Deutsche bank Report on China

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Deutsche bank Report on China

  1. 1. Research Deutsche Bank Deutsche Bank Research The House View: Waiting for growth July 25 2013 DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
  2. 2. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 2 Special report – China’s Rebalancing Act 1 The House View –July 25 2013: Waiting for growth
  3. 3. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 The House View – July 25 2013: Waiting for growth Despite sluggish growth in H1, we continue to expect the global economy to rebound in H2. The US recovery is gaining traction after being held back in H1 by one-off factors such as the sequester. In Europe, recent data points to an exit from recession. We have marked down our EM growth forecasts, however, given the slowdown in China, weaker capital flows, lack of growth enhancing reforms and limited policy flexibility We continue to expect the Fed to taper QE purchases in September, while keeping interest rates on hold until 2015. In Europe, both the ECB and BoE have taken steps to distance themselves from a possible Fed exit, with the former taking the unprecedented step of adopting forward guidance as a policy tool. As a result, core bonds should trade in a relatively narrow range over the coming months, with short-term rates kept low by central banks’ forward guidance, while long-term rates will rise only on the back of sustained data strength The recent reassurances from central banks have seen risk assets regain much of the taper-driven losses since late May. In the US, the S&P 500 has hit fresh record highs as it continues to generate decent EPS growth despite disappointing sales and GDP growth. With valuations in many sectors implying stronger sales growth, equities remain vulnerable to a delay in our expectations of an upturn in global growth in H2 In a special report this month (p. 21), we take a look at China where weaker growth has reignited fears of a ‘hard landing’ for the world’s second largest economy. We continue to believe these fears are overstated and remain confident that the country has sufficient policy flexibility and financial firepower to prevent a systemic crisis. Growth over the coming years will, however, slow relative to the past decade as the government attempts to rebalance the economy away from investment and export-led growth to one driven by consumption David Folkerts-Landau, Group Chief Economist The views in this publication are informed by Deutsche Bank’s Global Strategy Group, which advises management and clients on broad market risks and global economic and financial developments. The views and forecasts of the group, which consists of senior research staff, may occasionally differ from those disseminated by their research colleagues Editors: Raj Hindocha, Marcos Arana, Wolf von Rotberg, Sahil Mahtani, Erin Urquhart 2
  4. 4. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Strengthening US growth and a return to growth in Europe will support global growth in H2  Fed to taper QE purchases in H2 and end QE by mid- 2014, subject to continued strong macro data. Expect no asset sales, and no rate hikes until 2015  ECB on hold with easing bias. Unprecedented ‘rates low for long’ guidance; more dovish than expected  BoJ delivering on its promise of aggressive easing  BoE on hold with easing bias, also considering ‘forward guidance’ as a policy tool  PBoC on hold; additional financial reforms possible  EM mostly on hold; some countries easing to counter slow growth and others tightening to support currency  China / EM growth slowdown: weakens global recovery  Crisis returns to Europe: political breakdown raises tensions, growth fails to materialise  Monetary policy shock: Fed exit impacts real economy, undermines asset prices  US growth slowdown: unexpected slowdown in data; political deadlock amid debt ceiling  Global growth of 2.8% in 2013, 3.8% in 2014  US growth marked down to 1.8% in 2013 on slower Q2, 2014 at 3.2%. Recovery remains intact, with 3%+ growth in H2 and 2014 on housing and labour market recovery, and slower pace of fiscal tightening  Eurozone growth at -0.6% in 2013, 1.0% in 2014 Return to positive growth in Q2/Q3 on turn in credit and inventory cycles, slower fiscal tightening, export pick-up  EM growth revised down to 4.7% in 2013 and 5.6% in 2014 given China slowdown, weak capital flows, lack of growth enhancing reforms and limited policy flexibility  Euro crisis: political risk has risen in Italy, Spain, and Portugal, but expect overall impact to remain contained. Limited crisis resolution progress in 2013  Normalisation of monetary policy: Fed to taper from Sep; core rates to remain range-bound over near-term  China: disappointing H1 growth raises the risk of a sustained slowdown, but base case is stabilisation from Q4 amid mild policy support and stronger US / Europe  Japan: remain very positive on Abenomics and expect further rallies in the Nikkei and weakening of the JPY Economic outlook Central bank watch M M Note: H / M / L indicates estimated probability and impact of risk (High, Medium, Low) Key views Key risks to our view M 3 L
  5. 5. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Downside risks — China / EM growth slowdown: e.g., data continues to disappoint, structural barriers limit growth potential — Crisis returns to Europe: political breakdown raises tensions, recession deepens — Monetary policy shock: disorderly QE exit stokes volatility, undermines asset prices and growth e.g., rates rise sharper than anticipated, or equities react adversely — US growth slowdown: unexpected slowdown in data; political deadlock amid debt ceiling — Global ‘currency war’: e.g., rate cuts, tariffs, capital controls in EM economies in response to monetary easing in DM — Geopolitical tensions escalate and push up oil prices or slow economic activity, e.g., escalation of Syria conflict, civil unrest in Turkey, Brazil Upside risks — Global growth upside surprise: limited fiscal drag in the US, sharper-than-expected recovery in Europe, reforms and stronger growth in EM, effective policy stimulus in JapanLower Probability Impactonourbasecase Higher LowerHigher Higher risk Lower risk 2 The House View - Risk Matrix 1 2 3 4 5 7 6 7 * Moves represent change in risk outlook over previous month The key risks to our view are a sustained slowdown in EM / China and a return of the crisis in Europe 3 3 4 1 4 6 5 2 1
