Outlook 2013 n Global Outlook: Welcome to the QE Planet (December 17th, 2012) For important disclosures, refer to the Disclosure Section, located at the end of this report. For important disclosures, refer to the Disclosure Section, located at the end of this report.
Outlook 2013 Executive Summary and Asset AllocationAsset Classes Benchmark Current AllocationEquities 45.0% 47.5% • The macro picture is supportive: Global real GDP growth UK 3.0% 3.2% Europe 7.0% 8.0% in 2013 is expected to be quite similar to 2012. Recent North America 24.5% 24.5% measures have contained the euro area crisis. This has Japan 3.0% 4.0% Asia 5.5% 5.5% decreased the risk of financial spillovers from Europe to Global Emerging Markets 2.0% 2.3%Government Bonds 27.5% 24.5% other regions; UK 2.0% 1.5% • Central banks are helping too: Quantitative Easing should Europe 9.0% 8.0% United States 7.0% 6.0% remain a key theme in 2013, involving central bank Japan 3.5% 2.0% Dollar Bloc 1.0% 1.0% balance sheet expansion in the US (QE3), the euro area, EM Local Currency EM Hard Currency 3.0% 2.0% 3.5% 2.5% the UK and in Japan (the country is moving to a currentInflation Indexed Bonds 2.5% 2.5% account deficit); UK 1.0% 1.0% Europe 0.5% 0.5% • QE should continue to be positive for equities (growth United StatesCorporate Bonds 1.0% 10.0% 1.0% 10.5% plays, companies with an inflation‐link, GEM consumerSterling IG 0.5% 0.5% plays), real estate (Germany property, Japanese REITS andEuro IG 2.0% 2.0%US inv grade 6.0% 6.0% US housing) and commodities (mainly precious metals,US high yieldCommodities 1.5% 5.0% 2.0% 5.0% including gold); Agriculture 1.0% 0.5% • Although there remain risks to the macro outlook (e.g. US Livestock 1.0% 1.0% Energy 1.0% 1.0% fiscal consolidation), DM governments bond yields are Industrial Metals 1.0% 1.0% Precious Metals 1.0% 1.5% too low. Bonds are likely to underperform equity.Total Real Estate 5.0% 5.7% However, a large rise in yields is not expected due to UK 0.5% 0.5% Europe 0.5% 0.4% continued easy monetary policy by central banks and United States 2.5% 2.5% Japan 0.5% 0.8% financial repression; AsiaCash 1.0% 5.0% 1.5% 4.4% • A still high equity risk premium suggest that equitiesVolatility 0.0% 0.5% could outperform credit in 2013.
Outlook 2013 ‐ Macro Overview USUS: Private sector vs. Government sector• 2013 is expected to show a pace of growth very similar to 2012. Even considering that the fiscal cliff is mostly averted, the government sector is expected to continue to contract;• However, the private sector in the US should be able to support growth at around 2%. Bank credit is rising, activities measures of US housing are recovering fast (important for household wealth and banks’ balance sheets) and some pent‐up demand release could help to offset the fiscal retrenchment;• The uncertainty generated by the fiscal cliff hit business Housing Starts & NAHB Homebuilders Index 2600 90 spending. If the Congress reaches an agreement, a 80 rebound in business investment is likely; 2200 70• The FOMC central tendency of 2013 annual average 1800 60 GDP growth is 2.3%‐3.0%, with core PCE inflation 50 remaining below 1.9%. So, monetary policy is expected 1400 40 to remain accommodative, as the Fed continues to 1000 30 focus on growth; Housing Starts (000s Annualized, LHS) 20• The US economy is expected to continue outperforming 600 10 Europe, reflecting different policy choices in managing NAHB Housing Index (Adv. 4m, RHS) 200 0 the deleveraging process, provided near‐term fiscal 90 91 92 93 94 95 96 97 99 00 01 02 03 04 05 06 07 08 09 10 12 13 tightening is gradual. Source: National Association of Home Builders and US Census Bureau
Outlook 2013 ‐ Macro Overview US“Fiscal cliff”: Negotiations are still ongoing US Fiscal Deficit (% of GDP) 10.4%• The economy has continued to grow at a modest annualized rate of around 2.0% to 2.5%, despite massive 8.7% 8.2% money printing and large budget deficits. A deal to avert the “fiscal cliff” would remove the risk of the US 4.8% economy falling back into recession. November´s 3.5% 3.3% elections didn’t change the political landscape much. 2.1% 2.5% Nevertheless, both the Democrats and Republicans 1.5% 1.3% agree that, unless they change the current law, a huge tightening in fiscal policy will push US back into 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Bloomberg recession;• The bulk of the tax cuts bill is likely to be renewed and the bulk of the spending cuts will probably be postponed. However, some measures are still expected to expire, which means that a tightening in fiscal policy is likely next year (extending the contraction that began in 2011). The government cannot run massive budget deficits indefinitely. Even if the “cliff” is avoided, Congress will need to agree on a package that would put the budget on a sustainable medium‐term path, to prevent the markets from losing patience and avoid a new round of credit rating downgrades. This is expected to happen sometime in 2013. Source: Congressional Budget Office
