Mg 2009 Outlook 011509


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My explanation of a "balance sheet recession" - this was not understood by most analysts in 2009

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Mg 2009 Outlook 011509

  1. 1. The Outlook for 2009 Investing in uncertain times Marshall Gittler Chief Strategist, International Deutsche Bank (Suisse) SA Tel: +41(0)22 739 0463 e-mail:
  2. 2. The Outlook for 2009 Overview: a tough year economically; a better year financially? The first global balance sheet recession  We have seen a period of unprecedented drama in the financial markets, culminating in a collapse of most markets (stocks, credit, commodities) and a freezing of the world‟s credit markets  At the same time, governments around the world have gone to extraordinary lengths to offset the effects of the financial market disaster and prevent a downward spiral  Nonetheless, we believe economic policy cannot reverse the course of the business cycle, only soften it. This is because we are in a different type of recession than we have seen before in the post-war period: a global balance sheet recession. We expect the downturn to intensify in 2009 The question is, how much is in the price already?  No one expects the global economy to do well. On the other hand, markets have already plunged  The big question is whether they have fallen enough to discount the future economic problems or whether we will get hit again as the real economy catches up with the financial markets Strategy recommendations: we still like fixed income  This may be the buying opportunity of the century for equities, but with the economic outlook so uncertain we still prefer fixed income  Investment grade corporates are our preferred assets, as well as index-linked bonds  Within equities, we recommend infrastructure, a sector that is likely to benefit from government efforts to reflate. Also sectors with a guaranteed real yield, such as regulated utilities 2
  3. 3. The Outlook for 2009 Outlook for the economy 3
  4. 4. The Outlook for 2009 The typical recession  In the past, most US recessions came about through monetary policy. The Fed raised interest rates until the economy went into recession. Then it cut rates, and the economy eventually recovered  The previous two recessions – 1990/91 and 2000/01 – are different. In the first case, the Fed had already cut rates by 150 bps when the recession started (although it may have raised them too high to begin with); in the second case, the rise was not excessive, and in any case the Fed had started to cut rates before the recession started  The current recession too probably cannot be blamed on overly tight monetary policy Typically, recessions start & end with the Fed 20 Recessions Fed Funds % 15 10 5 0 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: Bloomberg, National Bureau of Economic Research 4
  5. 5. The Outlook for 2009 The balance sheet recession: a schematic 5
  6. 6. The Outlook for 2009 How a balance sheet recession unfolds Low interest rates encourage excessive borrowing  The cycle starts when interest rates stay too low for too long. People believe rates will stay low indefinitely. With the hurdle rate for investment low, companies are encouraged to invest in increasingly marginal projects, while low repayments allow households to borrow (often against their house) to buy financial assets, boats, expensive vacations, and more houses  When asset prices start to fall, the value of the debt does not. This creates balance sheet problems  Companies switch from profit maximisation (households = consumption maximisation) to repaying debt. Companies cut investment and slash jobs, households spend less, save more. Lower interest rates do not stimulate further investment or consumption until the debts are repaid. (Traditional economics could not explain this point until Japan’s balance sheet recession made it clear)  A vicious circle results as companies and households do what is best for them but worst for the economy overall (“fallacy of composition”). As the economy spirals downward, prices start to fall, which worsen the problem as incomes fall but debt doesn‟t  More and more borrowers default. Increasing amounts of non-performing loans (NLPs) make banks less willing to lend and increasing the pressure on even healthy borrowers to pay back debt.  Asset prices fall further as people sell assets to pay down debt (= deleveraging). Go back to step #2  Central bank tries to solve the problem by easing monetary policy, but it doesn‟t work because nobody wants to borrow. Even if they did, in many cases the banks wouldn‟t lend to them  We arrive at a liquidity trap, where monetary policy is no longer effective 6
