Investment Insights EMEA

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Investment Insights EMEA

  1. 1. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 1 Investment Insights Outlook 2012
  2. 2. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 2 Table of contents Introduction from the CIO 3 Regional perspective 4 Our House View: Economic and policy themes for 2012 5 Macroeconomic outlook 10 Portfolio management in 2012 17 Ten Investment topics for 2012 20 Forecasts and current data summarized 22 Asset Allocation 25 Key contacts: our Global Strategy Team 26 Our Global Investment Committee (GIC), Private Wealth Management Kevin Lecocq (Chair) Larry V. Adam Björn Jesch Anurag Mahesh Global Chief Investment Chief Investment Strategist, Head of Discretionary Head of Global Investment Officer US Portfolio Management, and Key Client Solutions, Germany Asia Pacific Arnaud de Servigny Yves Cochez (Deputy) Senior Portfolio Manager, Elke Speidel-Walz Christian Nolting Global Head of Discretionary Latin America Chief Investment Strategist, Head of Discretionary Portfolio Management and Germany Portfolio Management and Strategy Owen Fitzpatrick Strategy, Head of Global Equity Stéphane Junod Asia Pacific Practice, Head of Discretionary US Portfolio Management, EMEA Ben Pace Chief Investment Officer, Martyn Surguy Americas Head of Discretionary Portfolio Management, UK Art builds. Art questions. Art transcends borders. Art works. Deutsche Bank has been opening up the world of contemporary art to the public through its own substantial collection, its exhibitions, and its joint projects with partners. Around the world. For thirty years. More information can be found in the online art magazine at www.db-artmag.com. Drawing a Curtain by Ken Kiff at Deutsche Bank, London © The Estate of the Artist Photo: Jacqueline Duschkin
  3. 3. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 3 Kevin L. Lecocq Introduction from the CIO Dear reader, The world is now changing fundamentally, after a 30-year period following market deregulation in the early 1980s. Developed economies’ governments must now face up to unsustainable fiscal positions. Economic governance will have to change as result. Social welfare systems developed since World War II are no longer workable, and this is likely to add to political and social stresses. In this environment, any policy consensus is likely to be less assured. This is already being demonstrated by the debate over the desirable role for central banks. There will be major implications for investment management. Under conditions of continued uncertainty and volatility, it will be necessary to take a dynamic approach to portfolio rebalancing, and to use financial instruments and other shock absorbers to reduce risk. But remember that – assuming some resolution to the Eurozone crisis – global economic growth is still likely to be greater than 3 percent, and this will create investment opportunities. Equity in well- governed, flexible companies plugged into this global growth is trading at attractive valuations. More tactical opportunities will exist as a result of policy changes. 2012 could still prove an interesting year for investors. Best wishes for 2012. Sincerely, Kevin L. Lecocq, Global Chief Investment Officer Investment Insights December 2011 Page 3
  4. 4. RZ_Investment Insights_12_REGIO_Investment Insights_REGIO 07.12.11 18:31 Seite 2 Stéphane Junod Perspective from EMEA Stock markets around the world continue to be buffeted by are already moving towards more European fiscal integration the Eurozone crisis and concerns about global growth. The US and an enhanced role for the European Central Bank. Financial economy is expanding at below its historic potential growth markets need a credible guarantor for euro-denominated rate, although corporate profits have done much better than sovereign debt. expected. Over the world, the impact of the Eurozone crisis is being The Eurozone crisis has reached a stage where major policy felt particularly acutely by China and the rest of Asia. The catalysts are needed to rejuvenate optimism, reduce the risk reason is that Asia is heavily tied to manufacturing and trade, premium and boost economic growth. Policy makers here and as such, the fallout in European demand is filtering have had to deal with a very toxic brew of a banking system through to these economies quickly. Lower inflation in 2012 crisis and a sovereign debt crisis. The size of the problem should, however, give Asian monetary authorities scope is such that it will no longer be possible to solve the banking to boost demand through monetary policy easing, and we crisis without exacerbating the sovereign debt crisis. We expect a only a small slowdown in growth in these economies. As we approach the end of another challenging year in financial markets, we want to re-iterate our conviction that a flexible and dynamic asset allocation approach, combined with strong risk management, is key when managing your investment portfolio. We have, once again, experimented extreme market volatility over the last few months, and I hope that you have found the analysis in this monthly publication useful in this context. Stéphane Junod, Head of Portfolio Management EMEA Page 4 Investment Insights December 2011
  5. 5. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 5 Untitled A / 7, Untitled A / 15, Untitled A / 8. All by Ken Kiff at Deutsche Bank, London © The Estate of the Artist Photo: Jacqueline Duschkin Our House View Economic and policy themes for 2012: facing up to change Arnaud de Servigny
  6. 6. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 6 Arnaud de Servigny / Our House View Investors will remember 2011 as the year of sovereign debt 1. The year when the bills come due crises, just as other previous years stay linked in the collective Unfortunately it is already clear that 2012 will be the year memory with credit crunches, stock market rallies and so on. when the bills come due for most developed economies. But, in reality, events do not arrange themselves so neatly to Paying them will be painful. suit calendar years, and we go into 2012 with many questions still unanswered. Most obviously, will the Eurozone survive The “bills” were presented in 2011, as the size of the problem in its current format? Will the sovereign debt crisis get worse posed by fiscal and debt imbalances became evident. This in 2012? Will it mutate into a rather different form? Will this problem had been brewing for three years: after the 2008 credit inevitably further sharply reduce the performance of risky shock, governments compensated for anaemic levels of assets? And in this environment of extreme uncertainty, is the economic activity by expanding public spending, through tax concept of a “risk free” asset still meaningful? Presumed safe reliefs to individuals, enhanced support to the unemployed havens as AAA-rated debt, gold, cash, and real estate (in some or through ad hoc public capital spending. Increased spending regions) are now looking increasingly uncertain. combined with subdued levels of tax collection resulted in rapidly increasing public deficits, which in