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Global Strategic Outlook

3rd Quarter 2012

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Global Strategic Outlook - 3rd Quarter 2012

Qui leno suspicor Amor quibus mido Consido noster luvabrum

Content

6 Section one: Executive summary

10 Section two: Sector allocation summary

12 Section three: Thematic piece

16 Section four: Strategy summary and global economic outlook

20 Section five: Equities outlook

34 Section six: Fixed income outlook

40 Section seven: Multi asset outlook

42 Section eight: Sustainability Research - long term trends

44 Section nine: Economic forecast and valuation review

47 Section ten: Market valuations

63 Section eleven: Global Policy Council biographies

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The increasing complexity of financial markets and blurring of boundaries between asset classes means that the tool kit of asset managers has had to be expanded from traditional financial market analysis, research and security selection to also consider secular trends in geopolitics and macroeconomics that might shape the behaviour of financial markets in the medium to longer term. In 2011, Allianz Global Investors/RCM decided to complement its monthly Global Policy Council meetings, which discuss tactical and strategic asset allocation, with a twice-yearly Investment Forum. Senior CIOs, investment professionals and business leaders from Allianz Global Investors are joined by outside speakers for a full day of in-depth debate. Its conclusion informs individual strategies, affects the development of new investment strategies and helps clients with their own asset allocation.

I will summarise the findings of these meetings for our readers in the introduction to the Global Strategic Outlook (GSO) henceforth. Readers will recognise the topics developed at the Investment Forum in future GSOs and thought pieces.

Understand.Hong Kong in June provided a fitting backdrop for Allianz Global Investors’ most recent Investment Forum, which considered some of the themes that shape the investment horizon.

Dear reader

Andreas Utermann Global Chief Investment Officer, Allianz Global Investors

“The world is overloaded with information but to have value it needs to be understood. Once information is understood, we then need to act.”

At Allianz Global Investors we follow a two word philosophy.

Understand. Act.

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Exit strategyOne of the key points of discussion centred on the central banks’ exit from QE – what plans, if any, those in OECD economies have for extricating themselves from unprecedented balance sheet expansion through that stimulus. The extra funding made available has not found its way into real economies in the way it was hoped. Indeed, QE has increasingly become an instrument to refund public debt and keep yields low. When it comes to finding an exit from this cycle, there are no immediately obvious (successful) precedents on which to draw.

An exit from QE seems unlikely anytime soon, even if there is excess liquidity in the banking system, with the Euro OverNight Index Average (EONIA) sticking close to the deposit rate. We need to get accustomed to low central bank and money market rates. In addition, when central banks do exit QE, the effect will be double-edged: increased yields for investors will be offset by the prospect of write-downs of existing investments.

European Monetary UnionFollowing an in-depth discussion on the future of the European Monetary Union, we maintained our view that the most likely scenario is that the euro will remain with its current membership. Nevertheless, the risks of an adverse development – in particular the political risks – remain as high as ever.

As the positive, market-calming effect of each EU intervention is felt for ever-shorter periods of time, it has become clear that the European strategy chosen three years ago – to kick the can down the road in the hope of a strong economic recovery in the meantime – has failed.

At the very least, a combination of three measures seems to be necessary:

• amorecrediblebankingregime–whichentailsmovestowardsabankingunion

• theEuropeanCentralBank(ECB)continuingtoplayitsroleasalenderoflastresort

• theintroductionofburdensharing,suchasthedebtredemptionfundsuggestedbytheGermanCouncilofEconomic Advisors (Sachverständigenrat)

Even with these measures, success cannot be assured. The ‘more Europe,’ which was voiced last autumn, will need to amount to more than Maastricht 2.0.

Financial repressionThe Forum confirmed the view that OECD economies are in the grip of a period of financial repression – the combination of low yields and moderate to elevated inflation rates has led to negative real rates. When real rates are lower than GDP growth, public debt can be inflated away. After the Second World War, public debt as a proportion of GDP in the US was successfully reduced at the expense of bondholders and savers.

Act.In this environment, which is unlikely to be reversed in the near term, the central banks’ exit strategy is unlikely to be implemented soon. Interest rates on the money markets will stay low for longer. (Long-term) bonds are particularly overvalued in the current climate, and unless held to maturity and in portfolios that can avoid being marked to market, bond holders face the risk of valuation write-downs when the tide of repression ebbs.

With bondholders getting squeezed, we need to better look for real returns, for example in the form of commodities (including gold and silver); real estate and infrastructure investments; and companies with sustainable growth even in a low-growth, higher-inflation environment:


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• Smallcapsandcompanieswithhighpayoutratios should be investors’ first choice.

• Intimesofmoderateprice/earningsratiosandlow – not to say negative – real bond yields, dividends should be the main drivers of equity returns.

• Equitieswillprobablyremainhighlyvolatile.Bebrave. History tells us that bounces in a financial repression environment might be significant.

• Currencies,primarilyAsianones,shouldbeseenas a new, favourable asset class. Asian currencies are, broadly speaking, undervalued while the corresponding economies are catching up.

• HaveacloserlookatAsianbonds,too.TheAsianeconomies have moderate budget deficits and tax levels as well as strong current accounts and foreign currency reserves.

• Remainpreparedfortheunexpected.Therearea lot of historical shifts and changes happening right now, for example a natural gas revolution in the US, which might help to drive energy prices lower, spur consumption and shrink imbalances. Butthatisanotherstorywejuststartedtodrillinto at our latest Investment Forum.

The next Investment Forum takes place in Europe in January 2013. I will report back on this meeting in the Q1 2013 GSO.

Andreas Utermann Global Chief Investment Officer, Allianz Global Investors

Understand. Act.

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Sector allocationDue to its link to risk aversion, the European debt crisis has once again had an increasing influence on global sector performance trends. As the euro crisis more than ever starts to threaten global financial stability, its run and its interconnection with the global cycle will be the major influence on our sector stance in the coming months. We have not changed our sector allocation in recent months and keep an overall balanced portfolio structure. We continue to avoid financials yet have refrained from getting outright defensive, as we see a potential for forceful policy actions in Europe. We envisage steps toward more political and fiscal integration sooner rather than later, which could lead to a turnaround in risk sentiment for a while.

Thematic piece: The shale and oil revolutionIn this quarter’s thematic article, Lucy Macdonald, CIO of Global Equities, discusses the ongoing shale and oil revolution and whether this has potentially profound economic and political implications affecting companies, industries and countries globally. The Energy Information Administration projects that, by 2035, domestic natural gas production will be 25% higher, with shale gas accounting for nearly half of total gas production. On top of this, investment into domestic US oil production will drive 65% growth in oil output by 2020 and reduce US imports of oil from 9 million barrels to 6 million barrels per day, with the biggest reduction in oil imports being from Saudi Arabia and other Persian Gulf states.

With the US using three times as much coal as gas for power generation, there is a huge incentive to switch to a cleaner and cheaper fuel sooner rather than later. The economic and political implications – encompassing employment, growth, trade, geopolitics, currencies, inflation and investment – are likely to be significant. However, it is the environ-mental concerns and regulatory developments that probably pose the biggest risks to the shale industrial complex.

Global and economic outlookWhen writing the previous Global Strategic Outlook three months ago, we were quite optimistic on the future development of risky assets in the subsequent months. What went wrong? Why did equity prices start to fall at the end of March in Europe and one month later in the US? Could this risk-off mode in markets have been anticipated? With the benefit of hindsight, we can identify various explanations for the decline in risky assets. These include: capital markets becoming addicted to ever more liquidity injections fromtheEuropeanCentralBank(ECB)afterthesecond long-term refinancing operation (LTRO) in February; global cyclical data starting to weaken; the election outcome in Greece adding to additional political uncertainty and; the Spanish banking system remaining fragile.

Since May 2010, European politicians have tried relentlessly to fight the debt crisis by addressing its symptoms rather than the underlying fundamental problems such as an imperfect monetary union and diverging economic trends. It is only since late 2011 that the real problems are being addressed however, measures being taken so far are anything but sufficient. As history shows, a currency union without fiscal and political union is usually quite unstable. There is no guarantee that Europe will actually implement these measures however, we do think that all EMU member countries would face costs in case of an EMU breakup which exceed the costs of keeping the union alive. This is the reason why we think it is increasingly likely to see more steps towards a tighter fiscal integration.

Bond and equity marketsCentral bank interest rates will have to remain very low in the eurozone – and not only there. The US, too, is unlikely to see a rate hike any time soon. As a house we think that it is increasingly likely that more steps towards a tighter fiscal integration will be taken. Admittedly, any decisions toward a tighter fiscal and political union would need a long time to be implemented. Nevertheless, we would expect the

1. Executive summary

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market to react positively to any credible roadmap in that direction.

We think we will have to live with a low (real) rate environment for longer, which is typical for a de-leveraging period. Governments have an incentive to keep nominal and real yields low in such an environment. Central banks, too, will need to keep rates at very low levels and also distort the prices of government bonds by intervening in the bond markets. We reduced our equity exposure in April back to neutral. Having added to the position in January, we have locked in profits from our risk-on position, which we had for three months as headwinds became too strong to justify an ongoing long position.

Asset allocationOuroutlookforUStreasuriesandGermanBundsisrather cautious. Even though the price risk is moderate, as central banks are unlikely to hike rates anytime soon, thereby anchoring the long end of the yield curve, total return expectations in inflation-adjusted terms are very meagre. In the fixed income space, we have warmed up to corporate bonds, which offer a higher yield than government bonds in the US, Germany and the UK and we think valuations are quite attractive.

We reduced our equity exposure in April back to neutral. Having added to the position in January, we have locked in profits from our risk-on position, which we had for three months. Regionally, we are currently underweight US equities against a global equity benchmark. In line with our reduction of equities in our global tactical asset allocation portfolio, we also trimmed our European equities exposure. We are holding on to our constructive view on emerging market equities, which tend to outperform in times of low real interest rates – which is likely to be the case in the foreseeable future. Our currency views reflect our constructive views on emerging markets. We have reintroduced our secular constructive view on emerging markets in general.

US equities outlookIn the US, long bond yields are near historical lows, driving more investors who need income from their investments in the direction of dividend-yielding stocks. Low yields also help create a valuation underpinning for equities. With the Fed extending Operation Twist, and the possibility of QE3 to come if

inflation continues to fade and growth remains subpar, there is little reason to expect competition from bond yields. Only in a deflationary environment would we expect bonds to outperform equities from here, and that is not our base case. Subpar growth, continued fiscal policy ease in emerging markets abroad, diminishing inflation pressures and the possibility of some steps toward deeper unification in the eurozone all make us optimistic that US equity indices can bounce back from their May slump.

European equities outlookThe long-term convergence story for Eastern Europe remains intact. However it is the short- and medium-term outlook for these economies that is affected by fiscal austerity in the eurozone via direct trade links and capital flows, as well as the de-leveraging process of Western European banks. 80% of the banks in Central Europe are owned by Western European banks, which partially funded the growth in the region by external sources. As Western European banks are currently in the process of de-leveraging in order to strengthen their capital positions, Eastern Europe is also exposed to the de-leveraging process. Austerity measurements and the de-leveraging process have also resulted in lower capital inflows to Eastern Europe. The key risk for the region is a severe worsening of the situation in the eurozone which might lead to much sharper de-leveraging and the risk that banks might be forced to sell subsidiaries in the region, despite their increasing profitability and growth outlook.

Asia-Pacific equities outlookThe European debt crisis will continue to be the central factor driving market sentiment into midsummer. Although the Asian equity and currency markets have been negatively affected as the European sovereign debt crisis intensified, the fundamentals of Asian economies are still largely intact. Lower oil prices are also quite positive for economies due to high energy import dependence. Inflation has been retreating, which should allow Asian central banks more flexibility in the event of worsening external demand. Outside of aggressive monetary policy action from developed markets, we would continue to expect the economic activity of emerging economies of Asia to continue to be key drivers of incremental global growth through the rest of the year.

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Equities outlook – styleQ2 has been a solid quarter for style investors as among the long-term investment style winners, only value was lagging. The performance of investment styles over the past three years was mainly driven by one investment theme, the risk-on/risk-off trade. Q2 2012 was no different in this respect. Lower-risk investment styles, like stable growth or high quality, did well, but so did styles such as high price momentum and positive revisions that are currently biased toward more defensive names that held up in the down markets of the past 12 months. The investment style attractive valuation, on the other hand, is biased toward financials and cyclicals and hence suffered from the reescalation of the European debt crisis and weaker economic data.

Many investors have benefitted over the past quarters from stronger performances of these defensive investment styles, but are also worried of losing performance from a value bounce. Such relief rallies are always hard to predict or time, but assuming the risk environment does not deteriorate and combined with significant underperformance and relative cheapness, we think investors should review their underweight in cyclical value stocks.

Global fixed income outlookThe global economic situation remains characterised by healthy growth rates in emerging market economies and growth below potential in the developed world, where some countries have seen a loss of confidence reemerging due to structural headwinds, leading to the abrupt slowdown seen in the past two quarters. US government bonds have reached new all-time low yields, driven by renewed safe haven flows following the resurgence of European-related risks. In this environment, treasuries should continue to trade at extremely low yields while investor demand for ‘safe spreads’ continues. Eurozone economic activity had stabilised during Q1, but recent data point to a renewed contraction. Political uncertainties have played a major role in financial market moves in recent weeks and months and the volatility in European government bond markets is expected to remain extraordinarily high.

Overall, softer economic data and ongoing political uncertainty is the basis for continued and extended volatility in bond markets.

European fixed income outlookThe sovereign debt crisis in the eurozone has taken a more ominous turn as Spain and Italy have come under attack. The latest Greek episode involving elections, has become almost anecdotal in light of the systemic nature of current developments. The domino effect – already observed last year – signifies the failure of political and monetary authorities to confine the crisis to Greece and marks a new level of investor wariness regarding eurozone unity and durability. Technical initiatives are no longer sufficient to restore calm; political decisions are required. Confidence will only be restored once the market no longer perceives a risk of euro-dominated sovereign issues being redenominated into local currencies. We are convinced that the current tensions herald an imminent intervention. We maintained our defensive positioning in peripheral debt during the quarter however, if political and monetary authorities intervene to provide a credible crisis-exit framework, these weightings should be rapidly reversed.

Asia-Pacific fixed income outlookThe softening of Chinese growth is a major component of global weakness. South Korea’s export-oriented economy clearly reflects the weak global macro backdrop as exports fell in May and imports decreased year-on-year. Taiwan’s economic data was also weak, however this is unsurprising as Taiwan is among the emerging markets most dependent on exports to China. As a consequence of the global risk aversion originating from the situation in Europe, Asian currencies sold off. However, the recent FX weakness in Asia should be seen as temporary, as Asian economies are still in a position of relative strength. If the global economy should worsen further, Asian countries have room for policy stimulus both on the fiscal and monetary side. There is a good chance that active policy support combined with strong underlying economic fundamentals, will enable emerging Asia to grow just below trend this year, despite the poor global macro backdrop.

Global multi asset outlookQ2 saw concerns about eurozone growth reemerging and the eurozone debt crises taking a turn for the worse in May. In addition there was evidence of austerity apathy combined with deteriorating economic fundamentals in parts of Europe and evidence of the US economy losing momentum as well as slowing Chinese growth. In response to this,

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we progressively reduced our exposure to risky assets and reflected a more defensive stance in our portfolios where appropriate. Within developed market equities, we favour investments in the UK, France and Singapore where valuations and economic momentum, make these markets attractive. Regionally, we have a preference for Asia ex-Japan, where inflation pressure is fading and debt-to-GDP levels are relatively low. We also recommend global REITs based on positive sentiment and trend signals. We are cautious on commodities and recommend an underweight position. In fixed income, we are marginally long duration in most markets and retain a preference for emerging market, high-yield and convertible bonds as satellite investments.

Sustainability research outlookThere are over 500 internationally agreed-upon goals and objectives to support the sustainable management of the environment and human well-being. However, little or no progress has been achieved for 24 of them, including biodiversity loss, fish stocks, climate change, desertification and drought. In every instance, agriculture has a

significant role to play in contributing to this downward spiral. Globally, landscapes are being altered at an alarming rate to grow food and currently, 40% of the land’s surface is committed to agriculture. This has resulted in the stress on natural resources increasing as the pressures of population growth, growing meat and dairy consumption rising energy costs and bioenergy production are taking their toll. We need to strike a balance between feeding the world while protecting the environment.

Ideas are increasingly being put forward for a new kind of agricultural revolution yet these will require significant capital investments over the coming years at a time when global capital is less accessible and likely to become increasingly expensive. Although technological innovation may be part of the solution, it also requires a change in mindset on the part of governments. Companies, too, should place greater emphasis on how they take account of their resource-related risks and opportunities and should work toward being part of the solution rather than part of the problem.