  6. 6. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 43% 20% 15% 12% 11% 10% 6% 3% 3% 2% -1% -6% -7% -20% 4% 1% 1% 1% -2% 6% 3% -1% -2% -2% -11% 0% 3% -5% -6% -7% -7% -12% -13% 1% -3% -12% -20%(25)% (20)% (15)% (10)% (5)% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% JapanNikkei USS&P500 UKFTSE100 FrenchCAC40 EuropeStoxx600 GermanDAX30 PortugalGeneral SpainIBEX35 ItalyMilan IndiaNifty HangSeng GreeceAthex MSCIEM Bovespa USHighYield EUSovereign EUIG EUIGFin USIG Spain Italy Germany US UK AUDUSD EURUSD DollarIndex GBPUSD TRY INR BRL ZAR JPYUSD CommodityIndex BrentOil Copper Gold YTD 2013 Since 22 May 22 May - 24 June Equities Corporate credit Sovereign debt FX Commodities Note: Total return accounts for both income (interest or dividends) and capital appreciation. Source: Bloomberg Finance LP, Deutsche Bank Research. Prices as of 24 Jul 2013, 9:00 GMT Total returns YTD 2013, change since 22 May and between 22 May – 24 June (when most metrics bottomed) The ‘taper tantrum’ is over: markets have retraced much of their post May 22 sell-off, with US equities reaching fresh all-time highs 5 Nikkei has regained more than half its losses since 22 May
  7. 7. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  The global economy continues to expand, however, the pace of growth slowed in H1  Developed economies are accelerating − US: despite Q2 softness due to one-off factors e.g., sequester-related spending cuts, underlying growth is improving − Eurozone: entering a cyclical recovery − Japan: positive momentum from Abenomics  Whereas most major emerging economies are slowing − China: the authorities did not intervene to prevent slower growth in H1 − Brazil: economy has stalled amid rising inflation and lower commodity prices impacting exports − India: capital outflows, INR depreciation and weak consumer sentiment weighing on growth 6 The global economy remains sluggish with positive momentum in DM offset by weakness in EM 50 52 54 56 58 2010 2011 2012 2013 Global Composite PMI: the global economy continues to expand (PMI> 50) but the pace of growth slowed in H1 Source: Haver Analytics, Deutsche Bank Research Eurozone US UK France Germany Italy Japan Spain Brazil India Russia China 44 46 48 50 52 54 44 46 48 50 52 54 Manufacturing PMIs: developed economies accelerating whereas most major EM slowing *June data, July flash for China, US, Eurozone, Germany and France Source: Haver Analytics, Deutsche Bank Research Latest* Prev. 3m avg Acceleration Deceleration EM DM
  8. 8. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 8.2 6.2 6.9 5.5 4.8 3.5 4.3 3.3 2.6 7.6 6.0 5.0 4.7 3.7 2.9 2.8 2.1 2.1 0 2 4 6 8 10 Mar-13 Jul-13 We have revised down growth forecasts for major EM economies 2013 GDP growth (%yoy) As of  We have revised down our EM growth forecasts on a disappointing H1 2013 performance and weaker outlook going forward  Prospects of weaker capital flows in a rising US rates environment will leave policies more constrained and weigh on growth prospects  Monetary policy will generally be less supportive going forward as outflows raise prospect for currency weakness and inflation  Countries with stronger external positions or where inflation remains at very low levels will have more room for maneuver e.g., Russia, Mexico  Continued political risks, although apparently not systemic, will continue limiting upside  Meanwhile, the prospect of an accelerating US and, to a lesser extent, Europe, reduces downside risks 7 We have revised down EM growth given the slowdown in China, weaker capital flows, lack of reforms and limited policy flexibility EM Monthly - Shifting from Technicals to Fundamentals 19 July 2013
  9. 9. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 8 -0.3 -0.6 0.1 0.1 0.2 0.3 0.3 0.3 0.4 -0.6 1.0 -0.8 -0.4 0.0 0.5 0.9 % qoq, saar 2013 %yoy 2014 Eurozone: return to positive growth in Q2-Q3 Source: Haver Analytics, Deutsche Bank Research  US growth is set to accelerate to 3%+ over H2 2013  Reduced fiscal tightening  The housing market recovery is on track despite rising rates  Labour market recovery The recovery in DM will strengthen in H2 with Europe emerging from recession and the US accelerating to 3%+ growth  Eurozone to return to positive growth in Q2/Q3  Inventory cycle is turning  Fiscal tightening has peaked  Supportive credit impulse*  Export demand to pick-up 1.8 2.2 1.3 3.0 3.5 3.2 3.2 3.3 3.2 1.8 3.2 0 1 2 3 4 % qoq, saar 2013 %yoy 2014 US: growth to accelerate to 3%+ rate  Japan to gain from Abenomics  Rising asset prices supporting confidence and consumption  Trade balance is improving on the back of yen depreciation  April 2014 consumption tax hike to take a toll on growth 4.1 1.9 4.5 2.9 1.6 3.1 -7.8 2.9 1.1 2.0 0.6 -10 -6 -2 2 6 Actual Deutsche Bank forecast 2013 2014 Japan: April 2014 VAT hike to take a toll % qoq, saar %yoy *DB’s non-consensus view is that what is important for domestic demand growth is not credit growth, but the change in credit growth. A slowdown in the pace of deleveraging boosts spending growth, even though credit growth is still negative. We call this change in credit growth the “Credit Impulse”
  10. 10. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 9 In Europe, the improving data trend reinforces the view of a growth turnaround and a return to expansion over Q2-Q3 40 42 44 46 48 50 52 54 56 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Germany France Non-core* Eurozone <50: contraction >50: expansion * Italy, Spain and Ireland, GDP weighted. **Latest is flash PMI for Eurozone, Germany and France Source: Markit, Haver Analytics, Deutsche Bank Research Composite PMI**: the eurozone is back in expansion in July for the first time since Jan-2012; the improving trend is encouraging 70 80 90 100 2008 2009 2010 2011 2012 2013 Industrial Production is turning, with the exception of Italy Index (100 = Jun-2007; 3m moving average) Source: Haver Analytics, Deutsche Bank Research Germany Eurozone France Italy Spain  Europe is emerging from its longest recession on record (6 quarters)  Macro data has strengthened and latest PMIs suggest the economy expanded in the last month − Eurozone PMI up to 50.4 in July (+1.7pt mom vs. +0.4 expected) − PMIs for the eurozone as a whole, and more encouragingly for the periphery, have risen consistently over the last 4-5 months − Industrial production is turning – except in Italy  Expect a return to positive growth from Q2-Q3 − Improving peripheral export performance − Inventory cycle is turning − Fiscal tightening has peaked − Supportive credit impulse
  11. 11. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 10 Despite rising political risk, especially in Spain, Italy and Portugal, we do not expect a material escalation of the crisis Greece: pressured to stay on course  Staggered disbursement of aid conditional on reform progress  First ‘real’ lay-offs in public sector could face public opposition  Official sector debt relief needed, but cuts to principal are politically toxic in Germany and impossible before elections in September Germany: elections in September 2013  Euro crisis subordinated to domestic politics  Reactive approach to crisis management likely to remain the default approach Spain: Rajoy under pressure  Questions over Rajoy’s involvement in funding scandal have weakened the government and its ability to deliver reforms  Near-term election unlikely as major parties would lose out while fringe parties gain  Crisis may deepen but will not be systemic Portugal: weaker government, funding uncertainty to linger  Snap elections avoided but government reshuffle will make relations with Troika more difficult  Pace / reach of reforms to slow down  Sovereign is fully funded through year- end, but funding uncertainty for 2014 and beyond will linger for a few months Under Troika programme Pursuing adjustment programme Italy: Berlusconi trial is a risk to government  Final verdict on Berlusconi case expected between end-July and September  If ruling is negative, he would be expelled as senator, and his party may call for early elections Focus Europe - Peripheral vision 19 July 2013
