye? v.59

7 June 2016 4

The Second Industrial Revolution (which is usually assumed to have commenced sometime

in 1870s-80s and lasted into the 1930s-40s) was centred on four key inventions: (a) ability to

generate, transmit and utilize electricity: (b) invention and adoption of internal combustion

engine: (c) revolution in chemical and pharmaceutical industries and finally (d) invention of

modern means of communication. It gave a number of countries which largely missed out on

the First Industrial Revolution (such as Germany, Switzerland, Sweden, Northern Italy, Japan

and to a large extent the US) the opportunity to catch up and quite often overtake early

leaders (such as Britain and France). It also presented new and by now almost

insurmountable obstacles to some of the laggards such as China or India, causing the

complete relative collapse of both civilizations.

As can be seen below, the Western World (i.e. Western Europe and offshoots) were barely

20% of the global economy as late as 18th-early 19

th centuries. However, the combination of

the First and Second industrial revolutions, propelled Western share of GDP to ~57%-58% by

the early 1900s whilst the share commanded by China, India and Japan was down from

~52% in late 18th century to below 19% by 1913, bottoming out at as little as ~8%-9% by

1950s.

Fig 5 GDP per capita (Britain=100%) – 1700-1913 Fig 6 Global GDP (GK$ 1990) – Share (%)

Source: Maddison data base, 2013; Broadberry data base; Macquarie Research, June 2016

Source: Maddison data base, 2013; Macquarie Research, June 2016

A similarly stark variation occurred in the overall size of the economies, as countries like

France and Russia fell behind newer powers that embraced and utilized benefits of the

Second Industrial revolution (such as Germany) from the 1870s-80s onwards.

Whereas in 1700, the German economy was only 70% the size of French economy, it was

~32% larger by the time of the Prussian-French War of 1870 and by 1913 (the onset of World

War I), the French economy was only 45% of the German economy and remained at ~50%-

55% at the beginning of World War II. A similar changeover occurred in Asia. Whereas in

1700, Japan was only ~20% of the size of the Chinese economy, by 1913 it had grown to

~30% and by 1939 it was ~70% of Chinese GDP. On a per capita basis, Japan in 1939 was

5x richer than China whereas in 1700 it was slightly poorer.

Fig 7 GDP (GK$ 1990 m) – 1700-1913 Fig 8 GDP/Capita (GK$ 1990) – 1700-1939

Source: Maddison data base, 2013; Macquarie Research, June 2016 Source: Maddison data base, 2013; Macquarie Research, June 2016

0%

20%

40%

60%

80%

100%

120%

France Germany US China India

1700 1820 1850 1870 1900 1913

1500 1700 1820 1900 1913 1950

Western Europe 17.8% 21.8% 22.9% 34.2% 33.0% 26.2%

Western Offshoots (US, Canada, Aus, NZ) 0.5% 0.2% 1.9% 24.6% 24.3% 30.7%

Western World 18.2% 22.0% 24.8% 58.7% 57.3% 56.8%

Japan 3.1% 4.1% 3.0% 2.6% 2.6% 3.0%

China 24.9% 22.3% 32.9% 11.1% 8.8% 4.6%

India 24.4% 24.5% 16.1% 8.6% 7.5% 4.2%

China + India + Japan 52.4% 50.9% 52.0% 22.3% 18.9% 8.8%

US Russia Germany Britain China India Japan France

1700 600 16,196 13,650 10,709 82,800 90,750 15,390 19,539

1820 12,548 37,678 26,819 36,232 228,600 111,417 20,739 35,468

1870 98,303 95,432 81,836 104,011 189,740 134,882 25,393 61,604

1890 214,714 114,518 136,243 151,998 205,379 163,341 40,556 79,315

1900 312,499 175,754 191,574 182,765 218,154 170,466 52,020 98,676

1913 517,383 265,089 280,005 229,604 241,431 204,242 71,653 122,988

1939 862,995 430,314 374,577 300,539 288,653 256,924 203,781 200,840

Cagr (%)

1700-1913 3.2% 1.3% 1.4% 1.4% 0.5% 0.4% 0.7% 0.9%

1700-1820 2.6% 0.7% 0.6% 1.0% 0.8% 0.2% 0.2% 0.5%

1820-1870 4.2% 1.9% 2.3% 2.1% -0.4% 0.4% 0.4% 1.1%

1870-1890 4.0% 0.9% 2.6% 1.9% 0.4% 1.0% 2.4% 1.3%

1890-1913 3.9% 3.7% 3.2% 1.8% 0.7% 1.0% 2.5% 1.9%

1913-1939 2.0% 1.9% 1.1% 1.0% 0.7% 0.9% 4.1% 1.9%

US Britain Germany France Japan Russia India China

1700 527 1,250 910 910 570 610 550 600

1820 1,257 1,706 1,077 1,135 669 688 533 600

1870 2,445 3,190 1,839 1,876 737 943 533 530

1890 3,392 4,009 2,428 2,376 1,012 1,050 584 540

1900 4,091 4,492 2,985 2,876 1,180 1,237 599 545

1913 5,301 4,921 3,648 3,485 1,387 1,488 673 552

1939 6,561 6,262 5,406 4,793 2,816 2,237 674 562

Cagr (%)

1700-1913 1.1% 0.6% 0.7% 0.6% 0.4% 0.4% 0.1% 0.0%

1700-1820 0.7% 0.3% 0.1% 0.2% 0.1% 0.1% 0.0% 0.0%

1820-1870 1.3% 1.3% 1.1% 1.0% 0.2% 0.6% 0.0% -0.2%

1870-1890 1.7% 1.1% 1.4% 1.2% 1.6% 0.5% 0.5% 0.1%

1890-1913 2.0% 0.9% 1.8% 1.7% 1.4% 1.5% 0.6% 0.1%

1913-1939 0.8% 0.9% 1.5% 1.2% 2.8% 1.6% 0.0% 0.1%

The Second

Industrial

Revolution (1880-

1940s) was even

more disruptive...

Macquarie Research What caught my eye? v.59

7 June 2016 5

The above shifts in relative economic fortunes were the basis for numerous conflicts and

geopolitical tensions that were experienced in the second half of 19th and the first half of 20

th

centuries, ranging from the Crimean War to wars of Italian and German unification; French-

Prussian war, various wars between Prussia and Austria to Boer War in South Africa and

finally World War I and World War II.

Essentially countries that embraced Industrial revolutions moved forward rapidly (mostly

delivering a 1%-3% per annum rise in per capita income) whilst countries that did not, such as

Russia (until 1890s), China and India (throughout the period) or France (until 1870s), have

fallen behind, sometime drastically.

The Second Industrial revolution has also caused a widening of income and wealth inequality

indices for countries that embraced innovation.

For example in Japan (which is now regarded as an egalitarian society), top 0.1% share of

income earners increased from ~5%-6% in 1895 to ~9% by 1937/38 whilst income share of

top 1% increased from 12%-13% in 1895 to ~20% by 1938. In 2010/11, Japan’s top 1%

controlled ~9% of national income and top 0.1% ~2.5% or broadly half the levels of inequality

experienced during the transition stage.

Similarly in Germany (another society that is currently regarded as egalitarian), top 0.1%

controlled by 1914 ~8%-9% of income whilst top 1% controlled ~18%. Currently top 1%

earners in Germany control ~13% of national income and top 0.1% is responsible for ~5% of

national income, again, a much lower level of inequality than was prevalent during the

Second Industrial revolution transition stage.

Fig 9 Japan – Income Share (%) – 1895-1938 Fig 10 Germany – Income Share (%) – 1894-1914

Source: The World Wealth and Income Data base; Macquarie Research, June 2016

Source: The World Wealth and Income Data Base; Macquarie Research, June 2016

There are various explanations for stagnating income and rising income and wealth inequality

levels in the midst of major industrial revolutions (ranging from Marxists to evolution of

political systems to technology based answers).

We tend to concur with academics like Gordon, Ford and Mokyr3 that significant innovation

and technological shifts tend to accelerate productivity in a select few sectors but until these

new sectors and specializations represent a much larger part of the economy (both products

and employment) aggregate productivity and income growth rates tend to stagnate and

sometime fall. At the same time, rising productivity divergence increases income and wealth

inequality.

Eventually, people and machines line up and new business practices proliferate, leading to a

considerable rise in aggregate productivity. However, as the first two industrial revolutions

illustrated, it usually takes at least 50-70 years (or in other words, two-to-three generations).

In the meantime social and geopolitical tensions rise, in tandem with stagnant productivity

and incomes; rising inequalities and differentiated economic performance.

3 Robert Gordon, “The Rise and Fall of American Growth”, 2016; Martin Ford “ Rise of Robots”,

2015; Eric Brynjolfsson and Andrew MCaffe, “The Second Machine age”, 2015

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

9.0

11.0

13.0

15.0

17.0

19.0

21.0

1895

1897

1899

1901

1903

1905

1907

1909

1911

1913

1915

1917

1919

1921

1923

1925

1927

1929

1931

1933

1935

1937

Top 1% Top 0.1%, rhs

6.0

6.5

7.0

7.5

8.0

8.5

9.0

15.0

15.5

16.0

16.5

17.0

17.5

18.0

18.5

19.0

1894

1895

1896

1897

1898

1899

1900

1901

1902

1903

1904

1905

1906

1907

1908

1909

1910

1911

1912

1913

1914

Top 1% Top 0.1%, rhs

...causing

significant

divergence

Macquarie Research What caught my eye? v.59

7 June 2016 6

Third Industrial Revolution - ...far more disruptive & insidious

As described in one of the latest books on disruption (it has recently become a bit of a cottage

industry), the past ‘industrial revolutions pale in comparison to today’s convulsions, because

shifts today are happening much faster and on a much bigger scale.’4 We would go even

beyond that and argue that not only are the latest changes impacting a much wider waterfront

of economic activity but also the Third revolution aims to largely replace rather than

augment humans.

As global economy progressed through decades of change between 1750s and 1970s-80s,

new and higher value-added jobs were (eventually) created to replace jobs lost (e.g. horse

buggy drivers became car drivers; manufacturing employees graduated to be designers). The

Third Industrial Revolution however aims for autonomous cars and not only manufacturing but

also design is increasingly done by machines. Over the next five-to-ten years, there would be

several waves of ‘extinctions’, with growing range of jobs and professions becoming extinct

whilst remaining jobs would be subject to massive disruptions. For example Walmart’s 2.1m

employees are today far less productive due to disruption caused by 200,000 Amazon

employees.

Fig 11 Probability of loss of Jobs due to computerization & robotics – 2013-2033

Fig 12 Labour Surplus – Low-to-medium skill jobs (m) - 2020

Source: Frey and Osborne, “The Future of Employment: How susceptible are jobs”, 2013; Macquarie Research, June 2016

Source: McKinsey Global Institute, 2013; Macquarie Research, June 2016

As McKinsey Global institute predicts, the global economy might by 2020 have a surplus of

~100m jobs in low and medium skill occupations (including ~60m in emerging markets alone).

However we believe that the real position is likely to be far worse as even higher skill jobs are

being rapidly displaced. As highlighted above, it is expected that over the next decade or two,

around 95% of accountants; 90% of technical writers and almost half of economists and pilots

would be replaced. The same largely applies to lawyers, paralegals, traders and investment

advisors. It is expected that almost 90% of real estate agents would disappear and almost

100% of telemarketers (a very large and high value industry in select few emerging markets,

such as India and the Philippines). Increasingly routine articles by magazines like Forbes or

various newspapers (such as sports news, weather etc) are written by computers, with

limited, if any, human involvement. The same unfortunately applies to routine tasks

undertaken by investment analysts (such as quarterly results notes).

4 Richard Dobbs, James Manyika and Jonathan Woetzel, “No Ordinary disruption”, 2015

0%

20%

40%

60%

80%

100%

Te

lem

ark

ete

rs

Acco

un

tants

Re

tail

sa

les

Te

ch

nic

al w

rite

rs

Re

al E

sta

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ial p

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fig

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Probability of loss of job due to computerization - 2013-2033 0 20 40 60 80 100

Advanced Countries

Emerging Markets

Global

The Third Industrial

Revolution

(commenced in

1970s) is even more

disruptive as...

...it aims to replace

rather than augment

humans...

Macquarie Research What caught my eye? v.59

7 June 2016 7

These are professions that require at least, secondary and more likely tertiary education and

training. Hence, McKinsey Institute’s estimate of skills shortage approximating ~90m in higher

end occupations (by 2020) is likely to be overstated. As the above charts suggest, any job

that requires human touch (such as clergy, nurses, sports coaches or bartenders) is likely to

be safe (at least for the time being). Whilst most commentators highlight the need for higher

education and skilling as the way to avoid ‘replacement’ and create higher value-added

occupations, current labour market outcomes disagree. For example according to a

CareerBuilder survey, in 2014, around 51% of the US graduates have been employed in

industries that do not require their academic qualifications. Similarly, a NY Fed survey for

2009-12 period highlights that more than 40% of graduates are employed in industries that do

not require four-year degree. This included around 20% of engineering graduates and almost

30% of Maths and Computer Science graduates. The same mixed picture emerges when

graduates were asked whether the cost of education was equal or outweighed the benefit.

