IQ - HSBC · 2012-12-19 · Reserve (Fed) and further quantitative easing (QE) from the Bank of Japan (BoJ). The ECB’s action removed some of the more problematic eurozone-related

Inside Outlook for 2013: the struggle for return

Special report (Part 2): the US ‘fiscal cliff’

Market focus: Korea

Ask the expert: emerging markets corporate debt

Global data watch

Outlook for 2013: the struggle for return

IQ Investment Quarterly

Q1 2013

2

Overview

IQ is part of a suite of investment communications produced by the Macro and Investment Strategy Unit of HSBC Global Asset Management. The views expressed herein are as at end of November 2012 and subject to change, as the macroeconomic environment evolves. Other short-term, thematic publications, such as New World Insights and events-based communications are also available. To be included in the distribution list for these communications, please contact your HSBC Global Asset Management Relationship Manager.

The US ‘fiscal cliff’There is a lot of pressure on US politicians to deal convincingly with the ‘fiscal cliff’, debt ceiling and long-term US debt dynamics, suggesting a compromise agreement will be found. However, the clock is now ticking for a resolution and until the fine details are agreed investors are likely to remain nervous and asset markets volatile. The good news is that if and when the ‘fiscal cliff’ and debt ceiling uncertainty is resolved, investors will once again be able to focus on the economic fundamentals. In the US, at least, these are improving. Households are gradually deleveraging. Average US household debt as a percentage of disposable income is currently 113% compared to 134% at its peak in 2007. The banking sector has largely recovered from the credit crisis through aggressive recapitalisation and recognition of losses, and is now able to support the recovery through increased lending. The US housing and labour markets are also gradually picking up.

Market focus on South Korea South Korea has a diversified economy and is home to some of the most competitive and well-known multinational companies in the world. However, Korea’s export-driven growth makes it vulnerable to external shocks. The high level of household debt has been holding back consumption at a time when the economy suffers from slowing global demand. The weak housing market adds to concern about default risks. Longer term, Korea faces the challenge of an ageing population. The possibility of a regime collapse or military escalation in North Korea is also an ongoing political risk. Rapid economic policy reform is unlikely under the in-coming government, and the economic dominance of chaebols (Korean business conglomerates) and their export focus will likely continue over the medium term. Prospects for the Korean won and fixed income investments in the medium term are positive given the solid fundamentals (current account surplus, export competitiveness, prudent public finances, etc). Current equity valuations are also reasonably attractive.

Outlook for 2013: the struggle for returnThe eurozone crisis, the US ‘fiscal cliff’ and China’s slowing rate of sustainable growth are likely to continue to constrain global GDP growth in 2013. But we expect economic stabilisation and below trend growth, not global recession. Given weak demand and stubbornly high unemployment, in this environment inflation is unlikely to be a problem in developed markets and monetary policy should remain very loose but largely impotent. In other words, the world is likely to be locked in a low rate environment for 2013 and probably several years to come. On the back of this macro view and based on starting valuations we have the following views on asset classes going into 2013.

Bonds look expensive relative to equities. The upside to core government bonds is likely to be capped by very low current yields with downside more significant if the incipient recovery evident in the US and China gathers momentum. This makes the return profile look asymmetric. Equity markets appear attractive relative to core government bonds. Markets and sectors that are at deep valuation discounts are particularly interesting (for example Russia and China in emerging markets) as are stocks that deliver decent yield in terms of regular dividend payments. High yield corporate and emerging markets credit fundamentals are generally strong, but in certain cases spreads are still relatively wide. These are less liquid markets when compared to core government bond markets but in our view this remains an opportunity. Property yields also provide a healthy margin over core government bond yields in this ultra-low yielding environment. In addition, because of its generally weak correlation with other assets, real estate provides helpful diversification in a multi-asset portfolio. From a currency angle, the euro could benefit in 2013 as the perceived risk of an EU break-up recedes and given that quantitative easing (QE) from the US Federal Reserve (Fed) is unsterilised, unlike European Central Bank (ECB) intervention. Over the longer-term, exposure to Emerging Markets (EM) currencies should help to capture both carry and appreciation versus developed market currencies and help to support emerging equity and local currency bond returns.