turn translated into Making an accurate prognosis based on tactical judgments higher debt levels. It was soon evident to some observers is impossible in such a quickly evolving context. But there is that public debt might quickly reach unsupportable levels. some value in stepping back, looking at the world we live in, In response, the much disparaged rating agencies downgraded and identifying some key ongoing themes that will make the several large developed economies. And, since June 2011, situation look different in 2012 and influence asset prices. financial markets have become increasingly selective on European sovereign debt, to the point where many of these The four themes below all demand substantial policy progress markets have, at times, almost frozen up. In a vicious spiral, in 2012, if the situation is not to deteriorate further. So, while the unfortunate interplay between rising fiscal deficits and sky- 2011 was a year of challenges, 2012 will be a year of rocketing spreads, threatens to make debt servicing costs unavoidable and major change – creating risks, but also almost unbearable. opportunities. There is now a consensus amongst both markets and policy makers that the developed economies cannot keep going in this fashion. Debt pressures mean that governments are running out of ammunition to support their economies via fiscal incentives. Moreover, the citizens and corporations of these economies – who have so far largely benefited from government support – are now affected too, and are being asked to contribute more through higher overall rates of taxation. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Page 6 Investment Insights December 2011
  7. 7. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 7 Scaling back current fiscal incentives is likely to have a big 2. Global economic governance in transition negative impact on growth. In the US, it could take close to 2 The second salient trend we have observed is a very strong percentage points off GDP growth in 2012 – which, despite contrast between the effectiveness of public and private this, is likely to exceed 2 percent – and possibly more in 2013 governance, with attention focused on some of the shortfalls (Figure 1). In Europe, with almost all countries implementing of public governance. In response, global economic more balanced and, one hopes, more sustainable fiscal policies, governance is in transition. the region seems certain to be in recession in the first half of 2012. Companies are not economies! Most corporates – especially larger ones – have steered their way through the current crisis effectively, adjusting their activities to suit the ebbing strengths of the domestic economies they operate in. They have been aided, of course, by high levels of unemployment exerting downwards pressure on wages. In contrast, public bodies in the US and in Europe have appeared to be performing quite poorly. In the US, the embarrassing How much changing fiscal policy will subtract from US growth outcome of the negotiations on the “debt ceiling” in mid-2011 in percentage points damaged perceptions of the effectiveness of US policy Under current law Under current policy makers; the failed negotiations of the “Super Committee” later in the year added to the scepticism. In Europe, enormous 0.0 confusion surrounds the decision making process at both a national and supranational European level, leaving the -0.5 damaging impression that policy makers are simply not up to -1.0 the task, and incentivising several countries to trust their fate to unelected “technocratic” administrations. It is hard to think -1.5 that this state of affairs can be sustained throughout 2012. -2.0 At present, it appears that the needed reform will require either a higher degree of political and fiscal integration around -2.5 the Euro or a partial dismemberment of the Eurozone. -3.0 -3.5 2011 2012 2013 Figure 1 Source: Deutsche Bank, Global Markets. As of November 29, 2011 Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Investment Insights December 2011 Page 7
  8. 8. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 8 Arnaud de Servigny / Our House View – continued In 2012, we need to get to the point where everybody 3. Rewriting the “social contract” understands what the Eurozone stands for, with each member Why is it proving so difficult to find solutions quickly, especially state having to make a choice to stay in it or not. Remaining given the shared sense of urgency, and the obviously awful a member will require a formal commitment to fiscal implications of failing to do so? Our thesis is that the convergence. Germany and France will have a historic role governments in developed economies are facing the challenge to play here, both in ensuring that the convergence process is of rewriting their “social contract”. Economies rely primarily totally transparent and also in supplying the determination on the dynamism of capital markets and labor forces to drive to carry the process through to its conclusion. In this delicate the engine of economic growth. But, as a residual, there situation, financial institutions who were at the center of the is, in effect, an implicit agreement between governments, 2008 crisis will continue to find themselves at risk. They carry, populations and corporations whereby taxation and in a sense, the collateral damage from previous European government spending are used in part to make provision for financial opacity, in the form of their detrimentally large holdings those who cannot work, for reasons of age, infirmity or of Eurozone sovereign debt. The risk is that, because they adverse labor market conditions. have to deleverage their balance sheet to cope with potential losses on this debt, they cannot therefore properly fulfil their As has long been understood, the process of economic role of funding a Eurozone economy through domestic lending. globalization results in a heightened level of competition, This critical situation means that a clarification of proposed with consumers benefiting greatly from abating market governance changes in Europe is needed very quickly, if we prices for goods and increasingly services set on a global are to bolster confidence in the financial institutions and avoid basis. But this process of competition also translates into some defaults (Figure 2). increased pressures on the financing of social systems, as the cost of them threatens both to make corporations uncompetitive and to weaken the productive economy overall. As we have noted above, governments’ financial resources are already stretched; increased taxation on corporations, likely to be already struggling with the consequences of bank deleveraging in 2012, risks making them uncompetitive – meaning that such a policy would Exposure of European banking systems to peripheral countries likely be counterproductive. in EUR bn Greece Italy Portugal Spain Ireland Belgium The conclusion is that, as with government finance more generally, the current situation cannot continue for much 250 longer, and that some major decisions will have to be taken in 2012. One central problem is that in most developed 200 economies, the existing expectations of citizens regarding the state provisions – whether explicitly labelled the “welfare 150 state”, as in Europe, or regarding Medicare, Medicaid and the individual elements of state provision in the US – were 100 established several decades ago, in a very different economic environment. Not only was global competition much less 50 intense, demographics were also skewed towards the young rather than the old, and healthcare provision did not entail 0 such high costs. It is no longer possible to pretend that France Germany Belgium Greece UK Nether- lands Other Spain Italy improvements in operating efficiency and spending control can, on their own, provide a remedy to the problems surrounding social provision. It is particularly difficult to Figure 2 Source: Deutsche Bank, Global Markets. As of November 29, 2011 curtail this social public spending to current realities at a Page 8 Investment Insights December 2011