  12. 12. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Peripheral sovereign bond markets are now more resilient − Macro picture is improving − Rebalancing is progressing in the periphery, e.g., structural primary balances are now positive, unit labour costs are falling − Peripherals reliance on foreign investors has declined making these markets more stable e.g., Italian and Spanish sovereign markets now have less <30% foreign ownership vs. >40% at end- 2010 − ECB’s OMT, though untested, continues to provide a strong backstop  However, risks remain − Public sector debt levels still rising − Political risk rising amid austerity fatigue, − Reduced market pressure likely to see pace of reforms stall − Banking sector balance sheets remain weak 43 45 45 30 27 21 0 10 20 30 40 50 Italy Spain Portugal End 2010 Q1 2013 Share of public debt held by international investors: markets are less vulnerable as they have re-domesticated Source: Haver Analytics, Deutsche Bank Research % of total debt 3 4 5 6 7 8 2010 2011 2012 2013 Italy Spain 10Y government bond yields: the recent spike remains far below previous crisis peaks Source: Bloomberg Finance LP, Deutsche Bank Research % 11 Stronger growth, the re-domestication of sovereign debt and the ECB’s OMT backstop have made Europe more resilient
  13. 13. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Recent victory for Abe’s coalition in upper house elections provide it with a majority in both houses until at least 2016, thus a strong mandate for reform − Despite strong political support, we expect structural reforms to be implemented only gradually and not to boost GDP in short-term  BoJ easing bias, a weaker yen and improving sentiment is set to drive the recovery − Q2 GDP growth expected to reach 4.7% saar − Consumer confidence is at a 7-year high − Trade balance improving on weaker yen  Stocks to gain on weak yen and strong earnings − USD/JPY to reach105-110 over next 6 months due to BoJ easing bias and solid US recovery − Q2 earnings may well surprise on the upside as macro data is strong and early earnings announcements have beaten so far 98 100 102 104 106 108 2007 2008 2009 2010 2011 2012 2013 Household consumption Private consumption is recovering rapidly as households feel the wealth effect from rising asset prices Source: Cabinet Office, OECD, Deutsche Bank Research 10,000 12,000 14,000 16,000 85 90 95 100 105 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 USD/JPY Nikkei, rhs Nikkei and JPY: The recent correction was overdone and the Abenomics trade of short JPY/Long NKY is back in favour Bernanke tapering announcement Source: Bloomberg Finance LP, Deutsche Bank Research 12 We remain positive on Abenomics even though structural reform efforts may fall short of expectations Japan - 2Q 2013 GDP preview 19 July 2013
  14. 14. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  US data remains generally strong… − Home sales & housing starts at highest since mid-2008, prices continue to rise; homebuilder sentiment at highest end-2005 − Labour market recovery continues, with private job creation around +200k per month and jobless claims down to early 2008 levels − Manufacturing activity strengthening, e.g., Philly Fed index at highest since Q1 2011, ISM Manufacturing back in expansion − Consumer confidence at highest since 2007 − But, IP and retail sales have disappointed  …and we remain fundamentally bullish on the US, with growth accelerating to 3%+ in H2 and 2014 − H1 softness due to one-off factors, i.e., poor weather and sequester-related spending cuts − Reduced fiscal uncertainty and continued improvement in housing and labour market 13 The US economy, meanwhile, remains on track for a decent recovery -1000 -800 -600 -400 -200 0 200 400 600 300 400 500 600 700 2007 2008 2009 2010 2011 2012 2013 Initial claims, 4-w ma, lhs Non-Farm Payrolls, rhs Jobless claims and change in non-Farm Payrolls continue to show a recovering labour market Source: DOL, BOL, Haver Analytics, Deutsche Bank Research ‘000 ‘000 0 10 20 30 40 50 60 70 80 02 03 04 05 06 07 08 09 10 11 12 13 US NAHB homebuilders index: largest monthly gain in a decade and highest print since end-2005 – evidence of resilience to rising rates Source: NAHB, Haver Analytics, Deutsche Bank Research
  15. 15. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Bernanke's statement on May 22 that the Fed would taper asset purchases if economic growth continued to improve sent markets down sharply. − Equities fell and credit spreads widened  Since mid-June, however, Bernanke has repeatedly emphasised that any tapering moves would be data-dependent − These dovish statements separated QE exit from the prospect of rate policy hikes − Equities rallied and credit tightened  Yields and rates volatility has stabilised as tapering is now priced and markets broadly accept that it will begin in Q3/Q4 2013 1,300 1,350 1,400 1,450 1,500 1,550 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Global equities (MSCI World Index) have retraced the losses that followed from the pricing-in of Fed tapering Index Source: Bloomberg Finance LP, Deutsche Bank Research 60 70 80 90 100 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Likewise, credit spreads have tightened back (example CDX IG) bp Source: Bloomberg Finance LP, Deutsche Bank Research 14 Stronger US data should allow the Fed to proceed with a gradual withdrawal of QE – which the markets have now come to accept Bernanke announces tapering Bernanke restates exit to be data dependent Bernanke announces tapering Bernanke restates exit to be data dependent
  16. 16. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  The Fed has explicitly laid out the Fed exit path – slowdown and subsequent end of QE, no asset sales, rate hikes only down the line  The more dovish tone from Bernanke in June separated QE exit from rate policy normalisation (the pricing in of rate hikes) – which was brought to a halt − Unemployment and inflation metrics presented as thresholds, rather than triggers for rate hikes – effectively delaying hikes − Weak inflation and adverse financial conditions concerns played up as arguments against exit  This has brought down near-term yields and pushed back rate hike expectations  In the meantime, investors will find it hard to reprice rate policy normalisation as long as the Fed’s messages conflict with improving macro data 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2013 2014 2015 24-Jul 24-Jun 01-May Markets started pricing in policy rate normalisation, but Bernanke’s dovish remarks put a stop to it. Implied Fed Funds rate % 1 Fed outlines exit path 2 Source: Bloomberg Finance LP, Deutsche Bank Research 1.2 1.6 2.0 2.4 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 US yield curve steepness (2s10s slope) bp Source: Bloomberg Finance LP, Deutsche Bank Research Policy normalisation as Fed outlines exit path Bernanke commentary brings normalisation to a halt 15 While maintaining the Fed’s exit bias, Bernanke signalled that rate hikes would come later, bringing rate normalisation to a halt Bernanke sounds more dovish