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Via its link to global risk aversion, the European debt crisis in recent months again had an increasing influence on global sector performance trends. The reemergence of the crisis, combined with deteriorating cyclical data – particularly out of Europe but also in various other parts of the world, including China – resulted in a marked outperformance of defensive sectors, while financials, cyclical and commodity-related sectors suffered. While also affected, technology names weathered these conditions best within the cyclical sector spectrum.

As the euro crisis more than ever starts to threaten global financial stability, its run and its interconnection with the global cycle will be the major influence on our sector stance in the coming months. We have not changed our sector allocation in recent months and keep an overall balanced portfolio structure. We continue to avoid financials. We have refrained from getting outright defensive, as we see a potential for forceful policy actions in Europe. We continue to envisage steps toward more political and fiscal integration sooner rather than later, which could lead to a turnaround in risk sentiment for a while.

The Allianz Global Investors Investment Forum, held in June, again stressed the importance of dividends in an environment of depressed yields and financial repression: companies with a proven willingness and ability to pay dividends (often characterised by high payout ratios) all have chances to outperform the market over the next cycle. According to our analysis over extensive investment periods, these companies should be found in greater number in sectors with structurally high return on equity, e.g. consumer staples/services or healthcare. Sectors which recently increased return on equity compared to their own longer-term history have the potential to grow dividends faster than before – provided the profitability improvement is sustainable. Those sectors include technology (foremost in the software area), energy and chemicals. Also, the automotive sector fits that criterion, but here the sustainability of

profitability improvement looks questionable except for a few select companies.

Within cyclical sectors, we stick to our preference for technology stocks. They do not appear stretched to us on relative valuation. Especially for bigger, established software companies, we structurally see potential for rising dividends due to the very high return on equity they generate. We have also kept our underweight in consumer discretionary names. While costing some performance in between, we now witness signs of approaching weakness in important subsectors. Many global car markets, particularly in Europe but also in China, show negative demand momentum, endangering recently high margins at car manufacturers. In terms of relative valuation, cyclical sectors derated again in the latest risk aversion moves and are, as a group, now at historically normal levels.

We continue to be underweight in financials. We still doubt that the sector can escape its structural derating versus the market at this juncture, where market sentiment is highly influenced by the Europeancrisis.TheEuropeanCentralBank’strialofindirect QE via the Southern European banking system has increased the clustering of bank and sovereign risks in the eurozone. Exactly this vicious cycle has caused the struggle of the Spanish government to improve the capital position of its domestic banking sector. Finally, the problem will now be transferred to one of the eurozone’s rescue fund vehicles, but this will likely involve a more junior creditor status of Spanish bond holders. We continue to see banks are incentivised to shrink their balance sheets due to regulation and – at least in peripheral European countries – extremely difficult funding conditions. Credit demand, particularly in Europe, is very weak but clearly improving in the US. Very generally speaking, we see no lasting rerating potential for banks as long we can see no signs of sustainable improvements in profitability. While insurance companies are somewhat less affected by the tensions in the financial system, the chances for a meaningful

2. Sector allocation summary

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rerating are low as long as government bond yields are at such depressed levels.

Within commodity-related sectors, we have a neutral weight on materials stocks and continue to moderatelyoverweighttheenergysector.Bothsectors now offer attractive relative valuation metrics, especially the mining segment. After the Chinese government recently announced a range of stimulation measures for the Chinese economy, hopes on a reacceleration of China’s commodity demand have the potential to – at least tactically – increase our positioning in the materials sector. We see signals from companies that conditions are improving in China.

While defensive sectors have been the winners of the latest risk aversion and a deteriorating growth outlook, many defensive areas are not without problems. For example, we see very weak domestic markets of big European telecom companies or the danger of increased taxation there, which also affects the utilities sector. Also, earnings revisions momentum and general profitability trends for those sectors remain on the weak side. For the time being, we stick to our preference for consumer staples and healthcare names over telecoms and utilities. The problem with consumer staples is an increasingly stretched valuation. According to our measures, they have never had a higher premium relative to the market (since 1975) than at the moment.

Sector Allocation - Virtual GPC Portfolio

GlobalSectors

ConsumerDiscr.

ConsumerStaples Energy Financials

HealthCare Industrials IT Materials

Telecom Services Utilities

Active Weight UW OW OW UW OW OW OW N UW UW

BMK Weight 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 %

Legend:N = NeutralOW = OverweightUW = Underweight

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While markets remain fixated on events in the eurozone, the ongoing US shale gas and oil revolution has potentially profound economic and political implications affecting companies, industries and countries globally. Utilising the strengths of Allianz Global Investors’ global research platform, we recently conducted a comprehensive examination of these issues and their investment implications at the recent Investment Forum held in Hong Kong.

Only 9 years ago, in 2003, former Federal Reserve Chairman Alan Greenspan highlighted the increasing requirement for US imports of liquified natural gas; concerns over security of US energy supply were paramount. Now, US domestic gas production has stepped up, and domestic oil production is forecast to increase more than 65% by 2020, far outpacing Saudi and Russian production growth this decade.

To successfully extract shale gas and oil through the process of hydraulic fracturing (‘fracking’) four conditions are required: the right geology, infrastructure to enable the extractration of oil and gas, processing plants and pipelines to enable the transportation of hydrocarbons to market, and a friendly regulatory regime. The US has some of the best shale rocks in the world, an existing energy industry and regulatory system, and an abundance of pipeline infrastructure. It is for this reason that shale has taken off so rapidly.

Earlier this year, the Energy Information Administration (EIA) estimated that the lower 48 states have 482 trillion cu ft of shale gas resources. At the current rates of consumption this is the equivalent of at least 100 years of supply. (Proven reserves will be less but still sufficient for several decades.) The EIA also projects that, by 2035, domestic natural gas production will be 25% higher, with shale gas accounting for nearly half of total gas production. In comparison, shale gas currently accounts for 29% of all total gas production and less than 2% in 2001 (see chart). Clearly, shale gas is here to stay.

What has happened with US natural gas is now happening with oil, which has even better economics due to the higher value of the hydrocarbons produced. Most US oil shale plays are economic due to $60 per barrel WTI oil price. Investment into domestic US oil production will drive 65% growth in oil output by 2020 and reduce US imports of oil from 9 million barrels to 6 million barrels per day, with the biggest reduction in oil imports being from Saudi Arabia and other Persian Gulf states. This improves the US balance of payments and also reduces – though does not end – US reliance on the Middle East to fuel its economy.

Industry impactsWith the US using three times as much coal as gas for power generation, there is a huge incentive to switch to a cleaner and cheaper fuel sooner rather than later. This will increasingly give the US an energy cost advantage; Asian buyers of natural gas are paying four times the price of US natural gas, and Europe two and a half times.

Almost one-third of gas is used in power generation (seechart).LawrenceBerkeleyNationalLaboratory(adivision of the Department of Energy) suggests that households spend $241 billion each year on home energy bills. This makes gas turbine suppliers look more interesting. General Electric has seen an increase in turbine orders in the past 12 months. Over the past few years this big business had almost evaporated however it could come back, given the rising utilisation and growth in demand for natural gas power.

An unintended effect of low-priced natural gas is the impact on alternative energy. Compared to even the most economic renewable technology – wind– natural gas makes even more economic sense. This means natural gas will slow the development of wind resource in the US, with consequences mainly for the wind turbine manufacturers.

3. Thematic piece: The shale gas and oil revolution

Lucy Macdonald, ASIPCIO Global Equities, London

Christopher Wheaton Senior Research Analyst, European Energy, London

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Industrial companies make up 19% of total energy demand in the US and are among the largest beneficiaries of cheaper petrochemical feed stocks. We are already seeing a growing number of new projects commissioned to take advantage of the gas and oil revolution:

• NucorSteelisconstructinga$750millionoperation to develop iron from natural gas.

• ChevronPhillipsChemicalbelievesthatthechemical industry may invest up to $300 billion to develop new plants.

• PPGthinksitcannoweconomicallyproducecaustic soda or chlor-alkali in the US rather than importing it.

• LargemethanolproducerMethanexrecentlyrelocated a plant from Chile to the US Gulf Coast.

The transportation area will also be transformed by the gas and oil revolution. Transportation currently accounts for 27% of total energy demand in the US, 94% of which is petroleum. Compressed natural gas (CNG) is 47% cheaper than gasoline/diesel, but transportation uses only around 3% of all natural gas in the US.

At current prices, the cost of a natural gas gallon equivalent is ~$0.32 per gallon vs. a diesel price of close to $4 per gallon. This is attracting adoption in many applications of local-usage for example heavy-duty trucks, such as for rubbish collection. A number of such applications have two to three years payback even if the natural gas prices double from the current levels.

Heavy truck conversion has been limited due to a range of concerns, but technology is catching up; in the past year, Cummins has developed a 12 litre 400 hp engine that runs on a diesel/CNG blend. Natural gas vehicles (NGV) reduce greenhouse gas emissions and offer fuel cost savings. In the developed world, penetration of NGVs is low (only 124,000 vehicles in the US). The main challenge is the access to infrastructure, such as refuelling. There are roughly 1,500 natural gas stations in the US, compared to the 190,000 gasoline stations. Early applications are likely to include trucks used for shale drilling and mining operations.

Macro impactDevelopment of shale gas has profound implications far beyond the US energy sector. The economic and political implications – encompassing employment, growth, trade, geopolitics, currencies, inflation and investment – are likely to be significant. For example:

• Gas and oil imports. The US is likely to be a net exporter of natural gas by 2018 (see chart), and new oil production could amount to about 7% of global supply. According to Citi Global Markets, using long-term EIA projections for global oil demand, US real oil prices could be 14%–16% lower than they would have been without the surge of oil/liquids production and exports.

• US current account and GDP. Again, according to Citi Global Markets, the current account deficit will be reduced by nearly 2% of GDP, and GDP itself will grow an additional 2.5% through the rest of the decade from increased hydrocarbon output, reduced energy consumption, higher gas activity, production revenue and multiplier effects.

• Employment. The shale revolution is already creating new jobs in politically important states. Ohio, a swing state in the upcoming November election, is benefitting from employment in Utica Shale. So far, 204,000 new jobs have been created, causing unemployment in the state to fall from 8.1% to 7.4%.

• Geopolitical impact. Increasing gas exports from the U.S. are likely to put pressure on natural gas prices globally, especially in Asia, where prices are currently oil linked. Additionally, OPEC nations are seeing rapidly increasing domestic demand for oil. The long-term accumulation of petrol dollars in OPEC nations could begin to reverse, with potentially important social implications.

Environmental and regulatory risksEnvironmental concerns and regulatory developments probably pose the biggest risks to the shale industrial complex. Fracking releases methane, is energy-intensive and uses copious amounts of water. The eventual environmental impact on watersheds remains unclear.

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Shale gas production is increasing in almost every region of the US, and some of the greatest controversy has been in Pennsylvania and New York, two states with little experience in gas drilling. Reports that New York Governor Andrew Cuomo is considering relaxing fracking restrictions has led to strong opposition from environmental conservation groups. The shale industry has shown an ability to respond to environmental concerns; for example, fracking fluid recycling technologies are becoming more available. State and federal regulation of the industry is likely to increase but not to the point of having a meaningful adverse impact on the economics of extraction.

Investment implicationsThere are extensive investment implications across all asset classes arising from the development of the shale energy resource. Looking at equities in particular, beneficiaries would include companies involved in the energy equipment food chain, those that gain a cost advantage from cheaper feedstocks (such as chemical and agricultural companies), energy pipelines and water treatment firms. Coal and alternative energy companies would seem to be clearly disadvantaged. Having a long-term investment horizon and accessing these opportunities globally are paramount to maximising the investment opportunities that present themselves.

Figure 1: US natural gas production (2009 - 2035)

Source: Energy Information Administration, AEO2012 Early Release Overview, 23 January 2012

0

5

10

15

20

25

30

2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Shale gas 49%

Tight gas 21%

Non-associated offshore 7%Alaska 2%

Coalbed methane 7%Associated with oil 7%

Non-associated onshore 9%

2010 Projections

trill

ion

cubi

c fee

t

Figure 2: Breakdown of US natural gas end markets

Source: Energy Information Administration , 2009

Industrial, 34%

Other, 3%

Commerical, 13%

Residential, 20%

Electrical, 29%

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Figure 3: WTI oil price impact from new production and reduced consumption, 2012E-20E

Source: Citi Global MarketsReduced consumptionNew production

-16.0%

-14.0%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2012 2014 2016 2018 2020

Real global oil prices fall-14% from new productionand another -2.5% from reduced consumption

% pr

ice im

pact

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When writing the previous Global Strategic Outlook three months ago, we were quite optimistic on the future development of risky assets in the subsequent months. At the time, global cyclical data were strong, central banks globally pursued an expansionary monetary policy and, as a consequence, spreads in the European Monetary Union (EMU) sovereign bond market were tightening. This relaxation of tensions in the financial markets also led to a better outlook for the banking sector, which is crucial for an improvement in the credit cycle. So what went wrong? Why did equity prices start to fall at the end of March in Europe and one month later in the US? Could this risk-off mode in markets have been anticipated?

With the benefit of hindsight, we can identify various explanations for the decline in risky assets. First, capital markets have become addicted to ever more liquidityinjectionsfromtheEuropeanCentralBank(ECB)afterthesecondlong-termrefinancingoperation(LTRO)inFebruary.EventhoughtheECBhas continued to provide unlimited liquidity to the market – albeit at shorter maturities than three years, as under the LTRO – market participants seemed to have disliked this. Artificial demand was generated which was probably caused by the LTRO in conjunction with “soft pressure” from national Treasuries in the EMU periphery. National treasuries wouldhavewantedtouseECBliquiditytobuysovereign bonds which were issued by the respective government. As there has been no follow-up LTRO, demand for sovereign bonds has dried up. We did not really expect this market reaction, as central bank policy has been and still is extremely loose globally.

Second, global cyclical data have started to weaken. Initially, only surprise indicators, measuring the actual reading of economic data relative to market expectations, have disappointed. This was followed by a rollover in various high-frequency data globally. Against our expectations from one quarter ago, data now points to an ongoing recession in the eurozone. In the US and Asia, though, we are not anticipating a hard landing; data are still consistent with a normal

cyclical moderation in activity and may be explained by weather effects (in the US) and lagged effects of last year’s policy tightening (in Asia). However, in contrast to our expectations, data continue to surprise on the downside. In addition, the renewed spread widening in the eurozone is surely also having negative ramifications on US and Asian growth via an increased stress in the financial system.

Third, the election outcome in Greece has added to additional political uncertainty. While three-fourths of Greek voters are still in favour of holding on to the euro, the vast majority has voted in favour of parties opposing fiscal austerity. The risk of a Greek disorderly exit from the eurozone has increased. In case Greece is not ready to implement austerity measures, it is quitelikelythattheTroika(ECB,EU,IMF)wouldcutthelines. Even the mere risk of this happening could already lead to a further escalation of the situation. Why? If the Greeks anticipated the risk of an EMU exit, the withdrawal of bank deposits could ultimately turn into a real bank run and increase the liabilities of the BankofGreecevis-à-vistheECB.Hence,Target2imbalances would increase further. It is difficult to predict how Greece or the rest of the EMU would react in this environment. The outcome of the June 17 elections, which resulted in a new government of austerity supporting parties, has brought some short-term relief. However, the fundamental problem still prevails: low growth and continuing high public sector debt. Such uncertainty will continue, as, based on our estimates, Greek public debts are still on an explosive path, even after the haircut in March.

Fourth, the Spanish banking system continues to remain fragile. Even after the recent €100 billion recapitalisation, investors remain sceptical if the amount is sufficient. It potentially is, but we can not be sure either. In our stress scenario, we came to the conclusion that a figure of around €150 billion would probably have been more appropriate and we anticipate a further decline in house prices and an ongoing weakness in economic activity. Spanish bank clients seem not to trust the banking system either.

4. Strategy summary and global economic outlook

Stefan Hofrichter, CFAHead of Global Economics and Strategy Group, Frankfurt

Global | US | Europe | Asia-Pacific


17


Deposits have started to shrink, albeit still at a much lower pace than in Greece.