  9. 9. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 9 time when the divide between the rich and the poor is very A more highly integrated environment is not a simpler one, large, having been increasing for at least a decade. Hence, however. In fact, its functioning appears more complex. Old we now need to rewrite the “social contract” between the economic rules may now look either less universal or less state and its citizens, something that will have major effective, as policy makers, central bankers and regulators are implications for corporates, too. The debate on the “social forced to sail into uncharted seas. The policy consensus is contract” is moving onto a deep and potentially disruptive as a result less solid. One illustration of this is the disputed level. In essence, what does fairness mean? In the US, many role of central banks as “market makers of last resort”, in of the existing political divisions are prompted by precisely order to stop a drying up of liquidity. The Fed has been doing this issue. Ideological divides in Europe may not appear so this most willingly, to protect the mortgage market in the acute, but any redefinition of the European “welfare state” will US, while the European Central Bank (ECB) is proceeding much require an answer to this question – and some major changes more cautiously regarding the sovereign debt market in to the status quo. the Eurozone. The reality is that we cannot fully assess all the long-run positive / negative consequences of these policy It is worth stressing that a resolution to the debate around the actions for the economies concerned and must accept the fact social contract would be equally to the wealthy’s advantage, that we will have to operate under conditions of considerable as to the recipients of government spending. One of the most uncertainty in the foreseeable future. In the following pages we interesting observations from 2011 is that financial assets therefore highlight some of the immediate economic problems do not tend to do well when there is uncertainty around the that we face in the key regions of the US, Eurozone and Asia “social contract” and its sustainability – this is at the root of before returning to their investment implications. the European crises. It is therefore in the interest of all citizens, at all wealth levels, to find a compromise, for both economic and social reasons. We need a lot of clarification on this issue in 2012, but must accept that the complexity of the underlying issues here will work against immediate progress. 4. The world is also getting smaller, but more complex Precisely because of globalisation, the world is also getting smaller, but more complex to navigate. This has already had a major impact on investment decision making. Until recently, the received wisdom had been that portfolio diversification across regions would help mitigate losses. But the events of 2011, and of 2008 – 2009, have shown us that, during a period of economic tension, investors cannot rely on regional asset valuation independence to provide safe havens. Markets in Asia, Europe and the US are largely intertwined, so asset prices have been moving together with a high degree of correlation. This probably corresponds to a structural trend, and one that will continue to be particularly observable during highly stressed market conditions. Put this way around, this observation might be taken as unfavorable to globalization, but this view would be over-simplistic as closer integration obviously has its positive side too, with, for example, the Chinese government’s efforts in 2009 to support growth through very aggressive state-driven investment programs having had substantial positive side-effects globally. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Investment Insights December 2011 Page 9
  10. 10. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 10 The Estate by Sigmar Polke at Deutsche Bank, London © VG Bild-Kunst, Bonn 2011. Photo: Jacqueline Duschkin Macroeconomic outlook Larry V. Adam, Christian Nolting, Elke Speidel-Walz
  11. 11. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 11 The US in 2012: it’s all about confidence Larry V. Adam Economic growth of 2– 2.5 percent expected Federal Reserve can implement further non- in 2012, but substantial domestic and external traditional policy stimulus if necessary risks Our base case scenario is that the US grows at 2– 2.5 percent Retail sales have been resilient so far, despite poor consumer (Figure 1) in 2012, having picked up pace in Q3 2011, but confidence, but this situation cannot continue indefinitely. Weak substantial domestic and external risks remain. Uncertainty wage growth would be one factor holding back a recovery means that our market forecasts must be muted, if positive, of consumer confidence, and we are concerned that the labor too. 2013 could, in fact, prove to be worse than 2012, as the market will remain tepid in 2012, with the unemployment rate economy is simultaneously hit by the “automatic” remaining above 8.5 percent. Congressional budget cuts, the expiration of the Bush tax cuts, the likely end of the 2 percent payroll tax cuts and the Another – linked – risk to sustainable US economic growth introduction of taxes tied to healthcare reform. is the still poor state of the US housing market. A weak housing market stifles economic growth as job seekers are Challenges not able to move to take new jobs (because their existing While a recession is likely avoidable in 2012 – thanks to strong home is difficult to sell, or because negative equity means business spending, robust exports to the emerging markets, that selling it would crystallize a loss that they cannot fund). positive job growth and some politically-driven initiatives in Moreover, declining house prices can trigger a negative net an election year – the US economy will not be without its wealth effect, reducing consumer spending; further declines challenges. The most immediate domestic risk is a tamping in home prices would of course also put the banking sector down of consumer and business confidence by economic, at risk of further write downs. It is becoming increasingly political and international uncertainty. Depressed