2 william blair global market outlook - december 2013

1. December 2013
2014 Global Market Outlook
Navigating Tomorrow’s Global
Challenges and Opportunities
Stephanie G. Braming,
CFA, Partner
Simon Fennell,
Partner
W. George Greig,
Partner
Olga Pomerantz

2. 2014 Global Market Outlook December 2013 | 2
Key Issues of 2013
Both media and market focus during 2013 can be characterized as “more of
the same.” Investors focused on continued crises in Europe, notably in Italy
and Cyprus. In the U.S., headlines were dominated by concerns about the
sequestration and general Washington dysfunction. The promise of Abenomics
in Japan and the market implications of a transitioning Chinese economy under
new Chinese leadership also garnered continued attention.
The stock market seemed to thrive on this general anxiety, as reflected in Figure
1. Peripheral Europe, core Europe, and the U.S. were top returning markets
from an equity perspective during this timeframe. Japan also made the list,
returning approximately 26% in USD terms. In local terms, the market was up
46% when adjusted for the Yen’s weakening as part of the monetary easing arrow
of Abenomics. Noticeably absent from this list are traditional emerging markets
equities. While frontier markets did well, emerging markets significantly
underperformed in 2013.
Country Returns
Ireland 46.3
Finland 38.7
Spain 29.8
U.S. 29.3
Greece 29.0
Denmark 28.3
Germany 28.2
Netherlands 27.9
Japan 26.0
A year ago, William Blair was relatively sanguine about the outlook
for equities in 2013, even though the media and the markets were
concerned about the outlook given macroeconomic issues. The
2012 Global Market Outlook highlighted anticipated improvements
in Europe, the promise of Abenomics in Japan and improving U.S.
growth, which were poised to set the stage for a strong equity market.
Source: FactSet, MSCI IMI Net Official Index.
Year to date as of 11/30/2013. Excludes frontier
market countries.
Fig. 1: Top 10 Equity Markets

3. 2014 Global Market Outlook December 2013 | 3
The summary of regional return drivers is illustrated in
Figure 2. It is not surprising to see the United States led
with a 29% return. Pushed by Japan, developed markets
showed decent performance. Significantly lagging were
emerging markets.
In analyzing return sources, it is interesting to note that
earnings revisions were broadly negative in 2013. The
true driver of the markets in 2013 was significant multiple
expansion both in the U.S. as well as in developed markets.
In emerging markets, a lack of confidence in the ability
of earnings growth to continue led to minimal multiple
expansion. This effect was the main difference between
price action and returns in 2013. Part of the developed
market valuation gain was a boost in confidence. The other
part was the push of unconventional monetary policy.
The Way Forward
Valuation expansion was the story in 2013. But how should
investors think about longer term potential for equity and
fixed income returns given current yields, growth potential,
and cash flow? It is important to consider the long term
return building blocks from a fundamental point of view.
Long term returns are built from cash flow distributable
to shareholders and the reinvestment-driven growth
produced by companies over an extended period. This
process constantly reviews these building blocks in various
markets, keeping in perspective what the potential really is.
Currently, the U.S. exhibits stronger return metrics than the
other developed markets because corporate cash flows and
returns continue to be stronger (Figure 3).
There is capacity for reinvestment growth and greater
surplus cash flow in Europe and Japan versus historical
results. For those markets to catch up in the long run,
however, corporate performance must improve. On the
other hand, emerging markets show strong profitability and
cash flow, driving strong growth in the corporate sector.
The story in emerging markets is about more than just
demographics and long term income growth. It is also about
the ability of companies to produce and sustain high returns.
While the growth potential of emerging markets is
significant today, on a cyclical or near term basis there is
a growth shift away from emerging markets and towards
developed markets. Specifically, over the past year,
developed markets growth has become more pronounced
and is accelerating at the same time as emerging markets
have been slowing. This slowdown has been occurring
since 2012, but has become more pronounced and more
visible in 2013.
More specifically, U.S. private sector growth has repeatedly
withstood multiple shocks created by dysfunction in
Washington as well as significant downsizing of public
sector spending over the past several years. With success
on the Federal budget front as well as the reduction of the
negative feedback loop caused by the fiscal retrenchment,
growth in the U.S. should become more apparent. At
the same time, the Euro area is finally exiting its second
recession in three years. While recovery and growth in
Europe is subpar, it is broad based, which offers some
degree of confidence in its durability. Finally, consumer
spending in Japan has accelerated on the back of the
government’s strong and credible commitment to end two
decades of deflation.
As of 11/30/13.
Source: FactSet. Universe is MCSI ACWI IMI.