How could the crisis be contained, and how likely is this? Since May 2010, European politicians have tried relentlessly to fight the debt crisis by addressing its symptoms – high debt and a weak banking sector – rather than the underlying fundamental problems such as an imperfect monetary union and diverging economic trends. It is only since late 2011 that the real problems are being addressed: structural reforms are being implemented in the periphery to improve international competitiveness, and economic policy is increasingly being harmonized. However, measures being taken so far are anything but sufficient. In addition, one flaw in the EMU financial architecture has not yet been really addressed: as history shows, a currency union without a fiscal and political union is usually quite unstable. The lack of any real fiscal integration has not been a problem in boom times. Now it is. Given the speed at which bank deposits are eroding in Greece and increasingly elsewhere in the periphery and the contagion risk in other countries in the EMU periphery, the market would need a signal soon, pointing at a tighter European integration. This could include a pan-European bank deposit insurance and a Europe-wide bank supervisor, at least for the banks operating across Europe, as well as a sort of burden sharing of existing government debts or even a transfer system. Several proposals are currently being discussed. The one which could gain traction is the debt redemption pack, proposed by the German Council of Economic Experts. Given that it is limited both in terms of size - maximum debt burden sharing limited to all debt in excess of 60% of GDP on the day the plan starts - and time, as it also requires a credible debt reduction plan for every country to bring debt-to-GDP levels back to 60% within a 25-year period, it could get the support from politicians in the core EMU much more easily than the conventional eurobond or eurobillproposals.Inaddition,theECBneedstoremain an active lender of last resort and potentially has to increase its scope of liquidity provisioning. One could think of lending to the European Stability Mechanism, in case this institution gets a banking licence.

Do we think that Europe will actually implement these measures? Clearly, there is no guarantee. However, we do think that all EMU member countries would face costs in case of an EMU breakup which exceed the costs of keeping the currency union alive. This is the

reason why we as a house think that it is increasingly likely to see more steps towards a tighter fiscal integration. Admittedly, any decisions toward a tighter fiscal and political union would need a long time to be implemented. Nevertheless, we would expect the market to react positively to any credible roadmap in that direction.

In any case, we think that central bank interest rates will have to remain very low in the eurozone – and not only there. The US, too, is unlikely to see a rate hike any timesoon.ForUStreasuriesandGermanBunds,thisimplies that the outlook is rather cautious. Even though the price risk is moderate, as central banks are unlikely to hike rates anytime soon, thereby anchoring the long end of the yield curve, total return expectations in inflation-adjusted terms are very meagre. We think we will have to live with a low (real) rate environment for longer, which is typical for a de-leveraging period. Governments have an incentive to keep nominal and real yields low in such an environment. Central banks, too, will need to keep rates at very low levels and also distort the prices of government bonds by intervening in the bond market. This mechanism, called financial repression, has been applied in the past in various economies and is being applied again today.

In the fixed income space, we have therefore warmed up to corporate bonds, which offer a higher yield than government bonds in the US, Germany and the UK. Valuations are quite attractive on our numbers. Implied default rates are still very high, too high actually, despite the recent outperformance. To give anexample:BBB-ratedbondswithafive-yearmaturity in Europe are priced for a default probability of around 20%. This is close to the actual default rates of all bonds, including non-investment-grade bonds, during the Great Depression in the 1930s in the US. Clearly, the implied default rates today look way too high. For long-term investors, we think there is value.

We also like to have a long position in emerging market bonds. With government debt levels being lower than in developed markets and continuing to trend down, we think that this market segment should deserve tighter spreads than what we are seeing today. On our numbers, the market is still pricing in a defaultprobabilityofaround10%–20%forBrazilandChina and 20%–40% for Russia and India, depending on varying assumptions on the recovery rate.

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Global Strategic Outlook - 3rd Quarter 2012 Global | US | Europe | Asia-Pacific

We reduced our equity exposure in April back to neutral. Having added to the position in January, we have locked in profits from our risk-on position, which we had for three months. The headwinds mentioned at the beginning of this article have become too strong to justify an ongoing long position in equities. Given that valuations, on average, are rather moderate for global equities, we are inclined to increase our exposure at a later point in time, provided that economic data are troughing. So far, this is not yet happening. However, surprise indicators have fallen to very low levels already and therefore could start to rebound soon. If and once this happens, this would be a positive equity market backdrop tactically. For sure, in case we get a break-up of the eurozone – currently the biggest risk case for capital markets – we would review our position and potentially reduce equities further.

Regionally, we are currently underweight US equities against a global equity benchmark. US equity valuations are not overly attractive based on our preferred valuation metric, the Graham-Dodd P/E ratio, relative to other markets. However, this position is under review, as the US market usually performs well in a risk-off mode and in times of growth moderation.

In line with our reduction of equities in our global tactical asset allocation portfolio, we also trimmed our European equities exposure. It is only when we see first signs of a credible solution to the EMU debt crisis and, consequently, a tightening of credit spreads that European stocks are likely to outperform again. Low valuations prevented us from going underweight.

Japan is a market on which we have a neutral weighting. Admittedly, we should have trimmed our Japan weighting to underweight, as Japan is highly cyclical – not the best place to be in times of growth moderation.However,theBankofJapan(BoJ)decidedto provide much more liquidity to the financial system. If this actually happens, the yen should weaken and support the equity market.

We are holding on to our constructive view on emerging market equities, which tend to outperform in times of low real interest rates – which is likely to be the case in the foreseeable future. In addition, very early indicators for growth in emerging markets are showing signs of improvements: the yield curve in most markets has started to steepen, consistent with a view of a better economic momentum towards the end of this year. Equity Valuations are not particularly low in Asia, albeit justified by high corporate profitability.

Our currency views reflect our constructive views on emerging markets. We have reintroduced our secular constructive view on emerging markets in general.

AftertheannouncementbytheBoJtoincreaseitstotal asset purchase programme, we have implemented a short of the yen versus the US dollar. This view is being reinforced by our assessment of the high valuation of the yen against most developed market currencies. Due to the ongoing divergence in growth dynamics between the US and Europe, we will stick to our tactical short of the euro against the US dollar.

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Asset Allocation - Virtual GPC Portfolio*

Global TAA

MSCIWorld

Citi GlobalBIG

DJ UBSTR

Euribor1M

Active Weight N N N N

BMKWeight 60 % 30 % 5 % 5%

EquityRegions

MSCIUSA

MSCIEMU

MSCIUK

MSCIJapan

MSCIEM

China A Shares

Active Weight UW N N N N OW

BMKWeight 35% 25 % 10 % 15% 15% 0%

USA EMU UK Japan EM Cash

FIRegions

JPUSA

ML USCorp

JPEMU

ML EMUCorp

JPMUK

JPMJapan

JPMEMBI

Euribor1M

Active Weight UW OW UW OW UW UW OW N

BMKWeight 20 % 15 % 20 % 15 % 10 % 10 % 0 % 10 %

Global FX EUR GBP JPY CHF AUD Emerging RMB

Active Weight S N S N N L L

1Emerging markets are not included within the benchmark. *The hypothetical or virtual portfolio has some inherent limitations. The asset allocation for a portfolio actually managed by Allianz Global Investors or its affiliates will differ from those presented here, due in part to a portfolio’s investment objective and guidelines and market and economic conditions that would impact the decision-making when managing actual portfolios. There is no guarantee that these investment strategies will work under all market conditions. Each sector of the bond market entails risk. The guarantee ofTreasuryandGovernmentBondsisthetimelyrepaymentofinterest,anddoesnoteliminatemarketrisk.Mortgage-backedsecurities&CorporateBondsmaybesensitivetointerestrates.Wheninterestratesrisethevalueoffixed-income securities generally declines. There is no assurance that private guarantors or insurers will meet their obligations. An investment in high-yield securities generally involves greater risk to principal than an investment in higher-rated bonds. Equity investing is subject to the basic stock market risk that a particular security or securities, in general, may decrease in value. Investing in foreign securities may entail risk due to foreign economic and political developments and may be increased when investing in emerging markets. The securities of emerging markets may be less liquid and subject to the risks of currency fluctuations and political developments.

Legend:N = NeutralOW = OverweightUW = UnderweightL = LongS = Short

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Q2 US macroeconomic results have continued to come in below expectations, while foreign economic developments became especially challenging in the eurozone, and fears of a hard landing in China have emerged as well. This has left the S&P 500 below the March 2012 close of 1,409 in Q2, with net selling pressure most evident in May’s cascading markets. As Q2 has come to a close, more evidence of favourable policy responses has developed, and this, along with the effective global tax cut implied by lower oil prices, should provide a better underlying tone to economic and earnings growth as well as US equity market prospects.

The downshift in US economic results that cropped up in Q2 appears across too many indicators to dismiss it as noise. Curiously, the downshift was first evident in capital goods orders. On a three-month trailing average level basis, capital goods orders have fallen 7.6% from the February peak through April. Since we know government expenditures have been flat so far in 2012 (and down 2% year-on-year [YoY] in real terms), and they are likely to be contracting more as we get deeper into 2012, it is extremely important that US private-sector growth picks up momentum as the year progresses.

This is especially relevant because, in 2013, a roughly $650 billion fiscal drag is due to be introduced as tax cuts are allowed to expire and spending reduction efforts are redoubled. With high profit margins and ample free cash flow, we were anticipating capital spending would take the lead, opening up more jobs and fuelling consumer income generation. While there is some increasing evidence of a return of manufacturing operations to the US from offshore sites, and activity in the energy sector has remained robust, especially in the shale oil segment, the decline in order levels through April raises a yellow flag. Duke University survey results show some deceleration of Chief Financial Officer capital spending plans, but they still remain positive at around 5% YoY growth. ISM new orders have also lifted of late from the March low of 54.5 to May’s 60.1, which is the highest level in nearly a

year, so there is still a chance of some reacceleration in 2012.

As has been made all too apparent in the eurozone situation, expansionary fiscal consolidations can work only if domestic private-sector spending revives or if foreign trade balances improve, in a more than offsetting fashion, against the fiscal expenditure cuts and the tax hikes. With the US merchandise trade deficit only barely improved in April relative to year-end levels and export growth running at 4% YoY, which is roughly half the pace at the turn of the year, much depends on how US capital spending and consumer spending evolves in the next 6–18 months.

On the employment front, initial unemployment claims have stopped falling, on a four-week trailing basis. Payroll employment gains have become a lot more tentative, shifting down to 69,000 per month from a peak of 275,000 per month at the beginning of the year. This has left real disposable income growth still below 1%, which in turn has left consumer spending too dependent on a drawdown in the personal saving rate. Retail sales growth has dropped mildly over the past two months, but with oil prices at eight-month lows, we anticipate a mild pickup in consumer activity in Q3.

The failure of the momentum developing in Q1 to spill over into Q2 is a disappointment and will of course influence Q2 earnings results. It has also accelerated the shift to defensive sectors in the US stock market. Already, there has been some net reduction in analyst earningsrevisionactivityfor2012estimates.Butwebelieve more of what has been weighing on the US equity market are events abroad, including the prospects of a Greek exit from the eurozone and concern over a hard-landing scenario in China.

With the newly elected coalition in Greece, there is a much better chance that reasonable compromises can be hammered out, and the exit card is unlikely to be placed so readily on the negotiating table. Paradoxically, the threats of dissolution may be

5. Equities outlook - US


Rob Parenteau, CFAEconomist, External Advisor, San Francisco

21


speeding up efforts at unification in the areas of banking regulation and supervision, region-wide deposit insurance, and some form of redemption fund for lowering interest expense on a portion of the region’s debt.

Regarding China’s hard-landing scenario, the weak data arriving in April on electricity production, industrial production and retail sales activity have already prompted an accelerated policy response. At thePeople’sBankofChina,reserverequirementcutshave given way to policy rate cuts, while on the fiscal front, infrastructure spending has been accelerated as well, with initiatives now targeted at some of the more interior cities. Estimates indicate that this wave of spending will be between 25%-50% as large as the one initiated in 2008–2009. India has also responded in the past month with its own increase in infrastructure spending plans. A reduction in concerns over both

China and the eurozone could help lift US equities in Q3.

Finally, in the US, long bond yields are near historical lows, driving more investors who need income from their investments in the direction of dividend-yielding stocks. Low yields also help create a valuation underpinning for equities. With the Fed extending Operation Twist, and the possibility of QE3 to come if inflation continues to fade and growth remains subpar, there is little reason to expect competition from bond yields. Only in a deflationary environment would we expect bonds to outperform equities from here, and that is not our base case. Subpar growth, continued fiscal policy ease in emerging markets abroad, diminishing inflation pressures and the possibility of some steps toward deeper unification in the eurozone all make us optimistic that US equity indexes can bounce back from their May slump.

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Although the long-term convergence story for Eastern Europe remains intact and is driven by low GDP per capita, better macro fundamentals and competitiveness (due to its low labour costs and tax environment), the short- and medium-term outlook of these economies is affected by fiscal austerity in the eurozone via direct trade links and capital flows as well as the de-leveraging process of Western European banks.

There are close trade links between countries in Eastern Europe and the EU. Whereas the trade links with the eurozone are the highest for the Czech RepublicandHungary(50%ofGDP),Bulgaria,Romania and Poland have a more moderate share (25% of GDP), and Russia and Turkey have the lowest (10% of GDP). Exports to the periphery are small, with theexceptionofBulgaria(10%ofGDP).

Besidesthetradelinkage,countriesinEasternEuropeare also affected by the financial sector linkage, given that around 80% of the banks in Central Europe are owned by Western European banks, which partially funded the growth in the region by external sources. As Western European banks are currently in the process of de-leveraging in order to strengthen their capital positions, Eastern Europe is also exposed to the de-leveraging process. While in many countries, foreign ownership is very high, the dependence on external funding is quite different. Therefore, markets which are characterised by high loan-to-deposit ratios, such as the Ukraine, Slovenia, Serbia, Hungary and Romania, feel the impact from de-leveraging more strongly than markets which are domestically funded, such as the Czech Republic, Slovakia, Turkey and Russia.

Austerity measurements and the de-leveraging process have also resulted in lower capital inflows to Eastern Europe. Although the inflow from the EU cohesion funds should support investments in general, many countries are facing a much lower capital inflow than before, which hinders the growth of investments and therefore lowers the medium-term growth potential of the countries.

On the back of weaker export markets and a slowdown of credit expansion, the economic outlook for Eastern Europe has already worsened and will remain below trend for a while. Countries with weak fundamentals and high dependency on external funding will have more difficulty recovering from the current situation than those that are better positioned, such as the Czech Republic, Poland, Russia and Turkey (see chart).

Due to the openness of their economy, the Czech Republic and Hungary will both be negatively affected by the weaker activity in the eurozone. Whereas sound fundamentals (moderate debt level, commitment to reforms) underscore the defensive character of the Czech Republic, the economic situation in Hungary is more fragile due to high public and private debt, exposure to FX loans, high external refinancing needs, and ongoing de-leveraging on the back of high foreign ownership in the banking sector. The Polish economy is well diversified, less exposed to exports, and its net external position versus foreign banks is relatively benign. Russia is also well positioned to cope with an economic slowdown in Europe (unless the oil price falls below $80 per barrel), as its direct trade exposure is limited and its fundamentals remain strong, with low public and private debt as well as a comfortable reserve backdrop. Turkey is facing an economic slowdown which was initiated by its central bank in order to bring down the high current account deficit (9% of GDP, which makes Turkey vulnerable to sudden stops of capital flows); long-term, the outlook for Turkey remains attractive on the back of its demographic trends, low debt level and low exposure to Europe.

The key risk for the region is a severe worsening of the situation in the eurozone which might lead to much sharper de-leveraging and the risk that banks might be forced to sell subsidiaries in the region, despite their increasing profitability and growth outlook. Some consolidation has already happened, with weaker banks selling their subsidiary and other international players taking advantage of those asset sales (i.e. Santander in Poland and Sberbank in Turkey).

Equities outlook - Europe

Neil DwaneChief Investment Officer Equities Europe, Frankfurt

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Figure 1: Public sector debt/GDP in % (ESA95 end-12F)

Source: MinsFins, European Commission

Est.

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Source: AMECO, European Commission

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Figure 3: Nominal compensation per employee (’000 EUR p.a.)

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Figure 4: Export exposures (% of GDP, 2011)

Source: AMECO, European CommissionEU-27 ex EurozoneEurozone ex GermanyGermany

Non EU-27

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Bulgaria Ukraine Poland Romania Russia Turkey

Figure 5: Share of banking assets controlled y foreign banks. 2009 %

Source: ERBD, UBS

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Figure 7: Capital inflows (% of GDP) - past and present

Source: EuroStat, National Banks, UBS2010-11 average2004-07 average

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Figure 8: Real GDP growth in Eastern Europe (%, YoY)

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-10-8-6-4-202468

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Equities outlook - Asia-Pacific

The resurgence of uncertainty in Europe and growing concerns about US unemployment have led to a risk-off environment. It is this that has exposed cracks in the otherwise largely resilient economic stories of Asia, as witnessed through the recent volatility of equity and currency markets. Despite Asian economies still having a significant susceptibility to exogenous factors, the long-term secular trends in most Asian economies are still intact. With adequate room for monetary, fiscal and structural stimuli to accommodate a slowing of exogenous demand, most Asian economies are also well poised to benefit from a resurgence of a risk-on environment should Europe and/or the US come up with substantial, credible fixes for their ailing economic situations. India remains the lone outlier in the region, as it faces a political paralysis that is bringing it closer to crisis conditions. Luck and significant structural reform are among India’s few remaining levers left to improve economic conditions in the current environment.