consumer evident that some sort of government intervention in the confidence could lead to reduced consumer spending and housing market may be necessary, something that might heightened risk aversion while weak business confidence could appeal to the current administration in an election year – limit job creation: together, they could lead to a self-fulfilling although its ability to implement stimulus measures would recession. be limited by the US’s debt and deficit situation. Policy response If the US economy were to show substantial signs of stress, we believe that the Federal Reserve would be inclined to engage in further quantitative easing. Fed Chairman Bernanke continues to make it clear that he will use all policy measures to avoid a recession. With headline inflation pressures likely to subside, helped by recent falls for many commodity prices, Forecast US growth in 2012 – quarter-on-quarter, annualized the Fed should have ample room to implement further non- in percent, quarter-on-quarter, annualized traditional monetary policy initiatives, and they may be in the form of mortgage-backed security purchases in order to offer more aid to the housing market. Declining inflationary 3.5 pressures will also allow the European Central Bank and 3.0 emerging market central banks to cut interest rates as well 2.5 to stimulate their economies. 2.0 1.5 1.0 0.5 0 Q3 2011* Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 *Actual Past performance is not indicative of future returns. No assurance can be given Figure 1 Source: Deutsche Bank, Global Markets. As of November 29, 2011 that any forecast, investment objectives and/or expected returns will be achieved. Investment Insights December 2011 Page 11
  12. 12. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 12 Larry V. Adam / The US in 2012 – continued The improvement in US economic data in the second half of S&P 500 Earnings per share reach record highs in Q3 2011 in USD, rolling four quarter sum 2011 has been in contrast to the increasingly poor outlook for the Eurozone outlook. But the US economy cannot decouple S&P 500 EPS Rolling Four Quarter Sum from trouble in other economic regions. A European credit contagion or a Chinese hard landing would have negative 100 repercussions for an already vulnerable US economy. Investors 90 cannot ignore the outcomes to these potential risks. 80 70 Asset classes 60 50 Given this uncertainty, our financial market outlook must be 40 muted as well. Continued volatility will dampen investor 30 sentiment, especially with ongoing risks in the run-up to the 20 election. Political positioning seen during the debt ceiling 10 debate and the failed “Super Committee” deliberations suggest 0 partisanship will remain in the fore. While heightened risk 1940– 1950– 1960– 1970– 1980– 1990– 2000– aversion and uncertainty are likely to keep Treasury rates “lower 1950 1960 1970 1980 1990 2000 2010 for longer”, our economic growth forecasts are supportive of a modest rise in Treasury yields from current levels, which are Figure 2 Sources: FactSet; FirstCall. As of November 29, 2011 more consistent with recessionary conditions. As a result, we remain cautious on US Treasuries and encourage investors to diversify into higher yielding, lower duration sectors such as high yield and emerging market debt. US equities, while volatile, are likely to be one of the better performing asset classes in 2012. US corporations remain a bright spot for the US economy, recording record earnings in Q 3 2011 (Figure 2). Based on fundamentals, the S&P 500 should trade upwards to 1.375 by the end of 2012. While correlations are likely to remain high, we believe selectively will remain critical as investors become more discerning and assess the visibility and sustainability of earnings for international regions, sectors, and individual securities. With earnings growth set to decelerate, strong operating leverage is likely to be replaced by financial leverage. With the Fed keeping interest rates low through mid-2013, corporations are likely to issue debt and/or use the record amount of cash on balance sheets for stock repurchases to bolster earnings. Similarly, low interest rates make dividends more attractive and we expect corporations to continue to increase their dividend payments to attract investors. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Page 12 Investment Insights December 2011
  13. 13. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 13 Asia in 2012: resilience in adversity Christian Nolting Growth slowdown is likely to be braked by Falling inflation should give policymakers intra-Asian trade and domestic consumption room for maneuver Asian economic growth is expected to continue to slow (albeit But just how much can Asian consumption growth offset gradually) in 2012, because of the impact of slower growth in the impact of slower developed markets growth? Looking the developed economies. Intra-Asian trade and further growth first at past consumption trends if, for example, we look in domestic consumption is likely to cushion the blow, however. at correlation data for the last six years, then it would appear Sustainable wage growth, low unemployment and low debt- that Chinese retail sales (taken as a proxy for domestic to-GDP ratios will be supportive of our positive stance on Asia. consumption) are much more correlated with household disposable income levels than with US and Eurozone Challenges growth. A broader look at pan-Asian consumption trends One of the key challenges that Asian economies must face will also reminds us that Asian consumption continued to be the impact on Asian exports of lower growth in the developed grow in 2009 despite the collapse in US demand in that year. economies. The more open and trade-reliant Asian economies The last time Asian consumption contracted was after such as Singapore, Hong Kong, Taiwan and South Korea are the Asian crisis of 1997– 1998. likely to suffer most from slower EU and US growth, and thus slower growth in exports to the developed markets. But, set A second, and very immediate, challenge could be posed by against this, stronger demand from the developing world has possible foreign investor money outflows if global risk aversion become increasingly important in driving Asia’s exports in rises. Previous global equity sell-offs have been accompanied recent years. by strong outflows from Asia, for example during the 2008/ 2009 world financial crisis and in mid-2011. In addition, domestic consumption in Asian economies has, so far, proved resilient to slower exports and has become There are various ways of measuring this. Figure 1 below looks an increasingly important source of GDP growth for Asian at the size of foreign portfolio debt relative to FX reserves; economies. Over the coming years, it will be interesting comparing October 2011 with November 2008 (at the height to see whether Asian policy makers can steer their economies of the credit crunch). It suggests that Indonesia, South Korea toward being rather more consumption-oriented. and India could now suffer more from a sudden withdrawal of foreign portfolio holdings than in 2008. Alternatively, one can compare the size of Asian economies’ short-term debt relative to GDP in October 2011 and November 2008. This is rather more reassuring, as the size of short-term debt relative to GDP has increased only in India, and there not substantially. Asian economies’ foreign portfolio holdings as a percentage Yet another approach is to look at the size of the Asian of FX reserves economies’ financing gap (their foreign exchange requirements in percent to fund debt service and imports, minus the revenue from November 2008 October 2011 exports). On this measure, Asian economies have become more vulnerable to outflows, if not by an alarming amount. India 140 has seen the largest increase in vulnerability on this measure, 120 thanks to a large increase in foreign investment inflows 100 combined with weak foreign reserves accumulation. Korea and 80 Taiwan would appear to have become less vulnerable. Overall, China, the Philippines and Thailand would appear to be the 60 least vulnerable economies, on this financing gap measure. 