  17. 17. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  UK and Eurozone growth outlook remains weak vs. US, but the Fed’s exit triggered a rise in global bond yields  As a result, the ECB and the BoE are trying to decouple from the Fed  The ECB has adopted loose ‘forward guidance’ to keep rates low for an extended period – an unprecedented move − Markets are pricing a first rate hike for Q1 2016  The BoE announced a policy communication change after Carney’s first meeting as Governor which we expect will be some form of forward guidance − Markets are pricing a first rate hike for Q3 2015 16 In Europe the relatively weaker growth outlook has prompted the ECB / BOE to differentiate themselves from the Fed’s exit bias “The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time” ECB President Mario Draghi, July 4 “this increase in (market) interest rates represented an unwelcome tightening in monetary conditions that, were it to persist, would risk hampering the emerging recovery” BoE July Meeting Minutes, July 17 0.5 1.0 1.5 2.0 2.5 3.0 Nov 12 Jan 13 Mar 13 May 13 Jul 13 USD 3Y1Y EUR 3Y1Y GBP 3Y1Y 3Y1Y* forward swap rates indicate a sooner and faster hiking cycle in the US than in the UK and the Eurozone Markets expect first Fed hike in H1 2015, before the first BoE hike in Q3 2015 and the ECB in Q1 2016 * Market-implied 1Y rate in 3 years timeSource: Bloomberg Finance LP, Deutsche Bank Research
  18. 18. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  We expect the US 10Y yield to sell-off by another 100bp+ by end-2014 when the Fed hiking cycle is fully priced-in  However, for now, US yields are fairly priced based on fundamentals – making further repricing unlikely at this stage − US 10Y yields will only break higher (e.g., above 2.75%) on stronger data and a pick-up in inflation, which will take a few months − In the meantime, treasuries should trade range- bound  In Europe the ECB and BoE forward guidance will effectively keep short-term rates low − Longer-term yields will only sell-off in response to rising US yields  Volatility should continue to decline as rates become range-bound 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 10 20 30 40 50 60 70 80 90 100 2005 2006 2007 2008 2009 2010 2011 2012 2013 US Surprise Index UST 10y (RHS) US 10Y yield vs. US data surprise index: 10Y treasuries now in line with US macro data; expect 10Y treasuries to trade range-bound Source: Bloomberg Finance LP, Deutsche Bank Research -8 -6 -4 -2 0 2 4 6 2004 2006 2008 2010 2012 2014 2016 Fed Funds rate (actual) Fed Fund path (market pricing) Fed rate implied by Fed's Crisis Taylor Rule and forward guidance US Short-term rates: yields are at fair value based on forward guidance and expected unemployment and inflation rates % Source: Bloomberg Finance LP, Deutsche Bank Research 17 Against this macro and central bank backdrop, we expect core US & Europe rates to stabilise and volatility to remain contained
  19. 19. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  50% of S&P500 companies have reported 2Q earnings so far  Reporting season is disappointing, with EPS beats close to historic average but revenue beats at their lowest since 2009 − 61% of companies beat on EPS, with a surprise of 3.5% – in line with previous quarters  However, only 35% of companies have beat on revenues, with a surprise of 0.9% − Weakness in China, business spending, trade and stronger dollar are weighing on the top line  Financials are dominating EPS beats to date − 79% of Financials have beat on EPS, with a surprise of over 11% − Non-financials disappoint, with a weighted EPS surprise of 0.7%  Investors have priced in the macro recovery story for H2 – with valuations in many sectors implying stronger sales growth, equities remain vulnerable to a delay in our expected upturn in global growth 18 In Q2 US Earnings, EPS growth beats are being driven by Financials while revenues are broadly missing expectations 35% 45% 55% 65% 75% 85% 2001 2003 2005 2007 2009 2011 2013 EPS Revenue EPS LTA Rev. LTA S&P 500 earnings beats are in line with their LT average but revenues are coming in well below expectations 65% 62% 3.5 0.7 -15 -10 -5 0 5 10 15 EPS Surprise Overall Surprise Ex-Fin Surprise Overall surprise to date of 3.5% comes mostly from Financials; ex- financials, the EPS surprise is only 0.7% xx Proportion of companies beating (%) Source: Bloomberg Finance LP, Deutsche Bank Research 79 59 58 71 36 66 0 33 44 China slower for longer: 25 China cyclical stocks in the S&P 500 11 July 2013
  20. 20. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Asset Class View Rationale Equities  US: fundamentally bullish long-term  Bullish view on the back of improving macro backdrop, EPS, DPS and P/E expansion  S&P could dip below 1,600 over the summer as earnings season fails to impress, providing attractive entry opportunities  Europe: strategically bullish  Increasingly confident on European growth turnaround, sell-offs provide attractive entry points  EM: bearish  EM to continue multi-year derating vs. the DM amid structural weakness, poor cash flow generation and unwinding of central bank induced inflows Rates  Strategically bearish core rates – but neutral in short-term  Improving global macro outlook to see core rates drift higher  In short-term, though, adopt neutral stance in US and Europe as central bank guidance keeps front-end yields anchored, and a rise in long-end yields will only come with a substantial improvement in data FX  Long USD  Entering a multi-year uptrend as a result of US growth resurgence, China economic rebalancing, higher real yields and change in USD / risk correlation (to positive correl.)  Short GBP, CHF, JPY (vs. EUR and USD)  GBP: stronger data should translate into weaker flow while monetary policy stays loose  CHF / JPY: return of capital outflows from Swiss / Japanese who are substantially underweight foreign assets, ultra loose monetary policy in Japan Credit  Tactically positive short-term  Credit should benefit in the short-term from the decline in volatility  Fundamentally, though, rising yields and steepening of curves are negative for credit EM  Normalisation process to be more gradual  Expect normalisation process to continue more gradually, with risks more two-sided  The more accommodative stance supports lower volatility, a deceleration of outflows (and possibly a return of inflows), and further retracement across EM assets Commodities  Overall neutral to bearish  Super-cycle is over. Global growth will be supportive, but new productive capacity is coming on stream and USD strength limits upside, especially in Oil over medium term Asset Price Views 19