Outlook 2013 ‐ Macro Overview USThe Fed’s balance sheet is set to keep expanding in 2013 Feds Economic Projections • In 2012, the Fed announced an open‐ended QE3 (Central Tendency mid‐point) focused on MBS purchases ($40bn per month or 3.5 8.1 8.0 $480bn per year) until it judges that the outlook for the 3.0 7.9 labor market has improved substantially; 2.5 7.8• Moreover, the Fed replaced the expiring Operation 2.0 7.7 Twist with an expansion of QE3. It will continue buying 7.6 1.5 $45bn of Treasuries securities per month in 2013 (27% 7.5 will have maturities of between 20 and 30 years); 1.0 7.4 Dec 12 Sep 12 Jun 12 Apr 12 Jan 12 Nov 11• The two added means that the Fed’s balance sheet will Change in Real GDP (%, LHS) Core PCE Inflation (%, LHS) keep expanding in 2013. The purchase of securities will Unemployment Rate (%, RHS) boost the monetary base ($85bn per month or Source: Board of Governors of the Federal Reserve System $1,020bn per year). However, up to now, it has had little impact on broad money or prices;• At the end of its mid‐December meeting, the Fed also announced the adoption of numerical thresholds. Rates will be held at near‐zero as long as the unemployment rate remains above 6.5% and as long as projected inflation is expected to remain below 2.5%;• As 2013 progresses, focus will likely switch to whether Bernanke will retire in January 2014. If so, who will President Obama choose as his candidate to replace him as Chairman of the Fed? Source: Board of Governors of the Federal Reserve System
Outlook 2013 ‐ Macro Overview Euro‐zoneEuro‐zone: A modest recovery is expected in 2013• Recession in the Euro‐zone started at Q4 2011 and European GDP Growth Forecasts (%) persisted through 2012, with a severe contraction of IMF OECD EC Consensus IMF OECD EC Consensus 2011 2012e 2012e 2012e 2012e 2013e 2013e 2013e 2013e GDP in the southern European countries; Euro area 1.4 ‐0.4 ‐0.4 ‐0.4 ‐0.5 0.2 ‐0.1 0.1 0.1• Data for November brought some evidence that the France 1.7 0.1 0.2 0.2 0.1 0.4 0.3 0.4 0.2 growth of output is stabilizing in Europe. Leading Germany 3.0 0.9 0.9 0.8 0.9 0.9 0.6 0.8 1.0 indicators bottomed and have risen recently. However, Greece ‐7.1 ‐6.0 ‐6.3 ‐6.0 ‐6.5 ‐4.0 ‐4.5 ‐4.2 ‐3.4 Ireland 1.4 0.4 0.5 0.4 0.1 1.4 1.3 1.1 1.1 they remain in contraction territory. The Euro exchange Italy 0.4 ‐2.3 ‐2.2 ‐2.3 ‐2.3 ‐0.7 ‐1.0 ‐0.5 ‐0.7 rate appreciation since July’s lows could be a cause for Netherlands 1.0 ‐0.5 ‐0.9 ‐0.3 ‐0.6 0.4 0.2 0.3 0.3 some concern; Portugal ‐1.7 ‐3.0 ‐3.1 ‐3.0 ‐3.2 ‐1.0 ‐1.8 ‐1.0 ‐1.8• A modest “U‐shaped” recovery in growth is expected in Spain 0.4 ‐1.5 ‐1.3 ‐1.4 ‐1.5 ‐1.3 ‐1.4 ‐1.4 ‐1.5 2013. Nonetheless, the Euro area economy should Source: OECD Economic Outlook Nov 2012 Preliminary Version; EC Forecasts Autumn 2012; IMF WEO Oct 2012; Consensus from Bloomberg stagnate next year. Core economies such as Germany Change in Cyclically Adjusted Budget Balance in 2013, % of GDP and France (although fiscal consolidation is a key risk in 0 the case of the latter) should avoid recession in 2013;• By contrast, Italy, Greece, Spain and Portugal should ‐1 continue to contract, reflecting a combination of private sector deleveraging, austerity measures and tough ‐2 financing conditions;• A successful OMT implementation will probably be ‐3 decisive to ease financial conditions. The outcomes in the Italian and German elections could be important ‐4 France Germany Greece Ireland Italy Netherlands Portugal Spain sources of political risk in 2013. Source: European Commission, National Governments
Outlook 2013 ‐ Macro Overview Euro‐zoneEuropean Politics: The path to greater integration will be a long one• At the last EU Summit of 2012, European leaders Greece ‐ Main Macroeconomic Projections endorsed the compromise on the single banking 2012 2013 2014 2015 2016 supervisory mechanism. However, the ECB will only Real GDP (% y/y) Troika Mar 2012 ‐4.8 0.0 2.5 3.1 3.0 assume its supervisory tasks on 1 March 2014 or 12 Troika Nov 2012 draft ‐6.0 ‐4.2 0.6 2.9 3.7 months after the entry into force of the legislation, Primary Budget Balance (% of GDP) whichever is later. Moreover, all decisions on closer Troika Mar 2012 ‐1.0 1.8 4.5 4.5 4.5 fiscal and economic integration were postponed to June Troika Nov 2012 draft ‐1.5 0.0 1.5 3.0 4.5 2013; Source: IMF, European Commission• Meanwhile the Eurogroup’s decision on Greece lower Key Eevnts in 2013 its debt‐servicing costs and its stock of debt, and has US Europe Rest of World removed a significant risk factor from the market in the January 2013 Israeli Elections short‐term. However, the risk is that Greek programme February 2013 US Forecast to hit Debt Ceiling Italian Elections projections prove optimistic once again, which would March 2013 US Emergency 6‐month Budget Expires April 2013 put debt‐sustainability target into jeopardy; May 2013• 12 elections are scheduled to take place in 2013. June 2013 However, Italy and Germany’s election are likely to play July 2013 August 2013 a key role in the Euro‐zone debate. The main election September 2013 issue in Italy will probably be the nation’s austerity October 2013 German Elections programme. In Germany, the debate will likely focus on November 2013 how much the country should give up (in terms of December 2013 money and sovereignty) to save the currency union. Source: Fincor