  7. 7. The Outlook for 2009 How a balance sheet recession ends (we hope) With monetary policy at an impasse, fiscal stimulus is needed to break the vicious cycle  Govt builds bridges etc. They buy steel, employ bridge-builders, and otherwise support demand  Over time, the private sector can pay down its debt:  Companies can continue to sell products. This provides them with profits to repay their banks; eventually they get their debt down to a manageable level  Individuals keep their jobs and, by cutting back on consumption, eventually repay their mortgages, credit card loans, auto loans, etc.  Meanwhile, the government‟s borrowing keeps the money supply growing while the private sector is repaying debt. This prevents deflation and thereby diminishes the forced deleveraging  Key word: eventually 7
  8. 8. The Outlook for 2009 Why quantitative easing is essential to the process Monetary and fiscal authorities have to work together  Fiscal stimulus is an essential part of the process of getting out from a balance sheet recession  Fiscal stimulus financed by raising taxes would be counter-productive, because there would be no net increase in demand. It must be debt financed  Selling large amounts of debt to the private sector could push long rates up. That would force borrowers to accelerate their repayment of debt, making things worse  Instead, the central bank often steps up purchases of bonds from the private sector to help fund the stimulus (technically known as “monetizing the debt,” popularly known as “printing money”)  In any event, rates tend to remainy low during such a period anyway because of deflation, the absence of other borrowers, and a lack of other attractive investment vehicles  It‟s natural then that interest rates should be unusually low, possibly around zero 8
  9. 9. The Outlook for 2009 Why the current recession looks like a balance sheet recession  The US is emerging from an enormous credit binge, equalled only during WWII. To bring the level of outstanding credit down to trend would mean a reduction of some $1.5tn in outstanding bank credit  US households are starting to reduce their debt and raise their savings – consumer credit fell by $6.4bn in August, $3.5bn in October and a record $7.9bn in November  This is somewhat different from the Japanese balance sheet recession, which was as much in companies as in households. Households are not marked to market  Their problems will be transferred to the corporate sector via the banks. We expect non-performing loans to double in the US to 3% and perhaps exceed the 3.4% at the depths of the Depression Unwinding the credit bubble Households starting to cut debt 15 12 % % Household debt payments as a % of disposable income (L) 10 14 Personal savings as a % of disposable income (R) 8 13 6 4 12 2 11 0 10 -2 1980 1985 1990 1995 2000 2005 Source: BCA Research Source: DB Global Markets Research 9
  10. 10. The Outlook for 2009 Hard-hit banks likely to make the problem worse Banks are tightening lending conditions at the same time as demand plummets  The recent Senior Loan Officer surveys from the US, Eurozone and Japan have all shown that banks are tightening up conditions for loans to both companies and households  The tighter lending conditions coincide with a sharp fall-off in demand for loans as well. In the US, 17% of banks reported weaker demand for loans from companies in October, while 48% reported weaker demand from households. The figures were 26% and 21%, respectively, in Europe  The unwillingness to lend and lack of demand for loans means lower interest rates are not likely to be as effective in reviving (releveraging?) the economy as they were in the past Businesses find loans harder to get as do households 80 60 Senior Loan Officer Survey in US and Europe Senior Loan Officer Survey in US and Europe Commercial loans Household loans 60 40 Tighter lending conditions, Tighter lending conditions, more demand for funds more demand for funds 40 20 20 0 0 -20 -20 Looser lending conditions, Lending conditions Looser lending conditions, Lending conditions less demand for funds less demand for funds -40 Demand for funds Demand for funds -40 2003 2004 2005 2006 2007 2008 2003 2004 2005 2006 2007 2008Source: US Federal Reserve, ECB, DB Private Wealth Management 10