  21. 21. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 2 Special report – China’s Rebalancing Act 1 The House View –July 25 2013: Waiting for growth
  22. 22. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 The House View – China’s rebalancing act Over recent months, weaker-than-expected data and a spike in interbank rates has seen downward revisions to consensus growth forecasts for China. This weakening momentum has been accompanied by a resurgence of China ‘hard landing’ fears on the back of near-term financial risks as well as the longer-term structural challenges faced by the economy We believe the ‘hard landing’ fears are overstated and remain confident that China has sufficient policy flexibility and financial firepower to prevent a systemic crisis. Growth over the coming years will, however, slow relative to the past decade as the government attempts to rebalance the economy away from investment and export-led growth to one driven by consumption. Nevertheless, China will remain a key driver of global growth although the beneficiaries of the past decade, such as commodity exporters, are likely to be replaced by sectors that are more levered to trends such as clean energy, urbanisation and the Chinese consumer The government’s challenge of transforming China’s business model while delivering sufficient near- term growth to ensure social stability means that this is both China’s most important period of reform as well as its most dangerous. As a result the risks to our above-consensus base case are skewed to the downside. The absence of a meaningful recovery in the US and Europe is a key risk over the coming quarters for the Chinese economy, as a stronger external environment would provide the government with the much needed ‘breathing space’ to push through reform efforts in support of rebalancing 21
  23. 23. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 0 1 1 2 2 3 3 4 1980 1990 2000 2010 Largest holder of FX reserves tn $ $3tn increase over past 10 years 22 China has grown into a dominant economic force over recent decades 0 2 4 6 8 10 12 0 10 20 30 40 50 60 70 80 1981 1988 1995 2002 2009 2016 Poverty % of population, lhs GDP/Capita, rhs ~500m people lifted out of poverty Beijing Shanghai Hong Kong *Living on less than 1.25US$ per day (as per World Bank) Source: UN Populations Division, World Bank, IMF, PBOC, Haver Analytics, Deutsche Bank Research CHINA 11 18 25 33 0 5 10 15 20 25 30 35 80's 90's 2000's* Past 3 years Largest driver of global growth *2009 contribution excluded being an outlier China contribution to global GDP growth% 0 2 4 6 8 10 12 14 16 1990 1995 2000 2005 2010 China Germany Japan US Largest trading nation % of world exports 0 5 10 15 1980 1990 2000 2010 % China share of world GDP Share of world GDP doubled in 6 years
  24. 24. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 23 China’s rapid ascent has seen it become a driving force across several markets Source: Global Insight, Haver Analytics, IMF, McKinsey, UN Populations Division, Deutsche Bank Research 57% 46% 38% 30% 29% 27% 24% 23% 21% 19% 17% 11% 11% 10% 8% 7% 3% 0% 0% 0% 20% 40% 60% 80% 100% China has #1 share of global total China does not have #1 share of global total China share of nominal global GDP Commodity Intensive growth Overdependence on investment Limited financial market depth / excess dependence on banks Emerging middle- class supportive of global brands High levels of carbon pollution Lowest private consumption of any major economy China is a large driver of various global indicators (China as % of global) Note: ^Luxury goods include fashion ready to wear, shoes, handbags, watches, and fine jewellery **ex Macau and HK, *Contribution of Chinese demand to global oil demand growth is forecast at 41% in 2013
  25. 25. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Chinese growth has surprised to the downside and is on track this year to be at its lowest since 1990 − Consensus estimates see growth at its slowest since 1990 at 7.5% − Average China growth since 1990 is 10%  Growth has slowed in 11 out of the last 14 quarters. Q2 13 growth was 7.5% yoy, down from 7.7% in Q1 − Weak overseas demand weighed on output − Retail sales (+13.3% yoy) were a positive surprise as consumption recovered from the earlier shock of an ‘anti corruption’ crackdown 24 However, growth has slowed and is on track this year to be at its weakest since 1990 11.9 9.8 7.9 10.3 9.6 9.7 9.5 9.1 8.9 8.1 7.6 7.4 7.7 7.5 4 6 8 10 12 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 13 Q4 13 Q1 13 Q2 13 Weaker Stronger Growth has slowed in 11 out of last 14 quarters % yoy Source: Bloomberg Finance LP, Deutsche Bank Research 1 3 5 7 9 11 13 15 90 92 94 96 98 00 02 04 06 08 10 12 13F BBG Consensus Actual GDP Avg. since 1990 China GDP growth is on track to be the weakest in over 20 years % yoy Source: Haver Analytics, Bloomberg Finance LP, Deutsche Bank Research “I don’t think China will be able to sustain a super- high or ultra-high speed of growth and that is not what we want. China’s model of development is not sustainable.” President Xi Jinping, April 2013 China: Q2 GDP slowdown to prompt modest policy easing 15 July 2013
  26. 26. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 35% 47% 46% 36% 16% 14% 2% 3% 0% 20% 40% 60% 80% 100% 2000 2012 Investment Private consumption Public consumption Net exportsYuan 9.9tn Yuan 51.7tn Investment now accounts for ~half of GDP Consumption increased 3.8x, but share of GDP fallen Source: Haver Analytics, Deutsche Bank Research Contribution to GDP: even as GDP has grown, consumption’s share has declined; growth remains investment driven  As the crisis decimated export demand, China relied on a mixture of investment, credit and fiscal stimulus to underpin growth − Investments spending/GDP grew to 47% from 35% in the decade to 2012 − Real private consumption has grown 3.8x in absolute terms, but contribution to GDP dropped to 36% from 46% by 2012  A growth model based on investment raises the risk of capital misallocation and overcapacity − Investment supports growth at time of expenditure but has limited impact on future growth − Promotes overcapacity and declining cash returns …e.g., MSCI China has underperformed the S&P 500 by ~51% since 2011 − If continued, losses or Non Performing Loans (NPLs) will arise risking corporate bankruptcies, default, and rising unemployment 25 China’s challenge is to move away from its investment and export-driven growth model… 0% 2% 4% 6% 8% 10% 12% 14% 16% CROCI ex Goodwill Implied LT CROCI Source: Deutsche Bank Research CROCI* for China / HK stocks highlight that cash returns for listed companies have declined over the past decade *CROCI: Cash return on cash invested, a cash-flow based metric for evaluating earnings.