ChinaIt is possible that Chinese policymakers have been behind the curve with their recent responses to economic slowing however, we maintain the view that the bottom of economic activity will be reached in Q2, with a likely rebound of economic activity into Q4. Our view of a scenario of no hard landing is corroborated by an assortment of recent policy measures aimed at supporting growth, President Hu Jintao recently stated that China will “maintain steady and robust growth,” and there is an increased likelihood for additional measures to further stimulate economic activity. China has conversely indicated that it will not embrace the scale of the record stimulus unleashed in 2008, yet stabilising its expansion rate at the very least would avert a greater drag on a global rebound hurt by Europe’s crisis and elevated US unemployment.

While visiting Mexico for the G20 meeting in June, President Hu said in a written interview with the Mexican newspaper Reforma that China has taken “targeted measures to strengthen and improve macroeconomic regulation, accelerate the shift of the

growth model, adjust economic structure and build long-term mechanisms to boost domestic demand.” Besidesthefirstreductionininterestratessince2008that was announced on 7th June, China has in recent weeks accelerated approvals for projects ranging from clean energy incentives and lower-polluting steel mills to aid for first-time home buyers.

While China remains an emerging market requiring substantial new investment, with estimates that the Chinese economy is at the equivalent stage of economic evolution as 1960s Japan or 1980s South Korea, fixed asset investments still represent more than 50% of economic activity and, though incrementally lower, is likely to remain elevated for years to come. If a sustainable path for economic growth is to be achieved, we should look for more concrete measures being instituted by the Chinese government to improve the structure of the economy by boosting drivers of domestic demand.

Another path toward a sustainable direction for economic growth includes the deregulation of the financial sector. Looking retrospectively at the past few decades, Chinese leaders have demonstrated both ability and willingness to deregulate, reform and otherwise free up productive forces in the economy every time it has hit a snag. This has not changed, as was recently demonstrated by the implied path towards financial deregulation implicit in the 7th June interest rate cut announcement. The rate cut was symmetric: -25 basis points both to lending and deposit rates; however, for the first time, banks were also granted the flexibility to offer loans 20% below benchmark and deposits 10% above benchmark. While likely to compress banks’ Net Interest Margins, this a clear and welcome step toward interest rate liberalisation and a strong signal of a loosening stance.

IndiaIndia is facing the most stressed macro backdrop in Asia, all while real credit growth has remained strong (suggesting unproductive lending) in the face of sharply slowing GDP growth, weak industrial

Raymond Chan, CFAChief Investment Officer, Asia-Pacific

27


production, soft gross fixed-capital formation, persistent inflation and a massive trade deficit. India’s woes center on quadruple deficits (current account, fiscal, governance and liquidity) which prevent monetary policymakers from taking any substantial options until many of these problems are addressed.

Currently, the biggest source of problems in India comes from the lack of political purpose and unity to embrace long-standing structural reforms on the supply side of the economy, as at present there is little slackintheeconomy.TheReserveBankofIndiarecently, and wisely, held off on a rate cut at its late-June meeting, as at this juncture it would have had little, if any, impact on lending rates due, ultimately, to political paralysis on structural reforms. In addition, a rate cut is likely to have exacerbated the inflation risks, given fiscal and current account deficits and the lack of slack on the supply side of the economy.

In the absence of progress toward any major reforms, the one virtuous cycle one can see evolving in India derives from a decline of oil prices and a recovery of capital flows – for now, placing the direction of the Indian economy in the hands of fate amidst political dysfunction.

JapanJapan’s current macro numbers, in particular the sequential production and export data, show the softening recovery of Japanese business conditions, despite the strong year-on-year rebound following reconstruction efforts and a large base effect. In a risk-off environment generally characterised by dwindling global growth, the yen tends to be sought as a safe-haven currency. Therefore, Japanese corporate earnings are largely affected by both the global economy and the exchange rate. In this sense, therefore,themonetarypolicyoftheBankofJapan(BoJ)willplayacriticalroleintheequitymarketaswellas the real economy.

InFebruary,theBoJsetthegoalofa1%annualincrease of CPI to get out of a deflationary spiral. The current price level and the expectation of the prices as of the end of 2012 are far below that goal (see chart), whichsuggeststhattheBoJwouldaccelerateeasingtoachievethisgoalinthenearfuture.TheBoJhasnotmade any additional, drastic easing policies since February, and some expected that proactive action would have been announced at the meeting in June.

However,itisdifficultfortheBoJtoimplementanewpolicy before more progress is made in Europe, alongside the G20 meeting and the EU summit as both could shape decisions that will affect the framework and financial stability of Europe.

The government is currently discussing a hike in consumption tax. Prime Minister Noda is eager to raise the tax rate to address the rapidly ballooning deficit and has, therefore, compromised with the opposition parties in various other areas in order to pass the bill. Although the possibility of a general election cannot be denied, the bill for the tax hike could pass legislative approval by this summer at the earliest.SincetheBoJwantsthegovernmenttomaintain a disciplined budget, the enactment of the tax hike could make them more willing to implement the additional accommodative policies.

IndonesiaIndonesia’s long-term structural story has been one of the most compelling secular stories in the region. It has been led by a relatively strong fiscal position, a historically resilient balance of payment positions, and a strong consumption and commodity linkage story (energy and soft and hard commodities). However, Indonesia currently faces cyclical pressures from a combination of global risk aversion, external funding linkages and a current account that is now falling sharply into deficit. Softening commodity prices, slowing global demand and resilient domestic demand from investments have contributed to a widening current account deficit, whereas high foreign ownership of government bonds (28.8% of sovereign government bonds) as well as a high external debt-to-FX reserve ratio (>200% – see chart) leave the Indonesian rupiah vulnerable to a reversal of capital flows in a risk-off environment.

In the current risk-off environment, policymakers recently have started rationing onshore US dollar liquidity in an effort to protect FX reserves; however, amidst the shortage of US dollar liquidity, widening bid/offer spreads have been placing further depreciation pressure on the rupiah. Should the risk-averse environment be prolonged, the rupiah could face continued pressure from a balance-of-payments perspective, so events in Europe and the US in the coming weeks and months will have significant bearing on the direction of the rupiah and the potential for severe capital outflow.

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While a rapid depreciation of the rupiah would destabilisetheeconomy,webelievetheBankofIndonesia will have enough ammunition this time around to combat the situation if it materialises. Foreign reserves stood at $113 billion at the end of May. Furthermore, the economy is strong fundamentally (GDP expanded at 6.3% in Q1FY12) with core inflation holding steady at 4% year-on-year. We believe, therefore, that with what looks like an increasing likelihood of resolution in Europe, the rupiah should find stability going forward.

CurrenciesRecent events in Europe and growing concerns in the US have led to a risk-off environment that has exposed cracks in the otherwise largely resilient economic stories of Asia, as witnessed through recent volatility of currency markets. In addition to Indonesia, other currencies susceptible to weakness should there be a prolonged risk-off environment include the Indian rupee and South Korean won due largely to significant exposure to external financing (see chart).

Despite the inherent economic risks that accompany a significant weakening of currencies, the export-oriented industrial productivity in South Korea and the substantial commodity export potential endemic to Indonesia provide significant buffers to ameliorate currency weakness. Whereas failed political direction in India has left the economy too dependent on domestic consumption without any significant export base, leaving the economy dramatically susceptible to substantial currency weakness.

Interestingly, a potential stopgap to augment FX reserves and mitigate capital outflow from Indonesia could be the renewal of a renminbi swap line with China that expired in March of this year, which policymakers appear to currently be in the process of renewing. As this swap line itself represents a minor policy tool, the ramifications for the expedition of the renminbi internationalisation process could be quite profound: the potential catalyst for a rapid transition to the adoption of the renminbi could be through a transition to renminbi financing in markets with significant export potential to China and susceptibility to a dearth of US dollar liquidity, such as we are now witnessing in Indonesia. If the risk-off, dollar-constrained environment continues, Indonesia may

well be the most likely candidate to test an expedited transition toward the rapid adoption of the renminbi trade settlement.

Specific to renminbi appreciation, we continue to see expectations for moderate, but slightly less stable, renminbi appreciation as the key catalyst supporting global stability. We expect that further easing expectations in China will allow further convergence between the onshore renminbi and offshore renminbi interest rate markets, which should bode well for the offshore renminbi bonds market. We believe the internationalisation of the renminbi will be the key important driving factor to support renminbi appreciation in the long term (and vice versa), although we expect the pace of appreciation likely will be slower this year owing to the uncertainties in the global economic environment. We continue to believe that stability in the pace of currency appreciation would be the preferred scenario as China rebalances its economy from mainly export driven to a more domestic-led economy, and a gradual renminbi appreciation trend should help shift the resources and capital from the production of tradable goods to services and non-tradable goods.

Summary outlookThe European debt crisis will continue to be the central factor driving market sentiment into midsummer. However, we maintain our base-case view that the eurozone is not going to collapse and that adequate liquidity will be provided to the financial systembytheEuropeanCentralBankandquitepossibly by the US Federal Reserve. Although the Asian equity and currency markets have been negatively affected as the European sovereign debt crisis intensified, the fundamentals of Asian economies are still largely intact. Lower oil prices are also quite positive for economies due to high energy import dependence. Inflation has been retreating, which should allow Asian central banks more flexibility in the event of worsening external demand. Outside of aggressive monetary policy action from developed markets, we would continue to expect the economic activity of emerging economies of Asia to continue to be key drivers of incremental global growth through the rest of the year.

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Figure 1: Japanese CPI, BOJs price stability goal

Source: Ministry of Internal Affairs and Communications,BOJ; compiled by Daiwa Securities, RCM ResearchCPI excluding food, energy

CPI excluding fresh food

-2.5-2.0-1.5-1.0-0.50.00.51.01.52.02.5

05 06 07 08 09 10 11 12 13FY

0.3%

BOJ CPI goal 1%

0.7%%

Apr 2012 forecastsby Policy Board

members

Figure 2: Regional exposure to external funding linkages (as at Q4 2011)

Source: World Bank, CEIC, Morgan Stanley Research, RCM ResearchTotal external debt/FX reserves

Short term external debt/FX reserves

0% 50% 100% 150% 200% 250%China

TaiwanThailandMalaysia

PhilippinesKoreaIndia

Indonesia

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Global Strategic Outlook - 3rd Quarter 2012 Global | US | Europe | Asia-Pacificc

However, in May, earnings revisions turned negative again. Was that just a blip, or have we already seen the peak of earnings revisions? Weak economic surprise indicators globally might indeed support the view that earnings revisions have already peaked. If so, then the defensive investment styles stable growth, high quality, high price momentum and positive revisions should continue to do well, and the investment style value should continue to suffer. However, if not and revisions turned positive again, historically, value has been the dominant investment style.

Investment style allocation and policy responses.Investors have priced in a bearish economic outlook. The investment style value is trading at a valuation discount to non-value names of between 20% and 40% across most markets, levels similar to last year’s lows.

If investors’ worst fears fail to materialise, a strong value bounce is more than likely. A forceful policy response to revive growth could be a trigger for a valuebounce.Butgiventhecheapnessofcyclicalvalue und institutional underweights after a multiyear underperformance, value could well be rallying without any trigger.

Investment style strategy between recession fears and policy hopes.In our base scenario, we expect the global recovery to muddle through the financial and economic uncertainties. Like from mid 1991 to mid 1994 or from 2004 to mid 2007, we expect the economy to grind higher against a backdrop of uncertainties that lets the markets oscillate between recession fears and recovery hopes. In a muddling-through environment, most long-term investment style winners are expected to do well, with growth taking the lead, followed by value and earnings revisions (see chart). Price momentum strategies have historically also done well in a muddling-through environment.

Q2 2012 has been a solid quarter for style investors.Q2 has been a solid quarter for style investors as favorites, such as high price momentum, positive revisions, stable growth or high quality, were ahead of the benchmark (see chart). Among the long-term investment style winners, only value was lagging.

Risk-on/Risk-off theme continues.The performance of investment styles over the past three years was mainly driven by one investment theme, the risk-on/risk-off trade. Q2 2012 was no different in this respect. After Q1 being risk-on, Q2 was risk-off again as investors reacted to much weaker economic data globally and a reescalation of the European debt crisis.

In May, performance of high-risk stocks was the third worst month on record; only September and October 2008 at the peak of the global financial crisis were worse.

In this risk-off mode, unsurprisingly, lower-risk investment styles, like stable growth or high quality, did well, but also styles such as high price momentum and positive revisions that are currently biased toward more defensive names that held up in the down markets of the past 12 months.

The investment style attractive valuation, on the other hand, is biased toward financials and cyclicals and hence suffered from the reescalation of the European debt crisis and weaker economic data.

Investment style allocation and the earnings revisions cycle.Earnings revisions bottomed out in late 2011 and turned positive in April. Historically, value strategies dominate after earnings revisions have bottomed out. Trend-following strategies, like earnings revisions and price momentum, struggle in the early stages of a pickup in revisions but return to efficiency about three months after earnings revisions have troughed. The performance of investment styles in Q1 indeed followed this historical pattern.

Equities outlook - style

Klaus TeloekenChief Investment Officer Equity Multi Styles, Frankfurt

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However, today, price momentum strategies are highly correlated with low risk; hence, price momentum strategies are at risk if investors’ worst fears fail to materialise, e.g. triggered by a new round ofQEintheUSora‘BigBazooka’ineuroland.Correlations are more than 1.5 standard deviations away from longer-term average at levels last seen in November 2009, February 2000 and October 1998. Post these periods, we saw strong mean reversions with value bouncing and price momentum suffering.

How severely could momentum strategies suffer? Momentum crashes historically have occurred when default spreads were wide, market volatility was high and market return in the prior 12 months was quite negative. See chart for a list of the weakest months for momentum strategies over the past 60 years. These conditions generally prevailed in the depths of the recession a few months before an economic recovery started. On a global scale, these conditions are not fully met, but in Europe, the potential downside for momentum strategies is meaningful.

For all these reasons, when implementing trend-following strategies, we prefer earnings revisions over price momentum, as this investment style is less correlated with investors’ risk aversion. However, high-momentum names at least do not look overly loved or overpriced on our numbers.

How to position within the investment styles value and growth?

Within growth, more emphasis should be put on a track record of delivered growth than on highest expected growth that might turn out to be overoptimistic in the next down leg of the muddling through.

Within value, investors should put more emphasis on cyclical valuation measures, like low price/book.

Low price/book strategies are the preferred diversifier – currently – to low-risk investment styles, like high growth, price momentum or earnings revisions.

Many investors have benefitted over the past quarters from stronger performances of defensive investment styles, like price momentum, growth or quality, but are also worried about losing performance from a value bounce. Such relief rallies are always hard to predict or time, but assuming the risk environment does not deteriorate and considering the significant underperformance and relative cheapness of value, we think investors should review their underweight in cyclical value stocks.

SummaryThe performance of investment styles over the past three years was mainly driven by one investment theme, the risk-on/risk-off trade, and Q2 2012 was no different in this respect. The performance of investments styles in Q2 was driven by the risk-off trade. Unsurprisingly, lower-risk investment styles, like stable growth or high quality, did well, but also the investment styles high price momentum and positive revisions that are currently biased towards more defensive names.

Many investors have benefitted over the past quarters from stronger performances of these defensive investment styles, but are also worried of losing performance from a value bounce. Such relief rallies are always hard to predict or time, but assuming the risk environment does not deteriorate and combined with significant underperformance and relative cheapness, we think investors should review their underweight in cyclical value stocks.

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Source: Allianz Global Investors research, as at 15 June 2012

Figure 1: Long/Short performance of global investment styles

Q2 2012

-15% -10% -5% 0% 5% 10% 15%

Apr May Jun

Value -1.6% 0.1% 0.4%

Growth 4.2% 4.2% 0.3%

Quality 4.5% 3.3% 0.1%

Momentum 6.4% 6.9% -0.4%

Revisions 2.4% 3.9% 0.0%

Risk -4.4% -8.0% 0.5%

Small Cap -2.0% -2.2% -0.6%

Figure 2: Relative performance of investment styles in a muddling-through environment

Source: Allianz Global Investors

RevisionsGrowthValue Momentum

Quality High Risk Small Cap

0.90

0.95

1.00

1.05

1.10

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

The chart shows the average performance of investment strategies over time starting with the initial peak of the OECD leading indicator after a recession trough. The analysis covers Europe, Japan and the US over the period from 1987 to 2011.