  11. 11. The Outlook for 2009 Housing market will be one key to finding the bottom  The housing market needs to bottom before we can feel confident that the worst is over. That‟s because stable home prices are necessary for investors to assess the value of banks‟ balance sheets and for consumers to feel confident of their net wealth  The signs so far are not encouraging. Price declines continue to accelerate, and the credit crunch has made it even more difficult for those few people who want to buy a home to do so  Our Mortgage group estimated on Sep. 10th that US house prices were only about halfway through the correction and would have to decline another 16% or so to restore affordability to historical levels  Of course, things could be even worse – in Japan, land prices have been falling for 16 years Inventory of unsold homes still rising Japanese market still hasn’t bottomed 20 12 M onths of Japanese land vs US house prices House prices and inventory 0% sup p ly 11 15 Japanese land prices -10% (peak = Sep. 1991) 10 10 US house prices (peak = % change from peak 9 -20% June 2006) 5 8 -30% 7 0 6 -40% -5 5 -50% -10 Median home prices % yoy (R) 4 Existing home inventory (R) -60% -15 3 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 -6 -5 -4 03 04 05 06 07 08 Years from peakSource: Bloomberg, DB Private Wealth Management 11
  12. 12. The Outlook for 2009 Outlook for the markets 12
  13. 13. The Outlook for 2009 Market dislocations have improved, but are still high  Indications of market dislocations, such as TED spreads, CDS spreads on US financials, US agency spreads and equity market volatility have generally receded from their previous highs, but they remain well above even the abnormally high levels of last year  Looking at the futures market, investors expect the dislocations to persist at least into early 2010, although expectations have improved notably from even just a month ago Credit markets bad, but not worst Market getting more optimistic 400 600 LIBOR/Fed Funds spread & market forecast 1 Jan 2008 = 100 HSBC Clog Index BPs 350 500 Market forecast 300 Includes Market forecast a month ago 400 1) TED spread & LIBOR-OIS spread; 250 3m LIBOR-Fed Funds spot 2) US Financial CDS spreads; 3) US spread agency credit spreads; and 4) VIX index Level (50 bps) that signifies 300 200 almost back to normal 150 200 100 100 50 0 0 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Source: Bloomberg 13
  14. 14. The Outlook for 2009 Market implications of the balance sheet recession  As we‟ve seen, a balance sheet recession can last for several years. It means little or no demand for funds, hence a fall in interest rates. It also means sluggish demand, at least in the country involved, and hence low corporate profitability  It‟s not surprising that Japan‟s balance sheet recession saw a multi-year rise in bond prices and fall in stock prices Nikkei and JGB futures after the bubble burst 40000 150 35000 140 30000 130 25000 Nikkei (L) 120 JGB futures price (R) 20000 110 15000 100 10000 90 5000 80 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Bloomberg, DB Private Wealth Management 14
  15. 15. The Outlook for 2009 Stock market performance during the balance sheet recession  From its peak at 39,000 in 1989, the Nikkei fell back to 14,800 in 1992, then spent the next nine years in a trading range of roughly 14,000~22,000 until the banking crisis sent it crashing out  There were substantial moves both up and down during this time: 13 rallies of over 20% from 1990 to 2003 and seven rallies exceeding 30%. But all the gains were lost eventually  The business cycle continued during this period and stocks continued to follow it. Once the major decline was over, the inflection points within the trading range were driven by the business cycle 13-year decline saw several rallies Nikkei followed inventory cycle 40000 23000 8% = rallies of more than 30% 6% 35000 21000 4% Period when companies 30000 were repaying debt 2% 19000 0% 25000 -2% 20000 17000 -4% -6% 15000 Nikkei (L) 15000 -8% Shipments-to-inventory ratio, 10000 -10% 6m change (R) 13000 -12% 5000 92 93 94 95 96 97 98 99 00 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 15Source: Bloomberg, DB Private Wealth Management
  16. 16. The Outlook for 2009 Stock market performance: stock picking matters more than ever  While the market as a whole was rangebound for years, some stocks did better than others  A basket of the 15 “best of breed” blue chip stocks – companies with the best balance sheets, best management and best products (e.g. Toyota and Canon) – outperformed the market significantly. This basket rose 330% during the decade vs a 40% decline in the broad TOPIX index  Small cap stocks on the other hand underperformed, because small cap companies are “price takers” that do poorly in a deflationary environment. Also they lack access to funding and so are particularly troubled by the need to repay loans “Best of Breed” in Japan vs TOPIX TOPIX small cap index 100 Jan 1990 = 100 90 Period when companies 80 were repaying debt 70 60 50 40 30 20 TOPIX Small caps index TOPIX 10 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008Source: Merrill Lynch GEMS Equity Strategy Source: Bloomberg 16
