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2 December 2009The Premium Review

Global StrategyThe investment opportunity of a generationor the start of another lost decade?

Albert Edwards & Dylan Grice

December 2009

IMPORTANT: PLEASE READ DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT

0

ThePremiumReview Paris

1, 2 & 3December2009

3Source : John Trever, Albuquerque Journal. Used by permission


2/19


4

Inflation is always and everywhere a fiscal

phenomenon

Source: Gokhale (2009)

0%

250%

500%

750%

Germany Spain France Italy UK EU US

Official Net Debt, % GDP* Total net liabilities (funded and unfunded), % GDP**

* 2010 OECD projections

** 2005 estimates of total Fiscal Imbalance

5

The last time China was about to take over Columbus ship next to Zheng Hes

Photograph by Lars Plougmann


3/19


6

Pocket of value? Grain hasnt participated in

the rally

Source: Datastream

40

50

60

70

80

90

100

110

30/06/08 30/08/08 30/10/08 30/12/08 28/02/09 30/04/09 30/06/09 30/08/09

GSCI Grains Spot

GSCI Grains Excess Return

S&P500

7

Anatomy of a bubble: the Kindleberger-Minskymodel

Crisis Euphoria

Revulsion Boom

Displacement

Source: Kindleberger, SG Cross Asset Research


4/19


8

Gold is cheap against USD: US monetary base

divided by gold held

Source: SG Cross Asset Research

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Q4

1968

Q4

1970

Q4

1972

Q4

1974

Q4

1976

Q4

1978

Q4

1980

Q4

1982

Q4

1984

Q4

1986

Q4

1988

Q4

1990

Q4

1992

Q4

1994

Q4

1996

Q4

1998

Q4

2000

Q4

2002

Q4

2004

Q4

2006

Q4

2008

Gold is expensive - USD overbacked by gold

Gold is inexpensive - USD underbacked b y go ld

9

Equities way behind government bonds

Source: Thomson Datastream

97 98 99 00 01 02 03 04 05 06 07 08 0980

100

120

140

160

180

200

220

240

260

280

80

100

120

140

160

180

200

220

240

260

280

Bonds

Equities

Cash


5/19


10

S&P 10 year compound returns 1936-2008

Source: S&P

11

Phases of inf lation & phases of investment:relationship between US bond & equity market yields


1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 20000

2

4

6

8

10

12

14

16

Interest rates

Equity yield

0

2

4

6

8

10

12

14

16

Culting of the equity The dismal years The long bull market

Equity yields are an averageof Dividend & Earnings Yield

Interest rates are a weightedaverage of bond yields (2/3) &short term interest rates (1/3)


6/19


12

Ice Age derating of equities v bonds

Bond yield

Equity yield

(av of earnings & dividend)

Source : Thomson Datastream

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 092

3

4

5

6

7

8

2

3

4

5

6

7

8

Equity yield

(av of earnings & dividend)

Bond yield

The Ice Age


13

Japanese bond/cash flow y ield ratio deratinghas led the US (strangely similar hey?)

Ice Age deratingrelatively

cheap US equities getting

cheaper and cheaper

US

Japan (led 10 years)

83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 170

0.20

0.40

0.60

0.80

1.00

1.20

0

0.20

0.40

0.60

0.80

1.00

1.20



7/19


14Source: Datastream

15

The Great Moderation l ie back to volatility

Source: St Louis Fed


8/19


16

Total US debt as % of GDP

Source: Lacy Hunt, Hoisington Investment Management

17

Leverage Ratios %

Source: San Fran Fed


9/19


18

US domestic borrowing by sector ($bn)

2005 2006 2007 2008 2009

-3000

-2000

-1000

0

1000

2000

3000

4000

5000

6000

-3000

-2000

-1000

0

1000

2000

3000

4000

5000

6000

non-financial domestic private sector

financial sectorfederal + state & local government

total domestic


19

Lessons from Japan: Equity markets becamehighly cyclical with frequent +/-25% moves

-50

-40

-30

-20

-10

0

10

20

3040

50

60

70

80

90

100

Jan-64

Jan-65

Jan-66

Jan-67

Jan-68

Jan-69

Jan-70

Jan-71

Jan-72

Jan-73

Jan-74

Jan-75

Jan-76

Jan-77

Jan-78

Jan-79

Jan-80

Jan-81

Jan-82

Jan-83

Jan-84

Jan-85

Jan-86

Jan-87

Jan-88

Jan-89

Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

YoY change in the Nikkei 225 25% fall 25% rise

Source: SG Cross Asset Research

Ice Age volatility


10/19


20

Japanese Ice Age PE de-rating followed

the cycle

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 0710

20

30

40

50

60

70

80

10

20

30

40

50

60

70

80

90

Forward PE

Cyclical lead indicator

(rhscale)


21

Bubble, upon bubble, upon bubble!

"It will not be too bad this year. Both China andAmerica are addressing bubbles by creating

more bubbles and we're just taking advantageof that. So we can't lose," he said.

Lou Jiwei, Chairman of Chinas sovereign wealth fund, ChinaInvestment Corp. Wealth Fund Muscles Up as Markets Recover: Reuters, August28, 2009


11/19


22

Is the Fed at it again?

Source: Zerohedge

23

US bank lending (ex securi ties yoy%)

74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08-5

0

5

10

15

20

-5

0

5

10

15

20



12/19


24

Deleveraging lasts well past end of the recession

1989 1990 1991 1992 1993 1994 1995

-4

-2

0

2

4

6

8

10

12

14

-10

-5

0

5

10

15

20

recessionbank loans (private)

loans to gov (treasuries)

total


25

Early 1990s stop/start recovery drove US bondyields lower and lower

1989 1990 1991 1992 1993 1994

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

10.00

50

60

70

80

90

100

110

expectations(rhscale)

10y yields



13/19


26Source: CSFB

27


14/19


28

The unwind goes on and on and on

29

The Feds printers are already working flat out

Source: SG Cross Asset Research (A. Edwards)


15/19


30

Have you forgotten how horrib le things were

when in flation last exceeded 20%?

Source: SG Cross Asset Research (A. Edwards)

31

US 10y st ill in c lear bull market


86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 082

3

4

5

6

7

8

9

10

2

3

4

5

6

7

8

9

10



16/19


32

US expectations ripe for correction

2002 2003 2004 2005 2006 2007 2008 2009

0

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

present situation

expectations


33

Watch the nominals (US GDP and wage bill)

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

-6

-4

-2

0

2

4

6

8

10

12

-6

-4

-2

0

2

4

6

8

10

12

wage income

nominal GDP



17/19


34

US core CPI crashes in the recovery phase

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

35

40

45

50

55

60

65 1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

headline ISM (inverted, 6mth mav)

core CPI (rhscale)


35

Spanish core CPI inflation heading to 0%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

core

headline



18/19


36

Australian annualised GDP growth 2Q

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

-6

-4

-2

0

2

4

6

8

10

12

14

-6

-4

-2

0

2

4

6

8

10

12

14

real

nominal


37

Hawley-Smoot here we come?


19/19

38

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