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