  17. 17. The Outlook for 2009 QE lowered yields, flattened the yield curve, helped MoF to issue bonds  Quantitative easing (QE) got yields down even more than the zero interest rate policy (ZIRP), especially at the short end (five years and below). The curve was quite flat out to two years  It had less of an effect further out the curve, in the 10s and beyond. Still, yields were extraordinarily low. The 10yr JGB hit the lowest level in recorded history for that maturity: 0.45% on 12 June 2003  This was despite massive bond issuance and downgrade of the country‟s credit rating  Low interest rates and purchases of JGBs by the central bank helped the Ministry of Finance (MoF) to issue a massive amount of bonds smoothly 2yr yields & 2yr/10yr curve Yield curve before, during & after 1.10 180 3.00 % % 1.00 ZIRP QE period 160 2001 (before QE) 0.90 2.50 2003 (during QE) 0.80 2005 (during QE) 140 2.00 2007 (after QE) 0.70 120 0.60 1.50 0.50 100 0.40 1.00 0.30 80 0.20 QE 0.50 2yr yields (L) 60 0.10 2yr/10yr curve (R) 0.00 0.00 40 1 2 3 4 5 6 7 8 9 10 15 20 30 3m 6m 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Source: Bloomberg, DB Private Wealth Management 17
  18. 18. The Outlook for 2009 Learning from past bear markets: How long might this bear market last?  During previous bear markets, stocks never went straight down, hit bottom and then rebounded. The market usually makes a few false bottoms on the way down and takes some time to recover  We regressed how far the market fell during previous bear markets against a) the length of time from peak to trough and b) the time it took to recover the peak level. Using the results, the 52% drop from the Oct. 2007 peak to the November trough means that the market should in theory fall for 40 months (= until Feb 2011) and would not recover the previous peak for 96 months (until Oct 2015)  On that basis, if past trends hold true the US economy should bottom around end-2010. That is quite a bearish estimate; Deutsche Bank‟s official forecast is for the economy to bottom in 1H 2009 % drop in market vs months to bottom % drop vs months to recover peak -15% -15% 1990~91 1990~91 y = -0.0034x - 0.1939 y = -0.0078x - 0.2071 -20% 1956~58 -20% 1966~67 1956~58 R2 = 0.5023 R 2 = 0.8902 1966~67 -25% -25% 1980~82 1980~82 -30% -30% 1961~62 1961~62 % decline % decline -35% -35% 1987~88 1987~88 1968~70 -40% 1968~70 -40% This time = 40 months = -45% 1973~75 -45% Feb 2011 This time = -50% 1973~75 -50% 96 months = 2000~03 2000~03 Oct 2015 -55% -55% 0 10 20 30 40 50 0 20 40 60 80 100 120 Months to recover peak Months from peak to bottomSource: Bloomberg, DB Private Wealth Management 18
  19. 19. The Outlook for 2009 Stocks don’t always go up every year  People in the financial world often say that “stocks always go up in the long term,” but they forget to specify just how long the long term is. After all, as Keynes said, “in the long term we are all dead.”  There have certainly been periods that anyone would call “long” when the US stock market did not go anywhere. And let‟s not even talk about Japan, where the Nikkei is now back to 1983 levels  This illustrates two points: 1) past performance is no guarantee of future performance, and 2) truisms about the financial markets based on historical experience are not like the laws of physics, which hold true everywhere and at any time DJIA has shown long periods of going nowhere 19 Source: BCA Research
  20. 20. The Outlook for 2009 The example that nobody wants to think about: 1929~1932  The Crash of 1929 remains the model for speculative booms & busts in the modern era  While everyone knows what happened in Oct. 1929, people forget that 1929 was only the beginning of the bear market. Stocks rebounded early in 1930 but then started falling again and didn‟t bottom until July 1932. By that time prices were down 89% from the 1929 peak  Anyone who bought at the bottom in 1929 was down 79% by 1932. They didn‟t recover their money until Dec. 1949. Anyone who bought at the 1929 peak didn‟t get their money back until end-1954 DJIA 1929~1932 DJIA 1929~1954 400 400 350 350 1929 high +48% from bottom 300 300 -48 ppt 250 (-48%) 250 200 -89% 1929 low 200 150 -41 ppt 150 (-79%) 100 100 50 50 0 0 Jan-29 Jul-29 Jan-30 Jul-30 Jan-31 Jul-31 Jan-32 Jul-32 1925 1930 1935 1940 1945 1950Source: Bloomberg 20