Q1 2013 3

Emerging markets (EM) corporate debtWe expect emerging markets corporate debt to become the dominant EM external debt asset class. While EM external debt has traditionally been associated with sovereign debt – with corporate debt remaining a niche – investors are often surprised to learn of the growing prominence of corporate debt in terms of assets, issuance and credit quality. EM corporates enjoy favourable cost structures compared to developed markets and are further sustained by attractive labour force demographics. Additionally, given the substantial improvements to their macroeconomic environment, EM countries now provide a stable operating base for private companies. Despite the positive trends for EM corporates, challenges such as investor perception and liquidity remain. However, these issues will improve as the asset class matures and we believe that the current benefits of investing in EM corporate external debt outweigh the challenges.

Global data watch In our global data watch section we review how economic data releases have been coming through, how consensus economic forecasts have changed and how markets have performed. After a flying start to the year, risk assets sold off aggressively in the second quarter on renewed concerns in the eurozone and weaker global growth. In the third quarter risk assets bounced back on positive actions by central banks in the US and the eurozone. In the final quarter of this year, risk assets have retreated somewhat as markets switched their focus to the US fiscal cliff and the ongoing debt concerns in the eurozone. Year-to-date in 2012, however, key risk assets are still in positive territory.

Growth in the US has moderated while conditions in the eurozone and Japan have deteriorated further. Consumer spending in much of the developed world has fallen from already low levels, being particularly weak in the eurozone but US unemployment is off its highs. EMs have not been immune to the troubles in the eurozone and growth generally slowed in 2012. Latest consensus forecasts have reflected the generally disappointing macro data and there have been downward revisions to 2013 growth for key economies. Growth for the US, Japan, the eurozone and India in 2013 has been revised lower since we published our last quarterly in September. On a more positive note, the slowdown in the global economy has helped to curb inflation in both developed and emerging economies and the US housing market is improving.

4

Looking back on a ‘risk-on, risk-off’ yearWinding back a year, when we started to think about prospects for financial markets in 2012 we noted that in the Chinese zodiac it would be the ‘Year of the Dragon,’ symbolising good fortune and power. As omens go, that certainly sounded auspicious, even though at the time the world was clouded by uncertainty. But how did it turn out? From a financial markets perspective it was a year of extreme contrasts. The first quarter was a rip roaring, ‘risk on’ ride that aggressively pushed up the valuation of risky assets (equities, corporate bonds, etc.) despite the lack of progress in addressing some of the key underlying risks, including the eurozone debt crisis. This was followed by an aggressive sell off in the second quarter when markets fretted about global growth and worried anew about failure to resolve problems in the eurozone and the risk of a ‘hard landing’ in China.

The third quarter had a different tone again sparked initially by comments from Mario Draghi, president of the European Central Bank (ECB) that he would do “whatever it takes” to preserve the eurozone which was eventually followed by the announcement of its new Outright Monetary Transactions (OMT) bond buying programme. The ECB’s move was augmented by additional monetary and fiscal stimulus from the authorities in China and eventually by QE3 from the US Federal Reserve (Fed) and further quantitative easing (QE) from the Bank of Japan (BoJ). The ECB’s action removed some of the

more problematic eurozone-related so-called ‘tail risk’ that had proven to be such a concern in Q2. Even though the markets still fretted about growth, risk assets bounced nicely.

The final quarter of the year was less volatile (chart below) and more of a holding period in which evidence of economic stabilisation started to appear, arguably justifying the rally that had already happened from the Q2 lows.

Outlook for 2013: the struggle for return

Market volatility has fallen but asset correlation remains high

Source: Bloomberg, HSBC Global Research, as of November 2012

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Source: Bloomberg, as of November 2012

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Philip Poole Global Head of Macro and Investment Strategy

Q1 2013 5

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2012 was a financial ‘roller coaster’ ride

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Q1 2013 7

Evidence that the cycle has started to turn has been strongest in the US where there was an improvement in labour and housing market data (see chart on page 4) and where consumer sentiment also showed signs of picking up, despite the uncertainty of the looming ‘fiscal cliff’. More generally, the forward-looking manufacturing purchasing managers indices (PMIs, see above) also started to provide tentative signs that the economic cycle is turning in the US and China and there was some evidence of a deceleration in the pace of contraction in parts of Europe.