Outlook 2013 ‐ Macro Overview Euro‐zoneWill the ECB ease policy further in 2013? ECB Key Interest Rates (%)• The ECB has shown its ability to evolve during the euro 5 ing Operations (Fixed Rate) area crisis. It has expanded its balance sheet as a 4 percentage of GDP since 2007;• At its December meeting, growth projections were 3 lowered markedly again. GDP is expected to fall by 0.3% 2 next year. Nonetheless, the ECB expects a recovery to set in H2 2013; 1• Given the weak economic outlook in Europe, the ECB 0 has left the door open to further Repo Rate cuts. 1998 2000 2002 2004 2006 2008 2010 2012 Negative deposit rates are also being discussed; Deposit Facility Main Refinancing Operations (Fixed Rate)• For now, the ECB is likely to hold steady. Monetary Source: Bloomberg conditions have already been eased considerably since the OMT was announced. Moreover, some leading indicators, such as purchasing managers’ indices have stabilized recently;• The near‐term focus will be on the Outright Monetary Transactions programme, as a measure to reduce market rates and effectively deal with one of the symptoms of the Euro‐zone crisis: high borrowing costs;• The Spanish government is still expected to request a precautionary programme, which would enable the ECB to start its bond purchase in 2013. Source: Bloomberg
Outlook 2013 ‐ Macro Overview Emerging MarketsEmerging Markets: Pace of structural reform is key• Given weak consumers in developed markets, emerging IMF OECD Consensus (*) IMF OECD Consensus (*) 2011 2012 2012 2012 2013 2013 2013 markets needs structural reforms. More importance Real GDP growth (%) should be given to the sources of domestic demand; Brazil 2.7 1.5 1.5 1.5 4.0 4.0 4.0• China is expected to show a moderate cyclical rebound Russia 4.3 3.7 3.4 3.6 3.8 3.8 3.5 China 9.3 7.8 7.5 7.7 8.2 8.5 8.1 in 2013. China´s leading indicators are pointing to faster India 6.9 4.9 4.4 5.5 6.0 6.5 5.8 growth over the next few months. Chinese policymakers Inflation (CPI) (%) will continue rebalancing the economy towards a more Brazil 6.6 5.2 5.3 5.3 4.9 5.3 5.5 Russia 8.4 5.1 5.0 5.2 6.6 6.4 6.7 sustainable growth model. With the political transition China 5.4 3.0 2.6 2.7 3.0 1.5 3.1 out of the way and the new leadership in place, India 8.9 10.2 10.0 7.6 9.6 7.7 8.5 delivering the structural reforms previously outlined will (*) Consensus from Bloomberg (*) Bloomberg, OECD Economic Outlook Nov 2012 Preliminary Version, IMF WEO Oct 2012 probably take centre stage;• In Brazil, an acceleration in growth is likely as the significant monetary stimulus boosts private consumption and fiscal policy consolidates at a looser stance. However, GDP growth could disappoint if the investment cycle remains sluggish;• Central and Eastern Europe is expected to lag, given the proximity to the weak Euro‐zone. Monetary policy should stay accommodative (excl. Russia), with further rate cuts expected for e.g. in Poland. The Euro‐zone crisis is likely to remain the dominant theme. Any positive news should benefit this region strongly. Source: Bloomberg, OECD Nov 2012 Preliminary Version; IMF WEO Oct 2012
Outlook 2013 ‐ Macro Overview PortugalPortugal: GDP is expected to contract for the third year in a row• The economy is expected to continue in recession, Bank of Portugal: 2012‐13 Projections (annual rate of change; %) Weights Autumn 2012 Summer 2012 reflecting the fiscal consolidation (heavy fiscal 2011 2011 2012 P 2013 P 2011 2012 P 2013 P tightening expected in 2013), and ongoing bank GDP 66.3 ‐1.7 ‐3.0 ‐1.6 ‐1.6 ‐3.0 0.0 Private consumption 20.1 ‐4.0 ‐5.8 ‐3.6 ‐4.0 ‐5.6 ‐1.3 deleveraging (private debts remain at high levels). Public consumption 18.1 ‐3.8 ‐3.9 ‐2.4 ‐3.8 ‐3.8 ‐1.6 However, net trade should provide some support; Gross fixed capital formation 103.8 ‐11.3 ‐14.9 ‐10.0 ‐11.3 ‐12.7 ‐2.6 Domestic demand 35.5 ‐5.7 ‐6.8 ‐4.5 ‐5.7 ‐6.4 ‐1.4• The plunge in domestic demand is expected to continue Exports 39.3 ‐5.3 ‐4.7 ‐2.3 ‐5.3 ‐6.2 1.5 and should contribute to a fall in imports (and to a trade Imports Contribution to GDP growth (in p.p.) balance improvement as % of GDP); Net exports 4.5 4.0 2.8 4.6 3.6 1.4• The unemployment rate is likely to continue rising. Domestic Demand ‐6.2 ‐7.0 ‐4.5 ‐6.2 ‐6.6 ‐1.4 Current account + Capital account (% of GDP) ‐5.3 ‐0.2 4.0 ‐5.2 ‐1.7 0.8 OECD expects the unemployment rate to increase Trade balance (% of GDP) ‐3.3 0.8 4.5 ‐3.2 0.4 2.5 towards 16.9% at the end of 2013 (OECD Economic Sources: Bank of Portugal, Economic Bulletin, Autumn 2012 104 104 Outlook, Nov 2012, Preliminary version); Quarterly Unit Labor Costs Q2 2009 ‐ Q2 2012• The economy will probably remain sensitive to a further 102 102 deterioration in domestic credit conditions and lower 100 100 demand growth in other euro area economies and export markets; 98 98• The authorities have announced new measures in the supplementary budget law for 2012 and the 2013 96 96 budget law. However, given the economic backdrop, a 94 94 further deficit overshoot seems likely. On a more Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 09 09 09 09 10 10 10 10 11 11 11 11 12 12 positive note, the current account should continue to Portugal Spain Euro area improve, reflecting some competitiveness gains. Source: OECD