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Figure 3: Weakest months for a US - momentum strategy

Date Return Standard DeviationMonths to End

of RecessionBook-to-Market

Return

January 1958 -11.8 -3.2 3 8.79

September 1970 -18.8 -4.5 2 -1.72

July 1973 -18.5 -4.1 0.97

January 1974 -19.1 -4.0 14 7.24

January 1975 -19.7 -4.1 2 19.64

March 1980 -17.5 -3.7 4 -9.00

April 1999 -18.7 -3.9 8.07

January 2001 -42.1 -7.6 10 2.07

November 2002 -20.4 -3.7 4.31

March 2009 -39.3 -6.4 3 3.39

April 2009 -45.9 -7.2 2 26.91

May 2009 -19.1 -3.1 1 -3.33

August 2009 -24.8 -3.9 -2 11.9

Average -24.3 3.9 6.1

Source: Fama-French, Macquarie Capital (USA), November 2011.

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The global economic situation remains characterised by healthy growth rates in emerging market economies and growth below potential in the developed world, where some countries (namely in Europe) have seen a loss of confidence reemerging due to structural headwinds, leading to the abrupt slowdown seen in the past two quarters. Recent global activity indicators indicate that growth momentum has slowed recently. On the upside, G4 central banks provided markets with the reassurance that they stand ready to expand non-standard measures should the outlook deteriorate. China has led the way by loosening monetary policy in June.

Fundamental data in the US continue to point at moderate growth of the economy in the coming quarters. Increases in household spending have been well sustained, and the recent declines in energy prices should lift real purchasing power. At the same time, the business sector is profitable, supporting demand for US exports, despite weakening demand from Europe. The recent slowing in the labour market appears to be influenced by seasonal adjustments and unusual weather conditions but might also be affected by a potential fading of catch-up demand for businesses that had pared their workforces significantly. Overall, household and business sentiment remain cautious. The housing market remains depressed, despite a few encouraging signs, such as the stabilisation of home prices in some areas. In addition, fiscal policy will likely weigh on US growth; in particular, the potential ‘fiscal cliff’ at the beginning of next year raises concerns. Going forward, there are valid reasons to expect lower inflation in the US due to still low capacity utilisation and, on balance, still relatively high unemployment. The large increase in energy prices earlier this year has pushed inflation upward. However, oil prices and gas prices have since retraced those earlier increases.

US government bonds have reached new all-time low yields, driven by renewed safe haven flows following the resurgence of European-related risks. The chance of some form of additional asset purchases has risen

lately. QE3 is clearly an option should the economy slow down markedly from current levels and the unemployment rate start to drift back up again. In this environment, treasuries should continue to trade at extremely low yields while investor demand for ‘safe spreads’ continues.

Japanese business surveys recently indicated that the non-manufacturing sector is doing well, most likely offsetting the weakness of the manufacturing sector, which has been rather volatile after having benefitted from the restoration of supply chains recently. Public spending for reconstruction and pent-up consumption demand for services is expected to support activity in the construction and service sectors. The decision to reactivate some capacity of nuclear power plants should support an uplift in industrial production and indicate ongoing economic developmentforthisyear.InMay,theBankofJapanproduced their monthly report on recent economic and financial developments in which they expressed confidence in the outlook by saying that “it has become increasingly evident that Japan’s economy is shifting toward a pick-up phase.”

Eurozone economic activity had stabilised during Q1, but recent data point to a renewed contraction. The eurozone PMI has reversed the bounce from the beginning of the year and has fallen below the October 2011 level. In line with the PMI figures, the eurozone economic confidence survey (ESI) disappointed and continued its downward trend. Industrial production in the eurozone remains negative on a year-on-year comparison. While the slowdown in some peripheral markets is significant, some core markets, like Germany, also experienced an impact. Severe fiscal tightening will continue to dampen growth, especially in peripheral European markets.WhiletheEuropeanCentralBank(ECB)hasremained on the sidelines recently, the likelihood for more support one way or the other in 2H 2012 has increased.

6. Fixed income outlook - global

Ingo MainertCo-CIO Multi Asset Europe

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Political uncertainties due to elections and the Spanish bank bailout have played a major role in financial market moves in recent weeks and months. In the meantime, there appears to be further realignment underway regarding the European crisis strategy. While fiscal austerity coupled with structural reforms will remain in the focus, it is acknowledged that – in addition – a prudent, forward-looking strategy to unleash some of the growth potential in the short run is required. While this has also been brought up by the ECB(Draghicallingfora“growth compact”), European leaders will hold a special summit on the topic at the end of June. A likely outcome will be a strengthening of the role (and the capital) of the European InvestmentBanktoenableinvestmentsinsensibleinfrastructure projects and possibly a redirection of structural EU funds. In addition, with regard to the banking system, the EU Commission has suggested that the EU set up a banking union, including centralised supervision; a eurozone-wide deposit

protection fund; and a pan-eurozone bank recapitalisation facility, which would be positive for funding conditions in the periphery.

As a result, the volatility in European government bond markets is expected to remain extraordinarily high. Given the close avoidance of an anti-reform result in the Greek election and assuming further progress on political and fiscal integration, we see a good chance that German government bond yields will retrace from their current extreme risk-aversion levels.

Overall, softer economic data and ongoing political uncertainty is the basis for continued and extended volatility in bond markets. Decisive political measures in Europe or additional measures of central banks can easily trigger yield levels in safe haven markets to normalise.

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History tends to repeat itself in the European fixed-income markets. The sovereign debt crisis in the eurozone has taken a more ominous turn over the past few weeks as Spain and Italy have come under attack. The latest Greek episode involving elections, which took the form of a pro-eurozone referendum, has become almost anecdotal in light of the systemic nature of current developments.

The domino effect – already observed last year – signifies the failure of political and monetary authorities to confine the crisis to Greece and marks a new level of investor wariness regarding eurozone unity and durability.

The facts are clear: Spanish and Italian refinancing levels, which are currently far above nominal economic growth rates, are unsustainable and require urgent action. Amid a context of self-fulfilling prophecies, which are difficult to elude, time is not an ally. As the situation drags on, it tends to take root, reinforcing investors’ convictions that an eventual restructuring is becoming increasingly likely. The market is currently failing to reflect the very different economic realities in the two countries, however.

In relative terms, Spain is not burdened by excessive public debt – its annual interest charge vs. GDP is lower than Germany’s. Nevertheless, the country has been beleaguered by its immense real estate bubble bursting. The building sector represented 23% of GDP in 2007 compared to 12.5% in 2012. Incertitude regarding the extent of future losses to be booked to banks’ balance sheets, in conjunction with disastrous handling by the authorities which lost most of their credibility in the eyes of the market in the space of several weeks, has caused Spanish rates to surge to an all-time high since the creation of the euro.

Italy undoubtedly does not deserve the current wariness of the markets. With public finances which are set to be balanced in 2013, a primary surplus as of this year, more than €235 billion of austerity measures

announced since 2010 and structural reforms underway absolute domestic debt – of more than €2 trillion – is nonetheless the highest in the eurozone. To complicate matters, sovereign risk has spilled over into banking risk both in Italy and Spain. This is one of the adverse effects of the long-term refinancing operation, which initially narrowed peripheral debt spreadsvs.theBund.Abundantliquiditywasinvestedmassively into national public debt and therefore automatically reinforced the link between local bank creditworthiness and domestic sovereign spreads.

Europe effectively finds itself at a crossroads, facing two fundamental alternatives with highly divergent outcomes. The choices can be resumed as follows: 1. broader European convergence, providing us with a potential medium-term solution to the crisis, or 2. at best a status quo, which would inevitably lead to a disintegration of the monetary union.

Although we are convinced that the first of the two options will triumph, given the importance of the political aspects of the European project and the potentially disastrous impact of a eurozone implosion on the global economy, we still believe it is too early to increase exposure on peripheral debt.

The markets’ recent reaction to the announcement of the €100 billion Spanish bank bailout, followed by a rapid rise in Spanish government bond yields, was enlightening. Technical initiatives are no longer sufficient to restore calm; political decisions are required. Confidence will only be restored once the market no longer perceives a risk of euro-denominated sovereign issues being redenominated into local currencies. This change in perception is also a prerequisite for the resurgence of a broader diversified investor base with an appetite for peripheral debt.

We are convinced that the current tensions herald an imminent intervention. Measures to be announced are likely to involve further banking integration within

Fixed Income outlook - Europe

Franck DixmierCIO Fixed Income Europe


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theeurozone,astrongerEuropeanCentralBankroleas the lender of last resort and the declaration of a decisive step towards the partial mutualisation of eurozone sovereign debt issues via a redemption fund or by issuing eurobills. We believe it is still too early for the issuance of eurobonds, and the clear German position on this topic supports our analysis. However, partial mutualisation, through its implied conditionality, would have the virtue of starting the ball rolling towards economic convergence as a prelude to greater fiscal integration.

We maintained our defensive positioning in peripheral debt during the quarter, as reflected by our holdings in credit and securitised-debt securities. If political and monetary authorities intervene to provide a credible crisis-exit framework, these weightings should be rapidly reversed. The most efficient hedge currently consists of setting up option strategies on the German Bund,whichislikelytolosepartofitssafe-havenstatus in the event of an intervention.


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According to recent data revisions, the cyclical momentum of the global economy might have already turned early this year and at a level lower than previously thought. Of course, Asia is not immune from these global developments. The softening of Chinese growth is actually a major component of global weakness, even though the main roots lie in the eurozone crisis.

South Korea’s export-oriented economy clearly reflects the weak global macro backdrop. South Korean exports fell 0.4% in May, while imports decreased 1.2% year-on-year (YoY). Exports to the US, theEUandChinawerealldown.BrightspotsweretheMiddle East and Japan. The latter, however, was due to higher demand for oil products to compensate for the shutdown of Japan’s nuclear power plants. Overall, the figures are not as gloomy as they might look, as the fall in exports was lower than consensus expectation and, more importantly, exports excluding ships and handsets, which tend to be less distorted, rose 4.2% YoY based on seasonally adjusted per-day figures. The South Korean manufacturing PMI fell to 51.0 in May from 52.0 in March. However, there is light here as well: as new orders hardly slipped, the ratio of new orders to inventories climbed to 110.5, the highest level since April 2011.

Even though Taiwan’s economy emerged from recession in Q1, early Q2 data tended to be weak, unsurprising as Taiwan is among the emerging markets most dependent on exports to China. Taiwan’s exports contracted 6.3% YoY in May. Exports to Europe fell 13.6%, while exports to China/Hong Kong and the US were down 10.0% and 12.3%, respectively. India’s Q1 GDP growth rate fell to 5.3% YoY, well below market expectations of 6.1%. On the other hand, the Philippines’ Q1 growth rate of 6.4% significantly surpassed market expectations of 4.3%.

As a consequence of the global risk aversion originating from the situation in Europe, Asian currencies sold off, following the typical pattern established in the past. Considering strong economic fundamentals and the fact that risk aversion originated from outside Asia, this could reverse quite

fast and significantly, if global sentiment normalises. Therefore, the recent FX weakness in Asia should be seen as temporary, with the long-term structural appreciation case remaining intact.

Asian economies are still in a position of relative strength. Even after recent downward revisions, Asian growth rates are significantly higher than those of most other countries. If the global economy should worsen further, Asian countries have room for policy stimulus both on the fiscal and monetary side. Therefore, in Asia, the downside risk to growth is lower than for most other economies. China is already on the easing path and has accelerated project approval. The recent outright cut of Chinese interest rates, the first since the end of 2008, is a strong signal that the Chinese government is committed to counteract economic weakness. There is a good chance that active policy support, not just in China, combined with strong underlying economic fundamentals, will enable emerging Asia to grow just below trend this year, despite the poor global macro backdrop, especially as domestic demand in Asia is quite resilient so far.

Apart from the export-driven impact on the real economy, potential global contagion risk could result from a withdrawal of global funding. However, the reduction of funding as a consequence of the de-leveraging of eurozone banks, a major supplier of global funding for Asia, has already been underway for some time. In 2H 2011, eurozone bank claims on Asia fell by $89 billion, or 18%, with a remaining lending balance in Asia ex-Japan of $400 billion. This funding reduction has so far been smoothly made up by Japanese, Australian and other regional banks. Today, Asia is in a much better position to cope with funding constraints than before the Asian crisis in 1997. Asian economies not only have much higher currency reserves, but the reliance of Asian banking systems on external wholesale funding has been significantly reduced as well. As a result, Asia is less exposed to a potential distress in global funding markets than are other emerging market regions.

Fixed Income outlook - Asia-Pacific

Eugen LoefflerChief Investment Officer, AllianzGI Asia-Pacific

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Asian bond market returns

HSBC ALBI (Asia Local Bond Index)

Total Return in USD

Total Return in local currency

Currency vs. USD (% Change)

10Y Government Bond Yield

2012 YTD

2011 20102012 YTD

2011 20102012 YTD

2011 2010Jun

2012Mar 2012

End 2011

China 0.8% 9.8% 5.0% 2.0% 5.0% 1.4% -1.2% 4.4% 3.5% 3.4% 3.5% 3.4%

India -0.2% -10.9% 9.5% 4.3% 5.8% 5.2% -4.4% -18.8% 3.9% 8.4% 8.5% 8.6%

Indonesia -2.8% 20.3% 28.3% 1.2% 21.5% 21.1% -4.0% -1.1% 5.3% 6.5% 5.9% 6.0%

Korea 1.2% 3.1% 11.8% 2.7% 6.4% 8.3% -1.2% -3.1% 2.9% 3.7% 4.0% 3.8%

Malaysia 1.6% 1.3% 17.9% 2.1% 4.8% 4.9% -0.6% -3.5% 11.1% 3.5% 3.7% 3.7%

Philippines 3.0% 12.2% 18.5% 1.6% 12.8% 12.1% 1.4% -0.6% 5.4% 6.0% 5.8% 5.4%

Singapore 3.1% 5.4% 12.4% 1.9% 6.7% 2.6% 1.0% -1.0% 8.6% 1.4% 1.7% 1.6%

Taiwan 2.6% 0.0% 11.4% 1.5% 3.8% 1.6% 1.0% 0.3% 5.2% 1.2% 1.3% 1.3%

Thailand -0.2% 0.0% 17.0% -0.1% 5.1% 5.4% -0.3% -5.1% 10.1% 3.6% 3.8% 3.3%

Total 1.2% 5.0% 12.2%

Source:Bloomberg,asat8June2012.

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Risk management and news flow–driven tactical trading is key Investor sentiment improved in Q1. Following the EuropeanCentralBank’s(ECB’s)long-termrefinancingoperations (LTROs), bank funding strains were reduced and attention shifted to global macro data. Solid consumption and employment data in the US, and the continued resilience of emerging market growth, led to the expectation of a steady economic recovery. A medium-term positive outlook for risky assets was also supported by elevated risk premiums in most risky asset classes and extremely accommodative monetary policies, with low or even negative real rates, which could lead to asset price inflation. Combined with a defensive positioning among end investors, and positive price momentum in many risky asset classes, an optimistic outlook was justified.

However, at the beginning of Q2, concerns about eurozone growth reemerged. The eurozone sovereign debt crises took a turn for the worse in May as a consequence of the Greek elections that presented the prospect of a left-wing party gaining power and renegotiating the original bailout package, or even worse, leaving the eurozone altogether. In addition, there was evidence of austerity apathy combined with deteriorating economic fundamentals in parts of Europe, especially Spain and Italy. Meanwhile, purchasing manager indices were weak, particularly in the eurozone and the UK, and there was also evidence of the US economy losing momentum as well as slowing Chinese growth. As macro news fell short of expectations, our economic surprise indicators turned negative. Moreover, as weaker price momentum emerged, our Market Cycle Model gradually turned from indicating a marginal overweight to a marginal underweight position in risky assets in Q2. Accordingly, we progressively reduced our exposure to risky assets and reflected a more defensive stance in our portfolios in Q2 where appropriate.

At the time of writing, the situation remains challenging. Major headwinds on the global economy

remain. Downgrades to economic growth during a period when the world economy is growing below potential, increasing macro risk perception, weak price momentum and political risk are likely to constrain the upside potential of risky assets, at least in the short run. In the medium term, however, other factors indicate that a more positive stance in risky assets may be justified: low valuations (i.e. high risk premiums of risky assets), the defensive positioning of investors and easy monetary policy (negative real yields). In addition, the probability of additional monetary policy support, such as rate cuts or QE, is high, as global growth is not gaining momentum.

The challenges facing Europe are the dominant factors driving all asset markets right now. Tail risk currently is elevated as the probability of an extreme binary outcome has increased due to the dependency on policy and politics to provide an ultimate solution. Therefore, we recommend seeking some protection in portfolios to protect against the, albeit very low, probability of an extreme outcome. ‘Crash puts’ provide the necessary protection, even if their cost currently is elevated.