  27. 27. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  China must navigate a shift away from export and investment dependence and towards consumption- led growth, a more sustainable economic model − Will make economy less vulnerable to exogenous shocks − Adjusts focus to sustainable long-term growth  Reforms are necessary to facilitate this transition − Develop a reliable social safety net − Reform the tax system to reward consumption − Financial reform for efficient allocation of capital − Deregulation, subsidy removals and so on 26 … to a consumption driven model that delivers more stable growth that is less vulnerable to exogenous shocks 18% 24% 47% 65% 58% 36% 19% 19% 14% -2% -1% 3% -20% 0% 20% 40% 60% 80% 100% G7 Average BRICS (excl China) China Investment Private consumption Public consumption Net exports Source: Haver Analytics, Deutsche Bank Research China’s economy is much less skewed to consumption and more skewed to investment relative to the G7 and other BRICS 32% 68% 8.9% 91.1% Savings Consumption A higher proportion of disposable income is saved in China, a reflection of the limited social safety net relative to the G7 Source: Haver Analytics, Deutsche Bank Research G7 China “China’s economic performance over the past three decades has been remarkable, a testament to its ability to implement necessary but difficult reforms. Continued success now needs another round of decisive measures” IMF June 27 2013 as % of disposable income
  28. 28. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 0 10 20 30 40 50 60 70 80 90 100 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Source: Google Trends, Deutsche Bank Research Google trends search for ‘China hard landing’: after receding in H2 2012 concerns have resurfaced over recent months Google Search (Monthly) (Index 100 = historical peak for the term search) Rising concerns over ‘China hard landing’ 27 A sharper-than-expected fall in growth, or ‘hard-landing’, has resurfaced as a concern over recent months  A ‘hard-landing’, which we define as sub-6% growth, risks rising unemployment which stokes social unrest that undermines the rebalancing goal  However, the government says it is on track to achieve its official growth target of 7.5%  There may be some flexibility around the target − Premier Li Keqiang reportedly said that growth shouldn’t be allowed to slip below 7%  The fall in growth has reignited concerns of near- term risks and long-term structural challenges. Among the common concerns are: 1. Poor demographics 2. Higher wages and RMB appreciation 3. Anti-pollution measures will slow growth 4. Rebalancing away from investments 5. Imminent financial crisis GEP - Addressing China Bears 19 July 2013
  29. 29. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 28 Concern 1: China’s demographics imply that it will get old before it gets rich  China’s working-age population will peak in 2015 at 1,015m − Dependency ratio will rise to 63 in 2050 from 37 today, placing a greater burden on the workforce given the limited levels of social security  China will be among the first countries in the world to get old before it gets rich − When ~25% of population is over 60, per capita incomes will be, at best, roughly one-third of that in developed economies  Growth will be driven by urbanisation, which will peak at about 970m people in 30 years − Greater labour productivity and growth in services will support higher incomes  Reforms will facilitate this process − Agricultural modernisation can free up under- utilised labour from rural areas − Relaxing Hukou* system can provide security for 250m migrant workers, boosting consumption by 2-3%** of GDP and reduce savings 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1975 2000 2025 2050 2075 2100 Working Population After peaking in 2015, the population will decline by ~27% in the next 50 yrs Bear case: China’s total working population will peak in 2015 bn Source: UN Populations Division, Haver Analytics, Deutsche Bank Research 0.1 0.3 0.5 0.7 0.9 1.1 1980 1990 2000 2010 2020 2030 2040 2050 Urban Population Rural Population Our view: urbanization will be a growth driver, unlocking surplus rural resources and boosting labour productivity bn Source: World Bank, Deutsche Bank Research *Hukou system is a record that identifies a person as a resident of an area and limits mobility by restricting social services to that area i.e., many rural migrants forego benefits when they relocate to cities from rural areas ** World Bank estimate
  30. 30. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 29 Concern 2: Higher wages and RMB appreciation will curb exports 6 7 8 9 2000 2002 2004 2006 2008 2010 2012 USD CNY Bear case: Chinese Yuan continues to appreciate Source: Bloomberg Finance LP, Deutsche Bank Research  Wage growth is moderating – real wages grew 13% p.a. pre-crisis and have been growing at ~9% since  Wage growth is being partially offset by higher productivity  Exports are moving up the value chain and are becoming less dependent on low wages and a cheap currency  RMB appreciation set to slow over the coming quarters, easing pressure on exports 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 00 01 02 03 04 05 06 07 08 09 10 11 Machinery and transport equipment Electronic data processing and office equipment Telecommunications equipment Integrated circuits and electronic components Automotive products Source: WTO, Deutsche Bank Research Our view: Exports as a % of global total - China is moving up the value chain through upgrading its manufacturing infrastructure  Chinese exports are becoming less competitive due to higher wages and a stronger currency − Unit labour costs in Chinese manufacturing rose to 50% of US level in 2009 from 29% in 2003 − The RMB has appreciated >30% over the past decade against the USD  Weakness in exports has been a major factor in China’s recent economic weakness (although much of this is due to the external slowdown)
  31. 31. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 30 Concern 3: Reforms to contain high levels of pollution will result in substantially lower growth  Government will pursue constructive structural change that will not slow growth, e.g., faster adoption of clean technologies, public transport  Impact will vary by sector but net GDP impact is neutral − Autos and coal to suffer at the expense of construction, railways and cleaner energy  Policies will improve the overall structure and sustainability of the economy  Pollution in parts of China has reached critical levels this year; empirical studies* highlight the impact on the potential workforce − Cut life expectancy by an average of 5.5 years − Air pollution in the north cost 2.5bn years of total human life expectancy during the 1990s; equivalent to one-eight of the workforce  Fears that efforts to curb pollution risk a substantial slowdown in growth 75 35 128 20 15 8 0 20 40 60 80 100 120 140 China Today China 2030 (reform) China 2025 (no reform) UK US Australia Source: WHO, NASA, Deutsche Bank. * Based on empirical research from Kings College London Bear case: Pollution in Beijing is at dangerous levels and poses a threat to growth in China μg/m3 annual average Reductioninlife expectancyof5.3years* WHO standard (25) -300 -200 -100 0 100 200 300 Our view: Change in GDP from baseline as a result of anti-pollution policies, 2020 (in 2011 Price, RMB bn) Source: Deutsche Bank Research * ‘Evidence on the impact of sustained exposure to air pollution on life expectancy from ‘China’s Huai River policy’, Proceedings of the National Academy of Sciences, May 2013 Made in China - Big bang measures to fight air pollution (2nd edition) 9 June 2013