Fig 13 US Graduates employed in jobs that do not require degree (2009-12)

Fig 14 US Graduates – Education cost vs Benefit - 2015

Source: Fed NY; Macquarie Research, June 2016 Source: Federal Reserve, 2016; Macquarie Research, June 2016

We maintain that labour markets are essentially dissolving, explaining for example why the

Fed or BoE have experienced such difficulty estimating the degree of labour market slack.

There is a clear competition now between various commentators to give a name to this new

phenomenon. The contenders so far have not yet caught on, and include: (a) ‘Fissured

Employment’; (b) ‘Contingent Employment’; and (c) ‘Gig’ Economy.5 Essentially, all of these

names attempt to describe a broadly similar phenomenon of radically altering nature of

employment which defies traditional classifications. The predetermined and stable career

paths (a la 1950s-80s) have largely disappeared and the new world of rapidly changing

occupations (quite often divergent from the original skills base) and mix of part-time, full-time

and casual jobs dominates. There are also now increasing opportunities to compete and

enter professions and jobs across geographic or industry lines (such as remote commuting

and off-shoring) which did not exist ten or twenty years ago.

In our view, technology and globalization are severely distorting labour markets. In

other words, the combination of de-regulation of labour, product and capital markets (since

1980s) enabled corporates to much better arbitrage global costs (via off shoring and creating

more complex supplier and value chains). Technology has provided another tool for

displacement and stratification of labour and individual tasks.

One could judge the degree of flexibility and potential dislocation of labour markets by asking

how long it has traditionally taken for the labour market to recover from previous recessions.

As can be seen below, whereas in 1950s-80s the peak US pre-recession employment has

usually recovered within 18 months, the average in the last three recessions (post 1990) has

been much longer, with the latest recession taking more than six years to recapture previous

high and it took almost four years after an extremely mild recession of 2001. In comparison, it

took only 18 months for the labour market to recover following the exceptionally deep

recession of 1973-75; similarly it took just over two years following the deep recession in

1981-82.

5 US Government Accountability Office “ Contingent Work Force: Size, Characteristics, Earnings

and Benefits”, April 2015; David Weil, “The Fissured Workplace”, 2015

0% 10% 20% 30% 40% 50% 60% 70%

Engineering

Maths & Computers

Sciences

Social Sciences

Business

Liberal Arts

Communications

Unemployed Jobs do not require degree

0% 10% 20% 30% 40% 50% 60%

Engineering

Computer Science

Maths

Law

Business

Health

Social Sciences

Humanities

Cost equal or Outweigh Benefit

...dissolving labour

markets and...

Macquarie Research What caught my eye? v.59

7 June 2016 8

The last two US recessions have also coincided with declining participation rates and rising

proportion of employment that is either part time or casual in nature; rapidly rising national

financial leverage levels and generally very low real interest rates.

Fig 15 US Recessions – Labour Market Impact

Source: CEIC; Macquarie Research, June 2016

One of the key issues that investors struggle to understand is how better labour utilization and

technology can lead to stagnant or declining levels of productivity. Most investors expect that

technology leads to higher not lower productivity. Unfortunately as two previous Industrial

Revolutions as well as more recent experience show, aggregate productivity rates in the

middle of the transition period tend to fall not increase.

As discussed in various academic papers, it is simply a question of cross-sector impacts. In

other words, whilst the new industries (whether it was cotton looms or Henry Ford car

manufacturing in the past or indeed IT and automation today) are highly competitive, initially

these industries represent a small part of the economy whilst traditional industries are not

only far larger but also tend to ‘warehouse’ the dominant part of the labour force. Until newer

parts of the economy and new products become far more prevalent, aggregate productivity

tends to stagnate and indeed fall. A classic example is declining productivity of equity and

fixed income traders under the pressure of computerised trading.

In other words, labour, capital and product market de-regulation significantly enhanced the

corporate and private sector’s ability to transfer value to capital away from labour that has

been a persistent feature of the investment landscape for several decades (refer Peter

Eadon-Clarke’s paper), explaining stagnant productivity and wage/earnings outcomes.

As we highlighted in our prior reviews, US TFP growth rates have significantly de-rated since

late 1970s (broadly coinciding with the above outlined structural shifts). Over the last three

decades, slowing productivity generally spread across all developed and most EM

economies. At the current juncture, only the least developed EMs (such as the Philippines,

India and Africa) still deliver meaningful productivity gains. However, these economies

represent less than 10% of global demand. Arguably the sharpest productivity contraction has

been suffered by China over the last three-to-four years.

Fig 16 US – TFP Growth Rates (%) Fig 17 UK – TFP Growth Rates (%)

Source: TED; Macquarie Research, June 2016 Source: TED; Macquarie Research, June 2016

Start End Duration From Previous Peak Unemploytment GDP Period to Recover Leverage Real 10Y Bond Labour Participation Part-Time/Total

(Date) (Date) (Months) (Months) (%) Peak/Trough (%) Peak Employment (months) Begining of Recession Begining of Recession Rate (%) Employment

Nov-48 Oct-49 11 37 7.9% -1.7% 22 58.7%

Jul-53 May-54 10 45 6.1% -2.6% 21 135% 1.8% 58.9%

Aug-57 Apr-58 8 39 7.5% -3.7% 13 136% 1.0% 59.3%

Apr-60 Feb-61 10 24 7.1% -1.6% 20 144% 3.0% 59.5%

Dec-69 Nov-70 11 106 6.1% -0.6% 17 148% 2.6% 60.2% 14.9%

Nov-73 Mar-75 16 36 9.0% -3.2% 18 151% 1.0% 61.2% 15.9%

Jan-80 Jul-80 6 58 7.8% -2.2% 9 162% -0.4% 64.0% 16.7%

Jul-81 Nov-82 16 12 10.8% -2.7% 27 162% 3.3% 63.8% 16.9%

Sep-90 Mar-91 8 92 7.8% -1.4% 31 233% 3.8% 66.4% 16.9%

Mar-01 Nov-01 8 120 6.3% -0.3% 46 272% 1.5% 67.3% 17.1%

Dec-07 Jun-09 18 73 10.0% -4.3% 75 357% 1.1% 66.0% 16.9%

? ? ? 84 ? ? ? 350% 1.3% 62.8% 18.5%

Average 11 58 7.9% -2.2% 27 1.9%

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1950

-1955

1956

-1960

1961

-1965

1966

-1970

1971

-1975

1976

-1980

1981

-1985

1986

-1990

1991

-1995

1996

-2000

2001

-2005

2006

-2010

2011

-2015

TFP Growth Rates (%) Average 1950-1980

Average (1980-2015)

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1971

-1975

1976

-1980

1981

-1985

1986

-1990

1991

-1995

1996

-2000

2001

-2005

2006

-2010

2011

-2014

Average 1971-2000

Average 2000-2014

...eroding aggregate

productivity levels

Macquarie Research What caught my eye? v.59

7 June 2016 9

Fig 18 Key DMs – TFP Growth Rates (%) Fig 19 Global TFP Growth Rates (%)

Source: TED; Macquarie Research, June 2016 Source: TED; Macquarie Research, June 2016

Fig 20 China TFP Growth Rates (%)

Source: TED; Macquarie Research, May 2016

Investors frequently mention that in their view, the problem with productivity is that we are

mismeasuring underlying productivity gains.6 We have always regarded this as an

intellectually incoherent proposition for three reasons:

1. If we are understating productivity of new technologies, then theoretically we are

probably also overstating productivity and value of old technologies and it is far from

clear that the net outcome would be an overall productivity enhancement;

2. There is considerable evidence that a decline in productivity growth rates reflects a

significant sectoral shift.

In other words, the aggregate level of productivity can only increase, if more

competitive and higher productivity segments become much larger and there is an

increasing flow of labour force towards these higher productivity occupations. As can

be seen below, over the last three decades, in the case of the US, there was an

increasing outflow from higher than average productivity occupations and growing

inflow into lower productivity pursuits (such as healthcare, education, community,

social and personal services, restaurants and hotels etc).

6 One of the better papers on the subject is from Brookings Papers on economic activity by David

Byrne, John Fernald and Marshall Reinsdorf, “Does the United States have a productivity slow down or a measurement problem?”, March 2016

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1990-1994 1995-1999 2000-2004 2005-2009 2010-2014

Germany Italy

Japan France

Average (1990-2000) Average (2000-2014)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1999-2006 2007-2012 2012 2013 2014

-Global -Developed -Emerging

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Official Wu-Maddison

Are we

mismeasuring

productivity?

Macquarie Research What caught my eye? v.59

7 June 2016 10

For example, between 1980 and 2010, the employment CAGR in the area of

Government services, healthcare and education averaged 1.7% per annum. This

segment now accounts for ~31% of the US labour force vs 19% in 1950 and its

productivity rate is ~30% below national average. Similarly, employment in trade,

restaurants and hotels has grown at 1.2% CAGR (almost 25% of the US labour force

is now in this area) and its relative productivity is 2/3 of the US national level. On the

other hand manufacturing employment declined at a 1.6% per annum clip whilst its

productivity exceeds national average by ~15%-16%. Similarly mining employment

contracted at a 1.2% clip (3x national productivity) whilst utilities employment

contracted at 70bps per annum (3.5x national productivity).

In the table below we have used the Groningen productivity data base, which on a

consistent and global basis, allocates labour and output to ten broad internationally

recognized categories. Although current series end in 2010, the data base provides a

window all the way from 1950 onwards (unlike BLS’s far more detailed data base,

which only goes back to 1980s).

Fig 21 US – Employment & Relative Productivity Comparison

Source: Groningen Data base, 2014; Macquarie Research, June 2016

Whilst the nature of sectors somewhat varies, broadly similar conclusions can be

derived for most other DMs and increasingly EMs. Growing employment in lower

productivity service sectors more than offsets rising productivity in isolated higher

technology areas and declining employment in some of the key traditional areas with

high productivity (such as manufacturing).

Fig 22 UK – Employment & Relative Productivity Comparison

Source: Groningen Data base, 2014; Macquarie Research, June 2016

Employment (Cagr) Output/Employee (US=100%) Employment Structure

1950-2010 1950-1980 1980-2010 1950-1960 1980-1990 2000-2010 1950 1980 2010

Low Productivity Occupations

Government, Health & Education 2.2% 2.7% 1.7% 150% 102% 69% 18.9% 25.2% 31.0%

Community, Social & Personal 2.2% 2.9% 1.5% 71% 73% 63% 4.1% 5.6% 6.5%

Trade, Restaurants & Hotels 1.7% 2.2% 1.2% 45% 48% 67% 20.1% 23.0% 24.0%

Construction 1.2% 1.7% 0.7% 228% 124% 82% 5.9% 5.7% 5.0%

Agriculture -1.6% -2.2% -1.1% 20% 37% 66% 9.1% 2.8% 1.5%

High Productivity Occupations

Finance, Insurance & Business Services 3.1% 3.6% 2.6% 257% 217% 186% 6.8% 11.4% 18.0%

Transport & Communication 0.5% 0.6% 0.3% 52% 86% 118% 7.8% 5.5% 4.4%

Utilities 0.3% 1.3% -0.7% 189% 300% 440% 0.7% 0.6% 0.4%

Mining -0.5% 0.2% -1.2% 371% 350% 425% 1.6% 1.0% 0.5%

Manufacturing -0.4% 0.9% -1.6% 49% 73% 116% 25.0% 19.2% 8.7%

Employment (Cagr) Output/Employee (UK=100%) Employment Structure

1950-2010 1950-1980 1980-2010 1950-1960 1980-1990 2000-2010 1950 1980 2010

Low Productivity Occupations

Government, Health & Education 1.3% 1.5% 1.1% 158% 111% 76% 15.8% 23.3% 30.1%

Transport & Communication 0.9% 0.9% 0.8% 29% 44% 76% 14.9% 12.3% 10.8%

Trade, Restaurants & Hotels 0.9% 0.9% 0.8% 109% 86% 83% 14.0% 17.3% 20.3%

Construction 0.4% 0.7% 0.2% 131% 108% 95% 6.7% 7.7% 7.5%

Agriculture -1.5% -2.3% -0.7% 18% 43% 50% 5.5% 2.5% 1.9%

High Productivity Occupations

Finance, Insurance & Business Services 3.0% 2.7% 3.3% 210% 143% 166% 2.2% 4.7% 11.6%

Community, Social & Personal 1.8% 0.8% 2.8% 161% 163% 108% 2.5% 3.0% 6.2%

Utilities -1.4% -0.3% -2.5% 79% 194% 480% 1.2% 1.0% 0.5%

Manufacturing -1.5% -0.3% -2.7% 71% 93% 121% 30.7% 26.1% 10.7%

Mining -5.0% -3.7% -6.2% 198% 378% 1123% 6.5% 2.0% 0.3%

The answer is no...

as neither the

aggregate allocation

of product and

labour nor....