Outlook 2013 ‐ Macro Overview SpainSpain: 2013 should be a challenging year• Spain returned to recession in 2012, albeit the rate of contraction has been probably less than was expected;• The country faces a difficult adjustment phase and structural shifts are required to restructure the economy (i.e. less domestic demand and more exports). But, important tough these reforms are, they do little to support output or employment in the near‐term;• The combined effects of fiscal austerity and private deleveraging should keep consumer spending weak in 2013. With bank deleveraging and credit tightness, Source: OECD Economic Outlook Nov 2012 Preliminary Version; EC Forecasts economic growth and public revenues are expected to Autumn 2012; IMF WEO Oct 2012 remain subdued. Fiscal policy should remain Spain Loan‐to‐Deposit Ratio contractionary in 2013, even though fiscal budget are 2.2 likely to miss targets; 2.0• Like Portugal, Spain is improving its competitiveness, which should help its already positive export 1.8 performance; 1.6• Spain´s external rebalancing is proceeding, as shown by the fast narrowing of its current account deficit. 1.4 However, the stock of external debt is one of Spain’s key 1.2 weaknesses and is still expected to lead the country to 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 request for sovereign support. Source: Bank of Spain
Outlook 2013 – Sovereign Bonds USUS Rates: Between the risk of a fiscal accident and a highly accommodative Fed US CPI vs. 5y Breakeven Inflation• At its December meeting, the Fed announced a 3 6 5 replacement of the expiring Operation Twist and further 4 2 balance sheet expansion. Monetary policy (via asset 3 purchase programmes) should continue to be used to 1 2 1 maintain the current low rate environment; 0• Further into 2013, a gradual move higher in yields is 0 ‐1 expected, as easy financial conditions lifts nominal ‐2 ‐1 ‐3 growth expectations; 2007 2008 2009 2010 2011 2012 2013• However, to trigger a sell‐off, it would probably take an 5y Breakeven Inflation (%, LHS) US CPI (% yoy, RHS) acceleration of growth, accompanied by higher inflation Source: Bloomberg, Bureau of Labor Statistics expectations. This would led to a re‐allocation of US 5‐year, 10‐year, and 30‐year TIPS Real Yields (%) investors into more risky assets. It would also reduce the 2.5 2.5 incentive for the Fed to continue with its QE 2.0 10Y 2.0 30Y programmes; 1.5 5Y 1.5 1.0• Where the US economy to enter a recession because of 1.0 0.5 the fiscal cliff, yields could decline further; 0.5 0.0• 2012 was a good year to TIPS. Real yields continued their 0.0 ‐0.5 downward trend and are now negative through the 20‐ ‐0.5 ‐1.0 year sector. The Fed plans to maintains its ‐1.0 ‐1.5 accommodative stance until economic conditions ‐1.5 2010 2011 2012 2013 ‐2.0 improve, which is likely to keep real yields at low levels. Source: Bloomberg
Outlook 2013 – Sovereign Bonds Euro‐zoneTrapped in a low yield environment 3.0 Core/Semi‐core Government Bond Yields (%)• The euro area sovereign crisis has now endured for more 2.5 that two years. Its impact on sovereign bond markets 2yr Germany 2yr France diminished in 2012 due to the 3y LTROs first and then 2.0 2yr Belgium 2yr Holland due to the OMT programme; 1.5• The modus operandi of European authorities are now 1.0 better understood by the markets; 0.5• Short rates in most countries are likely to remain low. Another refi rate cut by the ECB is possible in Q1 2013 0.0 (and possibly bringing the deposit facility into negative ‐0.5 territory). The short end of the curve is likely to remain Jan‐12 Mar‐12 May‐12 Jul‐12 Sep‐12 Nov‐12 Source: Bloomberg anchored at very low levels, especially in the first part of 2013; 5.0 Core/Semi‐core Government Bond Yields (%) 4.5• Long‐end rates are at very low levels, reflecting safe‐ 10yr Germany 10yr France haven flows and low nominal potential growth rates. 4.0 10yr Belgium 10yr Holland There doesn´t seem to have much room for a further 3.5 rally from current levels. However, a large sell‐off is not 3.0 expected, given current 2013 macro expectations; 2.5• Core/semi‐core EGBs – While fundamentals, mainly in 2.0 France, are still weak, the yield pick‐up theme will 1.5 probably still dominate in the current low yield 1.0 environment. Jan‐12 Mar‐12 May‐12 Jul‐12 Sep‐12 Nov‐12 Source: Bloomberg
Outlook 2013 – Sovereign Bonds PortugalIs further de‐risking possible in 2013?• 2012 was a great year for Portuguese sovereign risk;• Portugal is supposed to go back to the markets in Q3 2013 and to regain full access to funding by mid‐2014;• However, it could be difficult for Portugal to be completely independent from some sort of official lender’s support, given poor economic prospects and high debt and fiscal deficit;• Portugal could increase the use of T‐Bills. However, that will reduce the average maturity of the stock of debt. Moreover, it would probably be interpreted as a negative by markets as it will probably make bond holders junior; Source: Bloomberg• Further debt swaps could be announced in 2013 to help Portuguese Sovereign Curve (YTM in %) 18 18 alleviate refinancing pressures in 2014 and 2015. This 16 16 liability management could pave the way to market 14 14 access; 12 12• Further sovereign de‐risking will probably be news flow 10 10 dependent: Will Spain lose market access? Will OMT (if 8 8 activated) be able to bring peripheral yields lower? 6 6• Portugal is likely to need more support, relative to the 4 30 Dec 2011 11 Dec 2012 4 current adjustment programme. The ECB and the ESM 2 2 0 0 will probably be brought to the final decision on a 3M 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 30Y second programme. Source: Bloomberg