  32. 32. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 0 10 20 30 40 50 60 70 80 2004 2005 2006 2007 2008 2009 2010 2011 2012 Other services Manufacturing Real estate Infrastructure Mining Agriculture % of GDP Source: Haver Analytics, Deutsche Bank Research Our view: there is scope for investment expenditure to be targeted towards agriculture and services 31 Concern 4: China’s rebalancing from high levels of investment will result in a crisis  China has levers to prevent a crisis from becoming systemic − Largest FX reserves in the world − Government control of major banks ensures continued flow of interbank credit − Redirect investment to sectors where impact would be greater e.g., agriculture / services  Unlike Asia crisis countries, China not reliant upon external funding, while China has much greater scope for catch up growth than Japan post 1990 20 30 40 50 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 China (2002-12) Japan (1980-89) S Korea (1988-1997) Thailand (1993-2002) Source: Haver Analytics, Deutsche Bank Research Bear case: China’s investment levels (as a % of GDP ) are far greater than other Asian economies during economic take-off  Sustained periods of high investment enabled Asian economies to achieve faster growth, but this has typically led to banking / foreign exchange crises − Japan’s growth has averaged ~1% since 1991 compared to 4.65% in the previous decade − Thailand (-10.6%) and South Korea (-5.7%) experienced sharp GDP contractions in 1998 as foreign capital dried up during Asian crisis  China’s near 50% investment rate is far larger than other Asian economies during their take-off periods Agriculture / services make up ~60% of the economy but received only ~25% of incremental investment since 2004
  33. 33. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 32 Concern 5: a financial crisis is imminent due to higher leverage, a rise in shadow banking and risk of rising NPL’s  PBOC’s tolerance of recent interbank lending spike is a sign of policy shifting to limit ‘off-balance sheet lending’ and shrink the ‘shadow banking system’  WMP systemic threat is low as risks lie mainly in smaller regional banks, not large state driven banks  Credit to corporates and local governments is overstated as many outstanding loans being used to pay off old debts rather than for new investment  NPLs are at 1%, below earlier projections and in line with a typical cyclical downturn  Since 2008, non-traditional credit has risen by 5x and shadow banking by 6x − Lending is less liquid, less well capitalised, and less transparent, thus raising risk of a broader systemic crisis e.g., investors have flocked to Wealth Management Products (WMPs), that offer higher yield than deposits, in the belief that they will be honoured in any outcome  Risks are concentrated in the less-regulated regional smaller and mid-tier banks 72 26 25 0 20 40 60 80 100 120 Traditional loans Non-traditional credit (on balance sheet) Shadow banking (off balance sheet) Source: Haver Analytics, Deutsche Bank Research Bear case: The disproportionate rise in credit among the non- traditional and shadow sectors presents systemic financial risks RMB tn, 2012 2x 6x5x Growth since 2008 2 4 6 8 10 12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 7d Repo 1m Shibor 1 yr Depo Source: Haver Analytics, Deutsche Bank Research Our view: The PBoC did not intervene to offset the Chinese inter- bank lending spike In June as a warning to lenders % GEP - On Shibor 28 June 2013
  34. 34. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Interest rate liberalisation is crucial if capital is to be allocated efficiently  Currently, the financial system privileges less efficient state-owned enterprises (SOEs) at the expense of a more dynamic private sector − Private loans can cost >3X of SOE loans  The system also penalises household savings by paying very low interest rates  Flexibility in setting rates would be beneficial − Higher deposit rates would limit the growth of shadow banking and support consumption… − … and would lead to higher lending rates and improved capital allocation − However, this must be done gradually as a rapid shift could result in a sharp reallocation of credit away from SOE’s causing a credit crunch  The Communist Party Congress in October may announce an ambitious set of financial reforms China Bank Deposit / Loan Rate Primer  Chinese financial system takes household deposits at near-zero rates and lends these out to state-owned companies at low real interest rates  The system subsidises investment by SOEs, which risks contributing to industrial overcapacity and increasing costs for private firms  Deposit rates in China are set by the PBoC and often imply negative real returns for savers  Loan rates are completely deregulated but in practice banks charge very close to the benchmark rate of ~5%  Negative real rates have supported non-traditional and shadow-banking as investors redirect savings to higher yielding alternatives e.g., WMPs 33 Going forward, liberalising interest rates is a critical step towards enabling the efficient allocation of capital 0 5 10 15 20 25 30 2009 2010 2011 2012 2013 Benchmark 1 yr loan rate Benchmark 1yr Deposit rate Avg WMP yield Privare bank loan rate Official and ‘shadow market’ interest rates diverge significantly % Source: CEIC, Deutsche Bank Research Lending rate liberalization and next steps 19 July 2013
  35. 35. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  We expect growth of 7.6% in 2013 on a cyclical, not structural slowdown  Growth to bottom in Q3 before recovering from Q4 onwards − End of destocking − Normalisation of bank lending behaviour − Slowdown in RMB appreciation − Gradual pick up in G3 economies will contribute to a recovery in export growth  Government tolerance for lower GDP growth is not unlimited. Incremental policy easing steps are likely − Financing support for infrastructure, environmental, and new energy projects − Fiscal subsidies for clean power − RRR* cut for smaller banks and better access for developers to capital markets -80 -60 -40 -20 0 20 40 60 30 35 40 45 50 55 60 65 2005 2006 2007 2008 2009 2010 2011 2012 2013 US , EU Orders, lhs China exports, rhs Improving ‘G2’ manufacturing orders will boost Chinese exports Source: Haver Analytics, Deutsche Bank Research % qoq, saar 34 Chinese growth will stabilise from Q4 amid mild policy support and stronger US / Europe * RRR is the reserve requirement ratio, or the minimum fraction of customer deposits and that each commercial bank must hold as reserves rather than lend out Stay positive on 2014 despite SHIBOR shock 9 July 2013