Macquarie Research What caught my eye? v.59

7 June 2016 11

Fig 23 France – Employment & Relative Productivity Comparison

Source: Groningen Data base, 2014; Macquarie Research, June 2016

3. One could intellectually accept that perhaps real productivity growth rates are faster

than our current measurement, if there were evidence of significant and accelerating

growth in real and nominal wages. Given that over the long-term, there is a strong

correlation between productivity and wages, the presence of strong wage growth

over prolonged periods (rather than just occasional spikes) would confirm that

productivity growth rates must be mismeasured.

Unfortunately for productivity ‘bulls’ there is no evidence that this is the case. As can

be seen below, the US (2014) median real household income was ~US$53,000 vs.

the peak of US$58,000 in 1999-2000 and it is broadly at the same level as it was in

1996. Indeed, apart from a short-lived burst in the 1996-2000 period (coinciding with

what now looks like a temporary upward blip in productivity growth in the late 1990s),

the stagnating/negative trend has been well-imbedded in the US since the 1980s.

A similar message comes from UK statistics, with average real household income

per capita remaining on a broadly flat to declining curve since 2007, corresponding

with a considerable drop in most labour productivity ratios over the last decade.

Perhaps, one difference vs. the US is that the UK real household income remained

relatively firm through the entire period until 2007, whereas US household income

levels have been signalling a structural weakness for decades.

Fig 24 US – Median Real Household Income (US$) 3YMMA (%)

Fig 25 UK – Real Household Income per Capita (£) 3YMMA (%)

Source: US Census; Macquarie Research, April 2016 Source: ONS; Macquarie Research, April 2016

Employment (Cagr) Output/Employee (France=100%) Employment Structure

1950-2010 1950-1980 1980-2010 1950-1960 1980-1990 2000-2010 1950 1980 2010

Low Productivity Occupations

Finance, Insurance & Business Services 2.2% 1.8% 2.5% 75% 56% 42% 6.0% 9.3% 17.3%

Government, Health & Education 1.4% 1.4% 1.4% 231% 128% 102% 16.5% 22.8% 29.9%

Community, Social & Personal 1.4% 1.4% 1.4% 233% 127% 94% 1.9% 3.7% 6.6%

Trade, Restaurants & Hotels 0.9% 1.2% 0.6% 108% 98% 103% 12.5% 16.2% 17.1%

Agriculture -3.1% -3.2% -3.0% 24% 49% 85% 25.5% 8.7% 3.1%

High Productivity Occupations

Transport & Communication 0.9% 1.1% 0.7% 77% 100% 139% 4.8% 6.0% 6.5%

Utilities 0.8% 1.3% 0.3% 278% 497% 319% 0.6% 0.7% 0.7%

Construction 0.3% 0.9% -0.3% 170% 129% 121% 7.6% 9.0% 7.1%

Manufacturing -0.8% 0.3% -1.9% 51% 75% 126% 23.6% 23.2% 11.4%

Mining -3.3% -2.6% -3.9% 188% 239% 167% 1.1% 0.4% 0.1%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

35,000

40,000

45,000

50,000

55,000

60,000

69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14

Median Household Income (Real) 3Y MMA

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

62 64 67 69 72 75 77 80 82 85 88 90 93 95 98 00 03 06 08 11 13

UK Real Household Income per Capita 3Y MMA

...wage outcomes

support this

proposition

Macquarie Research What caught my eye? v.59

7 June 2016 12

The challenge facing both the US and the UK is that despite rapidly tightening labour

markets, there is no sign of any significant acceleration in wage outcomes whilst

overall household real incomes continue to stagnate.

The same trend is prevalent across most other DMs and increasingly it is starting to

emerge in EMs. Whilst in some emerging markets, it is still regarded as conventional

to expect at least 10% pay rise per annum (e.g. India), this is becoming far less

prevalent in countries like China, Brazil, Thailand and Indonesia.

Fig 26 Thailand – Real Wages – 3MMA (%) Fig 27 Indonesia – Real Wage Increase (%)

Source: CEIC; Macquarie Research, April 2016 Source: CEIC; Macquarie Research, April 2016

Fig 28 China – Real & Nominal Wages (%) Fig 29 Brazil – Real wages – 3MMA (%)

Source: CEIC; Macquarie Research, April 2016 Source: CEIC; Macquarie Research, April 2016

The message is simple: if productivity stagnates/declines then ultimately there

would be no increases in wages. However it is equally true that higher wage

outcomes would have implied that ‘real’ productivity growth rates are most likely

higher than currently reported levels.

Rapidly slowing productivity gains and increasing polarization has also led over the last two

decades to a significant increase in levels of income and wealth inequality (not dissimilar to

experiences from the First and Second Industrial Revolutions).

Whether one looks at the US or most other jurisdictions, income and wealth inequalities have

returned back to the levels prevailing in the ‘gilded’ age of the First and Second Industrial

Revolutions. Indeed, wealth inequalities tend to be larger and deeper than income

inequalities. This particularly applies to the top 0.1% and 1%. It also applies equally to

traditionally less egalitarian societies (such as the US or UK) as well as societies that

traditionally have had a much more equal distribution (such as France, Korea and Japan).

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Ma

r-1

3

Jun-1

3

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun-1

5

Se

p-1

5

Dec-1

5

Mar-

16

Real Wages (3MMA)

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2009

2010

2011

2012

2013

2014

2015

Real wage Increase

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Real Wage (%) Wages (%)

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Ja

n-0

6

Ju

n-0

6

No

v-0

6

Ap

r-0

7

Se

p-0

7

Fe

b-0

8

Ju

l-0

8

De

c-0

8

Ma

y-0

9

Oc

t-0

9

Ma

r-1

0

Au

g-1

0

Ja

n-1

1

Ju

n-1

1

No

v-1

1

Ap

r-1

2

Se

p-1

2

Fe

b-1

3

Ju

l-1

3

De

c-1

3

Ma

y-1

4

Oc

t-1

4

Ma

r-1

5

Au

g-1

5

As productivity and

income stagnate,

income & wealth

inequality increases

Macquarie Research What caught my eye? v.59

7 June 2016 13

Fig 30 US – Wealth Distribution top 0.1% & 1% (%) Fig 31 US – Wealth Distribution - Bottom 90%/top 10%

Source: Saez-Zucman 2015; Macquarie Research, June 2016 Source: Saez-Zucman 2015; Macquarie Research, June 2016

Fig 32 US – Income Share Top 0.1% Fig 33 US – Income Share Top 1%

Source: Saez-Zucman 2015; Macquarie Research, June 2016 Source: Saez-Zucman 2015; Macquarie Research, June 2016

Fig 34 UK, France & Italy – Top 0.1% Income Share Fig 35 Korea & Japan – Top 0.1% Income Share

Source: Saez-Zucman 2015; Macquarie Research, June 2016 Source: Saez-Zucman 2015; Macquarie Research, June 2016

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

1913

1917

1921

1925

1929

1933

1937

1941

1945

1949

1953

1957

1961

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

2009

Top 0.1% Top 0.01%, rhs

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1917

1921

1925

1929

1933

1937

1941

1945

1949

1953

1957

1961

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

2009

Bottom 90% Top 1%-10%, rhs

0%

2%

4%

6%

8%

10%

12%

14%

19

13

19

17

19

21

19

25

19

29

19

33

19

37

19

41

19

45

19

49

19

53

19

57

19

61

19

65

19

69

19

73

19

77

19

81

19

85

19

89

19

93

19

97

20

01

20

05

20

09

P99.9-100 Excluding capital gains

P99.9-100 Top 0.1% income share

0%

5%

10%

15%

20%

25%

30%

19

13

19

17

19

21

19

25

19

29

19

33

19

37

19

41

19

45

19

49

19

53

19

57

19

61

19

65

19

69

19

73

19

77

19

81

19

85

19

89

19

93

19

97

20

01

20

05

20

09

Top 1% Ex Capital Gains Top 1% Including Capital Gains

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

UK France, rhs Italy, rhs

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Japan Korea, rhs

Macquarie Research What caught my eye? v.59

7 June 2016 14

Fig 36 UK, France & Sweden – Top 1% Wealth Share Fig 37 UK, France & Sweden – Bottom 90% wealth

Source: IMF; Macquarie Research, June 2016 Source: IMF; Macquarie Research, June 2016

Stagnating productivity and income levels as well as rising income and wealth inequalities

seems to be fairly standard outcomes that countries encounter as they progress through

Industrial Revolutions. It takes considerable time to line up people, machines and societies

(decades). Each stage also tends to be far more complex than the previous stage. As

discussed above, the First Industrial Revolution impacted only a portion of the economy and

generally required skills comparable to basic literacy; the Second Industrial Revolution was a

far more comprehensive re-working of both economies and societies and required a far

higher level of education and skills. The Third Industrial Revolution is impacting every facet of

human activity (from manufacturing and trade; services and social interaction) and requires

not just a higher level of education (it is far from clear whether standard four-year degree

makes much difference) but special communication and human contact skills.

It seems indisputable to us that most people currently employed in low and medium skill

occupations are simply ‘warehoused’, pending their final replacement. As the power of

machines and processes exponentially improves (and we are undoubtedly now at the sharp

end of the technological S curve) most of these individuals would no longer be required. The

question then becomes how would society function and how would aggregate demand

multiply? We will come back to this question below, but first it is important to ask whether

Marxists are correct and whether there are other non-technological explanations.

Was Karl Marx right after all? - ...possibly but...

Whilst technological answers have thus far stolen most of the lime light, there is an alternative

explanation which also makes sense and has increasing support behind it. A number of

alternative explanations can be conveniently grouped under a very broad ‘Marxist or neo-

Marxist heading’. The classic example of these was a widely popular Piketty book (‘Capital in

the Twenty First Century’).

The Marxists explanations downplay technological reasons and instead highlight

contradictions that are inherent in the capitalist model. Marxists would argue that capitalists

have a strong tendency towards creation and maintenance of monopolies or oligopolies. In

order to achieve this outcome, they capture the key institutions of state (such as regulators

and political parties). As capitalists maximize profits, they divert income from ‘labouring

classes’ to controllers of capital. Eventually, the process comes to an end as consumption

cannot be maintained, and capitalists effectively ‘hang themselves’ with their own profit

maximizing policies.

The end outcome is that income stagnates; income and wealth inequalities increase, leading

to an explosion of social and geopolitical tensions (and either revolution, followed by

‘Communist Nirvana’ or war that destroys existing order). Either way, the ‘explosion’ would

reset economies and societies; reduce income and wealth inequalities and basically restart

the whole process all over again.

There is no doubt that there is considerable evidence from political science regarding success

of vested interests in capturing regulators (refer Olson, Fukuyama, Huntington). There is

also evidence that businesses (and investors) for obvious reasons prefer monopolies or

oligopolies. It is also true that the periods of rising income and wealth inequality have been

universally ‘crowned’ by revolutions and wars that have reset both societies and economies.

0%

5%

10%

15%

20%

25%

30%

UK France Sweden

1980 2010

0%

10%

20%

30%

40%

50%

60%

UK France Sweden

1980 2010

It takes decades &

multiple conflicts to

line-up humans,

society & machines

Marxists have a

point in highlighting

the tendency to

monopolistic profits

and capture of

institutions

Macquarie Research What caught my eye? v.59

7 June 2016 15

However, it is equally true that capitalist societies have a considerable degree of flexibility in

re-inventing themselves and re-building economies. For example the US ‘gilded age’ did not

end necessarily in a war but rather in aggressive anti-Trust policies pursued by the Presidents

Roosevelt, Taft and Wilson in 1901-21. There were similar attempts to halt monopolies in the

break-up of AT&T in 1980s and the dogged pursuit of Microsoft and Google by the European

anti-trust regulators. In other words, whilst there is evidence of institutional hijacking,

countries with strong and resilient institutions are able to fight back, albeit with a time gap.

...it is likely both explanations have elements of truth. However remedies are significantly different

Whilst we tend towards technological explanations, we have to admit that Marxist reasoning

does have a great societal and historical legitimacy. In our view the current period of stagnant

productivity and income and rising income/wealth inequalities is driven by a combination of:

1. Accelerating pace of the Third Industrial revolution.

Most academics agree that the process commenced sometime in 1970s (with the

introduction of first computers and production line robots) and if history is any guide it

would roll-on for at least fifty to seventy years (i.e. until 2020s-30s). Most investors

suggested to us that the current generation has access to better equipment and tools

and hence the progression should be faster than in the previous epochs. We believe

that investors underestimate the truly disruptive nature of the current transition vs.

previous Revolutions. Hence we are far from convinced that it would take less time

than in the past to line up people, machines and society.

Not to belabour the point, we believe that whereas previous Revolutions were aiming

to supplement and enhance humans, this one is aiming to completely or largely

displace human input and not only in routine but increasingly most of the professional

and medium and higher value-added occupations. Even if not completely displacing

humans, the technological evolution significantly reduces humans’ bargaining power.

We shall return later in the report to the likely political and societal responses.

2. Unlike Industrial Revolutions number one and two, the current period of change also

coincides with a significant degree of over leveraging and over capacity created

not by technology but rather by the societal response over the last three decades to

stagnating incomes and rising inequality.