Outlook 2013 – Sovereign Bonds SpainWill Spain ask for further support in 2013?• Spain is still weighing its options on a possible bailout. 2013 Fiscal tightening is quite significant. However, the Spains 2‐year and 10‐year Sovereign Spreads (%) 4.5% of GDP target for next year seems too ambitious 7 7 and will likely be missed. Moreover, some Spanish 6 6 officials have hint that the country could miss this year’s general government deficit target (7.4% of GDP). Of 5 5 Spain’s 8.5% 2011 budget deficit, 2.9% came from 4 4 regional governments. Will Spain’s regions be able to meet their deficit targets? 3 3• Spain has formally requested €39.5bn of European funds 2 10‐year Bond Spread 2 2‐year Bond Spread to recapitalize its banks. Addressing convincingly the 1 1 banking problems would be positive for the sentiment Jan‐12 Mar‐12 May‐12 Jul‐12 Sep‐12 Nov‐12 on the sovereign; Source: Bloomberg• Given Spain’s large financing needs and external debt problem, Spain is still expected to request for further Spanish 2013 bond issuance estimates external support. But, will the return of market pressures Net bond Total bond in €bn Redemptions issuance issuance being applied to Spain be the trigger? In 2013, supply Government base case 62 28 90 pressures will be notable for Spain. Furthermore, 2013 Source: Spanish Treasury Estimates regional issuance could be merged with that of central government. Spain’s sovereign is not far from HY (Baa3/BBB‐/BBB). Further rating downgrades would make a benchmark exit a distinct possibility.
Outlook 2013 – Corporate High Grade Credit USMore modest returns are expected in 2013 (mostly driven by carry) • In 2012, US high grade corporate credit achieved strong Median EBITDA/Interest Expense returns. Fed policy was supportive to IG credit sentiment. 12.0 The Fed doesn’t buy corporate bonds, but its ongoing 11.5 purchases of Treasury, agency and mortgage securities 11.0 are also intended to push investors to pursue higher 10.5 yields via risk assets such as corporate bonds. This is 10.0 expected to keep the demand for investment grade credit 9.5 supportive in 2013. Nevertheless, supply should also 9.0 maintain a robust pace, given the current low yield 8.5 environment; Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012• As long as central banks keep their supportive Source: Bloomberg programmes and the US economy avoid recession, the main concern are risks that could increase volatility. Macro concerns have led to high correlations. 2013 can show a more differentiate credit performance, which would increase the importance of sector and single name selection. US financials have improved their fundamentals (e.g. higher capital ratios), but their spreads remain wide relative to historical levels. Credit fundamentals in non‐ financials seem to be weaker (decline top‐line expectations and increasing return of cash to shareholders) when compared to financials. Source: Bloomberg
Outlook 2013 – Corporate High Grade Credit Euro‐zoneLow credit spreads in a low volatility regime iTraxx Indices• In 2012, spreads tightened amid declines in sovereign 400 1000 spreads and a lower equity volatility. European credit has 350 iTraxx Europe (LHS) 900 had a strong run in 2012, reflecting the outperformance 300 iTraxx Sr Financial (LHS) 800 of European credits trading at very wide levels (mainly 250 iTraxx Crossover (RHS) 700 peripheral names). At a sector level, Financials 200 600 outperformed; 150 500• Fiscal austerity and deleveraging (mainly in the 100 400 periphery) still poses downside risks to growth. Political 50 300 action will probably remain a key driver;• The search for yield could lead to tighter investment 0 200 2010 2011 2012 2013 grade corporate credit spreads, in an environment where Source: Bloomberg either growth begins to improve or policy makers provide more stimuli. However, spikes in volatility are expected, given the current low growth environment;• Peripheral vs. core and financials vs. non‐financials will probably be key on positioning for 2013;• With the bulk of bank rating changes likely behind us, and given the increase in capital ratios, IG financials could be a less volatile sector. Subordinated instruments still offer a significant premium to senior bonds. In the non‐financial area, the growth outlook will be decisive to take exposure to more cyclical sectors/names. Source: Fincor
Outlook 2013 – Peripheral Corporate Credit PortugalPolitical and ECB actions will remain the main drivers• The environment has been benign for the Portuguese 18 Portugal Telecom vs. BES (YTM %) corporate bond market since the ECB’s Outright 16 Monetary Transactions programme was announced; 14 Portugal Telecom 5.625% 2016• Portuguese credits remain exposed to a weak economic 12 BES 5.625% 2014 backdrop (GDP is expected to fall again in 2013) and 10 sovereign credit rating risk; 8• Moreover, bank deleveraging remains an important 6 challenge, with shrinking credit supply; 4• The ECB is expected to continue providing liquidity for 2 banks and focus on the OMT programme; Jan‐12 Mar‐12 May‐12 Jul‐12 Sep‐12 Nov‐12 Jan‐13• Given the growth outlook, we prefer to take exposure to Source: Bloomberg less cyclical credits and those names where restructuring Portugal / Germany Government Bond Spreads (%) 25 25 and consolidation are already under way. We prefer EDP 2‐year (defensive profile and expected B/S deleverage over the 20 20 5‐year coming years) and Portugal Telecom (high quality assets 10‐year and fully financed until mid 2016); 15 15• Portuguese banks have showed improving solvency 10 10 ratios and better funding condition. Banks continue to focus on B/S deleveraging (lower LTD ratios). Earnings 5 5 are subdued and asset quality pressures are expected to continue. Portuguese sovereign spreads will probably 0 0 2010 2011 2012 2013 remain the main driver in 2013 for the sector. Source: Bloomberg