  36. 36. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  Several major trends have many years to play out:  Shale gas could transform the Chinese economy − China has the most promising reserve assets − China could account for 40% of growth in global output of shale over the coming decades  Internationalisation of the RMB − China is 10% of world GDP and 10% of exports − Yet the RMB represents only 0.9% of global FX turnover and < 0.1% of global reserves. − A truly international RMB will enable China to diversify its reserves away from the USD and enhances the country’s ‘soft power’  Rising middle class consumption in China − China’s private consumption expenditure in 2010 was 38.5% of the US level − There is substantial room to grow, especially as the economy rebalances away from investment − China overtook US auto sales in 2009 35 In the longer-term, trends such as RMB internationalisation, shale gas and the rising middle class will play out Source: Deutsche Bank Research, Haver Analytics, Penn world tables OECD %, distribution of global middle class 2009 2030E APAC Africa & ME N. America Europe S. America Significant growth in Asian middle class 0 20 40 60 80 100 USD EUR JPY GBP AUD CHF CAD HKD SEK NZD KRW SGD NOK INR RMB The RMB is a negligible share of global FX turnover %, global currency turnover
  37. 37. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465  The beneficiaries of the past decade, such as commodity exporters, are set to be replaced by sectors more levered to trends such as clean energy, urbanisation and the Chinese consumer  Key winners and losers of China rebalancing − Positive for US as key exports to China are aircrafts and high tech computer goods − Positive for India, commodity poor (benefits from lower prices) with low China exposure − Negative for hard commodity exporting economies such as Australia, Brazil, Chile, although agricultural commodity exporters to benefit  Winning sectors include − Sectors linked to clean energy e.g., Gas − Sectors linked to urbanisation e.g., utilities − Sectors linked to emerging middle class e.g., banking, healthcare, luxury, education 36 China’s rebalancing will impact the world economy, as winners of the past model, e.g., commodity exporters, are replaced -7% 0% 7% 14% Banking *(including interest rate liberalization) Mining of ferrous metal Mining of non-ferrous metal Chemical raw materials Steel industry Urban public transport Telecom Medicine products Banking Electricity Health Education Refined oil Water Gas Reforms will benefit certain sectors and hurt others (% change in pre-tax margins from baseline) Source: Deutsche Bank Research 0 50 100 150 India Chile Indonesia Thailand Brazil Germany Australia US EU Korea Japan Exports to China in 2012 (USD bn) % of GDP 2.4% 11.6% 0.7% 0.8% 4.9% 1.9% 1.7% 7.3% 1.1% 7.0% 0.8%
  38. 38. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 DB forecasts 37 GDP growth (%) 2011 2012E 2013F 2014F Global 3.8 2.9 2.8 3.8 US 1.8 2.2 1.8 3.2 Eurozone 1.5 -0.6 -0.6 1.0 Germany 3.0 0.7 0.1 1.5 Japan -0.5 1.9 2.0 0.6 UK 1.1 0.2 1.1 1.8 China 9.3 7.8 7.6 8.5 India 7.5 5.1 5.0 6.0 EM (Asia) 7.5 6.1 6.1 7.0 EM (Lat Am) 4.3 2.8 2.6 3.3 EM (CEEMEA) 4.9 2.8 2.7 3.5 EM 6.4 4.8 4.7 5.6 DM 1.4 1.2 1.1 2.1 * CPI (%) forecasts are period averages CEEMEA: Czech Rep., Hungary, Poland, Russia, Turkey, South Africa, Israel, Romania, Kazakhstan, Ukraine, Egypt, Saudi Arabia and UAE LATAM: Argentina, Brazil, Chile, Colombia, Mexico, Venezuela ASIA: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand DM: US, Japan, Euro area, UK, Denmark, Norway, Sweden, Canada, Australia, New Zealand, Switzerland Key market metrics Current Q3-13 Q4-13 Q1-14 US 10Y yield (%) 2.58 2.50* 2.50* 3.00# EUR 10Y yield (%) 1.65 1.55 1.75 2.00^ EUR/USD 1.320 1.26 1.20 1.19 USD/JPY 100.1 102 110 111 S&P 500 1,686 – 1,675 1,850# Stoxx 600 301 – 315 Gold (USD/oz) 1,318 1,350 1,300 1,350 Oil WTI (USD/bbl) 105 95 97 98 Oil Brent (USD/bbl) 107 105 107 107 *H2 2013, # end 2014, ^Q2 2014 Current prices as of 25 July 3.00 GMT CPI inflation, YoY* (%) 2011 2012E 2013F 2014F US 3.1 2.1 1.7 2.3 Eurozone 2.7 2.5 1.5 1.5 Japan -0.3 0.0 -0.1 2.3 UK 4.5 2.8 2.7 2.1 China 5.4 2.6 2.6 3.5 India 9.5 7.5 5.2 5.5 Central Bank policy rate (%) Current Q3-13 Q4-13 Q1-14 US 0-0.25 0-0.25 0-0.25 0-0.25 Eurozone 0.50 0.50 0.50 0.50 Japan 0-0.1 0-0.1 0-0.1 0-0.1 UK 0.50 0.50 0.50 0.50 China 3.00 3.00 3.00 3.00 India 7.25 7.00 6.50 6.50
  39. 39. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Appendix 1 Important Disclosures Additional Information Available upon Request Analyst Certification This report covers more than one security and was contributed to by more than one analyst. The views expressed in this report accurately reflect the views of each contributor to this compendium report. In addition, each contributor has not and will not receive any compensation for providing a specific recommendation or view in this compendium report. Raj Hindocha/Marcos Arana Attribution The Author of this report wishes to acknowledge the contributions made by Shakun Guleria and Pravin Kumar, employees of Infosys Technologies Ltd., a third party provider to Deutsche bank offshore research support services. For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. 38
  40. 40. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Regulatory Disclosures 1. Important Additional Conflict Disclosures Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the “Disclosures Lookup” and “Legal” tabs. Investors are strongly encouraged to review this information before investing. 2. Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank’s existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com. 3. Country-Specific Disclosures Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively. 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For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements. 39
  41. 41. Research Deutsche Bank Research The House View –July 25 2013, TheHouseView@list.db.com, +44 207 545 8465 Global Disclaimer The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank"). The information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy or completeness of such information. Deutsche Bank may engage in securities transactions, on a proprietary basis or otherwise, in a manner inconsistent with the view taken in this research report. In addition, others within Deutsche Bank, including strategists and sales staff, may take a view that is inconsistent with that taken in this research report. Opinions, estimates and projections in this report constitute the current judgment of the author as of the date of this report. 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