As discussed in our prior reviews (refer), this is essentially a self-inflicted ‘wound’.

Prior to FDR’s ‘New Deal’ (1933-34), politics and society would have largely allowed

the business cycle to clear overcapacity and inefficiency. However, since 1930s, it

has become politically and socially unacceptable. The response has focused on de-

regulation and leveraging; allowing consumers (read voters and for non-democracy,

selectors) to compensate for the lack of income via leveraging and asset prices.

However leveraging eventually reaches the point where the private sector loses

confidence and velocity of money becomes first volatile and then declines, prompting

an even more aggressive public and CBs’ response. However, this in turn creates a

feedback loop, further eroding a private sector visibility and hence prompting even

more aggressive public sector responses. The net outcome is a highly deflationary

combination of over leveraging and associated over capacity, with cost of capital

declining to try to match stagnant demand and excess capacity. However, this in turn

precludes excess capacity from ever clearing or the private sector visibility ever

improving.

3. Institutional capture and social upheavals compound challenges.

It is also quite likely that Marxists’ Apocalyptic view of the world has some degree of

merit. We generally find that Marxists are far better sociologists than economists.

Their perception of build-up of economic pressures, flowing into societal and

geopolitical dislocation is an important one as indeed their view of market clearance

via violent upheaval. More recent academic literature also confirms Marx’s view of

institutional capture by vested interests.

How do politics and society respond to these challenges and how should investors change

their strategy?

We maintain that

current dislocation

is driven by a

combination of....

...the accelerating

pace of the Third

Industrial

Revolution...

...overleveraging

and overcapacity or

“a self-inflicted”

wound and...

...institutional

capture

Macquarie Research What caught my eye? v.59

7 June 2016 16

Pendulum is swinging back to the State “Liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate...it will purge

rottenness out of the system”, Andrew Mellon advise to President Hoover (1929-30)

“The New Deal is plainly an attempt to achieve a working socialism and avert a social

collapse in America; it is extraordinary parallel to the successive policies and plans of

the Russian experiment. Americans shirk the word socialism, but what else can one

call it”, H.G Wells (1937)

“The most terrifying words in the English language: I am from the Government and I

am here to help”, Ronald Reagan (1980)

“I made a mistake in presuming that the self-interests of organizations and others,

were such that they were best capable of protecting their own shareholders and their

equity in the firm...I discovered a flaw in the model that I perceived is the critical

functioning structure that defines how the world works”, Alan Greenspan (2008)

We maintain our view that the global Pendulum is strongly swinging back towards the

Government and the state power.

In many ways, we believe that societies and investors are positioned at similar juncture as the

US was just prior to the New Deal in 1933-34. Prior to 1933, Andrew Mellon’s advice to the

President Hoover was broadly in line with conventional thinking at the time. Broadly speaking

politics and society would have allowed for a large part of business and cyclical adjustment to

occur through 19th and early part of 20

th centuries. However since FDR’s New Deal (1933-34),

neither politics nor society were prepared to tolerate the degree of dislocation and the

unquantifiable contraction in aggregate demand that this strategy would entail.

Between 1933 and 1979, the state in most countries became the dominant driver of economic

and social outcomes. Indeed, the consensus was that there are no policies or activities that

the Government should not participate in. These included LBJ’s ‘Great Society’; repeated

nationalization of car and steel companies in Britain; nationalization of banks in Britain and

Sweden and the communist style Government direction in Japan. The 1960s was the apogee

or height of the belief in the role of the Government in smoothing out cycles and ensuring

well-functioning society and economy.

However by late 1960s, it has led the US, UK, Sweden, Netherlands and most other Western

economies into deep stagflation (at least five years before a rise in oil prices). As

unemployment began to rise (coinciding with rapidly accelerating prices), the consensus

broke, with Ronald Reagan and Margaret Thatcher in the lead from 1979 onwards. This

ushered the period when pendulum started to swing against the Government and in favour of

private sector. Reagan’s famous quip about the Government being a problem and not a

solution epitomized the new consensus.

Apart from some EMs and Japan, the pendulum between 1979 and 2008 swang aggressively

in favour of the private sector. Indeed, as we have discussed in our prior reviews, the

Government exited not only many areas that it should not have been involved, but also a

number of segments where the Governments’ role is critical, such as basic research,

regulatory and anti-trust functions. Whilst even in Reagan years, politics have never allowed

for any meaningful shrinkage of the Government’s share of GDP, there is no doubt that the

prevailing consensus emphasized private sector solutions.

Since 2008, the pendulum started to swing back towards the greater role of state and

away from private sector solutions. Whilst the pure followers (such as the Austrian school)

would argue that even in 1980s-90s, the system was not driven by free market but rather by

‘crony populist capitalism’, nevertheless, in the last decade, voters and populace started to

demand that state protects them from vagaries of the market and economic uncertainty and

politics are responding (and hence recent popularity of either extreme left or right wing

politicians). In our view, the above humble quote from Alan Greenspan regarding the logical

flaw in his view of the world is as a good marker as one would get delineating the two epochs.

Political and

societal response is

to increase reliance

on state...

...since 2008, the

pendulum has been

aggressively

swinging back

towards the greater

role of the state

Macquarie Research What caught my eye? v.59

7 June 2016 17

We maintain our view that pendulum in favour of more robust Government and state role

would accelerate significantly over the next 12-18 months. We view the current period as

more or less equivalent to 1933 prior to FDR’s New Deal. We agree with HG Wells that as in

a New deal, investors are entering the era of nationalization of credit and aggressive public

sector posture. As in 1930s, the logic behind it is also similar: “if private sector refuses to

multiply money, it is a responsibility of public sector to do so.”

If the history is any guide this swing towards the state would last at least one or two

generations (i.e. more than 20 years) and would increase in intensity. As identified in our prior

reviews, we believe that the state would become particularly aggressive in four areas:

1. Multiplication and support for consumption, through various mechanisms, such

as minimum income guarantees (despite recent defeat of Swiss referendum); short-

dated spending vouchers etc. Given our view that we inhabit the world of declining

returns on humans, it makes sense to ensure that aggregate demand continues to

multiply.

2. Fixed asset and infrastructure investment. We maintain that the bulk of the world

already has sufficiently good (acceptable) infrastructure and given that returns on

humans are declining, there does not appear to be very strong reasons for investing

significant further incremental funds, apart from countries that suffer from severe

shortage (a la India or Africa). However, from the Governments’ perspective the

advantage of fixed asset investment is its significant multiplier impact and a quick

‘bang for the buck’ (irrespective of whether incremental infrastructure improves

productivity).

3. R&D and skilling. We maintain that this is one area which was unnecessarily

abandoned by the public sector after 1979/80. The private sector tends to do very

little basic research and hence, it would make sense to significantly increase public

sector spending (such as resurrecting Bell Labs or NASA). Similarly, in many

countries the Government has retreated too far from skilling and education. However

the unfortunate part about this type of investment is that whilst potentially useful, it

has very long-term pay back periods.

4. Nationalization of finance and capital markets. We maintain that ultimately the

current structure and positioning of banking, finance, life and insurance and pension

systems is not sustainable. Hence it is highly likely that the state would need to get

increasingly involved, ultimately leading to nationalization or effective underwriting of

significant portions of capital markets.

As discussed in our prior notes, there are three ways of paying for this expansion of the role

of state:

1. Marxists re-distribution of wealth via higher tax rate at higher income levels and

perhaps globally-coordinated wealth tax (a la Piketty suggestions). Given that

success and innovation is very seldom motivated by taxes (or lack of them), it is quite

possible that it might work.

2. Increased state borrowing. Although clearly interest rates are exceptionally low, we

find it amusing that flow based economists tend to completely forget balance sheet

and the fact that even at zero rates, any country becomes bankrupt when leverage

reaches critical levels. It also leaves it unable to ever return back to some form of

normality.

3. Central Bank funded expenditure. In other words, it represents a different and far

more potent form of QE, whereby the state and CBs stop trying to convince the

private sector and switches to direct funding of projects and expenditure.

We maintain that (3) is the most likely alternative and we also maintain that Japan is likely

to be the first country to embrace this aggressive form of QE, probably within the next six to

twelve months. Over time, most other economies (certainly Eurozone and China) would join a

similar CB funded direct QE program. Although over the longer-term it would lead to lower

ROE and greater misallocation of resources, it is also likely to be successful in kick starting

aggregate demand multiplication.

What does it mean for investor styles?

We maintain that the

current period is

most reminiscent to

1933, just prior to

New Deal

State is likely to get

much more involved

in multiplication of

consumption...

...fixed asset

investment; R&D

and skilling as well

as...

...ultimate

nationalization (or at

least underwriting)

of capital markets

and finance,

pension and life

industries

The future

(unfortunately) lies

in the close merger

of fiscal and

monetary policies

Macquarie Research What caught my eye? v.59

7 June 2016 18

Thematics – uncorrelated strategy “In the midst of chaos, there is also opportunity”, Sun Tzu

As discussed in our latest notes (here and here), we believe that investors are facing a

choice between three different strategies:

1. Follow the Government. We believe that over the next several years this might

emerge as one of the most viable and popular investor strategies. Given that

Government and CBs would continue to dominate investment decisions as well as

the direction of capital allocation, it might make sense to simply follow Governments’

direction. If the Governments want to focus on stimulation of consumption, investors

would follow and invest in any product that benefit from stimulation of consumption at

the low end of the income distribution pyramid. On the other hand, if the Government

decides to invest more into basic infrastructure, then it would clearly lead investors

into buying material stocks. If the Governments prefer stimulating R&D and

education, investors would follow by investing into new Labs or education centres.

2. Quality-Sustainable growth. We believe that if one is uncomfortable with just

following the Government, then one of the best alternatives is to maintain Quality tilt.

As discussed (here), our definition of quality does not emphasise value, sectoral tilts

or defensiveness. Rather, we believe that the only reason for the existence of a

corporation is to reduce uncertainty/transaction costs and earn ROE above the cost

of capital. Hence, the key criteria in our global and regional ‘Quality & Stability’

portfolios is the ability to deliver sustainably high ROE (in excess of 12%), primarily

through margins (rather than sales) and without incremental leveraging. We also

emphasize free cash flow and only the financial sector is ruled out.

As discussed (here), our Asia ex Japan portfolio is currently up 2%-3% YTD (and is

up ~27% since inception in Feb’13). Our Global portfolio is also broadly flat YTD. It is

comforting to us that even in the midst of the strongest ‘trash rally’ since 2009, our

Quality portfolios withstood pressure, indicating that even in the world of strong

pendulum swing towards the state, Quality sustainable growth might remain a viable

strategy.

3. Thematics. In our view, the third and probably the most interesting investment

strategy is to exploit the above long-term structural shifts. Whilst in the past

Thematics focused on a range of topics that emphasized longer-term convergence

(such as middle class creation, emerging markets etc), we believe that the new

themes are far more likely to be growing economic divergence rather than

convergence. It is likely to emphasize stagnant productivity; lack of global trade

recovery and shrinkage of supply and value chains; increasing the trend towards de-

globalization and emphasis on protection of domestic markets.

Arguably most of these new trends are driven by the above described structural

shifts associated with a complex interaction of the Third Industrial Revolution and

self-inflicted wound of over leveraging and over capacity, with an overlay of multi-

decade transfer of wealth and returns to owners of capital. As discussed above, we

believe that technological explanations provide most of the power of this argument.

The key theme is replacement of humans and declining returns available on

human power. However, there are many other associated themes that one could

contemplate, including the above outlined need to support consumption through

variety of income and spending support policies. There is also a theme of rapidly

rising wealth inequality (although as upper middle class gradually get destroyed,

investors need to be careful how they classify luxury products, i.e. upper middle class

luxury could disintegrate or at least get massively commoditized).

The investment objective of this note is to identify the themes that promote and benefit from

declining return on humans. There are several Themes that quickly come to mind:

1. ‘Replacing Humans’. This is a very broad category that is attempting to focus on

industries that are actively working on complete replacement or at the very least

massive diminution of importance of human inputs. It includes various industries

specializing in robotics, automation and artificial intelligence.

We believe that

three stages would

come to dominate

equity investment...

Follow the

Government;

Quality-Sustainable

growth and...

...pure Structural

Thematics

Declining returns on

humans should be

the key theme

Macquarie Research What caught my eye? v.59

7 June 2016 19

2. ‘Augmenting humans’. It is quite likely that in one or two generations, humans

might not be humans (in our conventional sense). There are multitudes of companies

that are involved in various genome and other long-term augmentation and treatment

alternatives, with most belonging to various biotech sub-sectors.

3. ‘Opium of the people’. As Karl Marx once said, “religion is the opium of the people”.

Whilst that was true in 19th and 20

th centuries, we tend to believe that in 21

st century,

its place would be taken by games, entertainment and artificial 3D reality (sort of a

mixture of ‘Keeping up with the Kardashians’; ‘Super Bowl’; ‘Call of Duty’ and Sony

3D). There is a very large number of corporates that are attempting to fill this niche.