Fig. 2: 2013 Stock Market Returns by Region
29%
23%
4%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
United States Developed Markets Emerging Markets
LTM Earnings Revisions
Earnings Growth Estimate
Multiple Expansion/(Contraction)
Total Change in Market Value
Source: FactSet. Universe is MSCI ACWI ex Financials. Gov’t Bond Yield is country weighted.
Fig. 3: Cash Equity Returns
1.8% 3.0% 3.3% 1.6% 2.6%
2.0% 0.1%
(1.3%)
0.4%
(2.1%)
5.0%
3.5% 7.5%
1.3%
9.0%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
United
States
Eurozone United
Kingdom
Japan Emerging
Markets
Reinvestment Growth
Free Cash Flow (ex Stated Dividend)
Stated Dividend Yield
Gov't Bond Yield
8.5%
6.6%
10.8%
3.3%
11.6%

4. 2014 Global Market Outlook December 2013 | 4
Just as growth in developed markets is firming across
regions, emerging market economies are facing the opposite
side of this cycle. In order to absorb the negative impact of a
sharp drop in demand from developed economies following
the financial crisis, emerging markets extended significant
fiscal and credit stimulus to their domestic economies,
resulting in spectacular growth: 2010 and 2011 marked
some of the best years ever. As early as 2012, growth started
to moderate as policy makers retracted stimulus measures
as these economies rebounded. This trend has continued
throughout 2013.
The political dimension has become increasingly important
to the markets, particularly over the short term. Assessing
the crisis and the subsequent recovery through the prism
of political commentators and politicians, it appears every
nation is in the midst of rethinking its growth model and
its growth strategy. This is true for both developed and
emerging markets. In the U.S., the media and politicians
are busy downplaying the recovery, highlighting how
fragile and bubble-prone the U.S. economy is. In Europe,
it is a very similar story. The European Central Bank is
constantly discussing the need to broaden and extend credit
to peripheral economies, implying these countries cannot
grow without such credit. This is also happening in the
United Kingdom. In Japan, the government is aggressively
trying to change the economy after two decades of deflation
in a bid to promote sustainable growth.
In emerging markets, it is very much the same story. In
June 2013, there were mass demonstrations in Brazil,
largely held by lower-middle class people demanding
better public services and non-inflationary growth. These
demands are very different from those made in the past.
Finally, there is China with a similar story. New leaders are
coming in, and they are talking about ways to promote and
sustain non-inflationary rapid growth. In summation, all
around the world there seems to be recognition that credit-
driven growth has come to its logical conclusion and must
end. Everyone is in search of sustainable and equitable ways
to grow and to have wealth creation in the societies at large.
U.S. Trends
The U.S. recovery is progressing with improving housing
trends. Industrial production will probably regain pre-crisis
levels during the first part of 2014. Monthly auto sales
are tracking at an annualized rate of about 15 million
units, which is just one million short of pre-crisis levels.
Companies have been hiring for several years. Private
sector job creation consistently averages about 170,000 jobs
per month. More recently and more encouragingly, wage
growth has accelerated as reflected in Figure 4.
Sources: Bloomberg, Datastream
Fig. 4: Growth Rate of Hourly Earnings
Avg. hourly earnings, YoY
Feb-04
Jun-04
Oct-04
Feb-05
Jun-05
Oct-05
Feb-06
Jun-06
Oct-06
Feb-07
Jun-07
Oct-07
Feb-08
Jun-08
Oct-08
Feb-09
Jun-09
Oct-09
Feb-10
Jun-10
Oct-10
Feb-11
Jun-11
Oct-11
Feb-12
Jun-12
Oct-12
Feb-13
Jun-13
Oct-13
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Nov-03
Mar-04
Jul-04
Nov-04
Mar-05
Jul-05
Nov-05
Mar-06
Jul-06
Nov-06
Mar-07
Jul-07
Nov-07
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
Nov-10
Mar-11
Jul-11
Nov-11
Mar-12
Jul-12
Nov-12
Mar-13
Jul-13
Sources: Bloomberg, Datastream
Fig. 5: S&P 500 FY2 P/E
10 Yr Range
5.0x
7.0x
9.0x
11.0x
13.0x
15.0x
17.0x
FY2 P/E
Average 12.9x
Max 16.1x
Min 8.9x
Current 15.1x
Robust private sector job
creation combined with
good wage growth bodes
well for real personal
disposable income
growth, which ultimately
underpins consumption.
Many of these trends have
been in place for several
years. With the U.S. equity
market up about 29%
through November 30, it is
clear the market embodies
this optimism. Figure 5
shows the S&P 500 nearing
the top of its 10 year
valuation range at about
15.9x 2014’s earnings. The
market is clearly pricing in
a recovery.