In essence, market moves in 2012 can be explained by three factors: expectations about growth, valuations and tail risks. Valuations for risk assets began the year looking attractive but there were concerns about growth and big perceived tail risks. The biggest of these perceived risks was significantly reduced by ECB action that culminated in the ECB’s new bond buying programme.

The November elections in the US, that had also been a key element of uncertainty for much of the year, delivered an outcome that many commentators – including ourselves – had expected with Barack Obama’s return to the White House but still needing Republican support from the House of Representatives in order to legislate – in other words more of the same. As a result the so-called ‘fiscal cliff’ in the US came back into focus as a concern for markets and risk

assets drifted lower. However, all in all, for investors that kept their nerve on this roller coaster ride, the ‘Year of the Dragon’ turned out to be pretty decent, delivering real returns above long-term averages for many risky asset classes.

While there are additional macro risks as yet unresolved this was a big step forward and was supported in Q4 by evidence of potential stabilisation and a turn in the cycle in the US and China.

Over the course of the year risk assets have generally moved higher in valuation and in many cases are less attractive going into 2013 than they were going into 2012. Despite this, in general core government ‘safe haven’ bonds (US treasuries, UK gilts, German bunds, etc) continue to look unattractive, while equities and credit look relatively attractive but less than they did a year ago given the move up in valuations in 2012.

Manufacturing PMIs pointing to stabilisation in global demand in the US and China

Source: HSBC Global Asset Management, Bloomberg, Reuters, as of November 2012

Headline PMI

Jul 12 Aug 12 Sep 12 Oct 12

Global 48.4 48.1 48.8 49.2

US 49.8 49.6 54.5 51.7

UK 45.2 49.6 48.1 47.5

Germany 43.0 44.7 47.4 46.0

France 43.4 46.0 42.7 43.7

Eurozone 44.0 45.1 46.2 45.4

Japan 47.9 47.7 48.0 46.9

Australia 40.3 45.3 44.1 45.2

Brazil 48.7 49.3 49.8

China (HSBC) 49.3 47.6 47.9 49.1

India 52.9 52.8 52.8 52.9

South Africa 51.0 50.2 46.2 47.1

South Korea 47.2 47.5 45.7 47.4

Russia 52.0 51.0 52.4 52.9

Taiwan 47.5 46.1 45.6 47.8

Turkey 49.4 50.3 52.2 52.5

New Orders


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> 50 and rising > 50 and falling or > 50 and unchanged

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8

Should we trust in a snake?So much for 20122013 will be the ‘Year of the Snake’. To western ears this may not sound particularly auspicious but according to Chinese mythology the snake is the symbol of wisdom and ‘snake people’ are meant to be intelligent and wise. With the world still characterised by so much big picture uncertainty, a large dose of wisdom is certainly something that could come in handy in the coming 12 months. In particular, three big macro risks still loom large: ongoing eurozone-related problems, the ‘fiscal cliff’ in the US and the strength, or otherwise, of China’s economy.

As we argued in the previous edition of IQ, the ECB’s bond buying programme is certainly a relief for markets but it is not a panacea. And neither is QE in the US. Many hurdles and uncertainties remain, especially the capacity of European countries to increase their productivity and return to growth. On a shorter-term horizon, the challenge of fiscal adjustment in the US and Europe in the coming year will also come to the fore. Compared to developed countries, EMs mostly remain in a relatively favourable position, even though the stagnation of global trade evident this year has had a negative impact on countries most exposed to global demand.

What kind of economic bounce should we expect?In thinking about prospects for markets in 2013 and the extent to which current valuations are attractive, the consensus of economic forecasters’ expectations (see table to the right) about macroeconomic fundamentals provides a baseline for the macro-economic scenario that is priced into markets. So what is the ‘wisdom of the markets’ telling us about investment prospects in the ‘Year of the Snake’?