Future strategy, given unresolved EU sovereign debt crisis and fragile macro backdropUntil further policy actions in Europe have been implemented to stabilise markets and provide a reliable framework for dealing with fiscal consolidation and bank recapitalisation, we expect elevated price volatility. Therefore, a marginally defensive aggregate positioning is warranted in portfolios. However, we are conscious that tactically trading risk assets may add significant value should a sizeable relief rally result from a credible policy response in Europe, or significant monetary easing. Still, we recognise that such a rebound in risk assets must be accompanied by more favourable macroeconomic indicators to form the basis of a meaningful recovery.

Within developed market equities, we favour investments in the UK, France and Singapore.

7. Multi asset outlook

Herold RohwederGlobal CIO Multi Asset, Frankfurt


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Valuations, in combination with relative momentum, make these markets attractive. We prefer Spain, Canada and Australia the least on our country-ranking basis.

Regionally, we have a preference for Asia ex-Japan, where further economic stimulus via fiscal and monetary policy is possible, because inflation pressure is fading and debt-to-GDP levels are relatively low. Therefore, countries such as China, Thailand, South Korea and Indonesia remain relatively attractive satellite investments. We also recommend global REITs based on positive sentiment and trend signals.

We are cautious on commodities due to the weak commodityfundamentalindicators(e.g.BalticDryIndex and inventories), technical and sentiment indicators. We, therefore, recommend an underweight on commodities. Within commodities, our most significant short position is in energy and industrial metals, although we also prefer to underweight precious metals and agriculture in a balanced portfolio.

In fixed income, we are marginally long duration in most markets and still prefer to purchase bond segments with positive carry (e.g. corporates). We retain a preference for emerging market, high-yield and convertible bonds as satellite investments.


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In the run-up to the Rio+20 UN Conference on Sustainable Development, the publication of the GEO51 report reveals that the world continues to spiral down an unsustainable path despite over 500 internationally agreed-upon goals and objectives to support the sustainable management of the environment and human well-being. Although progress has been made on 40 goals, little or no progress has been achieved for 24 of them, including biodiversity loss, fish stocks, climate change, desertification and drought. In every instance, agriculture has a significant role to play in contributing to this downward spiral. This is further reinforced in a recent scientific paper in the journal Nature, which argues that the global ecosystems are shifting to a new critical tipping point as a result of human influence2.

According to the UN, the world population is growing by 75 million per year and is expected to reach 9 billion by 2040. How can we, therefore, solve the problem of feeding our growing planet without destroying it?

Globally, landscapes are being altered at an alarming rate to grow food. Currently, 40% of the land’s surface is committed to agriculture. About 16 million square kilometres of land (roughly the size of South America) is used to grow food, and about 30 million square kilometres of land (about the size of Africa) is taken up by pastures3. The remaining unfarmed lands (e.g. forests) are either biodiversity rich or delicate, providing many key environmental services for agriculture, such as water management, and serving as a carbon sink to mitigate global warming. Forests also play an important role in the food security for 1 billion of the world’s poorest people, who often do not have access to farmland, by providing food or cash income through a wide range of natural products4. Of the remaining unused available arable land, 80% is located in countries with insufficient infrastructure or political issues. The stress on natural resources is increasing. The pressures of population growth, growing meat and dairy consumption (up to 3 billion more middle-class consumers will emerge in the next 20 years5), rising energy costs and bioenergy production are taking their toll.

Agriculture and its related activities are the biggest emitters of greenhouse gases, being responsible for the emission of some of the more potent greenhouse gases, such as methane and nitrous oxide (methane has a global warming potential 72 times that of carbon dioxide, while nitrous oxide has a global warming potential of 289 times that of carbon dioxide), accounting for more than 30% of emissions globally, which is more than that emitted from all electricity and heat production, industry, and the world’s trains, planes and automobiles combined.

Water, a vital and scarce natural resource, is also being utilised at an alarming scale in agriculture. We already use 50% of the world’s fresh water, with agriculture accounting for 70% of that use. We use 2,800 cubic kilometres of water on crops every year, enough to fill 7,305 Empire State buildings every day. India and China particularly stand out with respect to water use in agriculture, as they are already facing water scarcity problems.

Yet agriculture is an absolute necessity if we are to continue to provide food, clothes, shelter and energy for the growing global population. While we will need to double global agricultural production to meet future population growth, can we afford to carry on business as usual, or do we need to freeze the environmental footprint of agriculture? If so, how? There is no silver bullet to solve this, but it is clear from the evidence that we need to strike a balance between feeding the world while protecting the environment. Botharecriticalifwearetomaintainsustainablelong-term food security and price stability. Ideas are increasingly being put forward for a new kind of agricultural revolution: one that mixes the best ideas of the Green Revolution with the best ideas of organic farming and environmental conservation6. This involves creating better incentives for farmers, making precision agriculture more widespread, introducing new crop varieties, making use of more drip-feed irrigation and grey water recycling and improved tilling practices.

These and other measures will require significant capital investments over the coming years at time

8. Sustainability Research – long term trends

Bozena JankowskaDirector, Global Head of Sustainability, London


43

when global capital is less accessible and likely to become increasingly expensive. Additional investment will also be necessary to help populations adapt to the potential impacts of climate change which will be exasperated by expanding agricultural production. Although technological innovation may be part of the solution, it also requires a change in mindset on the part of governments. A set of integrated, stable policies are needed which place a value on the natural capital that agriculture relies on and remove subsidies which artificially undervalue their true cost – or internalising the externalities. For example, deforestation (such as clearing forest for pasture) may generate an immediate value when the timber is sold, but the costs of this, such as the associated greenhouse gas emissions, soil erosion, biodiversity loss and water regulation (among other services), are not recognised in this value. If these costs were recognised, investors would have a better gauge on the true ROI potential.

Companies, too, should place greater emphasis on how they take account of their resource-related risks and opportunities. This, too, requires a new kind of thinking, which takes account of natural capital externalities beyond, for example, the usual focus on labour costs and competition for capital. Companies that succeed in improving their resource productivity will be more likely to develop a structural cost advantage; improve their opportunity to capture new growth opportunities (especially in resource-scarce, rapidly growing markets); and reduce their exposure both to resource- and environment-related interruptions to their business and resource price risk.

Companies in the food and beverage and food retail sectors stand to benefit especially. For example, companies that are working with local farmers and communities on things such as watershed management and better irrigation technologies not only maintain their supply chains but also stand to

enjoycommercialbenefits.SABMillernotesinits2010Sustainability Report that in procuring its raw materials, it works with local farmers to improve their farming practices and, consequently, the quality and yield of their produce and reliability of supply. Consequently,SABMiller’sbusinessesbenefitfromlower logistical and inventory costs; zero import duties; and shorter, more visible supply chains. The evidence is there: the sooner companies face this ‘other inconvenient truth’7 the better.

Companies should therefore tackle head-on the ‘other inconvenient truth’ and work toward being part of the solution rather than part of the problem. This means bringing green and innovative products to market, marketing resource efficiency attributes of their products, implementing sustainable value chains, reducing the environmental footprint of their own operations, and ensuring their risk-management systems incorporate natural capital externalities.

1 GEO5 Global Environmental Outlook, Environment for the future we want, UNEP, http://www.unep.org/geo/ pdfs/geo5/GEO5_report_full_en.pdf

2 Approaching a state shift in Earth’s biosphere, Nature; 6th June, 2012.

3 Global Landscape Initiative, Institute on the Environment, University of Minnesota.

4 Global Forest Resources Assessment 2010. FAO. 2010. Rome.

5 Resource Revolution: Meeting the world’s energy, materials, food and water needs, McKinsey Global Institute, November 2011 http://www.mckinsey.com/ Insights/MGI/Research/Natural_Resources/Resource_ revolution.

6 Global Landscape Initiative, Institute on the Environment, University of Minnesota.

7 Global Landscape Initiative, Institute on the Environment, University of Minnesota

44


9. Economic forecast summary

2012 2013

RCM Consensus RCM ConsensusUSReal GDP % chg SAAR 2.30 2.20 2.20 2.40CPI 2.30 2.20 2.00 2.00Short-Term (official) Rates 0,0-0,25 0.25 0,0-0,25 0.2510 Year Rates 2.25 2.17 2,70 2.57US Dollar Index 79.00 82.65 80.00 84.60UKReal GDP % chg SAAR 0.30 0.20 1.50 1.70HCPI 2.60 2.90 2.25 2.10Short-Term (official) Rates 0.50 0.50 0.50 0.5010 Year Rates 2.25 2.28 2.75 2.67GBP/USD 1.56 1.56 1.60 1.56EurolandReal GDP % chg SAAR -0.20 -0.40 0.90 0.80CPI 2.40 2.40 1.60 1.80Short-Term (official) Rates 0.50 0.88 0.50 0.8810 Year Rates (Germany) 1.80 1.91 2.70 2.24EUR/USD 1.28 1.25 1.37 1.25JapanReal GDP % chg SAAR 2.30 2.49 1.70 1.50CPI 0.60 0.10 0.40 0.10Short-Term (official) Rates 0,0-0,10 0.10 0,0-0,1 0.1010 Year Rates 1.20 1.09 1.50 1.28JPY/USD 82.00 82.00 85.00 85.00ChinaReal GDP % chg SAAR 7.60 8.20 8.00 8.40CPI 3.30 3.35 4.00 3.601 Y Lending Rate 6.06 6.00 6.06 6.0010 Year Rates 4.00 3.50 4.00 3.90USDCNY 6.25 6.26 6.00 6.10Hong KongReal GDP % chg SAAR 2.90 2.95 4.60 4.50CPI 4.40 4.40 3.90 4.003 M Interbank Rate 0.45 0.34 0.50 0.3410 Year Rates 1.85 1.68 2.05 1.75USD/HKD 7.80 7.78 7.80 7.78CommoditiesGold 1800 1720 1900 1835Oil 95 101 100 110

Allianz Global Investors

45


Financial markets review

30-Jun-12(1)

Qtr-to-date31-Mar-1230-Jun-12

Yr-to-date31-Dec-1130-Jun-12

% Change From Calendar Year 2011

Calendar Year High

Calendar Year Low

Equities USS&P 500 2363.79 -2.75% 9.49% -3.48% 9.49% 2.11%NASDAQ 2935.05 -5.06% 12.66% -6.01% 12.66% -1.80%MS Value 6724.07 -2.27% 8.02% -2.84% 8.02% 1.49%MS Growth 4635.29 -3.77% 10.81% -4.67% 10.81% 2.39%S&P 500 VIX 17.08 10.19% -27.01% -35.93% 19.78% 31.83%NASDAQ VIX 18.65 8.49% -19.37% -34.86% 17.15% 18.74%Equities JapanNikkei 225 9006.78 -10.68% 6.52% -12.17% 8.57% -17.34%Equities EuropeDJ Euro Stoxx 50 2380.99 -3.16% 0.48% -6.63% 7.57% -8.39%FTSE 100 5571.15 -3.42% -0.02% -6.61% 5.91% -5.55%Dax 30 6282.26 -9.38% 7.59% -12.13% 7.59% -15.55%Cac 40 3196.65 -6.63% 1.17% -11.08% 8.34% -16.95%Equities Asia-PacificMSCI Asia Pacific ex-Japan (USD) 1150.83 -6.00% 3.56% -8.93% 8.28% -16.25%Currencieseuro/usd 1.2590 -5.74% -2.70% -6.42% 2.17% -3.17%usd/yen 79.8050 -3.63% 3.70% -4.67% 4.74% -5.19%gbp/usd 1.5685 -1.83% 0.92% -3.41% 2.61% -0.74%Commoditiesoil brent 95.44 -22.66% -11.86% -24.52% 5.91% 16.67%gold (usd) 1597.36 -3.99% 1.45% -10.49% 3.65% 11.07%S&P Goldman Sachs Commodity Index 4532.03 -12.39% -7.23% -15.88% 7.24% -1.18%Short-Term RatesFed Funds Target 0.25% 0 bps 0 bps 0 bps 0 bps 0 bps3-MonthT-Bill 0.09% 2 bps 7 bps -3 bps 8 bps -10 bps3-Month Euro 0.65% -12 bps -70 bps -70 bps 0 bps 35 bps3-Month Yen 0.33% 0 bps 1 bps 0 bps 1 bps -1 bpsLong-Term Government Bonds2-Year Treasuries 0.32% -3 bps 8 bps -8 bps 10 bps -36 bps5-Year Treasuries 0.72% -31 bps -9 bps -48 bps 10 bps -118 bps10-Year Treasuries 1.66% -56 bps -22 bps -72 bps 19 bps -143 bps10-YearBund 1.60% -21 bps -23 bps -44 bps 45 bps -106 bps10-YearJGB 0.84% -15 bps -15 bps -20 bps 5 bps -13 bpsUS Corporate BondsBarclaysUSAggregateAAA10+years 3.28% -14 bps -51 bps -60 bps 6 bps -31 bpsBarclaysUSAggregateBAA10+years 5.15% -20 bps -25 bps -32 bps 7 bps -57 bpsspreadBAA/AAA 1.87% -6 bps 26 bps 28 bps 1 bps -26 bpsBarclaysHighYield 10.90% 66 bps -126 bps -126 bps 92 bps 229 bpsEMU Corporate BondsBarclaysEuroAggregateAAA 1.53% -19 bps -53 bps -67 bps 25 bps -50 bpsBarclaysEuroAggregateBAA 2.03% -56 bps -168 bps -198 bps 0 bps -16 bpsspreadBAA/AAA 0.50% -37 bps -115 bps -131 bps -25 bps 34 bps

*The periodic changes for equity indices are percentage changes, whilst for bond indices the change is given in basis points. A 1% point change is equivalent to 100 basis points. The calendar high and low columns represent the deviation of the index in percentage or basis points terms accordingly, compared to the index level at the end of the period of review. Source: Datastream.

46


Implied EPS growth (10-year)

Global sectorsRCM top-down

5 year earnings growth estimate (p.a.)

Market implied 5 year earnings

growth (p.a.)

Estimated growth < > market implied

growthRank

Oil & Gas 1.3% -6.2% 7.5% 1

Materials -0.1% -0.7% 0.6% 5

Industrials 0.7% 2.1% -1.4% 6

Consumer Goods 1.4% 5.4% -4.0% 9

Consumer Services 1.5% 7.4% -5.9% 12

Health Care 1.9% 7.4% -5.4% 11

Telecom 0.5% 5.0% -4.5% 10

Utilities 1.2% 4.8% -3.6% 7

Financials 1.7% -1.6% 3.3% 4

Banks 2.0% -3.4% 5.3% 2

Insurance 1.8% -1.6% 3.4% 3

Technology 1.6% 5.3% -3.7% 8

Source: Allianz Global Investors

47


10. Market valuations - US: Equity valuations

US S&P 500 P/B ratio

Source: BloombergAverageRolling 12-months standard deviationPrice to book ratio

1.0

2.0

3.0

4.0

5.0

6.0

Aug

97Fe

b 98

Aug

98Fe

b 99

Aug

99Fe

b 00

Aug

00Fe

b 01

Aug

01Fe

b 02

Aug

02Fe

b 03

Aug

03Fe

b 04

Aug

04Fe

b 05

Aug

05Fe

b 06

Aug

06Fe

b 07

Aug

07Fe

b 08

Aug

08Fe

b 09

Aug

09Fe

b 10

Aug

10Fe

b 11

Aug

11Fe

b 12

US S&P 500 P/E ratio

Source: DatastreamAverageRolling 12-months standard deviationPrice to earnings ratio

0.05.0

10.015.020.025.030.035.0

Jan

96Au

g 96

Mar

97

Oct 9

7M

ay 9

8De

c 98

Jul 9

9Fe

b 00

Sep

00Ap

r 01

Nov 0

1Ju

n 02

Jan

03Au

g 03

Mar

04

Oct 0

4M

ay 0

5De

c 05

Jul 0

6Fe

b 07

Sep

07Ap

r 08

Nov 0

8Ju

n 09

Jan

10Au

g 10

Mar

11

Oct 1

1M

ay 1

2

US S&P 500 real earnings yield

Source: BloombergAverageS&P 500 earnings yield - US inflation YoY

-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12


48


S&P earnings expectations

Source: DatastreamS&P IBES equity earnings expectations

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Q1 8

5Q1

86

Q1 8

7Q1

88

Q1 8

9Q1

90

Q1 9

1Q1

92

Q1 9

3Q1

94

Q1 9

5Q1

96

Q1 9

7Q1

98

Q1 9

9Q1

00

Q1 0

1Q1

02

Q1 0

3Q1

04

Q1 0

5Q1

06

Q1 0

7Q1

08

Q1 0

9Q1

10

Q1 1

1Q1

12

S&P 500 earnings gap

Source: BloombergAverageRolling 12-month standard deviation S&P 500 earnings gapS&P 500 real earnings yield – 10-year US treasury yield