4. ‘Bullets & Prisons’. As discussed above, stagnant productivity growth rates and

rising income and wealth inequality (both within a given state and between states) is

a perfect recipe for rising social and geopolitical pressures. In our view, this implies

an increasing demand for security firms, mercenary forces as well as manufacture of

various means of surveillance (such as cyber or drones) as well as weapon

manufacturers.

5. ‘Education & Skilling’. It is highly likely that the personal and societal response over

the next decade would be to even further push into acquiring new skills. Whilst it is

clear that in most cases it would make little difference, neither society, parents nor

individuals can accept this verdict. Another interesting area would be the

Government’s push into basic research, which would spawn new industries that

satisfy this requirement, including setting up labs, funded by the Government.

6. ‘Demographics’. As discussed in our prior reviews, we believe that the economic

divergence is now a far stronger force than convergence. In most cases the

conventional demographic analysis of 19th -20

th century would not work. Hence,

instead of amplifying middle class creation, we tend to prefer to play demographics

through hospitals, psychiatric institutions and funeral parlours.

7. ‘Disrupters & Facilitators’. This broad category attempt to capture companies that

are at the sharp end of disruption. For example, Amazon would probably never make

appropriate returns but it would ensure that Walmart’s earnings are ultimately

severely damaged and that the price of most products would gravitate closer to zero.

Another example is the current ‘gold rush’ in the automotive industry. It reminds us of

late 19th-early 20

th centuries when hundreds of companies were vying to design and

perfect first cars. It is clear that in the next decade, the car industry would be

revolutionized. However what is not clear is how and which company would end up

having a successful business model. Hence, various agreements between Tesla,

Google, Amazon, GM, Chrysler etc. Similarly, one can see the disruption occurring in

the advertising space between traditional channels and new competition.

In other words, this Thematic Portfolio accepts that the change is inevitable and instead

of fighting it, joins with other disrupters to bring the new age and the end of the Third

Industrial Revolution closer. This portfolio also liberates investors from constant second-

guessing of Fed’s signals and conflicting macro-trends. It essentially asks investors to

focus on longer-term structural themes that would continue to evolve, irrespective of short-

term gyrations in public and CB policies.

Summarized below are some of our key global stock selections in each of these categories.

Whilst Macquarie does not cover (globally or regionally) many of these stocks, we have

attempted to identify (arguably) the most prominent representative in each category. As

Macquarie coverage continues to expand, we will be monitoring and adjusting this portfolio.

As in the case of our Asia ex Japan ‘Thematic Winners’ portfolio, our Thematic choices do not

have any quality, valuation or momentum screen. The selection is purely based on our

assessment whether certain stocks provide exposure to a particular Theme. This is unlike our

Flagship ‘Quality & Stability’ portfolios which have an exceptionally strict set of quality and

growth criteria (refer).

Our global Thematic

Portfolio includes...

Replacement and

augmentation of

humans...

“Opium of the

people”, “Bullets &

Prisons”...

“Education &

Skilling” as well as

“Disrupters and

Facilitators”

The advantage of

these Themes is

that they are

uncorrelated and

independent of CB

policies

Macquarie Research What caught my eye? v.59

7 June 2016 20

Fig 38 Macquarie – Global ‘Thematics’ portfolio (June-2016)

Source: FactSet, Macquarie Research, June 2016; As of 6 June 2016; Uses FactSet Consensus estimates

Our notional back test shows that the above portfolio of 49 stocks (when created equally

weighted at the beginning of Jan-2015) would have delivered around +30% outperformance

over MSCI AC World (US$, total returns basis). Even when measured on YTD or last

12month basis, the portfolio would have still outperformed its benchmark (see chart below).

We expect Thematics to be a powerful portfolio strategy, delivering strong uncorrelated

performance. Indeed, our Asia ex Japan Thematics portfolio - which we have been running

since Oct-2014 - has delivered +5% outperformance (over MSCI Asia ex Japan) despite

having no quality or valuation criteria and very limited turnover (at most twice a year). The

current constituents of Asia ex Japan ‘Thematics’ portfolio and performance are highlighted in

the charts below.

BB Ticker Name Country Analyst RatingTarget Price

(listing cncy)

Upside /

Downside

Market Cap (US$

mn)

Since

1/2015,

perf ($), %

3M, perf

($), %

PER-12m

fw

PER-Avg

12M fw

(since'10)

12m EPS %

change vs

12M ago

Theme 1: "Replacing Humans": Robots, Industrial Automation and Artificial Intelligence

ABBN VX ABB Ltd. Switzerland N/R N/R N/R N/R 48,457 (1.6) 13.6 18 15 -1%

300024 CH SIASUN Robot & Automation, Class A China N/R N/R N/R N/R 6,196 37.6 17.4 83 48 -14%

6506 JP Yaskawa Electric Corporation Japan Kenjin Hotta Neutral 1,200.00 (9.1) 3,298 (4.5) 1.6 17 17 -24%

ISRG US Intuitive Surgical, Inc. United States N/R N/R N/R N/R 24,238 20.4 10.9 29 30 22%

SIE GR Siemens AG Germany N/R N/R N/R N/R 91,789 (4.8) 12.2 13 12 7%

HON US Honeywell International Inc. United States N/R N/R N/R N/R 87,483 14.9 6.3 17 15 9%

6503 JP Mitsubishi Electric Corp. Japan Damian Thong Outperform 1,600.00 23.4 26,077 0.7 13.2 13 14 -6%

6645 JP OMRON Corporation Japan Damian Thong Outperform 4,000.00 19.4 6,714 (31.0) 10.5 16 16 -31%

300124 CH Shenzhen Inovance Tech. Class A China N/R N/R N/R N/R 4,667 24.7 11.8 28 29 9%

1590 TT AirTAC Taiwan Jeffrey Ohlweiler Outperform 214.00 (4.9) 1,236 (19.2) 30.9 19 18 -2%

NVDA US NVIDIA Corporation United States Deepon Nag Outperform 45.00 (3.2) 24,820 131.8 42.4 30 19 84%

MLNX US Mellanox Technologies, Ltd. Israel Rajesh Ghai Outperform 70.00 45.2 2,297 12.8 (5.5) 13 22 52%

Theme 2: "Augmenting Humans": Genome/Biotechnology/DNA sequencing

AMGN US Amgen Inc. United States N/R N/R N/R N/R 119,586 (0.1) 9.2 14 13 16%

BIIB US Biogen Inc. United States N/R N/R N/R N/R 63,575 (14.5) 8.0 15 19 9%

ABBV US AbbVie, Inc. United States N/R N/R N/R N/R 105,128 (0.7) 16.2 13 14 12%

ILMN US Illumina, Inc. United States N/R N/R N/R N/R 21,423 (21.2) (7.6) 40 43 -2%

Theme 3: "Opium of the people": Games, Casinos/Virtual Reality

700 HK Tencent Holdings Ltd. China Wendy Huang Outperform 204.00 19.4 206,763 51.5 15.7 30 28 24%

ATVI US Activision Blizzard, Inc. United States Ben Schachter Outperform 40.00 5.8 27,912 87.6 20.0 19 15 46%

EA US Electronic Arts Inc. United States Ben Schachter Outperform 80.00 4.8 23,031 62.4 17.8 21 19 25%

NTES US NetEase, Inc. Sponsored ADR China Hillman Chan Outperform 188.00 7.1 23,099 77.1 25.3 16 13 45%

7974 JP Nintendo Co., Ltd. Japan David Gibson Outperform 21,300.00 34.6 20,994 41.0 1.4 46 45 23%

LVS US Las Vegas Sands Corp. United States Chad Beynon Outperform 54.00 15.5 37,153 (19.6) (11.1) 19 23 -12%

1928 HK Sands China Ltd. Macau Zibo Chen Outperform 32.50 17.3 28,763 (27.5) (3.3) 20 20 -8%

002241 CH GoerTek Inc. Class A China Allen Chang Outperform 37.00 29.4 6,630 9.8 14.4 23 26 -15%

Theme 4: "Bullets and Prisons": Defense, Security, Prisons/Correction Centres

047810 KS Korea Aerospace Industries, Ltd. South Korea Kwang Cho Outperform 114,000.00 65.7 5,666 60.5 (1.7) 23 24 47%

002415 CH Hangzhou Hikvision Digital Tech. Class A China Allen Chang Outperform 36.00 68.4 19,815 35.1 9.1 16 20 8%

LMT US Lockheed Martin Corporation United States N/R N/R N/R N/R 72,740 24.1 9.3 19 13 8%

RTN US Raytheon Company United States N/R N/R N/R N/R 39,754 23.7 7.2 18 12 8%

NOC US Northrop Grumman Corporation United States N/R N/R N/R N/R 38,830 46.0 12.0 19 12 12%

HO FP Thales SA France N/R N/R N/R N/R 18,279 59.1 10.0 17 12 20%

ESLT IT Elbit Systems Ltd Israel N/R N/R N/R N/R 3,983 53.2 11.0 NA 11 NA

CXW US Corrections Corporation of America United States N/R N/R N/R N/R 4,029 (5.6) 12.3 18 17 -1%

GEO US GEO Group Inc United States N/R N/R N/R N/R 2,522 (16.7) 9.8 16 16 0%

Theme 5: "Education & Skilling"

PSON LN Pearson PLC United Kingdom Tim Nollen Outperform 10.25 22.5 9,978 (34.6) 0.1 15 14 -29%

JW/A US John Wiley & Sons, Inc. Class A United States N/R N/R N/R N/R 3,082 (9.9) 18.4 17 15 -2%

EDU US New Oriental Education & Tech. Spons. ADR China Julia Pan Outperform 44.00 2.3 6,787 110.8 35.3 25 22 12%

XRS US TAL Education Group Unspons. ADR Class A China N/R N/R N/R N/R 2,455 97.4 10.4 39 29 24%

NORD US Nord Anglia Education, Inc. Hong Kong N/R N/R N/R N/R 2,365 19.1 13.8 29 28 -4%

WKL NA Wolters Kluwer NV Netherlands Giasone Salati Outperform 41.50 15.2 12,323 33.1 9.3 17 12 12%

Theme 6: "Demographics": Funeral Parlours and Psychiatric Centres

1448 HK Fu Shou Yuan International Group Ltd. China Jake Lynch Outperform 7.30 32.7 1,479 46.7 (6.0) 25 24 15%

SCI US Service Corporation International United States N/R N/R N/R N/R 5,295 20.4 11.7 21 17 2%

UHS US Universal Health Services, Inc. Class B United States N/R N/R N/R N/R 12,156 21.7 15.2 17 14 15%

ACHC US Acadia Healthcare Company, Inc. United States N/R N/R N/R N/R 5,233 (2.2) 0.3 19 25 30%

Theme 7: "Disruptors & Facilitators"

AMZN US Amazon.com, Inc. United States Ben Schachter Outperform 760.00 4.7 342,330 133.8 25.6 98 153 460%

TSLA US Tesla Motors, Inc. United States N/R N/R N/R N/R 31,946 (1.5) 11.9 139 135 -4%

FB US Facebook, Inc. Class A United States Ben Schachter Outperform 150.00 26.6 273,895 51.8 8.1 29 41 76%

CRM US salesforce.com, inc. United States Sarah Hindlian Outperform 97.00 17.5 55,928 39.2 16.6 75 87 40%

NFLX US Netflix, Inc. United States Tim Nollen Neutral 110.00 10.5 42,654 104.1 1.7 163 nm 91%

GOOGL US Alphabet Inc. Class A United States Ben Schachter Outperform 890.00 20.9 464,184 38.7 0.6 20 18 20%

Macquarie Research What caught my eye? v.59

7 June 2016 21

Fig 39 Macquarie – Global ‘Thematics’ portfolio notional performance relative to MSCI AC World

Fig 40 Macquarie – Asia ex Japan ‘Thematic Winners’ portfolio performance relative to MSCI Asia ex JP (since inception Oct-2014 until June 2016)

Source: Bloomberg, Macquarie Research, June 2016: Note – Equal weighted portfolio of the 49 stocks as highlighted above; Returns are dollar returns including dividends; Excludes transaction costs; Past performance is not a guarantee of future performance

Source: Bloomberg, Macquarie Research, June 2016: Note – Equal weighted portfolio; Returns are dollar returns including dividends; Excludes transaction costs; Past performance is not a guarantee of future performance; Until close of 3-June 2016

Fig 41 Macquarie – Asia ex Japan ‘Thematics Winners’ portfolio (April 2016 edition)

Source: Macquarie Research, June 2016; For further details refer ‘Rights, Wrongs & Returns - 2016 – Year of Living dangerously - sequel’, 13 April 2016

For the record, we also summarized below our key ‘Quality & Stability’ Portfolios. The latest

iteration and stock selections were completed in April 2016 (refer).