Outlook 2013 – Peripheral Corporate Credit SpainAt the mercy of the Sovereign…• Growth in Spain is projected to be negative again in 2013. Fiscal multiplers has been greater‐than‐expected;• Spanish banks will need to continue to reduce private sector loan‐to‐deposit ratios. Loans would have to keep decreasing, in a country where credit transmission is heavily dependent on bank lending;• Spain’s sovereign rating stands at Baa3/BBB‐/BBB (outlook negative). A downgrade to junk status is a key risk and would mean that nearly all banks will move in step. Moreover, a material subset of the corporate universe would probably be downgraded to high yield Source: Bloomberg (Utilities are deemed the sector with the highest Telefonica vs. Spain 5Y CDS (bp) exposure to country risk according to the agencies). The 700 magnitude of the economic recession, the progress in 600 Telefonica 5Y CDS restoring confidence in Spain’s banking sector and the 500 Spain 5Y CDS ability of the Sovereign to maintain market access (in a 400 year of strong debt issuance) should be decisive; 300• With Spain risk premium having declined in 2012, a more 200 cautious approach could be justified. Short‐dated issues are preferred; 100• We prefer to take exposure to credits with restructuring 0 2010 2011 2012 2013 potential and geographically diversified (e.g. Repsol). Source: Bloomberg
Outlook 2013 – High Yield USWelcome to the low yield world• Reduced tail risks from lower fears of a disorderly EMU breakup (LTROs and OMT), Fed policy action (open‐ended purchases of MBS and Treasuries), and yield‐starved investors have helped high yield bonds in 2012. However, weak Q3 earnings and post‐election “fiscal cliff” uncertainties have weighed on valuations at the end of the year;• A higher demand for yield in 2012 led to a fall in volatility;• Given a still favorable default outlook, 2013 could show investors still seeking current income;• Key risks for 2013: (a) re‐leveraging or a slower de‐ leveraging, given the easy access to low yields; (b) downside to US growth (driven by fiscal retrenchment); (c) a systematic shock from Europe (despite the efforts of the Source: Bloomberg Dividends and Stock Repurchases in the HY Bond ECB); 60 Market ($bn)• The upgrade to downgrade ratio for BB rated issuers 50 remains at solid levels and is even increasing; 40• Notwithstanding the low volatility and yield environment, 30 overleveraged balance sheets still face several headwinds, 20 given the sluggish economic recovery. In that sense, a 10 greater improvement in the macro outlook would strongly 0 2005 2006 2007 2008 2009 2010 2011 Jan‐Oct support the performance of CCC issuers. Source: Bloomberg 2012
Outlook 2013 – High Yield EuropeDemand is supportive but… there´s some potential downside risks• Pan European High Yield posted a robust performance in 2012, reflecting a huge contribution from financials and the performance of non‐financial peripheral credit;• Given central bank support from the ECB and the US Federal Reserve (which help easing lending standards), strong demand dynamics are still expected to be a support in 2013;• Euro HY default rates remain low, despite the weak economic backdrop. However, the downgrade of Spanish / Italian corporates from IG to HY could be a key concern next year; Source: Bloomberg• Moreover, call constraints can limit the upside, given the Pan European HY (excl. Financials): current low yield environment. Re‐allocation into equities Net Rating Moves (%) 60 could also be a possible concern in 2013; 50• Re‐leveraging strategies are possible, given low interest 2011 2012 rates. Nonetheless, issuers should remain cautious due to 40 the many uncertainties at the macro level. A reverse in 30 Euro‐zone progress, a weaker euro area economy or new 20 sovereign downgrades represent downside risks;• Risk/reward seems attractive in single‐Bs. Prospects for 10 triple‐Cs could improve during the year if economic 0 Upgraded Unchanged Downgraded growth in the Euro area improves. Source: Bloomberg
Outlook 2013 – Equity Markets USS&P 500 in 2013: Earnings will be key…• The market’s multiples has fallen. Multiples continue to be constrained by investors’ high level of uncertainty about the future direction of the economy, the impact of fiscal imbalances on long‐term growth and the sustainability of corporate profits. Moreover, an unprecedented monetary easing creates additional uncertainties (what will be the central bank’s exit strategy?);• Stocks could react positively (multiple expansion) if US policymakers can negotiate a plan that credibly Source: Standard & Poors addresses long‐term tax, spending, and entitlement S&P 500: Trailing P/E vs. Forward P/E reforms; 35 35• Unfortunately, even considering that the “fiscal cliff” is 30 30 averted, the most important structural issues will probably be pushed into the future; 25 25• Bottom‐up consensus continues to fall. Companies have 20 20 piled up cash during the earnings recovery. A stronger buyback activity would be a strong support for equity 15 15 indices;• Given the expected macro backdrop and low market 10 10 1988 1991 1994 1997 2000 2003 2006 2009 2012 multiples, stocks should be able to outperform Trailing P/E Forward P/E Treasuries. Source: Standard & Poors