5. 2014 Global Market Outlook December 2013 | 5
Interestingly, profit margins are concurrently at significant
highs as indicated in Figure 6 in both the S&P 500 and the
S&P 500 IT Indices. This is not particularly surprising given
the higher margin new economy names in these indices,
such as Apple with margins around 29%, Google at 26%, and
Oracle at 37%.
Given this move, the market will likely demand top line
growth and actual corporate performance in order to justify
current multiples. As a result, prospective performance
should be based on corporate differentiation as opposed to
a broad market rally.
Europe
Questions about the fundamental idea of Europe, let alone
the Euro, have been incredibly intense over the last several
years. It was about the only topic being discussed broadly
in financial markets. The start of a change in the European
outlook can be tagged to ECB President Mario Draghi’s
commentary in July 2012 and his aggressive stance to do
whatever it takes—“and believe me, it will be enough”—as
the catalyst. The effect on markets is exemplified in
Figure 7, reflecting select country bond spreads versus
Germany, and their compression, post mid-2012.
Combined with a change in banking regulations, the first
signs of growth have begun to appear as PMIs rank from
50 to 55 across countries, which is a significant positive.
Translated broadly, this effect is not lost on the equity
market, despite Europe remaining in recession.
European domestic focused equities are significantly
outperforming as the potential for a European rebound
begins to be priced in (Figure 8). There is no question
investors, particularly foreign investors, considerably
misread the will of European leaders to preserve this
structure of the Euro zone and of the larger European
entity as a whole. Recovery came first in the markets
and later in the economy. Much has been driven by real
structural political reform, which investors also doubted
could ever take place. Several European policy makers
throughout the last few decades have been fond of saying
“never let a good crisis go to waste.” Of course, what they
Sources: FactSet, Bloomberg
Fig. 6: S&P Net Profit Margin
0
2
4
6
8
10
12
14
16
18
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Mar-11
Sep-11
Mar-12
Sep-12
Mar-13
Sep-13
S&P 500 Index S&P 500 IT
Sources: GS, Bloomberg
Fig. 8: Domestically Focused Companies’ Performance
vs. Broad European Index
90
100
110
120
130
140
150
160
170
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Jan '12 = 100
GS DM growth Euro 600
Sources: GS, Bloomberg
Fig. 7: 10-Year Government Bonds: Spread vs. Germany
0
10
20
30
40
0
5
10
15
20
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
%
France Ireland Italy
Portugal Spain Greece (RHS)

6. 2014 Global Market Outlook December 2013 | 6
mean is European integration is typically preceded by
crisis and as a result of crisis. The reason is that European
integration ultimately involves voluntary surrender
of national sovereignty, which can only happen once
politicians have exhausted all other available means of
arriving at solutions for a particular problem.
The financial crisis forced the hands of politicians. Everyone
in Europe knew what needed to be done. Everyone was
aware of the structural imbalances that were built up in
Europe over the past decade. But as former president of the
Eurogroup, Jean-Claude Juncker said, “European politicians
all know what to do. We just don’t know how to get re-elected
after we do it.” The crisis forced changes that had to be made.
While the media were focused on forecasting European
disintegration, structural changes were being made, and
structural imbalances were being addressed. The result
is that competitiveness has improved. Ireland, with its
open, very dynamic economy was the first to recover. More
fundamentally, countries such as Spain and Portugal are now
running current account surpluses. This is the first for Spain
since the 1990s and the first for Portugal since the 1960s
(Figure 9).
The German current account surplus has halved since
2007, reflecting that not all changes have happened in
the peripheral region. Meaningful structural change has
already happened and it has not been all due to destruction
of domestic demand, which has collapsed across the
periphery. Structurally, exports are a much greater share of
GDP in both Spain and Portugal, as both of these countries
are actually gaining market share globally. Even Greece,
which has been the perennial underperformer, has seen its
export sector rebound.
A gradual recovery is occurring, although the adjustment
process is not over. At the same time, shorter term
indicators are definitely highlighting a pickup in
momentum. Retail and auto sales are up sequentially.
Industrial production is accelerating. PMIs are increasing,
which has been a broad indicator of business sentiment.
Japan
One of the largest areas of structural reform has occurred in
Japan with the promise of Abenomics and its three arrows
strategy; the significant monetary easing undertaken by Bank
of Japan Governor Haruhiko Kuroda at the beginning of
2013, fiscal improvement and structural growth. This has not
been lost on foreign investors. Foreign flows into Japan have
accelerated significantly since November 2012 (Figure 10).
Institutional asset managers are now overweighted in
Japan. About 35 percent of them are overweighted in
Japan versus being underweighted over the last several
years. Foreigners have begun to buy into the promise of
Abenomics, while still being understandably skeptical about
the growth arrow.
These flows have not occurred domestically. Public pension
funds and household equity allocations remain quite low.