  21. 21. The Outlook for 2009 Earnings still have to be revised down further 2008E & 2009E growth of country earnings (%) MSCI Latin America 16.1 MSCI EMEA 9.1 Spain: IBEX 35 1.6 France: CAC 40 2009E earnings growth (% ) -1.1 2008E earnings growth (% ) Italy: MIB 30 -2.8 S&P 500 -12.0 UK: FTSE 100 -12.1 Stoxx 600 -12.5 Euro Stoxx 50 -12.7 Euro Stoxx -13.6 MSCI Asia ex Japan -16.7 Germany: Dax 30 -29.8 TOPIX -35.0 96.6% Switzerland: SMI -41.3 -55 -45 -35 -25 -15 -5 5 15 25 35Source: Thomson Financial, IBES and Deutsche Bank Global Markets estimates 21
  22. 22. The Outlook for 2009 What to recommend in this environment 22
  23. 23. The Outlook for 2009 The key factor driving asset class performance is the business cycle  Investors have to decide whether growth is above or below trend and accelerating or slowing  Also, is inflation accelerating or decelerating?  Based on the level and direction of these two factors, we can identify four phases in a typical business cycle  Different asset classes tend to perform best in each phase Appropriate investments for each part of the business cycle 23
  24. 24. The Outlook for 2009 The phases of the business cycle --- Impact on asset allocation 24
  25. 25. The Outlook for 2009 Recommended portfolio strategy Maximum* Unconstrained* Capital Maintenance Balanced Growth Capital Preservation Benchmark Benchmark BenchmarkCash & FX 15% 20% 15% 10% 25%Fixed Income - Sovereign 10% 60% 20% 40% 15% 20% 5% 50%Fixed Income - Corporate 35% 30% 20% 15% 20%Developed Market Equity 10% 20% 10% 40% 20% 60% 30% 0%Emerging Market Equity 5% 5% 10% 15% 0%Private Equity 8% 0% 5% 8% 0%Absolute Return 7% 20% 5% 20% 5% 20% 7% 0%Real Estate & Infrastructure 5% 5% 5% 5% 0%Commodities 5% 5% 5% 5% 5%Expected Return 4.9% 4.6% 5.0% 5.5% 4.0%Volatility 5.6% 3.7% 6.9% 10.3% 3.6%* No benchmark 25
  26. 26. The Outlook for 2009 What to recommend in this environment: equities are for trading  With equity markets down so sharply so quickly and the prospective dividend yield greater than government bond yields for the first time in 50 years, we believe much of the bad economic news is already discounted in the market. However, valuations do not yet indicate “all clear”  Equity markets will need to see the credit markets and earnings expectations stabilize before they can embark on a sustainable rally. That‟s still some time away. Until then, markets run the risk of reacting again to news that‟s previously discounted (e.g., the impact of the credit crunch on companies)  This remains a trading market rather than an investing market. As a result, we remain defensive with our sector selection and recommend covered call writing to benefit from heightened volatility  In general, we favor US equities over Europe and Japan, primarily because of more aggressive government policy responses to the current credit crisis and slowing global economy. As a result, we expect the slowdown in the US to be shorter and less severe than in the other regions. In addition, our expectation that the dollar will continue to rally versus the euro and yen over the next year will hamper outflows from the US into other markets  While emerging market equities have been down significantly (more than 55% from peak), pressure will likely remain on these markets as de-leveraging, risk aversion and negative capital flows serve as headwinds. The preferred BRICs region is China due to growth remaining at potential, fiscal stimulus, decelerating inflation and flexible monetary policy. The two BRICs most vulnerable are Russia and Brazil, driven by the substantial declines in commodity prices 26
  27. 27. The Outlook for 2009 What to recommend: We like market-neutral plays  Most investments make money when an asset price goes either up or down. However, there are some investments that are not dependent on the direction of markets. These may be an attractive way to boost return with a minimum of risk during a period like this  The DB Commodity Harvest indices profit from the difference in the roll between various commodity contracts, not from the direction of commodity prices  The DB Currency Return index is a combination of carry, value and momentum currency indices DB Commodity Harvest Indices DB Currency return indices 120 130 1 Jan 07 = 100 15 Feb 2008 = 100 110 120 100 110 100 90 DB Commodity Harvest Total Return DB Commodity Harvest Excess Return 90 80 MSCI World stock market index DB Currency Returns Tracker 80 70 DB Currency Momentum Tracker DB Currency Carry tracker 70 DB Currency Valuation Tracker 60 MSCI World equity index 60 50 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 50 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Source: DB Global Markets, Bloomberg 27 Past performance is no guarantee of future results. No assurance can be given that the investment objectives of the financial products represented will be achieved.