Q1 2013 9

Consensus GDP and inflation forecasts

GDP Inflation

2009 2010 2011 2012F 2013F 2009 2010 2011 2012F 2013F

North America -2.6 3.0 1.9 2.1 1.9 -0.2 1.6 3.1 2.1 2.0

United States -3.5 3.0 1.8 2.2 1.9 -0.3 1.6 3.1 2.1 2.0

Canada -2.8 3.2 2.6 2.0 2.0 0.3 1.8 2.9 1.8 1.9

Western Europe -4.1 1.9 1.5 -0.2 0.3 0.6 1.8 2.7 2.2 1.9

Eurozone -4.2 1.7 1.5 -0.5 0.0 0.3 1.6 2.7 2.5 1.9

France -2.6 1.4 1.7 0.1 0.2 0.1 1.5 2.1 2.0 1.7

Germany -5.1 3.7 3.0 0.8 0.8 0.4 1.1 2.3 2.0 1.9

Italy -5.2 1.2 0.6 -2.4 -0.7 0.8 1.5 2.8 3.2 2.2

Spain -3.7 -0.1 0.4 -1.5 -1.6 -0.3 1.8 3.2 2.5 2.4

UK -4.9 1.4 0.9 -0.1 1.3 2.2 3.3 4.5 2.7 2.3

Switzerland -1.9 2.7 1.9 0.8 1.1 -0.5 0.7 0.2 -0.6 0.3

Sweden -5.3 5.4 3.9 1.1 1.7 -0.3 1.3 2.6 1.0 1.0

Norway -1.6 2.1 2.5 3.6 2.7 2.2 2.4 1.3 0.9 1.6

Eastern Europe -5.2 4.5 4.8 2.7 3.1 6.3 6.6 6.3 6.6 5.5

Hungary -6.7 1.2 1.6 -1.2 0.6 4.2 4.9 3.9 5.7 4.4

Poland 1.6 3.8 4.3 2.4 2.1 3.5 2.6 4.3 3.7 2.7

Czech Republic -4.1 2.2 1.7 -0.9 0.9 1.0 1.4 1.9 3.3 2.4

Russia -7.8 4.0 4.3 3.7 3.6 8.8 8.8 6.1 6.7 6.0

Turkey -4.8 9.0 8.5 2.9 4.0 6.3 8.6 6.5 9.0 6.9

South Africa -1.5 2.9 3.1 2.6 3.2 7.1 4.3 5.0 5.5 5.4

Israel 0.8 4.8 4.8 3.1 3.2 3.3 2.7 3.4 1.9 2.3

Asia Pacific 1.9 7.0 4.6 4.7 4.7 0.8 2.6 3.7 2.6 2.7

Japan -6.3 4.0 -0.7 1.8 0.8 -1.3 -0.7 -0.3 0.0 -0.2

Australia 1.4 2.7 2.1 3.5 2.8 1.8 2.8 3.3 1.9 3.0

New Zealand -2.0 1.7 1.3 2.4 2.6 2.1 2.3 4.0 1.2 1.9

China 9.2 10.4 9.3 7.7 8.1 -0.7 3.3 5.4 2.7 3.3

South Korea 0.3 6.2 3.6 2.3 3.3 2.8 3.0 4.0 2.3 2.7

Hong Kong -2.7 7.0 5.0 1.6 3.5 0.6 2.3 5.3 4.0 3.8

India 8.0 8.5 6.5 5.6 6.6 12.4 10.4 8.3 9.3 7.6

Singapore -0.8 14.5 4.9 2.0 3.4 0.6 2.8 5.2 4.6 3.6

Taiwan -1.9 10.9 4.0 1.2 3.5 -0.9 1.0 1.4 2.0 1.8

Thailand -2.3 7.8 0.1 5.2 4.4 -0.9 3.3 3.8 3.0 3.3

Latin America -1.7 6.3 4.2 2.9 3.8 5.7 6.6 7.1 6.0 6.4

Brazil -0.6 7.5 2.7 1.6 3.9 4.3 5.9 6.5 5.3 5.3

Chile -1.7 5.2 6.0 5.1 4.5 -1.4 3.0 4.4 2.2 3.0

Colombia 1.5 4.3 5.9 4.4 4.4 2.0 3.2 3.7 3.1 3.1

Mexico -6.1 5.4 3.9 3.9 3.6 3.6 4.4 3.8 4.2 3.7

World -1.8 4.3 3.1 2.5 2.7 1.3 2.8 3.8 3.0 2.9

Source: Consensus Economics, as of November 2012

Any forecast, projection or target, where provided, is indicative only and is not guaranteed in any way

10

On average, economic forecasters still expect economic activity to be weak and we agree with this conclusion (see table on page 9). Consensus economic forecasts for growth in 2013 have been cut sharply over the course of 2012. Global growth is now forecast to be 2.7% in 2013 versus an expected out-turn of 2.5% in 2012. In other words, no slippage into global recession, but a world where growth continues to be weak relative to prior trend and inflation remains well controlled, particularly in the developed world. On balance, we concur with these conclusions.