This allocation makes sense given Japan’s deflationary
economy for the past 20 years when holding cash was
prudent. But when assessing Japan relative to other
European economies or to the U.S. where Callan Associates
estimates that public pension plans have about 54% of their
allocation in equities, equity allocations remain quite low.
Japan’s Government Pension Investment Fund is the
largest fund in the world at $1.2 trillion. Given Japan’s
aging society, a government sponsored panel of experts has
recommended that it begin to increase the equity allocation
in order to provide for stronger growth. On the household
side, only about 12.5% of assets are held in equities. The
Japanese government is trying to address that as well
Sources: Datastream, IMF, BIS
Fig. 9: Current Account Position
-16
-11
-6
-1
4
Q12000
Q42000
Q32001
Q22002
Q12003
Q42003
Q32004
Q22005
Q12006
Q42006
Q32007
Q22008
Q12009
Q42009
Q32010
Q22011
Q12012
Q42012
% of GDP
Germany, vis-à-vis EA Portugal
Spain Italy
Euro Area
Sources: Bloomberg,BOJ, Japan Ministry of Finance, BAML
End-June 2013 figures for the US and Japan. End-March 2013 for the Euro zone.
Fig. 10: Net Foreign Inflows into Japanese Equities,
bn JPY, 12-m Cumulative
-2000
-1000
0
1000
2000
3000
4000
Mar-02
Nov-02
Jul-03
Mar-04
Nov-04
Jul-05
Mar-06
Nov-06
Jul-07
Mar-08
Nov-08
Jul-09
Mar-10
Nov-10
Jul-11
Mar-12
Nov-12
Jul-13
Bn JPY

7. 2014 Global Market Outlook December 2013 | 7
through Nippon Individual Savings Accounts (NISA), which
are effectively tax advantaged accounts that allow people
to save. Financial institutions are starting to see demand
from their client bases to open these accounts. These are
balanced or equity focused accounts that will be launched
in January 2014. The government estimates there are
approximately 20 million individuals that will be opening
these accounts. At approximately $10,000.00 each, this does
not represent a huge amount. However, the subsequent
shift into equities could have a positive impact.
Are the structural reforms in Japan hype or real? How
should forward progress be measured? First, the aggressive
domestic monetary policy in Japan is credible. This is
evidenced by the fact that one year forward inflation
expectations have moved up significantly. At the same time,
corporate bank lending has not only turned positive but
continues to accelerate. These statistics are indications
that people believe in the eventuality of inflation and that
price growth will become positive and prices will continue
to cease to decline sequentially.
Moving forward in 2014, investors will be assessing whether
the corporate sector will raise base wages. This process
in Japan usually follows corporate earnings performance
with about a lag of one year. Given that inflation is not
yet entrenched, investors probably should not expect
significant base wage growth across the board. However,
if quarterly bonus growth rates are similar to 2013, it will
probably be sufficient to maintain Japanese consumer
spending rates.
It will also be critical in 2014 for the administration to
address energy concerns. In the wake of the Fukushima
disaster, all nuclear capacity in Japan has been idle. There
has been renewed talk of bringing some of that electricity
production back online. The lack of nuclear power in Japan
has hit prices, as corporate electricity prices are up by about
30% since 2010. This increase represents a significant
headwind to corporate performance and margins. To the
extent that the government can bring some of the idle
capacity back online, it will be a significant boost near term
to the Japanese growth story.
Structural reforms in Japan face the same obstacles as
found elsewhere. Just like their European counterparts,
Japanese officials know what needs to be done. Driving
significant change is often blocked by significant vested
interests. That is exactly why structural reforms will be
quite slow to emerge and have largely underwhelmed to
date. However, we currently believe that there is enough
under consideration with enough momentum in the
system to keep going while the structural reforms begin to
trickle through.
Consider all of this from a corporate perspective. What
is the impact of changing structural issues on corporate
behavior? Earnings revisions in Japan are more positive
and valuation is broadly favorable, (Figure 11) providing
opportunities for investors.
The longer term issue is reflected in Figure 12, which
highlights corporate Japan’s performance. The 1980s were
significantly positive for Japan, with a return on equity
(ROE) of 9.5%. Issues following the crash in Japan, most
notably the very inefficient balance sheets—by cross
holdings and by a rollover of corporate debt—led to a very
low return on equity over the ensuing period. At the same
Sources: FactSet, Bloomberg
Fig. 11: Earnings Revisions Ratio and
Valuation Tradeoff
EM
Europe ex-UK
UK
US
-30%
-15%
0%
15%
30%
-30%-15%0%15%30%
AggregateEarningsRevisionRatio
% Premium (Discount) to 10 -Year Ave FY2 P/E
Japan
Sources: FactSet, Bloomberg
Fig. 12: Return on Equity
0%
3%
6%
9%
12%
15%
1990-20121981-1989
Japan
Germany
United States
China
9.5%
11.9%
7.0%
3.7%
10.0%
8.3%
12.2%

8. 2014 Global Market Outlook December 2013 | 8
time, China has risen with stellar returns. One could argue
that the Abenomics phenomenon is really coming as a
response to a very powerful China at the corporate level
that needs to be addressed. As an example, the new 400
Index in Japan, as put forward by the Government Pension
Investment Fund, is focusing on corporate returns, thus
making it in all the stakeholders’ interest that corporate
Japan improves.