40 20 0 China Vietnam Thailand Philippines Taiwan India Malaysia Korea Indonesia Figure 1 Source: Deutsche Bank, Global Markets. As of November 29, 2011 Investment Insights December 2011 Page 13
  14. 14. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 14 Christian Nolting / Asia in 2012 – continued Policy response Central government debt at end 2010, as a percentage of GDP: However, we should not forget that markets have already been Asian and other economies compared in percent pricing in slower growth in 2012. This has prompted many investors to anticipate some form of policy easing or stimulus Asian Other economies packages from many Asian policy makers in response. Indeed, with trade slowing and a broader slowdown now becoming 100 evident in Asia, Asian central banks are already beginning to 80 act. For instance in China, we have started to see some modest signs of credit easing with the monthly level of new lending 60 easing upwards. In the near term, we could see more credit easing policies coming from the Chinese policy makers albeit 40 still at a gradual and modest pace. They could, for example, 20 stop the issuance of People’s Bank of China (PBoC, the central bank) bills or cut further the banks’ reserve requirement ratio 0 (RRR). Recent announcements by the Reserve Bank of India UK China India Indonesia Malaysia South Korea Thailand G20 Advanced EU US Philippines (RBI) have also indicated a willingness on the part of Indian policymakers to ease their grip on liquidity for the first time in several months. Figure 2 Source: Deutsche Bank, Global Investment Solutions. If inflation in many Asian economies has peaked and continues As of November 29, 2011 to trend lower over coming months, this would provide some scope for Asian policymakers to further ease policy. Our view on inflation is supported by falling food prices, given that food accounts for about one-third of the CPI baskets for countries such as China and India. In addition, industrial metal prices have also declined as a result of fears over global growth in 2012. Besides monetary policy easing, Asian central banks could Asian equities look moderately undervalued based on both also probably consider implementing some stimulus packages a price-to-book (P / B) and price-to-earnings (P / E) basis. Our to support growth, if necessary. Most Asian economies still expectation is that margins should hold up relatively well, helped appear to have fairly strong fiscal positions, characterized by by decreases in the many of the prices of raw materials. low and stable deficits and debt (Figure 2), thus providing them with much more potential “firepower” than governments In the absence of any policy actions, high dividend yielding in the developed world to combat slower growth next year. sectors in Asia such as REITs, telecoms and utilities could remain attractive. Besides their stable yields, these sectors Asset classes are relatively less exposed to a slowdown in the developed Asian equities’ prices will also likely remain sensitive to economies and more dependent on local consumption. developed markets, as historically they have had a high beta relative to the developed world. Having said that, valuations On fixed income, Asian sovereign re-rating could be a positive are starting to look attractive to us and we are seeing issue running through the year, given that the ratios of Asian potential opportunities for investors with a medium to long countries’ public debt-to-GDP remain low relative to developed term perspective. Compared to their historical average, economies. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Page 14 Investment Insights December 2011
  15. 15. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 15 The Eurozone in 2012: no quick fix Elke Speidel-Walz Our base case forecast is for a controllable But the risk remains of a very sharp Eurozone recession in 2012 contraction and Eurozone disintegration At best, the Eurozone will experience a controllable recession tax take and boosting spending (through “automatic stabilizers” in 2012, with all economies contracting apart from Germany’s such as unemployment benefit) makes fiscal consolidation, (Figure 1). Uncertainties will weigh on government bond already a major problem (Figure 2) even more difficult. One markets, in the first half of the year at least. The second half of “rule of thumb” reckons that fiscal tightening equivalent to 1 the year could be rather better. The alternative is a full-blown percentage point of GDP pulls down GDP growth by 0.7 downturn, with several economies exiting the Eurozone. percentage points. On the other hand, a 1 percentage point reduction in GDP growth leads to a cyclical widening of the Challenges fiscal deficit equivalent to 0.4 percentage points of GDP. This The fundamental problem for the Eurozone is how to maintain makes the necessary fiscal adjustment in some countries a currency system where monetary policy is centralized, but extremely ambitious. Some countries have, so far, managed where members have very different approaches to fiscal policy. better in this environment than others, but none look The latest policy initiatives attempt to to tackle this. Previous completely secure. attempts to regain financial markets’ confidence by putting together impressive-sounding rescue programs, while granting Limited cash, together with political and legal hurdles, mean help only in exchange for progress on fiscal austerity, have not that further single-country rescue programs look unlikely. The managed to contain the crisis. And with one member, Greece, European Financial Stability Facility (EFSF) and its planned having a still unsustainable debt load, there is a possibility successor, the European Stability Mechanism (ESM) cannot of further debt defaults (above the already agreed 50 percent deal with a problem of the size of the Italian bond market “haircut”) and possibly a Greek exit from the Eurozone next (Euro 2 trillion, the world’s third largest). One initial idea was year. to leverage the available capital via an insurance program, but this seems unlikely to work due to the insufficient