Close Calls

April 2013

Presented by:Eric Lascelles, Chief Economist

2

Report Card

Positive Developments:

Risk appetite revives; equity markets touch record highGlobal economic data moving forward, but ebbing slightlyU.S. continuing resolution keeps budget funded until Sep 2013Resilient U.S. data in employment, housing and manufacturingCyprus received bailout

Negative Developments:

Serious negative consequences from Cyprus bailoutItaly still working on forming governmentU.S. debt ceiling looms in summerCanadian housing cools further

Interesting Developments:China’s leadership transition completed; government to tighten property control policy to curb housing activitiesJapanese inflation expectations reviveU.S. Fed to continue QE until labour market improves substantially

3

Equity Surge

Despite modest economic growth and earnings growth, equities have managed decent gains

Why? Because risk appetite has rebounded

S&P 500 On Upward Trend Since 2009

600700800900

10001100120013001400150016001700

2000 2002 2004 2006 2008 2010 2012

S&

P 50

0 In

dex

Source: Haver Analytics, RBC GAM

Flirting with all-time highLatest surge

Long recovery

4

Source of Stock Market Gains

5

Risk Appetite Renaissance

Risk appetite has risen back to its historical average, and may be capable of improving further in the coming years

This constitutes an important support for the economy and equity markets

Reviving Risk Appetite

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

1991 1994 1997 2000 2003 2006 2009 2012

Ris

k A

ppet

ite In

dex

(Ave

rage

= 0

)

Note: Measures risk appetite based on 46 normalized inputs. Source: Bloomberg, BofA ML, Consensus Economics, Credit Suisse, Federal Reserve Bank of Philadelphia, Haver Analytics, NedDavis, RBC GAM

Seeking

Loving

Neutral

Reluctant

Averse

6

Global Economy Wavering Amid Renewed Uncertainties

Global Economy Improving But Growth Has Slowed

50

51

52

53

54

55

56

57

58

Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13

Glo

bal P

urch

asin

g M

anag

ers'

Inde

x

Source: JP Morgan, Markit, RBC GAM

7

Economic Indicators Inconsistent With Recession

Note: Historical data since 1948. Bottom and top of box represent the 16th and 84th percentile.Source: DOL, ISM, University of Michigan, Haver Analytics, RBC GAM

U.S. Recession Threholds

86.6

71.8

73.0

Consumer Confidence

52.7

54.2

42.6

Manufacturing PMI

335

336

413

Initial Jobless Claims ('000)

Current Level ▬ Average ▬ Recession Average

8

U.S. Housing Market Continues to Improve

20

22

24

26

28

30

32

Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12

Sin

gle-

Fam

ily H

omes

with

a M

ortg

age

in N

egat

ive

Equ

ity (%

)

Note: Measure as % of total single-family homes with a mortgage.Source: Zillow, Haver Analytics, RBC GAM

U.S. Homeowners Emerging from Underwater Mortgages

9

U.S. Fiscal Update

Fiscal cliff – mostly resolved

Sequester – unresolved, but manageable (just ~0.5% of GDP) and likely to be revisited

Continuing resolution – resolved

Debt ceiling – pending

Thesis: American politicians are capable of action when the alternative is unacceptable

Economic consequences: Economic growth 1.75 percentage points slower in 2013

Market consequences: another debt rating downgrade remains likely

10

Bank Loss Hierarchy

11

Setting A Precedent: Cyprus Depositors

Is Cyprus really setting a precedent by reducing the value of uninsured deposits?Yes, within the context of this Eurozone financial crisis

• Future bank bailouts are much more likely to bail in depositorsBut possibly NO within a broader context

• Cyprus is “special” in that most deposits come from abroad, and are of potentially dubious origin

• Italian banks cut 0.6% from bank deposits in early 1990s• Icelandic banks declined to honour >€7B in British and Dutch deposits in 2008• Many small U.S. banks have defaulted both pre- and post-financial crisis, resulting in

losses to unsecured depositors

What is the risk of a major bank run?The risk is not trivialHOWEVER,

• This outcome was not a shock – it was cited as a possibility for several months• Cyprus has instituted capital controls to limit outflow• Most “fast money” has already left remainder of peripheral Europe

12

Do Europeans Want Europe?

General Public in Eurozone Is Pro-European

0 25 50 75 100

Better off inside EU?

Need reforms to face future?

Cannot delay fiscal austerity?

EU states need to cooperate more?

Like the single currency/ECB?

Strengthen EU into federation?

Positive impression of EU?

Trust national government?

Trust political parties?

% of Survey Respondents Who Agreed

Italy

Note: Shaded area represents the range of responses from Cyprus, France, Germany, Greece, Ireland, Italy, Portugal, Spain. Source: EC Standard Eurobarometer 78, RBC GAM

13

Japan Could Emerge From Deflation

Inflation Expectations Have Started to Rise

-5

-4

-3

-2

-1

0

1

2

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Japa

n B

reak

even

Infla

tion

(%)

Note: 10-year breakeven inflation up to 6/15/2009, 5-year breakeven inflation thereafter.Source: Bloomberg, RBC GAM

14

Canadian Inflation Is Quite Tame

Canadian Headline CPI and Core CPI

-1

0

1

2

3

4

5

2001 2003 2005 2007 2009 2011 2013

YoY

% C

hang

e

CPI Core CPI

Source: Statistics Canada, RBC GAM

15

Less Economic Slack Than Policymakers Think

16

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