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

Port. perf rel to MSCI AC World (US$)

Global Thematics (hypothetical perf)

MSCI AC World US$

95

97

99

101

103

105

107

109

111

113

115

Oct

-14

No

v-1

4

De

c-1

4

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Asia ex "Thematics" portfolio (rel to MSCI ASXJ, $ TR basis)

Ticker Name Country Ticker Name Country

Security, Prisons and Bullets Robots, Industrial, Automation and Technology

2357 HK AviChina China 300124 CH Shenzhen Inovance China

002415 CH Hikvision China HOLI US HollySys Automation Tech. China

2634 TT Aerospace Industrial Development Taiwan 002241 CH GoerTek China

047810 KS Korea Aerospace Industries Korea 2049 TT Hiwin Technologies Taiwan

079550 KS LIG NEX1 Korea 2308 TT Delta Electronics Taiwan

STE SP ST Engineering Singapore 1590 TT AirTAC Taiwan

Educational & Training services Shifts in manufacturing migration/competitiveness

EDU US New Oriental Education & Tech. China 2333 HK Great Wall Motor Company China

XRS US TAL Education Group China 600066 CH Zhengzhou Yutong Bus (A-Share) China

NORD US Nord Anglia Education China 600031 CH Sany Heavy Industry China

Environmental Constraint 425 HK Minth Group China

2208 HK Xinjiang Goldwind China 2382 HK Sunny Optical China

2688 HK ENN Energy China 1766 HK CRRC Corp Ltd China

3800 HK GCL-Poly Energy China 2313 HK Shenzhou International China

257 HK China Everbright International China 1476 TT Eclat Textile Taiwan

1193 HK China Resources Gas China 600741 CH Huayu Automative China

958 HK Huaneng Renewables China 3606 HK Fuyao Glass China

SIIC SP SIIC Environment Singapore Demographics

EDC PM Energy Development Philippines 2628 HK China Life Insurance China

MWC PM Manila Water Philippines 300015 CH Aier Eye Hospital Group Co. Ltd. China

Entertainment Services GE SP Great Eastern Holdings Ltd Singapore

1970 HK IMAX China China RFMD SP Raffles Medical Group Singapore

002739 CH Wanda Cinema China BDMS TB Bangkok Dusit Medical Services Thailand

700 HK Tencent China BH TB Bumrungrad Hospital Thailand

NTES US Netease.com China IHH MK IHH Healthcare Bhd Malaysia

GENM MK Genting Malaysia Malaysia KPJ MK KPJ Healthcare Malaysia

079160 KS CJ CGV Korea FORH IN Fortis Healthcare India

Macquarie Research What caught my eye? v.59

7 June 2016 22

Fig 42 Macquarie – Global Quality & Stability Portfolio (April 2016)

Source: Macquarie Research, June 2016; For further details ‘Rights, Wrongs & Returns - 2016 – Year of Living dangerously - sequel’, 13 April 2016

Fig 43 Macquarie – Asia ex Japan ‘Quality & Stability’ Portfolio (April 2016)

Source: Macquarie Research, June 2016; For further details ‘Rights, Wrongs & Returns - 2016 – Year of Living dangerously - sequel’, 13 April 2016

Ticker Company Name Country Ticker Company Name Country

MSFT US Microsoft Corporation US CON GR Continental AG GR

JNJ US Johnson & Johnson US ADP US Automatic Data Processing US

FB US Facebook, Inc. US INFO IN Infosys Technologies IN

700 HK Tencent Holdings Ltd. HK WPP LN WPP Plc UK

ORCL US Oracle US 4503 JP Astellas Pharma Inc. JP

7203 JP Toyota Motor Corp. JP 4452 JP Kao Corp. JP

DIS US Walt Disney Company US 6981 JP Murata Manufacturing Co. JP

V US Visa Inc. US ADS GR adidas AG GE

2330 TT TSMC TW TEL NO Telenor ASA NO

AMGN US Amgen Inc. US EA US Electronic Arts US

NOVOB DC Novo Nordisk DK HO FP Thales SA FR

MA US MasterCard Incorporated US MSIL IN Maruti Suzuki IN

OR FP L'Oreal SA FR CAP FP Cap Gemini SA FR

ABBV US AbbVie, Inc. US 7741 JP HOYA CORPORATION JP

BAYN GR Bayer AG GE COLOB DC Coloplast A/S DK

MC FP LVMH FR ITV LN ITV plc UK

NKE US NIKE, Inc. Class B US 8035 JP Tokyo Electron Ltd. JP

AIR FP Airbus Group SE NL/FR IPG US Interpublic Group US

BN FP Danone SA FR EIM IN Eicher Motors IN

ST SP SingTel SP 2313 HK Shenzhou International HK

FDX US FedEx Corporation US 669 HK Techtronic Industries Co. HK

Code Company Name Country

700 HK Tencent China

2330 TT TSMC Taiwan

ST SP SingTel Singapore

INFO IN Infosys Technologies India

ITC IN ITC India

000333 CH Midea Group (A-Share) China

035420 KS NAVER Korea

1044 HK Hengan China

288 HK WH Group China

EIM IN Eicher Motors Ltd. India

2313 HK Shenzhou International Hong Kong

669 HK Techtronic Industries Co. Hong Kong

GCPL IN Godrej Consumer Products Ltd. India

600066 CH Zhengzhou Yutong Bus (A-Share) China

1193 HK China Resources Gas Group China

1316 HK Nexteer Hong Kong

5347 TT Vanguard Taiwan

1999 HK Man Wah China

HTHT US China Lodging Group China

MSIL IN Maruti Suzuki India India

Macquarie Research What caught my eye? v.59

7 June 2016 23

Appendices

Fig 44 Index performance, (Local currency, unless stated otherwise), %

Note : Priced as of close of 3 June 2016 Source: MSCI, Thomson, Macquarie Research, June 2016

Fig 45 Index performance by MSCI country and sector (local currency) – Last three months, %

Note : Priced as of close of 3 June 2016 Source: MSCI, Thomson, Macquarie Research, June 2016

MSCI Indices - 1W - 1M - 3M - 1Y - 3Y - 5Y YTD Index

MSCI AC Asia ex JP (LC) 1.1 1.7 3.0 -15.6 -1.4 -3.5 -0.7 619

ASXJ Consumer Discretionary 0.2 -0.7 0.6 -11.3 -19.5 -20.9 -3.3 409

ASXJ Consumer Staples 1.4 2.2 7.5 0.5 13.1 31.2 6.3 507

ASXJ Energy 0.4 -0.5 4.1 -18.5 -24.4 -41.9 8.1 524

ASXJ Financials 2.0 1.5 4.0 -23.6 -5.3 -4.7 -5.0 275

ASXJ Health Care -0.7 1.0 -2.5 -7.1 41.0 76.3 -5.9 924

ASXJ Industrials 0.4 -1.5 -2.0 -24.2 -8.8 -26.9 -6.2 148

ASXJ Information Technology 1.0 6.1 5.0 -6.7 17.9 33.4 3.5 328

ASXJ Materials -0.1 -4.1 -1.5 -11.2 -7.6 -36.3 4.1 287

ASXJ Utilities 0.8 0.9 3.0 -9.1 7.3 27.9 1.7 223

ASXJ Telecom Svcs 0.9 1.2 2.8 -12.1 1.3 17.9 2.5 139

MSCI AC ASIA EX JP U$ 0.9 0.3 3.7 -18.4 -7.9 -13.7 -0.6 497

MSCI CHINA U$ 0.5 0.4 4.6 -30.9 -6.7 -16.9 -6.6 56

MSCI HONG KONG U$ 2.1 0.9 4.7 -17.3 2.7 7.5 -1.4 9,318

MSCI INDIA U$ 0.2 3.5 7.7 -5.1 10.4 -7.7 0.1 460

MSCI INDONESIA U$ 0.4 -2.0 -4.4 -8.3 -27.3 -24.9 6.0 692

MSCI KOREA U$ 0.8 -3.3 4.3 -9.4 -11.0 -19.0 0.5 358

MSCI MALAYSIA (EM) U$ -1.7 -5.9 -2.8 -16.7 -32.6 -27.7 1.1 344

MSCI PHILIPPINES U$ 1.5 8.1 10.0 -3.3 5.7 68.2 9.4 581

MSCI SINGAPORE U$ 1.2 -2.0 1.7 -17.7 -22.0 -22.9 0.8 3,280

MSCI TAIWAN U$ 1.9 4.0 2.1 -15.4 -0.2 -12.8 4.9 279

MSCI THAILAND U$ 1.7 1.9 2.5 -9.3 -19.8 -0.9 16.9 345

MSCI China 0.6 0.6 4.6 -30.7 -6.6 -17.0 -6.3 56

MSCI Hong Kong 2.2 1.0 4.7 -17.1 2.8 7.5 -1.1 13,038

MSCI India 0.6 4.9 7.6 -0.1 30.9 38.6 1.8 1,004

MSCI Indonesia 0.5 0.9 -1.8 -5.7 0.7 19.7 4.6 5,703

MSCI Korea 1.1 0.4 1.7 -2.9 -6.7 -11.2 1.4 534

MSCI Malaysia -0.1 -0.8 -2.6 -6.3 -9.9 -0.5 -2.4 573

MSCI Philippines 1.2 7.1 8.6 0.4 16.8 80.9 8.0 1,298

MSCI Singapore 0.1 -1.3 -0.4 -16.6 -15.5 -15.0 -3.3 1,450

MSCI Taiwan 2.2 5.3 0.9 -10.5 8.6 -0.9 4.1 318

MSCI Thailand 1.7 4.0 2.9 -4.1 -6.2 16.5 15.8 493

MSCI EMG 0.8 1.2 3.2 -12.0 -1.2 -3.6 1.8 45,301

MSCI World (Dev) -0.4 1.7 3.6 -6.7 19.6 40.3 -0.9 1,266

MSCI AC World (All) -0.3 1.7 3.6 -7.2 17.2 34.4 -0.6 466

MSCI Japan -1.0 2.5 -3.3 -21.8 18.1 57.9 -14.4 802

MSCI USA 0.1 1.9 5.5 -1.3 27.8 60.7 2.5 1,999

MSCI AC Asiapac x JP ($) 0.7 -0.5 3.7 -16.9 -10.8 -15.5 -0.3 410

MSCI AC WORLD U$ 0.2 1.0 5.0 -7.5 10.1 18.9 1.1 404

MSCI EM U$ 1.0 -0.6 4.6 -18.0 -18.3 -29.4 2.8 816

MSCI WORLD U$ (Dev) 0.1 1.2 5.0 -6.2 14.0 27.2 0.9 1,679

MSCI EM ASIA U$ 0.7 0.3 3.7 -18.6 -8.3 -15.8 -0.6 401

MSCI WORLD EX JP ($) -0.0 1.1 5.2 -5.9 14.4 28.0 1.4 1,692

MSCI EUROPE U$ -0.6 -0.1 4.0 -14.0 -2.5 -5.4 -2.7 1,481

MSCI EMU U$ -0.2 -0.6 4.2 -13.0 1.4 -9.1 -2.8 167

MSCI AC Asia ex JP

AC

Asia

ex JP

China HK India Indo Korea Mal Phils Sing TW Thai EMG World

(Dev) Japan

AC

World

MSCI Country Index 3.0 4.6 4.7 7.6 -1.8 1.7 -2.6 8.6 -0.4 0.9 2.9 3.2 3.6 -3.3 3.6

Cons. Disc 0.6 2.7 0.5 16.9 1.2 -3.7 -2.4 0.9 -4.9 -8.0 6.2 4.2 0.9 -4.1 1.1

Staples 7.5 8.6 23.3 9.8 -3.9 11.7 -7.8 -1.5 4.9 8.8 11.3 5.3 3.3 0.0 3.5

Energy 4.1 7.7 NA -1.9 15.3 0.3 -15.5 0.0 0.0 1.9 8.9 3.0 7.2 -1.3 6.7

Financials 4.0 3.7 7.7 14.2 -5.0 0.8 -0.0 9.5 0.9 0.6 -1.2 3.3 2.7 -6.7 2.8

Banks 4.2 5.3 9.1 13.0 -5.3 5.7 -0.3 6.9 2.3 3.5 -2.8 4.1 1.9 -5.0 2.3

Real Estate 3.5 -1.5 6.3 NA NA NA 11.6 10.9 -1.9 6.5 15.0 2.7 4.5 -4.7 4.4

Health Care -2.5 5.1 NA -6.5 8.7 -7.1 -2.3 NA 0.0 36.5 -2.4 -1.0 5.4 -2.1 5.3

Industrials -2.0 3.3 -4.0 8.6 -10.4 -7.6 -1.2 11.0 -6.8 -10.6 -1.2 0.2 3.4 -2.0 3.2

IT 5.0 8.7 -9.8 5.8 NA 8.0 0.0 0.0 0.0 1.3 -11.9 5.1 4.0 -2.4 4.2

Materials -1.5 -5.4 0.0 21.1 -16.0 -9.1 -7.1 0.0 NA -1.5 10.3 1.4 7.5 -0.6 6.6

Utilities 3.0 -0.1 4.3 15.7 -4.8 2.4 2.9 -1.0 NA NA 2.0 1.7 4.4 -17.6 4.1

Telecom Services 2.8 2.7 5.6 3.3 9.3 2.2 -8.7 14.1 2.9 6.0 -9.0 0.8 -0.0 1.9 0.1

Macquarie Research What caught my eye? v.59

7 June 2016 24

Fig 46 Valuations – Asia ex JP and key comps

Note : Priced as of close of 3 June 2016 Source: MSCI, Thomson, Macquarie Research, June 2016