Outlook 2013 – Equity Markets EuropeHas the ECB made the Euro‐zone investable again? • European equities have done well in 2012 (were you surprised?), with total returns not bad for a region in crisis and going through a recession;• In 2013, a further re‐rating for European shares is expected based on lower macro risks (i.e. no Chinese hard landing and no US “fiscal cliff”);• Nevertheless, 2013 doesn´t look great for earnings (euro strength could be a concern). Even considering that the euro area could start exiting its current recession, nominal GDP growth should be modest. However, “North” = France, Germany and Holland ; “South” = Portugal, Spain and Italy downgrades to 2013E estimates have already be Source: Bloomberg significant; MSCI EMU and S&P 500 Price Performance• Thematic views for 2013: (a) Increase in corporate 1600 300 action/restructuring (driven by low funding costs); (b) 1400 250 Long banks (still under owned?); (c) Tilt towards strong 1200 balance sheet (in a de‐leveraging world); (d) high‐yield 200 companies with the capacity to grow dividends; (e) 1000 companies with stable top‐line growth; and (f) consumer 800 150 plays into China/EM (but cautious on China 100 600 infrastructure plays); S&P500 MSCI EMU• The equity risk premium is still high. If the ECB’s OMT is 400 50 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 successfully activated, the risk premium could be lower. Source: Bloomberg
Outlook 2013 – Equity Markets Emerging MarketsChina is still expected to dominate the EM outlook• Easier financial conditions in many EM economies could China Industrial Production vs. MSCI EM ($) have created the backdrop for a rebound in domestic 20% 1,400 demand. Some acceleration in growth is likely in 2013; 15% 1,200• Key concerns are related to the pace of credit creation or 10% 1,000 housing imbalances (China and Brazil), current account 5% deficits (India, Turkey) and a strong increase in food 800 0% prices (potentially leading to a tightening of monetary 600 ‐5% policy); ‐10% 400• The economic outlook for China remains uncertain. 2006 2007 2008 2009 2010 2011 2012 2013 Many investors seem to believe that China´s demand for Chinese Industrial Production (% y/y, LHS) MSCI Emerging Markets (US$, RHS) commodities may be in secular decline and they are now Source: Bloomberg, National Bureau of Statistics of China fewer bulls on Chinese economic growth. Meanwhile, Trailing P/E: China vs. India recent economic data pointed to a (modest) economic 30 improvement and provided support for a rally. However, 25 investors will probably continue to track the data closely and focus on any change in policy by the new leadership; 20• 2013 will be all about the confirmation of the economic 15 recovery in Brazil. Both fiscal and monetary policy should help. Investors have been frustrated with the wait for a 10 recovery. Activity data should be at a center stage. There 5 could be room for a re‐rating considering that local 2009 2010 2011 2012 Shanghai Stock Exchange Composite BSE India Sensitive interest rates are at a historical low. Source: Bloomberg
Outlook 2013 – Equity Markets Japan2013: the year of the snake JPY / USD Exchange Rate (JPY per US$)• Real GDP decelerated sharply in H2 2012 (July‐ 86 September growth came at ‐3.5% q/q annualized). 84 Reconstruction works are gradually starting and will provide a support to the economy. 2013 could provide a 82 more favorable backdrop to Japanese equities; 80• We assume a LDP‐led government from the December 78 16th Lower House elections (as current opinion polls suggest is likely). Policies aimed at combating deflation 76 are expected to be announced, such as public works 74 investment and corporate tax cuts, given the weak Jan‐12 Mar‐12 May‐12 Jul‐12 Sep‐12 Nov‐12 economic conditions; Source: Bloomberg• The upcoming leadership transition at the Bank of Japan Key events in Late‐2012 and in 2013 could lead to additional monetary easing (explicit Dec 16 Lower House Elections inflation target of 2%, the resumption of a zero interest Dec 19‐20 BOJ Monetary Policy Meeting rate policy and the potential establishment of a public‐ Dec 17‐ Jan 15 New PM appointed and new Cabinet formed private investment fund to buy foreign bonds); January Supplementary Budget Discussion• Most foreign investors have a light positioning to Japan. Jan‐Mar FY13 Budget Deliberations and Passage Feb‐Mar Selection Process of BOJ Governor and two Vice Governors Macro and micro fundamentals improvement could lead March Submission of Preparatory Bill for Consumption Tax Hike to Diet to potential foreign purchases; Mar 19 2 BOJ Deputy Governors terms end• Further yen weakness (amid a persistent trade deficit) April 8 BOJ Governors term ends would be supportive to growth. It would also underpin July Upper House Elections Source: Fincor the Topix and help earnings revision momentum.