means A combination of fiscal austerity, rising financing costs and of the EFSF, the result both of its limited financial firepower heightened uncertainty over the future of the Euro, is pushing and also the expectation that the number of Eurozone countries the region into a recession. Recession, through lowering the able to finance a rescue package will fall. Eurozone 2012 GDP growth/contraction, by country Eurozone: Fiscal indicators reveal seriousness of the problem in percent as percentage of GDP Fiscal balance Public sector debt 0.5 Germany -1.4 81.1 0 France -5.4 86.8 -0.5 Italy -2.5 119.8 -1 Spain -6.0 71.0 -1.5 Netherlands -3.5 64.0 -2 Belgium -5.0 97.5 -2.5 Austria -3.2 75.4 -3 Finland -1.5 52.2 -3.5 Greece -6.6 166.0 Portugal -6.4 107.4 Italy Greece Germany Portugal Ireland Eurozone France Spain Belgium Austria Finland Netherlands Ireland -9.1 117.9 Eurozone -3.6 88.7 Figure 2 Sources: Deutsche Bank, Global Markets; EU Commission. Figure 1 Source: Deutsche Bank, Global Markets. As of November 29, 2011 As of November 29, 2011 Investment Insights December 2011 Page 15
  16. 16. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 16 Elke Speidel-Walz / The Eurozone in 2012 – continued Both the German Bundesbank and the President of the ECB, than raise capital. Another risk stems from the very challenging Mario Draghi, do not want the ECB to assume the role of a policy outlook. Fiscal austerity-fatigue and rescue-fatigue, lender of last resort for governments, and it is supported in this already on the rise, could become more serious. And if the wish by the German government. Even if a majority of the number of AAA-rated sovereigns gets reduced, Germany ECB’s Council were to try and overrule the German position, could lose credibility due to stretched guarantees, and markets this might not be well received by the financial markets as might then lose confidence in any bail-out program. Were it could be seen as endangering Germany’s commitment to Italy to embark too late on reform plans, or were France not to the Eurozone. Jointly-issued Eurobonds would also be no step up its reform drive after its May elections, there could miracle solution: the pre-condition – fiscal union – needs be a much worse outcome. In this scenario, the Euro system time, and the risk that large-scale issuance of Eurobonds could could break down in its current form and leave only a few trigger a rise in German bund yields has clearly risen. countries with a common currency. Policy response Asset classes Overall, we expect a disruptive first half of 2012 for the Eurozone Even under our base case scenario, government bonds would but more clarity in the second half of the year. In our base still have substantial risk. (Consider, for example, what would scenario, Eurozone output as a whole contracts by 0.5 percent happen in the new Greek government did not stick to reforms in 2012, pulled down by fiscal tightening, higher financing after its election in February or were Italy’s very high financing costs in most countries, and uncertainty damaging sentiment. needs in Q 1 to cause problems.) In the course of 2012, reforms But continued global growth, falling Eurozone inflation (below in Spain and Ireland could start to have more obvious results 2 percent) and ECB rate cuts will, we hope, limit the downside. and the high spreads available on these countries’ bonds might eventually become attractive. In our base case scenario, the expectation is that the drive for fiscal and structural reform would gather pace in the larger Our overall view is that equities are likely to be the most countries, with Italy starting structural reforms and restoring attractive asset class in the Eurozone in 2012. But this assumes market confidence (helped by ECB purchases in the first that global growth remains robust, supported by emerging quarter of 2012, due to the country’s large financing need). markets and moderate but decent growth in the US; also, we Reforms in France could step up a gear after the May 2012 continue to dislike Eurozone financials. Equities valuations elections. Spain, Ireland and Portugal are likely to make further are attractive, and corporate fundamentals and balance sheets progress on their fiscal and reform agendas. They could get appear sound. further help and / or limited debt relief to ease fiscal and social problems. But in Greece there is a high risk of a disorderly default, with losses much greater than the planned 50 percent. It is easy to envisage a much worse scenario, however, with a deeper recession in the Eurozone. This could be either the result of weaker global growth and/or a more serious credit crunch in the Eurozone as banks opt to sell assets rather Page 16 Investment Insights December 2011
  17. 17. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 17 Untitled by Richard Smith at Deutsche Bank, London © Richard Smith, Flowers Galleries London. Photo: Jacqueline Duschkin Portfolio management in 2012 Arnaud de Servigny Coping with risk, capturing opportunities.
  18. 18. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 18 Arnaud de Servigny / Portfolio management in 2012 In the context of all this transition – of global governance, of — Lastly, while precious metals make sense in an inflationary social provision systems, and of policy responses – we think it context, they should appeal less in the present environment is possible to make two, very broad observations on portfolio where inflation risk is receding quickly, at least in Asia and management. in Europe. Of course, individual policy events may push up the gold price, probably temporarily, but a sustained and 1. We should expect sustained volatility in 2012, which will substantial rise in precious metals prices is unlikely to be on require a careful, structured but active investment approach the agenda in 2012. One positive is that, as argued above, we know that things will have to change — there can be no more “kicking the can So investors find themselves in a situation where “safe” assets down the road”. These necessary changes are likely to create cannot guarantee wealth preservation, and therefore must sustained volatility on the markets, which we can prepare for. contemplate how best to invest in risky assets. Doing this well requires several things. The first requirement is to build The traditional reaction in a situation of high volatility is almost active risk management into the portfolio, using either always to “fly to quality and then do nothing”, that is to avoid financial instruments that reduce downside risks, or assets risky assets and to go instead for cash, sovereign bonds, real that constitute shock absorbers. The second requirement is estate and precious metals. But what is clear to us is that this to manage a portfolio dynamically through a robust investment time is different and that, because of the nature of this crisis, process that captures which investment “regime” we are none of these options can guarantee wealth preservation. in, while avoiding the expensive pitfalls of spurious market Looking at these investment areas in turn: timing. — Cash highlights some potential dilemmas. In a situation of high sovereign debt tension, one traditional tool used by governments has been currency debasement. Moreover, this process is not always voluntary, as the strength of a currency is linked with the stability of its government. So, with this crisis deeply related to governments’ effectiveness and thus stability, some real caution is needed here: cash Actual vs. model-predicted levels for US 10-year Treasury yields is by no means as “safe” as it might appear. in percent Actual Model-predicted forecast — Among sovereign debt, the current safe haven would appear to be US Treasuries but fundamentals-driven 7 models suggest a fair value for US rates of around 3.20 percent rather than their current levels of close to 2 6 percent (Figure 1). So, again, “safe” could prove very 5 risky, if Treasuries start being driven more by reality than by an emotional response. 