Key macro challenges for 2013The schizophrenic market behaviour evident in 2012 convinces us of the need to see short-term prospects in a longer-term context. Looking ahead, for much of the world we expect growth rates to be structurally lower than prior to the onset of the financial markets crisis in 2008. The growth ‘deficit’ in 2012 reflects this conclusion as well as a cyclical slowdown which was in evidence for much of the year. High levels of indebtedness and population ageing represent a structural overhang for growth in most of the developed world with specific challenges including the eurozone debt crisis, the US ‘fiscal cliff’, the continued downside risk to activity in China, and the seemingly unending struggle for growth in Japan: all of which point to a need for structural changes in the drivers of economic growth for the future.

As the chart above shows, since 2000 there has been a dramatic increase in the burden of indebtedness in the government and household sectors in large parts of the developed world. In terms of government indebtedness, this is a constraint on future growth in Europe – including the UK – the US and Japan. By contrast, EMs generally have much lower levels of indebtedness. In this balance sheet constrained world, monetary policy in developed economies has lost much of its potency to stimulate. Massive central bank monetary injections have mostly failed to revive growth – or generate inflation – because the transmission mechanism through to the real economy is effectively broken. Banks do not want to lend and households and firms mostly do not want to borrow. Moreover, the need for fiscal

consolidation, particularly in the periphery of Europe, will also continue to limit the policy response. And with so much economic slack, interest rates at close to zero and ongoing fiscal adjustment in many countries, fiscal multipliers are likely to be above 1, meaning that fiscal adjustment will represent a major drag on economic growth.

Population ageing will also be a structural drag on growth and an added complication for fiscal performance. As the proportion of the people of working age falls (see chart on the right), less people pay into the system and more try to take out in the form of pensions, healthcare and other social payments. The experience of Japan also points to ageing weighing on economic growth. Again, to varying degrees this will be a factor for Europe, the US, Japan and some key emerging markets, including China and Russia.

Within this longer-term context, let us now consider the specific macro challenges on the radar screen for 2013.

Leverage ballooned in the developed world

Source: OECD, as of November 2012

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Ageing populations will be a structural drag on growth

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Eurozone to remain an overhang for markets in 2013First, the eurozone crisis. In reality, this is a subset of the broader problems in the developed world, compounded by the system of monetary union without fiscal union and the bloc’s convoluted governance structure, which makes it difficult to take and then effectively implement decisions. Eurozone-related concerns will continue to be a drag on global growth in 2013 (and beyond) and from time to time problems will likely resurface creating financial angst in markets. Solving the eurozone’s problems will require a multi-year debt work out, whether or not it holds together. There are two key requirements: 1. to clean up the existing mess and 2. to convince markets that it will not happen again. In terms of the first requirement, in 2012 the debt swap for Greece was an important step forward as were efforts to recapitalise Spanish banks – the first time in this crisis that enough cash has been put on the table to do the job. Yields have to be brought down further for Italy and Spain if additional progress is to be made in 2013. The ECB’s new bond buying programme should continue to help to cap yields but can only buy time, not fix the problem.

The longer-term solution will necessitate implementation of credible fiscal adjustment plans. It will also require macro stabilisation and concrete moves towards fiscal union. In addition, there needs to be fundamental structural reform to enhance competitiveness. For policy makers and politicians, this remains a difficult act to pull off.

US fiscal concerns – scaling a cliff of worryThe ‘fiscal cliff’ relates to a set of temporary tax measures due to expire and automatic spending cuts (sequestration) due to kick in that if unaltered would drag the US economy into recession in 2013 – see chart on page 12. In total the expiration of the so-called Bush tax cuts, the payroll tax ‘holiday’ and other measures combined with the sequestration measures are equivalent to a fiscal drag of around 5% of GDP in calendar year 2013.