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Feb

96Au

g 96

Feb

97Au

g 97

Feb

98Au

g 98

Feb

99Au

g 99

Feb

00Au

g 00

Feb

01Au

g 01

Feb

02Au

g 02

Feb

03Au

g 03

Feb

04Au

g 04

Feb

05Au

g 05

Feb

06Au

g 06

Feb

07Au

g 07

Feb

08Au

g 08

Feb

09Au

g 09

Feb

10Au

g 10

Feb

11Au

g 11

Feb

12

49


Market valuations - US: Bond valuations

US real yield (10-year – CPI)

Source: Bloomberg10-year US treasury yield less US CPI YoY

-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%5.0%6.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

US investment grade corporate bond yield spread

Source: BloombergUS investment grade corporate bond yield spread

0

100

200

300

400

500

600

700

Jun

80Ju

n 81

Jun

82Ju

n 83

Jun

84Ju

n 85

Jun

86Ju

n 87

Jun

88Ju

n 89

Jun

90Ju

n 91

Jun

92Ju

n 93

Jun

94Ju

n 95

Jun

96Ju

n 97

Jun

98Ju

n 99

Jun

00Ju

n 01

Jun

02Ju

n 03

Jun

04Ju

n 05

Jun

06Ju

n 07

Jun

08Ju

n 09

Jun

10Ju

n 11

Jun

12

Basis

Poin

ts

US High Yield Corporate Bond Spread

Source: BloombergUS High Yield Corporate Bond Spread

0

500

1000

1500

2000

2500

Jul 8

7Ju

n 88

May

89

Apr 9

0M

ar 9

1Fe

b 92

Jan

93De

c 93

Nov 9

4Oc

t 95

Sep

96Au

g 97

Jul 9

8Ju

n 99

May

00

Apr 0

1M

ar 0

2Fe

b 03

Jan

04De

c 04

Nov 0

5Oc

t 06

Sep

07Au

g 08

Jul 0

9Ju

n 10

May

11

Apr 1

2

Basis

Poi

nts

50


US inflation expectations

Source: Bloomberg10-year US treasury yield less 10-year US inflation linked bond yield

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Sep

97

Aug

98

Jul 9

9

Jun

00

May

01

Apr 0

2

Mar

03

Feb

04

Jan

05

Dec 0

5

Nov 0

6

Oct 0

7

Sep

08

Aug

09

Jul 1

0

Jun

11

May

12


51


Market valuations - Europe: Equity valuations

CAC 40 P/B ratio

Source: DatastreamAverageRolling 12-months standard deviationPrice to book ratio

0.50.81.01.31.51.82.02.32.5

Jan

04Ap

r 04

Jul 0

4Oc

t 04

Jan

05Ap

r 05

Jul 0

5Oc

t 05

Jan

06Ap

r 06

Jul 0

6Oc

t 06

Jan

07Ap

r 07

Jul 0

7Oc

t 07

Jan

08Ap

r 08

Jul 0

8Oc

t 08

Jan

09Ap

r 09

Jul 0

9Oc

t 09

Jan

10Ap

r 10

Jul 1

0Oc

t 10

Jan

11Ap

r 11

Jul 1

1Oc

t 11

Jan

12Ap

r 12

DAX P/B ratio


0.5

1.0

1.5

2.0

2.5

3.0

Apr 0

2

Oct 0

2

Apr 0

3

Oct 0

3

Apr 0

4

Oct 0

4

Apr 0

5

Oct 0

5

Apr 0

6

Oct 0

6

Apr 0

7

Oct 0

7

Apr 0

8

Oct 0

8

Apr 0

9

Oct 0

9

Apr 1

0

Oct 1

0

Apr 1

1

Oct 1

1

Apr 1

2

FTSE 100 P/B ratio


1.0

2.0

3.0

4.0

5.0

6.0

Aug

97Fe

b 98

Aug

98Fe

b 99

Aug

99Fe

b 00

Aug

00Fe

b 01

Aug

01Fe

b 02

Aug

02Fe

b 03

Aug

03Fe

b 04

Aug

04Fe

b 05

Aug

05Fe

b 06

Aug

06Fe

b 07

Aug

07Fe

b 08

Aug

08Fe

b 09

Aug

09Fe

b 10

Aug

10Fe

b 11

Aug

11Fe

b 12

52


CAC 40 P/E ratio


5.0

10.0

15.0

20.0

25.0

30.0

Jan

96Au

g 96

Mar

97

Oct 9

7M

ay 9

8De

c 98

Jul 9

9Fe

b 00

Sep

00Ap

r 01

Nov 0

1Ju

n 02

Jan

03Au

g 03

Mar

04

Oct 0

4M

ay 0

5De

c 05

Jul 0

6Fe

b 07

Sep

07Ap

r 08

Nov 0

8Ju

n 09

Jan

10Au

g 10

Mar

11

Oct 1

1M

ay 1

2

DAX P/E ratio


5.0

10.0

15.0

20.0

25.0

30.0

Jan

96Ju

l 96

Jan

97Ju

l 97

Jan

98Ju

l 98

Jan

99Ju

l 99

Jan

00Ju

l 00

Jan

01Ju

l 01

Jan

02Ju

l 02

Jan

03Ju

l 03

Jan

04Ju

l 04

Jan

05Ju

l 05

Jan

06Ju

l 06

Jan

07Ju

l 07

Jan

08Ju

l 08

Jan

09Ju

l 09

Jan

10Ju

l 10

Jan

11Ju

l 11

Jan

12

FTSE P/E ratio


0.05.0

10.015.020.025.030.035.0

Jan

96Au

g 96

Mar

97

Oct 9

7M

ay 9

8De

c 98

Jul 9

9Fe

b 00

Sep

00Ap

r 01

Nov 0

1Ju

n 02

Jan

03Au

g 03

Mar

04

Oct 0

4M

ay 0

5De

c 05

Jul 0

6Fe

b 07

Sep

07Ap

r 08

Nov 0

8Ju

n 09

Jan

10Au

g 10

Mar

11

Oct 1

1M

ay 1

2


53


CAC real earnings yield

Source: BloombergAverage CAC real earnings yieldCAC earnings yield - French inflation YoY

0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%16.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

DAX real earnings yield

Source: BloombergAverageDAX earnings yield - German inflation YoY

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Jun

96De

c 96

Jun

97De

c 97

Jun

98De

c 98

Jun

99De

c 99

Jun

00De

c 00

Jun

01De

c 01

Jun

02De

c 02

Jun

03De

c 03

Jun

04De

c 04

Jun

05De

c 05

Jun

06De

c 06

Jun

07De

c 07

Jun

08De

c 08

Jun

09De

c 09

Jun

10De

c 10

Jun

11De

c 11

Jun

12

FTSE real earnings yield

Source: BloombergAverage (since inception - 25 January 1980)FTSE earnings yield - UK inflation YoY

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

54


DAX earnings gap

Source: BloombergAverageRolling 12-month standard deviation DAX earnings gapDAX real earnings yield – 10-year German government bond yield

-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%

Feb

96Au

g 96

Feb

97Au

g 97

Feb

98Au

g 98

Feb

99Au

g 99

Feb

00Au

g 00

Feb

01Au

g 01

Feb

02Au

g 02

Feb

03Au

g 03

Feb

04Au

g 04

Feb

05Au

g 05

Feb

06Au

g 06

Feb

07Au

g 07

Feb

08Au

g 08

Feb

09Au

g 09

Feb

10Au

g 10

Feb

11Au

g 11

Feb

12

FTSE earnings gap

Source: BloombergAverageRolling 12-month standard deviation FTSE earnings gapFTSE real earnings yield – 10-year gilt yield

0.0%2.0%4.0%6.0%8.0%

-4.0%-2.0%

10.0%12.0%

Jun

96De

c 96

Jun

97De

c 97

Jun

98De

c 98

Jun

99De

c 99

Jun

00De

c 00

Jun

01De

c 01

Jun

02De

c 02

Jun

03De

c 03

Jun

04De

c 04

Jun

05De

c 05

Jun

06De

c 06

Jun

07De

c 07

Jun

08De

c 08

Jun

09De

c 09

Jun

10De

c 10

Jun

11De

c 11

Jun

12


CAC 40 earnings gap

Source: BloombergAverageRolling 12-month standard deviation CAC earnings gapCAC real earnings yield – 10-year French government bond yield

-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

Feb

96Au

g 96

Feb

97Au

g 97

Feb

98Au

g 98

Feb

99Au

g 99

Feb

00Au

g 00

Feb

01Au

g 01

Feb

02Au

g 02

Feb

03Au

g 03

Feb

04Au

g 04

Feb

05Au

g 05

Feb

06Au

g 06

Feb

07Au

g 07

Feb

08Au

g 08

Feb

09Au

g 09

Feb

10Au

g 10

Feb

11Au

g 11

Feb

12

55


CAC earnings expectations

Source: DatastreamCAC IBES equity earnings expectations

-50.0%-30.0%-10.0%10.0%30.0%50.0%70.0%90.0%

Q2 8

8

Q2 8

9

Q2 9

0

Q2 9

1

Q2 9

2

Q2 9

3

Q2 9

4

Q2 9

5

Q2 9

6

Q2 9

7

Q2 9

8

Q2 9

9

Q2 0

0

Q2 0

1

Q2 0

2

Q2 0

3

Q2 0

4

Q2 0

5

Q2 0

6

Q2 0

7

Q2 0

8

Q2 0

9

Q2 1

0

Q2 1

1

Q2 1

2

DAX earnings expectations

Source: DatastreamDAX IBES equity earnings expectations

-50.0%

-30.0%

-10.0%

10.0%

30.0%

50.0%

70.0%

90.0%

Q2 8

8

Q2 8

9

Q2 9

0

Q2 9

1

Q2 9

2

Q2 9

3

Q2 9

4

Q2 9

5

Q2 9

6

Q2 9

7

Q2 9

8

Q2 9

9

Q2 0

0

Q2 0

1

Q2 0

2

Q2 0

3

Q2 0

4

Q2 0

5

Q2 0

6

Q2 0

7

Q2 0

8

Q2 0

9

Q2 1

0

Q2 1

1

Q2 1

2

FTSE earnings expectations

Source: BloombergFTSE IBES equity earnings expectations

-30.0%-20.0%-10.0%

0.0%10.0%20.0%30.0%40.0%50.0%

Q4 8

7

Q4 8

8

Q4 8

9

Q4 9

0

Q4 9

1

Q4 9

2

Q4 9

3

Q4 9

4

Q4 9

5

Q4 9

6

Q4 9

7

Q4 9

8

Q4 9

9

Q4 0

0

Q4 0

1

Q4 0

2

Q4 0

3

Q4 0

4

Q4 0

5

Q4 0

6

Q4 0

7

Q4 0

8

Q4 0

9

Q4 1

0

Q4 1

1

56


Market valuations - Europe: Bond valuations

France real yield (10-year – CPI)

Source: Bloomberg10-year French government bond yield - French CPI YoY%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

Germany real yield (10-year – CPI)

Source: Datastream10-year German government bond yield - French CPI YoY%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

UK real yield (10-year – CPI)

Source: Bloomberg10 year gilt yield - UK CPI YoY%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

Jun

96De

c 96

Jun

97De

c 97

Jun

98De

c 98

Jun

99De

c 99

Jun

00De

c 00

Jun

01De

c 01

Jun

02De

c 02

Jun

03De

c 03

Jun

04De

c 04

Jun

05De

c 05

Jun

06De

c 06

Jun

07De

c 07

Jun

08De

c 08

Jun

09De

c 09

Jun

10De

c 10

Jun

11De

c 11


57


EU inflation expectations

Source: Datastream

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%

Mar

05

Aug

05

Jan

06

Jun

06

Nov 0

6

Apr 0

7

Sep

07

Feb

08

Jul 0

8

Dec 0

8

May

09

Oct 0

9

Mar

10

Aug

10

Jan

11

Jun

11

Nov 1

1

Apr 1

2

UK inflation expectations

Source: Bloomberg10-year UK gilt yield less 10-year UK inflation linked bond yield

0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%4.0%4.5%

Mar

05

Aug

05

Jan

06

Jun

06

Nov 0

6

Apr 0

7

Sep

07

Feb

08

Jul 0

8

Dec 0

8

May

09

Oct 0

9

Mar

10

Aug

10

Jan

11

Jun

11

Nov 1

1

Apr 1

2

EU Investment Grade Corporate Bond Yield Spread

Source: BloombergEU Investment Grade Corporate Bond Yield Spread

0

100

200

300

400

500

Jan

99

Sep

99

May

00

Jan

01

Sep

01

May

02

Jan

03

Sep

03

May

04

Jan

05

Sep

05

May

06

Jan

07

Sep

07

May

08

Jan

09

Sep

09

May

10

Jan

11

Sep

11

May

12

Basis

Poi

nts

58


EU High Yield Corporate Bond Spread

Source: BloombergEU High Yield Corporate Bond Spread

0200400600800

100012001400160018002000

Jul 9

9No

v 99

Mar

00

Jul 0

0No

v 00

Mar

01

Jul 0

1No

v 01

Mar

02

Jul 0

2No

v 02

Mar

03

Jul 0

3No

v 03

Mar

04

Jul 0

4No

v 04

Mar

05

Jul 0

5No

v 05

Mar

06

Jul 0

6No

v 06

Mar

07

Jul 0

7No

v 07

Mar

08

Jul 0

8No

v 08

Mar

09

Jul 0

9No

v 09

Mar

10

Jul 1

0No

v 10

Mar

11

Jul 1

1No

v 11

Mar

12

Basis

Poi

nts

UK Investment Grade Corporate Bond Yield Spread

Source: BloombergBarclays GBP corporate bond average spread vs. UK gilts

0

100

200

300

400

500

600

Jun

98

Jun

99

Jun

00

Jun

01

Jun

02

Jun

03

Jun

04

Jun

05

Jun

06

Jun

07

Jun

08

Jun

09

Jun

10

Jun

11

Jun

12

Basis

Poi

nts

59


Market valuations - Asia-Pacific: Equity valuations

Hang Seng P/B ratio

Source: BloombergAverageRolling 12-month standard deviationPrice to book ratio

1.0

1.5

2.0

2.5

3.0

3.5

Aug

97Fe

b 98

Aug

98Fe

b 99

Aug

99Fe

b 00

Aug

00Fe

b 01

Aug

01Fe

b 02

Aug

02Fe

b 03

Aug

03Fe

b 04

Aug

04Fe

b 05

Aug

05Fe

b 06

Aug

06Fe

b 07

Aug

07Fe

b 08

Aug

08Fe

b 09

Aug

09Fe

b 10

Aug

10Fe

b 11

Aug

11Fe

b 12

Nikkei P/B ratio


0.5

1.0

1.5

2.0

2.5

Nov 0

2Fe

b 03

May

03

Aug

03No

v 03

Feb

04M

ay 0

4Au

g 04

Nov 0

4Fe

b 05

May

05

Aug

05No

v 05

Feb

06M

ay 0

6Au

g 06

Nov 0

6Fe

b 07

May

07

Aug

07No

v 07

Feb

08M

ay 0

8Au

g 08

Nov 0

8Fe

b 09

May

09

Aug

09No

v 09

Feb

10M

ay 1

0Au

g 10

Nov 1

0Fe

b 11

May

11

Aug

11No

v 11

Feb

12M

ay 1

2

Hang Seng P/E ratio

Source: DatastreamAverageRolling 12-month standard deviationPrice to earnings ratio

5.0

10.0

15.0

20.0

25.0

30.0

Jan

96Au

g 96

Mar

97

Oct 9

7M

ay 9

8De

c 98

Jul 9

9Fe

b 00

Sep

00Ap

r 01

Nov 0

1Ju

n 02

Jan

03Au

g 03

Mar

04

Oct 0

4M

ay 0

5De

c 05

Jul 0

6Fe

b 07

Sep

07Ap

r 08

Nov 0

8Ju

n 09

Jan

10Au

g 10

Mar

11

Oct 1

1M

ay 1

2

60


Topix P/E ratio

Source: DatastreamAverageRolling 12-month standard deviationPrice to earnings ratio