4 — Real Estate valuation depends largely on the availability 3 of mortgages. But in the current environment where banks 2 are being forced to deleverage massively, credit will be scarcer and thus more expensive. The US is still dealing with 1 the aftermath of a burst housing bubble and it is highly 2000 2002 2004 2006 2008 2010 unlikely that, in the future, limited capital resources elsewhere will be deliberately funnelled into unproductive real estate, particularly in a context of subdued growth. Figure 1 Source: Deutsche Bank, Global Markets. As of November 28, 2011 Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Page 18 Investment Insights December 2011
  19. 19. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 19 2. There are ways to leverage this global growth through At some point, we will also need to revisit the geography smart asset selection “dimension”. At the moment, as we have observed above, More fundamentally, it is important to realise that risky assets market correlation means that geography does not make can offer opportunities in 2012. Global growth in 2012 should a vast difference, although US equities have been still be close to 3 percent, which is substantial. So our second outperforming other regions recently. Conversely, Asian portfolio management theme is that we strongly believe that equities have not done well, despite the secular upward there are ways to leverage this global growth through smart trend of the Asian economies – a useful reminder that markets asset selection. do not always follow macroeconomic developments. We believe that all regions will benefit in the first instance from For very opportunistic investors, focused on trading, 2012 clarification on our four economic and policy themes that could represent a year of many opportunities, with periods will drive developments in Europe and in the US. Once we of market dislocation (and thus rapid price change) coming have passed this tipping point, then fundamentals will start as a consequence of a likely raft of policy announcements, to matter more. together with central banks and regulator intervention. Remember, too, that banks may well be in such a weak position that they cannot provide their usual market-making smoothing function, potentially increasing the scope for tactical gains. But there should be longer-term, more fundamentals-driven, opportunities. Large firms, well organized from a governance perspective, and fully plugged into global growth, should be in a position to take advantage of the situation, with sustained or growing earnings. In addition, valuations currently appear very low with price / earnings (P/E) ratios that are typically around Current price / earnings ratios (LTM*) in 12 in the US and below 10 in Europe (Figure 2). This situation the US and Europe should not last forever. Market sentiment is very negative at the S&P 500 MSCI Europe moment, but periods of negative sentiment have in the past often been very good entry points into risky assets. One could 14 add that, from a behavioural finance perspective, the perfect timing for entering into such investments is when one is 12 comfortable with them from a rational perspective, but must 10 first overcome an emotional reluctance to invest. During 2012, 8 we could encounter such a “tipping” point but it will always be difficult to time the entry point precisely. Of course, the 6 journey to this tipping moment may well prove bumpy, and the 4 complexities outlined above could lead to some accidents along the way. A gradual stepping up of exposure to risky 2 assets could be one solution. Overall, it will be important to 0 remember that financial markets do not wait for solutions to be implemented before they adjust. Instead, they are primarily * Last twelve months looking for credible solutions to be outlined, accompanied Figure 2 Source: Bloomberg Finance L. P. with a degree of certainty on their execution – then they move. As of December 2, 2011 Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Investment Insights December 2011 Page 19
  20. 20. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 19:07 Seite 20 10 Investment topics for 2012 Arnaud de Servigny, Christian Nolting, Larry V. Adam, Elke Speidel-Walz, Paul Wharton We now suggest 10 investment topics that we think will run through portfolio management decisions in 2012. Investor focus 1. Safe may not be safe. 4. Be nimble, but with a safety net. Don’t react to future periods of uncertainty by taking refuge Risk management will remain key throughout 2012, both in traditional safe havens such as cash, sovereign bonds, through use of options and through shock absorbing assets real estate or precious metals without realizing that the current (including through equities sector rotation). Consider resorting risk environment means that they may prove less safe than to regular, dynamic portfolio rebalancing to adjust to economic they appear, and be vulnerable to the effects of frequent and market developments. policy change – the likely backdrop to 2012. 5. Reason should dominate emotion. 2. Walk before you run. Investor responses to longer-term changes – as well as short- After a bruising 2011, and in a context of continuing uncertainty, term market dislocations – will be driven by fear followed, investors will be understandably wary of investing in risky at some stage, by relief. Avoid an emotion-driven response assets. One strategy to overcome reluctance may be to build that is likely to result in wrong investment decisions, and up holdings gradually, first focusing on “equity lite” type wrong timing, and make sure that reason always dominates holdings (e. g. high dividend-paying stocks, convertibles and the decision-making process. high grade corporate debt) which are supported by fundamentals. 3. Ready, steady…go? Fixing Eurozone and other problems will take time in 2012. But when we get some clarity on progress, not only equities but also bond markets will start to have a different momentum and regional dynamics will reassert themselves. Timing will be key for investments in both Asia and, more selectively, in Europe. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and /or expected returns will be achieved. Page 20 Investment Insights December 2011