Outlook 2013 – Equity Markets PortugalStill addicted to lower sovereign yields?• The market now trades at 14.4x the consensus 2013 EPS forecast; PSI 20• PSI 20 sales are expected to rise by 4% in 2013. EBITDA margins will (€mn) Consensus (**) y/y remain static; Revenues (*) 2011 64,106 • The economic backdrop will remain weak, with Portuguese real GDP 2012 F 68,161 6% expected to contract again in 2013. The government continues to make 2013 F 70,878 4% its best efforts to contain public deficit, imposing austerity measures. EBITDA (*) Sovereign yields declined as the ECB’s decision to engage in outright 2011 11,347 monetary transactions provided a turning point for sentiment; 2012 F 11,724 3%• BES (strong presence in the corporate segment) and Sonae (leveraged 2013 F 12,237 4% B/S and almost fully exposed to Iberia) are our preferred vehicles to Net profit play further sovereign de‐risking next year; 2011 1,687 • International footprint, restructuring appeal, attractive valuations and 2012 F 2,069 23% 2013 F 3,058 48% solid balance sheet are key investment themes to select our preferred Net debt (*) stock list: Galp, EDP Renovaveis, Portucel and ZON. 2011 40,998 PSI 20: Large caps vs. Small caps 2012 F 40,883 0%CAGR 2013‐11 (Excl. EBITDA mg) ‐ Consensus (**) 2013 F 39,961 ‐2% EBITDA mg EBITDA mg (*) Excluding financial stocks Revenues (*) EBITDA (*) 2012 F (*) 2013 F (*) Net profit Net debt (*) (**) According to BloombergLarge Caps 6% 4% 17% 17% 7% ‐1% Source: BloombergSmall Caps 2% 4% 19% 19% n.m. ‐3%(*) Excluding financial stocks(**) According to BloombergSource: Bloomberg
Outlook 2013 – Equity Markets SpainStock picking is decisive given macro challenges• With the ECB reducing the tail risks, the risk‐reward of Spanish companies least exposed to Iberia (% sales) Company Sector Iberia Latam N.America Others the Spanish equity market has improved; Ebro Foods Food 6 0 52 42• However, the macro backdrop for Spain remains Amadeus Travel & Leisure 6 8 7 79 Acerinox Cap. Goods 8 0 51 41 challenging. GDP is expected to decline again in 2013. Grifols Healthcare 13 4 63 21 The retrenchment in activity was already severe and Viscofan Food 17 14 28 41 Abengoa Utilities 22 36 18 24 consumer spending has also taken a significant step back; Santander Financials 23 54 6 17• Although it is far from over, structural adjustment is OHL Infrastructures 27 39 14 21 Telefónica Telecoms 29 47 0 24 ongoing. There is probably still a tough road ahead, given BBVA Financials 30 52 11 7 the magnitude and duration of past excesses; Prossegur Ind. Services 31 59 0 10• Spanish corporate 12‐month forward earnings have been Repsol Oil & Gas 32 38 15 15 Ferrovial Infrastructures 37 0 26 73 downgraded significantly lower by analysts and are now Iberdrola Utilities 37 17 9 37 well below their peak; Source: Financial Statements• The focus will probably remain on whether Spain will Santander, BBVA, Popular and IBEX 35 Price finally ask for further assistance to the ESM; 120 Performance in 2012• Stocks with geographic diversification, attractive 100 valuation, with growth opportunities and a solid B/S are 80 preferred, such as Ebro Foods (defensive profile), Almirall 60 and Tecnicas Reunidas (growth opportunities);• We remain cautious on Spanish banks due to B/S 40 deleverage. We’ll prefer to play Sovereign de‐risking 20 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec through Antena 3 (restructuring potential), Enagas (stable BBVA Banco Popular Ibex35 Santander growth) and Acerinox (recovery in profitability). Source: Bloomberg
Outlook 2013 – CommoditiesCommodities should remain a hedge against supply disruptions• With commodity supply constraints easing and China´s potential growth expected to decrease over the following years, a more cautions opinion could be warranted;• However, we believe that commodities could still be supported in 2013 by more QE policies and by some cyclical pick‐up expected for next year. Brent crude oil prices continue to trade in a trading range. This represents a change from the upward trend of 2008 ‐ H1 2011. Prices are expected to be capped by the perception that oil prices above $125/bbl represent a Source: Bloomberg, 2012 refers to Jan‐Nov return significant threat to economic growth and the Gold Price vs. Size of Fed Balance Sheet perception that policymakers will respond with for e.g. 3,500 2,000 the release of strategic oil reserves; 3,000 Size of Fed Balance Sheet ($bn, RHS) 1,800• The low level of volatility seen in all asset classes Gold Bullion US$/Troy Ounce (LHS) 1,600 2,500 1,400 probably explain why gold prices have remained range 1,200 2,000 bound since October 2011. However, we expect gold 1,000 1,500 price to remain supported by a negative real Fed Funds 800 600 rate (a proxy of the opportunity cost of holding gold), 1,000 400 and the continuing expansion of Central Bank’s balance 500 200 sheets (hedge against the possible inflationary 0 0 2002 2004 2006 2008 2010 2012 consequences of policy actions). Source: Bloomberg, Federal Reserve
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