Interestingly, the valuation of Japanese equities on a
price to book basis is about half what it is in the U.S. The
allocation to equities by the aggregate of domestic and
foreign institutional investors is also about half what it is
in the U.S. If those gaps are going to close, it will have to be
because of an improvement in corporate performance.
Emerging Markets
The cycle in emerging markets has been a mirror image
of the one in the developed markets and has largely been
a response to the fallout of the developed markets crisis.
Substantial fiscal policy and credit policy stimulus across
regions and geographies in emerging markets led to a
sharp rebound in domestic demand. At the first signs of
acceleration and growth, overheating began to manifest
itself. As a result, policy makers gradually began to withdraw
stimulus. This resulted in growth starting to decelerate as
early as 2012 (Figure 13), declining slowly but consistently.
At the same time, current account balances and buffers have
been reduced. Absent China, the current account position in
emerging markets as a whole is at about zero. Combine both
of those factors and it is clear why emerging markets equities
began to underperform developed markets as early as 2012.
In May 2013, the seriousness of the Fed’s discussion about
tapering quantitative easing brought into sharper focus
those declining, decelerating trends and vulnerabilities. It
should be emphasized, however, that longer term potential
growth is still intact. Balance sheets in the emerging
markets—in the corporate sector in the household sector,
and in the government sector—are broadly solid and very
sustainable moving forward, albeit across a heterogeneous
group of countries.
Consider what has happened to short term equity and bond
flows in response to the tapering discussion and what that
means for valuations and yields. Cumulative fixed income
flows were regularly positive up until May, and then had a
sharp reversal from that point. However, it has not been a
complete reversal (Figure 14).
Sources: IMF WEO Database, October 2013; Bloomberg
Fig. 13: Real GDP, YoY % Change
0%
2%
4%
6%
8%
10%
12%
14%
16%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Emerging Markets China
Sources: Bloomberg, Datastream; EPFR Global; IMF WEO Database, October 2013;
J.P. Morgan; MSCI. BRIC Funds separated from EM funds from 11 May 07.
Fig. 14: EM Fixed Income Flows (Strategic and Retail)
Yearly, Cumulative
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
120
100
80
60
40
20
0
-20
US$ bn
97.5
80.1
46.6
43.2
12.7
2012 2013
2009 2010 2011

9. 2014 Global Market Outlook December 2013 | 9
In considering the bond market spreads themselves,
emerging markets are maturing (Figure 15). The bond
market has seen some changes on a spread basis, but again,
it is not the radical dislocation that occurred in the late
1990s for instance.
Figure 16 illustrates equity market flows. Unlike fixed
income, there was only a two to three month consistent
equity fund outflow. We do not believe these trends will be
sustained, but are cognizant of the volatility. Sources: FactSet. Universe is MSCI.
Fig. 17: Emerging Markets Aggregate
Earnings Revisions Ratio
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
Nov-12
Dec-12
Jan-13
Feb-13
Feb-13
Mar-13
Apr-13
Apr-13
May-13
Jun-13
Jun-13
Jul-13
Aug-13
Aug-13
Sep-13
Oct-13
Nov-13
Nov-13
EM Asia ex-China & India China
India EMEA
LATAM
Sources: FactSet. Universe is MSCI.
Past performance does not guarantee future results. The above graph reflects the cumulative
performance of the top minus bottom quintile companies within the MSCI Emerging Markets
Investable Market Index. Information is for illustrative purposes only, is not intended to
represent any actual portfolio, and does not reflect the deduction of any fees or expenses.