Fig 47 MQ-Asia ex JP – Country Allocation tilts (%)

Source: Macquarie Research, June 2016

Avg since 2010

MSCI Indices PER P/B EPS gr ROE DY PER P/B ROE DY PER P/B PER P/B

MSCI AC Asia ex JP 11.7 1.2 6.4 10.4% 3.0% 12.0 1.6 13.1% 2.9% 11.5 1.5 2% -17%

ASXJ Consumer Discretionary 11.8 1.4 11.6 11.5% 2.5% 11.1 1.8 15.8% 2.4% 11.1 1.8 7% -24%

ASXJ Consumer Staples 21.5 2.9 14.0 13.6% 2.0% 16.1 2.6 15.4% 2.4% 18.9 2.7 14% 8%

ASXJ Energy 13.9 0.9 9.5 6.2% 2.9% 9.9 1.7 15.0% 3.2% 10.3 1.4 35% -36%

ASXJ Financials 8.5 0.8 2.5 9.9% 4.0% 11.9 1.4 11.5% 3.3% 10.3 1.2 -17% -29%

ASXJ Health Care 22.3 3.5 20.5 15.6% 1.0% 18.6 3.2 15.8% 1.1% 21.4 3.2 4% 7%

ASXJ Industrials 12.2 1.0 8.2 8.5% 2.8% 13.1 1.4 10.7% 2.5% 12.6 1.3 -3% -20%

ASXJ Information Technology 14.2 1.9 9.8 13.4% 2.2% 13.1 2.0 15.8% 2.2% 12.0 1.9 18% 0%

ASXJ Materials 13.2 1.0 22.7 7.5% 3.0% 10.3 1.4 13.0% 3.2% 11.7 1.3 13% -22%

ASXJ Utilities 10.3 1.2 -5.7 11.5% 3.7% 12.6 1.4 10.8% 3.3% 13.2 1.4 -22% -16%

ASXJ Telecommunication Services 15.2 1.7 4.0 11.4% 3.8% 13.1 2.0 15.1% 4.1% 13.6 1.9 12% -7%

MSCI China 10.1 1.2 7.2 11.6% 2.8% 11.5 1.8 15.0% 3.0% 9.9 1.5 3% -20%

MSCI Hong Kong 14.0 1.0 4.3 7.2% 3.7% 15.4 1.4 8.8% 3.3% 14.7 1.3 -5% -20%

MSCI India 16.9 2.5 17.0 15.0% 1.8% 14.4 2.6 16.6% 1.6% 15.1 2.4 12% 6%

MSCI Indonesia 14.5 2.4 11.0 16.2% 2.7% 11.3 2.8 22.1% 3.2% 13.7 2.9 6% -20%

MSCI Korea 9.9 0.9 6.4 8.9% 2.0% 9.3 1.2 12.5% 1.7% 9.2 1.1 7% -20%

MSCI Malaysia 15.0 1.5 5.9 10.1% 3.3% 14.3 1.9 13.1% 3.6% 14.7 1.9 2% -20%

MSCI Philippines 18.5 2.5 8.5 13.3% 1.8% 15.0 2.2 14.7% 2.7% 16.8 2.6 10% -4%

MSCI Singapore 11.8 1.0 1.4 8.7% 4.4% 14.1 1.5 11.0% 3.7% 13.2 1.4 -11% -26%

MSCI Taiwan 12.3 1.4 1.6 11.7% 4.4% 14.0 1.7 13.2% 3.9% 13.2 1.7 -7% -15%

MSCI Thailand 13.9 1.7 9.6 12.2% 3.2% 10.9 1.8 16.3% 3.9% 11.8 1.9 18% -9%

MSCI EMG 11.4 1.3 10.1 11.0% 3.0% 10.7 1.6 14.4% 3.3% 10.6 1.4 7% -13%

MSCI World (Dev) 16.0 2.0 7.3 12.4% 2.8% 14.6 1.9 13.6% 2.7% 13.5 1.8 18% 13%

World(Dev) Consumer Discretionary 15.4 2.6 11.4 16.7% 2.2% 16.5 2.0 13.5% 2.0% 14.8 2.2 4% 16%

World(Dev) Consumer Staples 20.5 4.0 7.6 19.6% 2.7% 16.6 3.2 19.2% 2.8% 16.4 3.1 25% 29%

World(Dev) Energy 33.9 1.5 1.2 4.4% 3.8% 13.6 1.8 14.4% 2.8% 14.3 1.5 138% 1%

World(Dev) Financials 12.4 1.0 3.7 8.4% 3.6% 11.9 1.3 10.8% 3.4% 11.5 1.0 8% 0%

World(Dev) Health Care 16.0 3.4 8.4 21.1% 2.1% 15.9 2.9 19.6% 2.3% 14.3 2.8 12% 20%

World(Dev) Industrials 15.8 2.4 13.2 15.1% 2.6% 15.2 2.1 14.5% 2.4% 14.0 2.1 13% 17%

World(Dev) Information Technology 16.4 3.2 8.2 19.8% 1.7% 19.1 2.9 18.2% 1.2% 14.1 2.7 16% 19%

World(Dev) Materials 17.4 1.7 7.9 9.8% 2.5% 13.9 1.8 13.7% 2.4% 13.2 1.7 32% 4%

World(Dev) Utilities 15.9 1.5 -1.0 9.7% 4.0% 13.9 1.6 10.8% 4.2% 14.4 1.4 10% 14%

World(Dev) Telecommunication Services 15.1 2.1 7.2 13.8% 4.2% 19.8 1.8 12.6% 4.6% 13.5 1.8 12% 17%

MSCI AC World (All) 15.4 1.9 7.7 12.2% 2.8% 14.2 1.9 13.7% 2.9% 13.1 1.7 17% 9%

MSCI Japan 13.0 1.1 14.3 8.2% 2.4% 16.8 1.3 8.5% 1.7% 13.6 1.1 -5% -3%

MSCI USA 17.1 2.6 7.2 15.3% 2.2% 15.2 2.3 15.5% 2.1% 14.3 2.2 20% 20%

MSCI Australia 16.1 1.7 5.3 10.7% 4.7% 13.9 2.0 14.4% 4.7% 13.4 1.8 20% -3%

12 Month forward estimates LT Average (12M forward ests) Current vs post-2010 avg

-2 -1 0 1 2 3

India

Philippines

Taiwan

China

Korea

Malaysia

Singapore

Thailand

Hong Kong

Indonesia

Macquarie Research What caught my eye? v.59

7 June 2016 25

Recent Asia Equity Strategy Research

What caught my eye? v.58 - Divergence, convergence & confusion 24 May 2016 What caught my eye? v.57 - Portfolios: The case of less is more 17 May 2016 What caught my eye? v.56 - Capital – Time for a vegetarian diet? 11 May 2016 What caught my eye? v.55 - Why are we staying in China & India? 29 April 2016 Ready for Battle - Macquarie earnings survivors’ guide 21 April 2016 Rights, Wrongs & Returns - Year of Living dangerously – sequel 13 April 2016 Central Banks & Markets - Mutually assured destruction 31 March 2016 Global Travel Notes - The blind leading the blind 29 March 2016 MicroStrategy - Earnings season – A letdown so far but there is a silver lining 22 March 2016 What caught my eye? v.54 - Negative rates and the war on savers 2 March 2016 What caught my eye? v.53 - Philippines shelter; CBs calling E.T 23 February 2016 Is it a policy dead-end? - Consistency in an inconsistent world 11 February 2016 What caught my eye? v.52 - Launching global portfolios 4 February 2016 Central Banks - Why insistence on failed policies? 1 February 2016 China’s hard landing - Has it already happened? 27 January 2016 What caught my eye? v.51 - Bulls, Bears and low rates 22 January 2016 What caught my eye? v.50 - The Fed and the need for redemption 11 January 2016 MicroStrategy – Growth it is - Five reasons we prefer Growth over Value 8 January 2016 China choices – narrowing - Between a rock and a hard place 7 January 2016 What caught my eye? v.49 - China’s savings dilemma 4 January 2016 Fed hikes. What now? - Implications for EM equities 17 December 2015 20 YEARS IN ASIA, 14 December 2015 Is it Bear Stearns moment? - Year of living dangerously, part II 14 December 2015 Rights, Wrongs & Returns - 2016 - Year of living dangerously 25 November 2015 Policy cross-currents - What would unhinge PBoC? 12 November 2015 Bihar dreaming - On impossibility of reforms 9 November 2015 What caught my eye? v.48- EMs – downside to the upside, 3 November 2015 What caught my eye? v.47- The more they do; the worse it gets, 27 October 2015 What caught my eye? v.46-Equities – irrational exuberance?, 8 October 2015 Time for a policy U-turn? - Back to the future: British Leyland, 18 September 2015 What caught my eye? v.45 - Today is more insidious than 1997, 16 September 2015 Old Friend Deflation is Back - From traders to shareholders, 25 August 2015 EM vs DM Equities - What would the average opinion say?, 20 August 2015 Deflators of the world unite - Impact on the US & Global PPIs, 17 August 2015 China’s dilemma - Between a rock and a hard place, 13 August 2015 Return of deflationary vortex - Commodities – canary in a coalmine?, 10 August 2015 What caught my eye? v.44 - Barbarians at the gate, 5 August 2015 China’s policy response - How different is it to G4 economies?, 20 July 2015 Rights, Wrongs & Returns - 2H–Falling knives & deflating bubbles, 13 July 2015 Are dominos finally falling? - Greece, Puerto Rico, China, 6 July 2015 What caught my eye? v.43 - Why consumer & business reticence?, 29 June 2015 China drama & Greek farce - Are CBs at the end of the road?, 29 June 2015 What caught my eye? v.42 - Resisting China; Asia ex earnings, 17 June 2015 Trade & Cyclicality - Stagnation in both = lower yields, 28 May 2015 What caught my eye? v.41 - China & Global Manufacturing, 27 May 2015 What caught my eye? v.40 - CBs vs deflation: will liquidity win?, 8 May 2015 What caught my eye? v.39 - China & Indonesia: Binary outcomes, 29 April 2015 What caught my eye? v.38 - When size does not matter, 13 April 2015 Rights, Wrongs & Returns - 2Q-3Q’15 - The Hall of Mirrors, 27 March 2015 Global Liquidity Watch - Return of Greenspan’s conundrum?, 10 March 2015 What caught my eye? v.37 - India hope is still intact; travel notes, 5 March 2015 Chasing dividends - No mean reversion = desire for yield, 13 Feb 2015 What caught my eye? v.36 - Secular stagnation & four horsemen, 6 Feb 2015 Global liquidity watch - Liquidity tight but should improve, 27 Jan 2015 What caught my eye? v.35 - Focus on Thailand; CBs’ effectiveness, 26 Jan 2015 What caught my eye? v.34 - Trade & Flow watch; A vs H shares, 8 Jan 2015 Is deflation almost here? - What do DXY & bonds tell us, 6 Jan 2015 Global contagion risks - Commodities: canary in a coal mine?, 17 Dec 2014 China A retail exuberance - Damned if you do and damned if you don’t, 9 Dec 2014 Global Liquidity Watch - Eroded in 3Q’14 & Oct/Nov, 8 Dec 2014 Rights, Wrongs & Returns - 2015 preview: the “known unknowns”, 2 Dec 2014