  28. 28. The Outlook for 2009 What to recommend: Private equity returns are best at the bottom of the cycle Meltdown Meltdown years years 35% 34% 20% 19% 19% ? Potential for 10%(3) excellent vintage years „86-„90 „91-„93 „94-„97 „98-„00 „01-„03 „04-„07(3) „08E-„10E Average Net IRR of top quartile Average Net IRR of top quartile MSCI World(1) private equity firms(2) private equity firms (1986 to 2007)(2)(1) Source: Bloomberg and Deutsche Bank calculations. Represents index value from 12/31/1987 through 10/10/08(2) Source: Cambridge Associates and Deutsche Bank calculations. 28
  29. 29. The Outlook for 2009 One big question: will the cure cause its own problems?  Central banks have been pumping money into the system like there‟s no tomorrow (which they probably thought seemed entirely possible a few weeks ago). As a result, bank reserves have been growing at a record pace  The world‟s supply of dollars relative to the size of the US economy has exploded (latest reading = up over 50% yoy)  Will this cause inflation further down the line? Soaring commodities? Collapsing dollar? Exploding world dollar means world awash in USD 20 Excess growth in world dollar vs USD index % yoy -30% % yoy World Dollar - Nominal US GDP growth (L) 15 USD Index (R, inverted) -20% 10 -10% 5 0% 0 10% -5 20% -10 30% 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Note: World dollar = US Base money + Treasuries held by foreign officials. Latest observation is Nov. 19. Using expecrted US Q4 2008 GDP -5 % ( YoY ) . 29
  30. 30. The Outlook for 2009 Long term: what could provide the next economic theme? The infrastructure story is coming back into fashion  The world‟s population is still growing by some 78mn people a year. That should continue until 2020  These people will want a higher standard of living than those who came before them: more and better houses, roads, bridges, electricity  The developed world‟s infrastructure also badly needs refurbishment (seen JFK Airport recently?)  Why now? Because infrastructure investment is a great way for governments to inject money into an economy during a downturn The world is still growing There is still demand for cars in EM 100 12% 200 mn Registered motor vehicles MN Annual change in world population 90 # of people (L) 10% 80 % change (R) 150 US 70 8% 60 Forecast China (1908 = 1984) 50 6% 100 40 4% 30 20 50 2% 10 0 0% 0 55 65 75 85 95 05 15 25 35 45 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 19 19 19 19 19 20 20 20 20 20Source: UN Population Division 30 Source: US Dept of Transport, CEIC
  31. 31. The Outlook for 2009 Long term: what could provide the next economic theme? The commodity story is only delayed, not derailed  The sharp fall of commodity prices now has caused a major setback in plans to expand production – in fact, some production capacity in industrial metals has been mothballed. This sets the stage for future shortages as population continues to grow and people expect their living standards to rise  Global warming is not affected by the business cycle  The grain situation is particularly worrisome longer term as production growth is not keeping pace with population or rising living standards Oil use to rise as EM countries develop Grain output not keeping pace with population 360 0.25 Per Capita Oil Consumption Relative to GDP 3.0 KG Grain production and harvested area per person Hectares Canada US Oil consumption per capita (gallons per day) 340 2.5 0.20 South Korea Taiwan 320 2.0 Japan Australia 1.5 300 0.15 Germany Sweden France UK Italy 1.0 Venezuela MexicoRussia 280 0.10 Thailand Grain production per person (L) 0.5 Indonesia Brazil 260 China Grain harvested area, per person India 0.0 240 (R) 0.05 0 5 10 15 20 25 30 35 40 45 50 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 GDP per capita (000 USD)Source: Earth Policy Institute Source: IMF, IEA, DB Global Markets Estimates 31
  32. 32. The Outlook for 2009 Long term: what could provide the next economic theme? The Law of Accelerating Returns  Moore‟s Law states that the capacity of ICs doubles every 18 months. This is exponential growth, not the linear growth that we usually experience. Exponential growth is common among high-tech products, because of the evolutionary way that they develop (building on previous developments): DNA sequencing, electronic memory, ISPs, nanotechnology, brain scanning, software capabilities…  What‟s harder to see is that this exponential pace of growth is itself accelerating at an exponential rate as technologies reach the limit of their capabilities and are subsequently replaced by new technologies that progress even faster. This means the rate of technological progress in the 21st century is likely to be about 1,000 times faster than in the 20th!  Who knows what will arise from this unprecedented pace of development in electronics, energy, communications, etc.? And how should we value companies whose products improve like this? Chip speed rises exponentially Growth grows exponentially too MHz Intel chip speed10,000 1,000 100 10 93 94 95 96 97 98 99 00 01 02 03 04Source: Intel 32 Source: Ray Kurzweil