  21. 21. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 21 Investment focus 6. Big will grow bigger. 8. Asian growth generates performance at last. Large multinational corporations, especially in the US but Despite continued strong Asian growth in 2011, Asian equities elsewhere too, should be able to take better advantage of still performed poorly, with fund flows a major performance strong global growth, and able to control costs through contributor. However, with rising clarity on the developed strong governance, which they have exhibited since the 2008 economies’ recovery, the scene may be set for a recovery crisis. Sectoral and other preferences will change as the in Asian equities and some possible decoupling later in 2012. year progresses, with an initial preference for defensive, high Look for local longer-term trends too, for example an dividend-paying stocks. In the US, we like technology, increasing emphasis on domestic consumption. And with energy and healthcare stocks; in Europe ex-UK and UK, we falling rates of inflation giving Asian policy makers a degree favor oil and industrials. of leeway for monetary policy easing, Asian bonds should offer an attractive risk / return balance. 7. Capital over labor. 9. Phoenix companies in Europe. Medium-sized companies will find it more difficult to cope with a lower growth environment, as bank lending becomes Later in 2012, the European market is likely to offer some more restricted, with their management looking more strong opportunities for longer-term investors. Strong, defensive. But significant opportunities may exist to restructure, undervalued, truly global companies may merit consideration, consolidate and revive companies, particularly through particularly in the larger peripheral economies of Italy and private equity investments, potentially boosting productivity Spain. against the background of a difficult labor market. 10. Volatility can be your short-term friend. While the topics above reflect a fundamentals-driven approach, remain aware that volatility and market dislocation in the wake of expected policy actions are likely to cause substantial, very specific, short-term trading opportunities. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and /or expected returns will be achieved. Investment Insights December 2011 Page 21
  22. 22. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 22 Forecasts and current data summarized Untitled – Motif by Karl Horst Hödicke at Deutsche Bank, London © VG Bild-Kunst, Bonn 2011 Photo: Jacqueline Duschkin
  23. 23. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 23 Economics GDP growth Inflation Key interest rates in percent in percent official, in percent 2010 2011 2012 2010 2011 2012 Current* 3 month 12 month USA 3.0 1.8 2.3 USA 1.6 3.3 3.2 USA 0.25 0.25 0.25 Eurozone 1.8 1.6 -0.5 Eurozone 1.6 2.7 1.8 (Fed funds) UK 1.8 1.1 1.3 UK 3.3 4.5 3.2 Eurozone 1.25 1.00 1.00 Japan 4.1 -0.4 0.5 Japan -0.7 -0.3 -0.3 (Ref. rate) Asia ex Japan 9.5 7.6 7.2 Asia ex Japan 4.6 6.0 4.0 UK 0.50 0.50 0.50 Latin America 6.3 4.1 3.6 Latin America 8.4 8.2 8.2 (Base rate) EMEA 4.7 4.3 3.8 EMEA 7.6 7.1 6.7 Japan 0.10 0.10 0.10 World 5.1 3.7 3.5 (Ref. rate) Fiscal balances Current account balances in percent of GDP in percent of GDP 2010 2011 2012 2010 2011 2012 USA -8.8 -8.5 -6.2 USA -3.2 -3.1 -2.7 Eurozone -6.0 -4.7 -3.7 Eurozone -0.5 -0.7 -0.3 UK -10.3 -8.2 -6.9 UK -2.5 -2.5 -2.4 Japan -8.7 -8.7 -9.1 Japan 3.6 2.2 1.9 Asia ex Japan -2.9 -2.3 -2.9 Asia ex Japan 4.0 3.1 2.3 Latin America -2.4 -2.0 -1.8 Latin America -0.9 -0.9 -1.3 EMEA -4.7 -2.1 -2.3 EMEA 0.3 0.3 -0.5 Markets Equities Key sovereign bond yields (10-year) Currencies index levels in percent Current* 3 month 12 month Current* 3 month 12 month Current* 3 month 12 month USA (S&P 500) 1,247 1,305 1,375 USA 2.08 2.25 2.75 EUR/USD 1.35 1.30 1.35 Eurozone 2,330 2,275 2,360 Eurozone 2.27 1.90 2.30 USD/JPY 77.63 77.00 80.00 (EuroSTOXX 50) UK 2.14 2.60 3.10 EUR/CHF 1.23 1.25 1.25 Germany (DAX) 6,089 6,000 6,500 Japan 1.08 1.00 1.25 GBP/USD 1.57 1.55 1.55 UK (FTSE 100) 5,505 5,650 6,000 EUR/GBP 0.86 0.87 0.87 Japan (Nikkei) 8,435 8,750 9,200 Asia ex Japan 456 500 535 (MSCI, $) Latin America 3,670 3,750 4,050 (MSCI, $) Light blue colored forecasts indicate upward revisions and italicized forecasts indicate downward revisions to the numbers published in last month’s Investment Insights. Commodities *As of December 1, 2011 2010 and current numbers are actual. 2011, 2012, 3 month and 12 month numbers are Deutsche Bank forecasts, as of December 1, 2011 Current* 3 month 12 month Sources: Deutsche Bank, PWM Global Investment Committee; Deutsche Bank, Global Markets. Past performance is not indicative of future returns. No assurance can be given that any Oil ($, WTI) 100 95 100 forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions Gold ($) 1,750 1,750 1,850 and hypothetical models or analysis which may prove to be incorrect. Investment Insights December 2011 Page 23
  24. 24. RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 24 Asset classes in 2012 in summary Opportunities and concerns for each of the main asset classes in our Global Investment Committee (GIC) model portfolio. Fixed income – sovereign, developed and emerging markets. Emerging market equity. US Treasuries could do a good job at helping protect against If there is a sustained recovery in the developed economies, against a further sharp deterioration in the investment particularly in Europe, Asian equities could eventually start to environment, but yields could increase (i.e. prices fall) under better reflect strong regional growth, after poor recent more favorable scenarios. European debt is unlikely to fulfill performance. this protective role, but could offer some value opportunities. Emerging market sovereigns appear better placed than developed market sovereigns, but there is currency risk to be Private equity. considered. This will have a role to play in financing the consolidation of medium-sized companies, and in distressed debt and equities opportunities in Europe. Fixed income – corporate, investment grade and high yield. US high yield is likely to appeal, but has some liquidity and volatility risk. Investment grade corporate bonds are likely Absolute return. to outperform government bonds. Increasing clarity on the Eurozone – which would allow an increasing range of approaches, rather than simple good/bad outcome plays, and a greater focus on fundamentals – could Developed market equity. enable some hedge fund strategies to perform better in 2012 US equities are likely to outperform European equities, early than in 2011. in the year at least. Improving price multiples could offset the effect of decelerating earnings growth. Prefer large caps. Look for longer-term opportunities in globally-focused Commodities. multinationals in Europe. There is some moderate possible upside in gold, but there is likely to be no clear direction. Elsewhere, many cyclical commodities prices may struggle, particularly if global growth drops below 3 percent. Oil could be slightly more resilient to lower economic growth. Page 24 Investment Insights December 2011

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