Fig. 18: Top-Bottom Quintile Model Performance
Within MSCI EM IMI From 10/31/11 - 11/30/13
0%
10%
20%
30%
40%
50%
60%
Oct-2011
Dec-2011
Feb-2012
Apr-2012
Jun-2012
Aug-2012
Oct-2012
Dec-2012
Feb-2013
Apr-2013
Jun-2013
Aug-2013
Oct-2013Sources: MSCI, Datastream, EPFR Global, BRICFunds separated from EM funds from
11 May 07.
Nov-11 Apr-12 Oct-12 Mar-13 13-Nov-13
6,000
4,500
3,000
1,500
0
(1,500)
(3,000)
(4,500)
US$ mils
12.7
Weekly Net Flows (L) MSCI EMF Index (R)
12.7
1,120
1,080
1,040
1,000
960
920
880
Index
Fig. 16: Net EM Equity Fund Flows, Global Emerging
Markets Funds, Weekly Net Flows
Fig. 15: Bond Market Yields
0%
2%
4%
6%
8%
10%
12%
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13US 10-y bond yields EM USD debt yield
From a corporate perspective, earnings have begun to
improve (Figure 17). The reaction to tapering in the
summer of 2013 was something of a scarring experience,
but earnings revisions ratios are starting to move in the
right direction.
Figure 18 shows William Blair’s Composite model
performance in emerging markets. This chart represents
a summary of corporate performance along multiple
factors. Over the last several years, the top quintile of high
quality companies with good fundamental performance
have outpaced the bottom quartile. When emerging
markets are no longer a “play,” as investors stop seeking

10. 2014 Global Market Outlook December 2013 | 10
emerging markets for improving growth relative to
developed markets, and corporate competition increases,
focus on companies and quality will be paramount.
China
No examination of emerging markets is complete without a
discussion of China. As with most other emerging markets,
China’s growth decelerated over the last several years.
This deceleration, however, has largely already occurred.
Growth has stabilized at a high but lower than historical
rate and corporate performance has improved in line with
the new lower trend rate of growth. In addition, the once
in a decade transition to new leadership took place quite
successfully throughout the first half of 2013. Crucially,
these new leaders appear to be willing and able to push
through significant structural reforms, liberalizing many
resource and services sectors of the economy that were
previously either completely or partially closed to private
capital. Of course, in the long term that bodes well for the
sustainability, quality, and pace of growth. In the short
term, in order to enact some of these structural changes,
China needs to reduce or eliminate some of the extra credit
stimulus that is still lingering in the economy. Specifically,
it needs to reduce credit growth to be more in line with
nominal GDP growth, which has already decelerated.
Figure 19 reflects the interbank borrowing rate and the
slow and steady progression towards the higher end of the
chart as the People’s Bank of China guides rates higher. In
doing so, the central bank is withdrawing extra liquidity
from the system and gradually moving bank borrowing
rates higher in a bid to tighten credit provisions. This
trend is broadly expected to continue in 2014.
The structural reform in the way China’s economy works is
analogous to Europe in the 1980s when there was a wave of
private sector expansion and public sector contraction in
the economy. This could have the same energizing effect on
stimulating growth.
2014 Outlook and Risks
In summary, in the U.S., valuation is relatively full
despite 2014’s expected economic growth. Corporate
differentiation will be key for driving stock prices higher.
European growth remains lackluster but is improving
from a low base and the financial sector continues to
restructure. Japan’s economy is improving, but the
three arrows strategy of Abenomics will be critical. In
particular, the corporate response to policy is crucial to
drive the markets going forward. All of these factors can
help emerging markets weather the Fed tapering that is
expected to occur in the first half of 2014. In particular,
manufacturers and exporters could benefit from weaker
emerging markets’ currencies.
Risk 1: Unconventional Monetary Policy
There continues to be considerable uncertainty in exiting
unconventional monetary policy. There has been a
considerable market revaluation since the financial crisis.
Much of the fear, the expectation of crisis, built in over the
past several years has been eliminated. In spite of the fact
that economic growth has now stabilized, investors face a
potentially more uncertain environment in a number of
different ways. As economic growth begins to stabilize and
moderately accelerate and the cycle looks to normalize,
what will happen to monetary policy?
Investors have never been in a monetary policy
environment like this. What will the unintended
consequences look and feel like? This question could be
answered in the course of 2014. The general assumption
is that the Fed will withdraw asset purchase stimulus
while dealing with interest rates more cautiously. It is also
assumed with the market expecting this to happen, the
Fed will not react in any particularly unpredictable way.
However, there are a number of ways that assumption could
go wrong. If the economy starts to recover too fast, and the
Fed is caught between the dilemma of not responding or
responding too quickly, considerable instability in the bond
market could result. That, in turn, could drive financial
institution instability and could drive an equity market
valuation correction on the order of the 1994 correction or
even possibly more severe.