  33. 33. The Outlook for 2009 Summary Economy: recession could last longer than market expects  Investors are not familiar with a balance sheet recession. They expect that this recession will be a normal one and that fiscal and monetary easing will allow the economy to recover in short order  As a result, we expect there could be some surprise at the depth and length of the recession  Europe may have fewer balance sheet problems, but it is less able to take coordinated fiscal action and therefore may suffer more than people think  Even after the problems are over, growth is likely to be sluggish due to “debt rejection syndrome” Equities: a market of stocks  Equities overall tended to trade in a range during Japan‟s balance sheet recession. Simply buying and holding the market did not provide any return at all lover the long term in Japan  The best companies were able to perform nonetheless with products that set them apart and allowed them to maintain prices even in a deflationary environment. They also had better financial resources and so were able to get their balance sheets in order faster. Stock picking was essential  Small cap stocks on the other hand underperformed, for the opposite reasons Bonds: unbelievable bull market  Short-term rates went down to zero and remained there. Long-term rates eventually hit the lowest level in history. Bond yields stayed low for a surprisingly long time. The yield curve flattened  Enormous issuance was not a problem as banks and insurers had no other outlet for funds. This time it could be different for US as US is a debtor nation, not a creditor  Credit spreads narrowed as investors moved further out the credit curve in search of yield 33
  34. 34. Important notesPrivate Wealth Management offers wealth management solutions for wealthy individuals, their families and select institutions worldwide. Deutsche Bank Private Wealth Management,through Deutsche Bank AG, its affiliated companies and its officers and employees (collectively “Deutsche Bank”) have published this document in good faith and on the following basis.It has been prepared without consideration of the investment needs, objectives or financial circumstances of any investor. Before making an investment decision, investors need toconsider, with or without the assistance of an investment adviser, whether the investments and strategies described or provided by Deutsche Bank, are appropriate, in light of theirparticular investment needs, objectives and financial circumstances.Deutsche Bank does not give taxation or legal advice. Investors should seek advice from their own taxation agents and lawyers, in considering investments and strategies suggested byDeutsche Bank.Investments with Deutsche Bank are not guaranteed, unless specified. Unless notified to the contrary in a particular case, investment instruments are not insured by the Federal DepositInsurance Corporation (FDIC) and are not traded on any regulated market.Investments are subject to investment risk, including market fluctuations, regulatory change, possible delays in repayment and loss of income and principal invested. The value ofinvestments can fall as well as rise and you might not get back the amount originally invested at any point in time.The document is provided as general information only and consequently may not be complete or accurate for your purposes. It is not intended as financial advice or as an offer orrecommendation of securities or other financial products. While the information is updated from time to time, it is subject to changes in the intervening period. All the financial servicesand product classes referred to in this document may not be available in all locations or to all Deutsche Bank Private Wealth Management clients.This document has been prepared by Deutsche Bank Private Wealth Management for discussion purposes only. It is not a research product in the meaning of the “Directive on theIndependence of Financial Research” of the Swiss Bankers Association. Therefore, the directive does not apply to it. Any opinions expressed herein may differ from the opinionsexpressed by other Deutsche Bank departments including the Research Department.The manner of circulation and distribution of this brochure may be restricted by law or regulation in certain countries. Your local Deutsche Bank Private Wealth Management office will beable to provide more information. 34