Macquarie Research What caught my eye? v.59

7 June 2016 26

How exposed is Korea? - Yen “doomsday machine”, 17 November 2014 What caught my eye? v. 33 - Currency wars & their discontents, 13 November 2014 What caught my eye? v.32 - On social upheavals, schools & robots, 30 October 2014 What caught my eye? v.31 - Is China in a liquidity trap? EM risks, 16 October 2014 What caught my eye? v.30 - EM vulnerabilities; U/W Indonesia, 9 October 2014 What caught my eye? v.29 - China’s city vs global city, 18 September 2014 What caught my eye? v.28 - Unstoppable China; EM equity rally, 9 September 2014 Global Liquidity - Most measures are looking better, 21 August 2014 ASEAN at the crossroads - Complex choices; uncertain outcomes, 18 August 2014 Phils – Fading optimism - ST concerns overshadow LT story, 31 July 2014 What caught my eye? v.27 - Importance of Trust; China’s rerating, 29 July 2014 Trade – Waiting for Godot - Small pick-up but no robust cyclicality, 18 July 2014 Rights, Wrongs & Returns - Higher rates or perhaps no rates, 15 July 2014 What caught my eye? v.26 - Oil, geopolitics & family formation, 3 July 2014 What caught my eye? v.25 - Value - many ways to skin a cat, 23 June 2014 What caught my eye? v.24 - Financial stability & catch 22, 13 June 2014 What caught my eye? v.23 - Reforms: who will & who will not, 30 May 2014 What caught my eye? v.22 - Upgrades and stagflations, 21 May 2014 Coups & Martial laws - Not necessarily a bad choice, 20 May 2014 What caught my eye? v.21 - China tourism; Portfolio update, 12 May 2014 What does FIC market tell equity investors? - All quiet on the Western front, 9 May 2014 What caught my eye? v.20 - Investments & geopolitical risks, 29 April 2014 What caught my eye? v.19 - Liquidity in its various forms, 16 April 2014 Rights, Wrongs & Returns - Policy errors, cyclicality & EM volatility, 28 March 2014 FOMC – Impact on EMs - Higher US$, rates and lower demand, 20 March 2014 Difficult case of Indonesia - Euphoria vs. terms of trade & liquidity, 17 March 2014 What caught my eye? v.18 - Is China unravelling? Not Yet, 11 March 2014 “Each unhappy family is unhappy in its own way” - Ukraine, Thailand, Argentina, et al, 3 March 2014 DM vs. EM push & pull - Beware what you wish for, 26 February 2014 Bond Yields & Equities - The question of foreign demand, 24 February 2014 What caught my eye? v.17 - Is the Philippines for real?, 24 February 2014 What caught my eye? v.16 - Third industrial revolution & its impact, 12 February 2014 What caught my eye? v.15 - Investment Cycles & Funds Flows, 17 January 2014 Liquidity trap vs. Stagflation - China vs India – tough choice, 15 January 2014 What caught my eye? v.14 - Would Indian corporates invest?, 6 January 2014 Tapering is on, so is the put - What is likely to happen to volatilities?, 19 December 2013 Investment Outlook – 2014 - “Out with the old and in with the new” Is it 1998 or 1999 – Buy all or Sell all?, 11 December 2013 What caught my eye? v.13 - China's savings conundrum & Plenum, 25 November 2013 What caught my eye? V.12- Hardware vs software; China's "divide & conquer” reform agenda?, 6 November 2013 What caught my eye? v.11 - Leading indicators and “blind alleys”, 28 October 2013 What caught my eye? v.10 - Corporate leverage – how much of a problem?, 3 October 2013 Asia Strategy - When you rely on asset bubbles, what else do you do?, 19 September 2013 What caught my eye? v.9 - Rmb: How exposed is China?, 18 September 2013 What caught my eye? v.8 - In and out of “shadows”, 6 September 2013 What caught my eye? v.7 - If something cannot go on forever, it will stop, 22 August 2013 ASEAN 4 – risks & returns - Kaleidoscope of themes, 16 August 2013 What caught my eye? v.6 - China industrial sector – the Good, the Bad and the Ugly, 31 July 2013 Reviewing Tactical Portfolio - Tough choices: damned if you do and damned if you don't in a slowing world, 10 July 2013 What caught my eye? v.5 - Liquidity – receding tide, 5 July 2013 What caught my eye? v.4 - Central Bank’s “chicken run”, 27 June 2013 What caught my eye? v.3 - QEs to eternity whether successful or not, 12 June 2013 What caught my eye? v.2 - Korea - is China or Japan a greater threat?, 29

May 2013

What caught my eye? - Inflation falling everywhere, 22 May 2013

Macquarie Research What caught my eye? v.59

7 June 2016 27

Rights, Wrongs & Returns - Bears and the Investment Clock, 24 April 2013 DXY rises and Yen falls - The pincer movement for EM equities, 8 April 2013 APAC – Competitive Edge - Separating winners from losers, 21

March 2013

Walk on the wild side - Macro threats - what, if and when, 4 March 2013

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Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie – South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada

Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be

expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 31 March 2016

AU/NZ Asia RSA USA CA EUR Outperform 50.34% 59.09% 46.67% 44.76% 60.66% 46.12% (for global coverage by Macquarie, 3.72% of stocks followed are investment banking clients)

Neutral 34.14% 25.66% 32.00% 49.90% 30.33% 35.10% (for global coverage by Macquarie, 4.79% of stocks followed are investment banking clients)

Underperform 15.52% 15.26% 21.33% 5.33% 9.02% 18.78% (for global coverage by Macquarie, 2.31% of stocks followed are investment banking clients)

Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. General disclaimers: Macquarie Securities (Australia) Ltd; Macquarie Capital (Europe) Ltd; Macquarie Capital Markets Canada Ltd; Macquarie Capital Markets North America Ltd; Macquarie Capital (USA) Inc; Macquarie Capital Limited and its Taiwan branch; Macquarie Capital Securities (Singapore) Pte Ltd; Macquarie Securities (NZ) Ltd; Macquarie Equities South Africa (Pty) Ltd; Macquarie Capital Securities (India) Pvt Ltd; Macquarie Capital Securities (Malaysia) Sdn Bhd; Macquarie Securities Korea Limited and Macquarie Securities (Thailand) Ltd are not authorized deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia), and their obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 (MBL) or MGL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any of the above mentioned entities. 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Asia Research Head of Equity Research

Peter Redhead (Global – Head) (852) 3922 4836

Matt Nacard (Asia – Head) (852) 3922 1362

Jake Lynch (Asia – Head) (852) 3922 3583

Automobiles/Auto Parts

Janet Lewis (China) (852) 3922 5417

Zhixuan Lin (China) (8621) 2412 9006

Amit Mishra (India) (9122) 6720 4084

Lyall Taylor (Indonesia) (6221) 2598 8489

Takuo Katayama (Japan) (813) 3512 7856

James Hong (Korea) (822) 3705 8661

Banks and Non-Bank Financials

Matthew Smith (China) (8621) 2412 9022

Suresh Ganapathy (India) (9122) 6720 4078

Lyall Taylor (Indonesia) (6221) 2598 8489

Keisuke Moriyama (Japan) (813) 3512 7476

Leo Nakada (Japan) (813) 3512 6050

Chan Hwang (Korea) (822) 3705 8643

Gilbert Lopez (Philippines) (632) 857 0892

Thomas Stoegner (Singapore) (65) 6601 0854

Dexter Hsu (Taiwan) (8862) 2734 7530

Passakorn Linmaneechote (Thailand) (662) 694 7728

Conglomerates

Gilbert Lopez (Philippines) (632) 857 0892

Consumer and Gaming

Linda Huang (China, Hong Kong) (852) 3922 4068

Zibo Chen (Hong Kong) (852) 3922 1130

Amit Mishra (India) (9122) 6720 4084

Fransisca Widjaja (Singapore) (65) 6601 0847

Hendy Soegiarto (Indonesia) (6221) 2598 8369

Toby Williams (Japan) (813) 3512 7392

HongSuk Na (Korea) (822) 3705 8678

Karisa Magpayo (Philippines) (632) 857 0899

Emerging Leaders

Jake Lynch (China, Asia) (852) 3922 3583

Aditya Suresh (Asia) (852) 3922 1265

Neel Sinha (ASEAN) (65) 6601 0562

Timothy Lam (Hong Kong) (852) 3922 1086

Mike Allen (Japan) (813) 3512 7859

Kwang Cho (Korea) (822) 3705 4953

Industrials

Janet Lewis (Asia) (852) 3922 5417

Patrick Dai (China) (8621) 2412 9082

Inderjeetsingh Bhatia (India) (9122) 6720 4087

Lyall Taylor (Indonesia) (6221) 2598 8489

Kenjin Hotta (Japan) (813) 3512 7871

James Hong (Korea) (822) 3705 8661

Insurance

Scott Russell (Asia, Japan) (852) 3922 3567

Thomas Stoegner (ASEAN) (65) 6601 0854

Leo Nakada (Japan) (813) 3512 6050

Chan Hwang (Korea) (822) 3705 8643

Dexter Hsu (Taiwan) (8862) 2734 7530

Passakorn Linmaneechote (Thailand) (662) 694 7728

Software and Internet

Wendy Huang (Asia) (852) 3922 3378

David Gibson (Asia) (813) 3512 7880

Hillman Chan (China, Hong Kong) (852) 3922 3716

Nitin Mohta (India) (9122) 6720 4090

Nathan Ramler (Japan) (813) 3512 7875

Prem Jearajasingam (Malaysia) (603) 2059 8989

Oil, Gas and Petrochemicals

James Hubbard (Asia) (852) 3922 1226

Aditya Suresh (Asia) (852) 3922 1265

Duke Suttikulpanich (ASEAN) (65) 6601 0148

Abhishek Agarwal (India) (9122) 6720 4079

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669

Isaac Chow (Malaysia) (603) 2059 8982

Pharmaceuticals and Healthcare

Wei Li (China, Hong Kong) (852) 3922 5494

Abhishek Singhal (India) (9122) 6720 4086

Property

Tuck Yin Soong (Asia, Singapore) (65) 6601 0838

David Ng (China, Hong Kong) (852) 3922 1291

Raymond Liu (China, Hong Kong) (852) 3922 3629

Wilson Ho (China) (852) 3922 3248

Abhishek Bhandari (India) (9122) 6720 4088

William Montgomery (Japan) (813) 3512 7864

Aiman Mohamad (Malaysia) (603) 2059 8986

Kervin Sisayan (Philippines) (632) 857 0893

Corinne Jian (Taiwan) (8862) 2734 7522

Patti Tomaitrichitr (Thailand) (662) 694 7727

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Coria Chow (China) (852) 3922 1181

Rakesh Arora (India) (9122) 6720 4093

Stanley Liong (Indonesia) (6221) 2598 8381

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669

Technology

Damian Thong (Asia, Japan) (813) 3512 7877

Allen Chang (852) 3922 1136 (China, Hong Kong, Taiwan)

Nitin Mohta (India) (9122) 6720 4090

David Gibson (Japan) (813) 3512 7880

George Chang (Japan) (813) 3512 7854

Daniel Kim (Korea) (822) 3705 8641

Soyun Shin (Korea) (822) 3705 8659

Patrick Liao (Taiwan) (8862) 2734 7515

Louis Cheng (Taiwan) (8862) 2734 7526

Kaylin Tsai (Taiwan) (8862) 2734 7523

Telecoms

Nathan Ramler (Asia, Japan) (813) 3512 7875

Danny Chu (852) 3922 4762 (China, Hong Kong, Taiwan)

Abhishek Agarwal (India) (9122) 6720 4079

Prem Jearajasingam (Malaysia, Singapore) (603) 2059 8989

Kervin Sisayan (Philippines) (632) 857 0893

Transport & Infrastructure

Janet Lewis (Asia) (852) 3922 5417

Azita Nazrene (ASEAN) (603) 2059 8980

Corinne Jian (Taiwan) (8862) 2734 7522

Utilities & Renewables

Alan Hon (Hong Kong) (852) 3922 3589

Inderjeetsingh Bhatia (India) (9122) 6720 4087

Prem Jearajasingam (Malaysia) (603) 2059 8989

Karisa Magpayo (Philippines) (632) 857 0899

Commodities

Colin Hamilton (Global) (4420) 3037 4061

Ian Roper (65) 6601 0698

Jim Lennon (4420) 3037 4271

Lynn Zhao (8621) 2412 9035

Matthew Turner (4420) 3037 4340

Rakesh Arora (9122) 6720 4093

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Peter Eadon-Clarke (Global) (813) 3512 7850

Larry Hu (China, Hong Kong) (852) 3922 3778

Tanvee Gupta Jain (India) (9122) 6720 4355

Quantitative / CPG

Gurvinder Brar (Global) (4420) 3037 4036

Woei Chan (Asia) (852) 3922 1421

Anthony Ng (Asia) (852) 3922 1561

Danny Deng (Asia) (852) 3922 4646

Per Gullberg (Asia) (852) 3922 1478

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Viktor Shvets (Asia, Global) (852) 3922 3883

Chetan Seth (Asia) (852) 3922 4769

Peter Eadon-Clarke (Japan) (813) 3512 7850

David Ng (China, Hong Kong) (852) 3922 1291

Erwin Sanft (China, Hong Kong) (852) 3922 1516

Rakesh Arora (India) (9122) 6720 4093

Lyall Taylor (Indonesia) (6221) 2598 8489

Chan Hwang (Korea) (822) 3705 8643

Gilbert Lopez (Philippines) (632) 857 0892

Conrad Werner (Singapore) (65) 6601 0182

Jeffrey Ohlweiler (Taiwan) (8862) 2734 7512

Alastair Macdonald (Thailand) (662) 694 7753

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Miki Edelman (Global) (1 212) 231 6121

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Nik Hadi (Malaysia) (603) 2059 8888

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Regional Heads of Sales cont’d

Paul Colaco (San Francisco) (1 415) 762 5003

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Sales Trading

Adam Zaki (Asia) (852) 3922 2002

Stanley Dunda (Indonesia) (6221) 515 1555

Sales Trading cont’d

Suhaida Samsudin (Malaysia) (603) 2059 8888

Michael Santos (Philippines) (632) 857 0813

Chris Reale (New York) (1 212) 231 2555

Marc Rosa (New York) (1 212) 231 2555

Justin Morrison (Singapore) (65) 6601 0288

Isaac Huang (Taiwan) (8862) 2734 7582

Brendan Rake (Thailand) (662) 694 7707

Mike Keen (UK/Europe) (44) 20 3037 4905