Sources: Bloomberg, Datastream, Worldscope, William Blair analysis
Fig. 19: 30-day Interbank Borrowing Rate
0%
2%
4%
6%
8%
10%
12%
14%
Dec-2011
Feb-2012
Apr-2012
Jun-2012
Aug-2012
Oct-2012
Dec-2012
Feb-2013
Apr-2013
Jun-2013
Aug-2013
Oct-2013

11. 2014 Global Market Outlook December 2013 | 11
Alternatively, the Fed could adhere to a policy of no stimulus
withdrawal until the unemployment rate hits 5%, or capacity
utilization hits 90% or some other benchmark. This policy
could cause the markets to begin to worry that the Fed is
ignoring obvious signals and is not paying attention to the
economic strength. While not committing to any specific
sequence of events, it is accurate to say the potential for
unstable outcomes is probably higher than the market
assumes today. The bond market, in particular, has been very
unresponsive to signs of strength in the U.S. economy.
Risk 2: Wealth Distribution
The other key economic and investment environment risk
is a concern about concentration of wealth and distribution
of income being skewed to the upside. The economic
concern is that growth is retarded when the bulk of the
population is not making income gains. When median
income is not keeping pace with overall growth, the concern
is that spending power will not be there. The second area
of concern for the markets is that if the trend reverses then
profit growth will suffer. The risk is that it is a very difficult
situation in which either the economy will lose steam and
stall, or the economy will do better, but profits will fail to
keep pace. The other area of concern connected to this is
that redistributive measures may be enacted politically,
such as higher taxes or spending program increases that
end up hurting either incomes or profits. This issue is not
limited to the U.S. It is an issue for emerging markets as
well as other developed market economies. Many emerging
markets have even more severe income distribution issues.
In considering this issue and challenge moving forward,
it is important to consider the corporate growth disparity.
Unit labor costs have grown by about 10% since 2000, but
non-labor costs have increased by over 40%. Why aren’t
corporations paying higher wages? There is perhaps a
middle ground in a long, protracted adjustment period of
reducing non-wage inflation while maintaining corporate
margins and moving wages up simultaneously. The question
is whose non-labor costs are other people’s profits?
Risk 3: Long Term Market Leadership
This is an area that’s intrinsic to the market and an
important issue for stock investors. This has nothing
to do with the growth outlook or the cycle or policy. It
is really just the evolution of the way markets develop
over time. Markets are driven by consumer taste and
preference and by the producer’s ability to bring industrial
technologies to bear on the economy. There have been 20
years of developing what used to be referred to as the new
economy. The new economy as it was thought of in the
1990s is now pretty well established. The internet and social
media companies are not emerging companies anymore.
Google and Apple are not unknown, small interlopers in
the growth outlook. Emerging market consumption was
the biggest story in international markets even in 2013
when emerging markets did not do very well. Luxury
goods has been a dominant theme in the market for at
least most of the decade. Biopharmaceuticals was the best
performing industry in the U.S. market in 2013. These are
big companies, big industries, established trends. They are
not necessarily going to stop growing. However, neither
are they going to surprise investors as they did in the last
decade. What is the wave of the future? If investors do not
really know what bioinformatics is, they certainly will not
know any companies that benefit from it. There is a hiatus
between the established themes in the market and the
future themes in the market that are not exploitable yet.
When this kind of period has occurred in the past, there is
generally some degree of uncertainty and hesitation in the
market movement as a whole. Combining this type of pause
from a market leadership position as well as some of these
macro and political uncertainties may make the market a
little bit more uncertain in the near term.
It is important to note that the economic cycle and the
market cycle are not necessarily in sync. When uncertainty
is at its height, potential is at its height. When confidence
is at its height, risk is probably at its high point as well.
There appears to be a considerable degree of momentum
in the market as evidenced by high valuations and high
profitability levels. Such an environment leads to a bit more
uncertainty and a little bit more risk than has occurred
over the last few years when high risk perception meant
that gains were a lot easier to come by. 2014 could be an
unpredictable year, a volatile year, and a year in which the
trends do not persist. First quarter trends may not occur
in the second quarter. Perhaps some of the emerging
market discount gets corrected by emerging markets
outperforming in a weak global environment. That has
not happened in the last several corrections in the market,
as emerging markets have done much worse, were high
beta, and higher risk. But maybe this time because of the
discount, because of the fact that monetary policies are
already normalizing, and because political improvements
as well as earnings improvements are occurring, perhaps
emerging markets are a bit more of a safe haven than
historically. Regardless, stronger corporate performance
will be key either to provide better distributable cash flow
and income or to provide fundamental surprise relative to
expectations. This will continue to be William Blair’s area of
focus both in emerging and developed markets.

12. 2014 Global Market Outlook December 2013 | 12
Conclusions
The equity market environment is stabilizing and
improving and should provide a better growth outlook
in the intermediate term, while valuations are attractive
relative to low risk assets. This valuation opportunity
affords investors an opportunity to achieve significantly
better returns in equities and real assets than in risk
avoidance strategies. These returns can likely be sustained
and improved over the long term. The long-term outlook
remains governed by corporate performance, but also
by technology advances, lifestyle changes and consumer
expectations. Since the technology bubble at the end of the
1990s, the market has gone through a slow digestion period.