0.05.0

10.015.020.025.030.035.040.045.0

Feb

05

Aug

05

Feb

06

Aug

06

Feb

07

Aug

07

Feb

08

Aug

08

Feb

09

Aug

09

Feb

10

Aug

10

Feb

11

Aug

11

Feb

12

TOPIX real earnings yield

Source: BloombergAverageTOPIX earnings yield - Japanese inflation YoY

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

Jun

01Se

p 01

Dec 0

1M

ar 0

2Ju

n 02

Sep

02De

c 02

Mar

03

Jun

03Se

p 03

Dec 0

3M

ar 0

4Ju

n 04

Sep

04De

c 04

Mar

05

Jun

05Se

p 05

Dec 0

5M

ar 0

6Ju

n 06

Sep

06De

c 06

Mar

07

Jun

07Se

p 07

Dec 0

7M

ar 0

8Ju

n 08

Sep

08De

c 08

Mar

09

Jun

09Se

p 09

Dec 0

9M

ar 1

0Ju

n 10

Sep

10De

c 10

Mar

11

Jun

11Se

p 11

Dec 1

1M

ar 1

2Ju

n 12

Hang Seng real earnings yield

Source: BloombergAverageHang Seng earnings yield - Hong Kong inflation YoY

-6.0%-3.0%0.0%3.0%6.0%9.0%

12.0%15.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

61


Hang Seng earnings gap

Source: DatastreamAverageRolling 12-month standard deviation Hang Seng earnings gapHang Seng real earnings yield – 10-year US treasury yield

0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%

May

03

Nov 0

3

May

04

Nov 0

4

May

05

Nov 0

5

May

06

Nov 0

6

May

07

Nov 0

7

May

08

Nov 0

8

May

09

Nov 0

9

May

10

Nov 1

0

May

11

Nov 1

1

May

12

TOPIX earnings gap

Source: BloombergAverageRolling 12-month standard deviationTOPIX earnings gap (real earnings yield less real bond yield)

0.0%

2.0%

4.0%

6.0%

8.0%

May

03

Nov 0

3

May

04

Nov 0

4

May

05

Nov 0

5

May

06

Nov 0

6

May

07

Nov 0

7

May

08

Nov 0

8

May

09

Nov 0

9

May

10

Nov 1

0

May

11

Nov 1

1

May

12

TOPIX earnings expectations

Source: DatastreamTOPIX IBES equity earnings expectations

-500%

0%

500%

1000%

1500%

2000%

2500%

Q2 8

8

Q2 8

9

Q2 9

0

Q2 9

1

Q2 9

2

Q2 9

3

Q2 9

4

Q2 9

5

Q2 9

6

Q2 9

7

Q2 9

8

Q2 9

9

Q2 0

0

Q2 0

1

Q2 0

2

Q2 0

3

Q2 0

4

Q2 0

5

Q2 0

6

Q2 0

7

Q2 0

8

Q2 0

9

Q2 1

0

Q2 1

1

Q212

62


Market valuations - Asia-Pacific: Bond valuations

Japan real yield (10-year – CPI)

Source: Bloomberg10-year Japanese government bond yield - Japanese inflation YoY

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Mar

94

Sep

94M

ar 9

5Se

p 95

Mar

96

Sep

96M

ar 9

7Se

p 97

Mar

98

Sep

98M

ar 9

9Se

p 99

Mar

00

Sep

00M

ar 0

1Se

p 01

Mar

02

Sep

02M

ar 0

3Se

p 03

Mar

04

Sep

04M

ar 0

5Se

p 05

Mar

06

Sep

06M

ar 0

7Se

p 07

Mar

08

Sep

08M

ar 0

9Se

p 09

Mar

10

Sep

10M

ar 1

1Se

p 11

Mar

12

Hong Kong Real Yield (7-Year – CPI)

Source: BloombergHong Kong Real Yield (7-Year – CPI)

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

May

96

Nov 9

6M

ay 9

7No

v 97

May

98

Nov 9

8M

ay 9

9No

v 99

May

00

Nov 0

0M

ay 0

1No

v 01

May

02

Nov 0

2M

ay 0

3No

v 03

May

04

Nov 0

4M

ay 0

5No

v 05

May

06

Nov 0

6M

ay 0

7No

v 07

May

08

Nov 0

8M

ay 0

9No

v 09

May

10

Nov 1

0M

ay 1

1No

v 11

May

12

63


Biog

raph

ies11. Global Policy Council

Andreas E F UtermannGlobal Chief Investment Officer, Equities, Allianz Global Investors

Andreas Utermann joined the company in October 2002 as Global CIO and is a board member of Allianz Global Investors. Prior to joining, Andreas worked for 12 years at Merrill Lynch Investment Managers (formerly Mercury Asset Management), where he wastheGlobalHeadandCIO,Equities.BeforejoiningMLIM,AndreasworkedfortwoyearsatDeutscheBankAG.HeholdsaBScinEconomicsfromtheLondonSchoolofEconomics and an MA in Economics from Katholieke Universiteit Leuven. Andreas is an Associate of the Institute of Investment Management and Research and is fluent in English, German, French and Dutch.

Raymond Chan, CFAChief Investment Officer, Asia-Pacific

Raymond is responsible for all investment professionals in Asia ex-Japan, reporting to theGlobalCIOinLondon,andistheChairmanoftheHongKongBalancedInvestmentCommittee in Hong Kong. Raymond has overall responsibility for the investment process and performance and is a full member of the Global Equity Team. He has over eighteen years of portfolio management experience in the region and is the lead manager for Core Regional (Asia-Pacific ex-Japan equity) and Korean equity products. PriortojoiningtheGroup,RaymondwasanAssociateDirectorwithBarclaysGlobalInvestors in Hong Kong and Head of their Greater China team, where he specialised in Hong Kong, China and Taiwan stockmarkets and managed single country and regional portfolios.Raymond’sHongKongFundatBarclayswasrankedno.1offshorefundin1997. He is a CFA charterholder and holds an M.A. in Finance and Investment from the UniversityofExeterandaB.A.(Hons)inEconomicsfromtheUniversityofDurham,UK.

The Global Policy Council (GPC) is a monthly meeting of the regional CIOs, Economics and Strategy team and senior investment professionals chaired by our Global CIO, Andreas Utermann. The council focuses on the direction of the global economy, regional economic outlooks, prospects for the global bond and equity markets, and periodic thematic pieces of proprietary research. Each month the GPC produces a forecast for regional equity, bond, currency markets on tactical and strategic horizons. The tactical horizon is expected to be roughly three months, while the strategic focus is expected to be longer than one year. The allocations suggested are not reflective of any single product or recommendation and may differ from other existing products. The members share seven votes between them, which determines the ‘virtual’ portfolios.


64

Neil DwaneChief Investment Officer Equities Europe, Frankfurt

Neil is Chief Investment Officer Europe, based in Frankfurt, and is responsible for all portfolio management, research and trading activities in Frankfurt and London. Neil is a member of the Global RCM Executive Committee and is Chairperson of the European Equity Management Group, which consists of the most senior investment team leaders in Europe. Neil joined the company in 2001 as Head of UK and European Equity Management from JP Morgan Investment Management where he had been a UK and European specialist portfolio manager since 1996. Hebeganhisinvestmentcareerin1988withKleinwortBensonInvestmentManagementasananalyst,laterasafundmanagerbeforemovingtoFlemingInvestmentManagementin1992.NeilholdsaBAinClassicsfromDurham University and is a member of the Institute of Chartered Accountants.

Scott T. Migliori, CFAChief Investment Officer, San Francisco

Scott joined in 2003 as a Senior Portfolio Manager on the US Large Cap Equity Portfolio Management Team. He is currently the CIO of the firm’s US Large Cap Select Growth and Focused Growth strategies. In 2010, Scott was promoted to CIO of RCM San Francisco, and continues to actively drive the investment process for the Large Cap Select Growth and Focused Growth products. Prior to joining the company, he was with Provident Investment Counsel, Inc. where he co-managed over $2 billion in large cap growth portfolios and had also served as a Portfolio Manager and Analyst on mid and small cap growth funds. Prior to his investment career, Scott served as a business litigationattorney.HereceivedhisBSinAccountingfromtheUniversityofSouthernCalifornia,hisJDfromtheBoaltHallSchoolofLawattheUniversityofCalifornia,Berkeley,andhisMBAfromtheAndersonSchoolattheUniversity of California, Los Angeles. Scott holds a CFA charter.

Stefan Hofrichter, CFAHead of Global Economics and Strategy Group, Frankfurt

As Head of the Global Economics and Strategy Group, Stefan’s research primarily covers global economics, as well as global and European multi-asset allocation, and equity country, sector and style allocation. Stefan joined the firmin1996asanequityportfoliomanager,movingtoaneconomistandstrategistrolein1998.Between2004and 2010, he additionally had responsibility for various retail and institutional mandates, including global and European classic balanced funds, global multi-asset absolute return and multi-manager alpha-porting funds. Stefan became a member of the Global Policy Council in 2004, and in January 2010 was appointed chair of the European Asset Allocation Committee. He holds a degree in economics from the University of Konstanz (1995) andinbusinessadministrationfromtheUniversityofAppliedSciencesoftheDeutscheBundesbank,Hachenburg(1991). Stefan became a CFA Charterholder in 2000.

Ingo MainertCo-CIO Multi Asset Europe

IngojoinedfromcominvestinFebruary2009,followingCommerzbank’spurchaseofDresdnerBank.IngoisaManaging Director and Co-CIO Multi Asset Europe. Ingo takes this role having headed Asset Management of cominvest since June 2006. Ingo started his professional career with Commerzbank in 1988 and first held analyst and currency specialist functions following his traineeship, before taking management responsibility in Commerzbank as Team Head Equity Strategy Germany in 1994 and Head of Fixed Income Research in 1998 before moving to the Asset Management side of the business as Head of Global Markets Research Division in 2001 at CommerzAssetManagers.Since2002heheldapositionasHeadofBalancedPortfolioManagementDivisionatcominvest,wasthennamedHeadofAssetManagementPrivateBankingatCommerzbankinAugust2004andwas finally appointed Managing Director and CIO of Cominvest. Ingo is a Certified Investment Analyst and a board member of the DVFA Society of Investment Professionals in Germany; he graduated from the Johann Wolfgang Goethe-UniversitywithaDiplomainBusinessAdministration.

65


Franck DixmierCIO Fixed Income Europe

Franck Dixmier holds a Master’s degree in General Management with a specialisation in Finance and a Master in EconomicsfromParisDauphineBusinessSchool.HejoinedAllianzGIFrancein1995asHeadofFixedIncome.Since 2008 he has been working as CIO of AllianzGI France and in 2011 was named CIO of Fixed Income for AllianzGI Europe. He was also nominated in 2011 as CEO of AllianzGI France. Franck has 21 years of experience in the finance industry.

Eugen LoefflerChief Investment Officer, AllianzGI Asia-Pacific

Dr. Eugen Loeffler is Chief Investment Officer Fixed Income Asia Pacific for Allianz Global Investors and is based in Korea. Dr. Loeffler has been with the Allianz group for 20 years, having worked in various roles within the group. Hismainfocushasbeenoncapitalmarketresearchandinvestmentmanagement.BeforerelocatingtoAsiainearly 2010, Dr. Loeffler was Chief Investment Officer of Allianz Suisse in Zurich, responsible for the investments of AllianzLifeandNon-LifeinsurancecompaniesinSwitzerland.Dr.LoefflerhasadoctoraldegreeinBusinessadministrationandstudiedBusinessadministrationaswellasGermanliteratureandHistoryatJohannWolfgangGoethe University in Frankfurt.

Klaus TeloekenChief Investment Officer Systematic Equity, Frankfurt

Dr. Klaus Teloeken is the Co-CIO of the Systematic Equity team. He joined Allianz Global Investors in 1996 as a quantitative analyst, and in 2001 he assumed the role as Head of Systematic Equity. He oversees more than EUR 9 billion of assets under management, and is responsible for the development and the management of systematic investmentstrategiesforequities.Inthisrole,Klaushasdevelopedtheteam’sBestStylesandHighDividendproductline.HeisalsoresponsibleforthemanagementoftheBestStylesGlobalandHighDividendGlobalproduct. Klaus studied mathematics and computer science in Dortmund, Germany.

Contributors – non GPC members

BozenaJankowskaDirector, Global Head of Sustainability, London

BozenaistheGlobalHeadofSustainabilityResearch.SheisbasedinLondonandisresponsibleforrunningsustainability research which involves on-going evolution of the sustainable research and investment philosophy, strategyandprocessatagloballevel,aswellasclientrelationshipmanagement.Bozenaisalsoresponsibleforspearheading Allianz Global Investors’ work as a thought leader in Sustainability Research within the industry and responsible for the establishment and management of partnerships within other entities of Allianz as well as externalresearchproviderssuchasuniversitiesandthink-tanks.From2006to2010,Bozenawasalsoresponsiblefor the design, launch and management of the Global Ecotrends Fund, a clean technology themed fund strategy whichevolvedintoasuccessfulglobalfranchiserepresentingoverabillionEuroinassets.Beforejoiningthefirmin2000,Bozenaworkedfortheconstructionfirm,JohnLaingPlcastheirBusinessandEnvironmentAdviserdeveloping and implementing corporate sustainability policy and strategy. She graduated from the University of SussexwithaBSc(Hons)inEnvironmentalScienceandgainedanMScinEnvironmentalTechnologywithDistinction,fromImperialCollegeofScience,TechnologyandMedicine,specialisinginBusinessandEnvironment.BozenaobtainedherInvestmentManagementCertificateinJuly2001.

66


Dr. Herold RohwederGlobal CIO Multi Asset, Frankfurt

Herold Rohweder is a managing director and the Global Chief Investment Officer of RCM Multi Asset at RCM/Allianz Global Investors. He is a member of the RCM Executive Committee and the Global RCM Equity Management Group. He began his career as an equity and multi-asset portfolio manager at Allianz in 1989, and initiated the Quantitative Asset Management effort at Allianz Asset Management in 1998. RCM Multi Asset covers multi-asset & absolute return products. Herold Rohweder graduated from Wayne State University with a MA in Economics and received a PhD in Economics from the University of Kiel.

Robert Parenteau, CFA

Economist, External Advisor, San Francisco

As the sole proprietor of MacroStrategy Edge, Rob employs macroeconomic insights to contribute to asset allocationandequitysectorselection.RobreceivedhisBA(Hons.)inpoliticaleconomyfromWilliamsCollegeinJanuary 1983 and earned his CFA in 1989. Rob also serves as a research associate of the Levy Institute.commercial enterprises.

Lucy Macdonald, ASIP

CIO Global Equities, London

Lucy joined RCM in October 2001. She heads the Global Equity Fund Management team, which is responsible for global mandates from clients around the world with currently over $6bn of assets under management. She was instrumental in launching the Global High Alpha product in 2003, now representing over $5bn of global equity assets, which she also manages. Retail funds following this strategy include the Allianz RCM Interglobal retail fund (S&P AA rated since December 2007) and the Allianz RCM Global Equity Fund (also S&P AA rated). Lucy is a member of the RCM Global Policy Council, which is responsible for setting company-wide macro-economic and strategicpolicy.PriortoRCM,Lucyspent16years,latterlyasaDirectorandSeniorPortfolioManager,atBaringAssetManagementmanagingHighAlphafunds.LucygraduatedfromBristolUniversityin1984,andisanAssociate of the Society of Investment Professionals (ASIP). She was made a Managing Director of RCM in December 2007 and sits on the London Executive Committee.

Christopher WheatonSenior Research Analyst, European Energy, London

Christopher is a member of the European research team covering UK and continental European oil services and refining companies, and managing the Allianz RCM Energiefond. He joined the firm as a media analyst in 2005 from Morley Fund Management, where he spent four years covering the media, transport and leisure sectors, and from 2003-2005 the Oil & Gas sector, during which time he was voted one of Institutional Investor magazine’s “BestoftheBuyside”.Priortothis,heworkedforfiveyearsatFidelityInvestmentsasbothamemberoftheirfinancials team and as their European transport analyst. Chris graduated with a Master’s (Hons) in Chemical Engineering from Magdalene College, Cambridge in 1996.

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Investments involve risk. The value of an investment and the income from it may fall as well as rise and investors may not get back the principal invested. Past performance, or any prediction, projection or forecast, is not indicative of future performance. No offer or solicitation to buy or sell securities, nor investment advice/strategy or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. Forecasts are inherently limited and should not be relied upon as an indicator of future results. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer and/or its affiliated companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or willful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This is a marketing communication. This material has not been reviewed by any regulatory authorities, and is published for information only, and where used in mainland China, only as supporting materials to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This presentation is being distributed by the following investment advisory firms: RCM Capital Management LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Europe GmbH, a licensed provider of financial services (Finanzdienstleistungsinstitut) in Germany, subject to the supervisionoftheGermanBundesanstaltfürFinanzdienstleistungsaufsicht(BaFin)andaninvestmentadviserregistered with the U.S. Securities and Exchange Commission; RCM (UK) Ltd., which is authorized and regulated by the Financial Services Authority in the UK; Allianz Global Investors Hong Kong Ltd. and RCM Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; RCM Capital Management Pty Limited, licensed by the Australian Securities and Investments Commission; and RCM Japan Co., Ltd., registered in Japan as a Financial Instruments Dealer.

Copyright © 2012 Allianz Global Investors

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