There will be a technology reacceleration in the next 5-10
years, which will stimulate long term growth. At the same
time, mature economies will need to address productivity in
intense service sectors (Healthcare, Government, Finance),
which may also provide investment opportunities.

13. 2014 Global Market Outlook December 2013 | 13
About the Authors
Stephanie G. Braming, CFA, Partner
Stephanie Braming is the International and Global Equity Product Specialist. She is
responsible for product design and product development, and participates in the team’s
decision-making meetings, conducts portfolio analysis and is responsible for communicating
current portfolio structure and outlook to clients, consultants, and prospects. Prior to
joining the firm in 2004, Stephanie was a Principal at Mercer Investment Consulting, where
she was responsible for the strategic investment direction of her public fund, corporate,
healthcare and foundation clients. In addition to her client responsibilities, Stephanie served
on Mercer’s United States Research Rating Committee, which assessed research ratings
for investment manager strategies. Prior to her role at Mercer, Stephanie worked at the
Federal Reserve Bank of Chicago. She is a member of the CFA Institute and the CFA Society
of Chicago where she served on the Society’s Board of Directors. Education: B.A. DePauw
University; M.B.A., University of Chicago Booth School of Business.
Simon Fennell, Partner
Simon Fennell, Partner, is a co-portfolio manager for the International Growth and
International Leaders strategies. Since joining the firm in 2011, Simon previously served as
a TMT Research Analyst, also focusing on idea generation and strategy more broadly. Prior
to joining William Blair, Simon was a Managing Director in the Equities division at Goldman
Sachs in London and Boston, where he was responsible for institutional, equity research
coverage for European and International stocks. Previously, Simon was in the Corporate
Finance Group at Lehman Brothers in London and Hong Kong, working in the M&A and
Debt Capital Markets Groups. Education: M.A., University of Edinburgh; M.B.A., Johnson
Graduate School of Management, Cornell University.
W. George Greig, Partner
George Greig joined William Blair & Company in 1996 as International Growth Team leader.
In addition to this role, George is co-portfolio manager for the William Blair International
Growth, Global Leaders, and International Leaders strategies. He also serves as the global
strategist for William Blair & Company’s Investment Management Group and is on the
firm’s Executive Committee. Prior to joining the firm, George headed international equities
for PNC Bank in Philadelphia and previously served as Investment Director with London-
based Framlington Group PLC, where he also managed global and emerging markets funds.
George has over 34 years of experience in domestic and international investment research
and portfolio management. Education: B.S., Massachusetts Institute of Technology; M.B.A.,
Wharton School of the University of Pennsylvania
Olga Pomerantz
Olga Pomerantz joined William Blair & Company in 2009. She is responsible for economic
research across all regions and sectors. Prior to joining the firm, Olga was a Senior Economist
at the National Institute of Economic and Social Research in London, UK, where she was
responsible for macroeconomic forecasting and thematic research projects for international
organizations and government bodies. Education: B.A., University of Chicago; M.S.c
Economics, London School of Economics and Political Science.

14. 222 West Adams Street
Chicago, Illinois 60606+1 312 236 1600 tel
About William Blair Investment Management
William Blair Investment Management is the asset management operation of William Blair & Company, L.L.C.,
consisting of the institutional, mutual fund, high-net-worth, and private wealth management businesses. With more
than $58 billion in assets (as of September 30, 2013), William Blair Investment Management provides portfolio
management for international, domestic, and global equities, domestic fixed income, multi-asset and alternatives
organized by geographies, market capitalizations and styles. The group also acts as the investment advisor to a
family of 26 open-end mutual funds, as well as eight SICAVs for non-U.S. citizens or residents. An independent and
employee-owned firm, William Blair is based in Chicago, with office locations in 12 cities including London, New
York, Shanghai, and Zurich. We are committed to building enduring relationships with our clients and providing
expertise and solutions to meet their evolving needs. For more information, please visit williamblair.com.
Important Disclosure
This material is provided for information purposes only and is not intended as investment advice nor is it a recommenda-
tion to buy or sell any particular security. Any discussion of particular topics is not meant to be comprehensive and may be
subject to change. Data shown does not represent the performance or characteristics of any William Blair product or strategy.
Any investment or strategy mentioned herein may not be suitable for every investor. Factual information has been taken from
sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Past performance is not
indicative of future results. Information and opinions expressed are those of the author and may not reflect the opinions of other
investment teams within William Blair & Company, L.L.C.’s Investment Management division. Information is current as of the
date appearing in this material only and subject to change without notice.