On balance we expect a political accommodation to be reached between the Democrats and Republicans that reduces the fiscal drag closer to 1-2% of GDP. The deal that gets struck could be around the need for the new Obama administration to increase the government’s debt ceiling, the ‘political’ price for which will probably be Republican demands to roll forward most of the temporary tax cuts and other allowances. Nonetheless, even this reduced burden will keep US growth depressed relative to past trends (we expect growth slightly below 2%) and could lead to additional sovereign rating downgrades from credit rating agencies.

12

What a (fiscal) drag…

Fiscal cliff

Source: Congressional Budget Office website, as of November 2012

-8%

-7

-6

-5

-4

-3

-2

-1

02012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Pro

ject

ed f

eder

al b

udge

t de

ficit

as a

per

cent

age

of G

DP

If current policies are extended

-60

-40

-20

0

20

40

60

80

100

China’s slowdown has been broad based…

…including a weaker real estate market

Source (charts above): CEIC, HSBC Global Asset Management,as of November 2012

Per

cent

age

of G

DP

US

Dbn

Trade balance (rhs)

Exports (lhs)

Imports (lhs)

-40

-20

0

20

40

60

80

100

120

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12

%

Per

cent

age

yoy,

3m

ma

Real estate FAI (Fixed Asset Investment)

Floor space started (commodity building)

-60

-40

-20

0

20

40

60

80

100

Jul-12Aug-11Sep-10Oct-09Nov-08Dec-07Jan-07

China – ‘hard’ or ‘soft’ landing?China has become a key driver of almost everything. Its growth rate has dramatically exceeded growth in the rest of the world over the past two decades. But the economy was slowing for most of 2012 (see charts to the right) and this generated much concern, with investors around the world watching Chinese data ever more closely. In 2012 there was a heated debate about the extent of the current cyclical slowdown – whether it would end up being a ‘hard’ or a ‘soft’ landing – and questions were raised about sustainable growth prospects. Longer term, we believe China’s potential growth is set to moderate over the next decade as the economy matures, while inflation is likely to be structurally higher. From a policy perspective, Japan’s experience shows that attempts to compensate for lower growth by overly stimulating investment can backfire badly. This said, short term, we are in the ‘soft’ landing camp and expect recent signs of recovery in high frequency data to spill over into 2013 as the effects of earlier easing continue to carry through. We think China should be able to achieve 8-8.5% growth in 2013, lower than the halcyon years of 2005-2007 but well in excess of most of the rest of the world.

Q1 2013 13

Economic and political calendar for 2013

Date for the diary Country / Region Event

01 Jan EU E Deadline for EC agreement on the SSM1 legislative framework

02 Jan US E Sequesters take effect regarding the US ‘fiscal cliff’

03 Jan US P New Congress takes office

10 Jan Venezuela P Hugo Chavez begins fourth term as President

11 Jan Czech Republic P Presidential elections

20 Jan US P Presidential inauguration

20 Jan EU E Eurogroup meeting of eurozone Finance Ministers

21 Jan IMF E IMF World Economic Outlook revisions

22 Jan Israel P National elections

23-27 Jan Switzerland E World Economic Forum holds annual meeting in Davos

Jan Ireland E Troika’s next review meeting with Ireland

Feb EU E EU summit (provisional date)

Mar China P Presidential, Prime Ministerial and Senior Cabinet handover

Mar EU E EU summit (provisional date)

16-17 Mar Portugal P EU NATO summit

26 Mar Iraq P Arab League summit

08 Apr Japan CB Bank of Japan Governor’s five-year term ends

13 Apr Italy P Parliamentary elections

19 Apr US E Spring meetings – World Bank and IMF

May EU E EU Summit (provisional date)

13 May Italy P Presidential elections

Jun EU E EU summit (provisional date)

Jun EU E Terms of €110bn Greek rescue restructuring of debt expire

13-14 Jun UK P G8 summit

17 Jun South Africa P BRICS2 leaders’ summit

30 Jun UK CB Bank of England Governor steps down

Sep Germany P Federal parliamentary elections

Sep Russia P Russia to host its first G20 summit

20 Sep EU P EU and Chinese officials hold summit in Brussels

Oct China P CPC3 third plenum to set long-term reforms and policy direction

11 Oct US E Annual meetings – World Bank and IMF

27 Oct Turkey P Local elections

17 Nov Chile P Presidential elections

30 Nov Australia P Australian federal elections

Year End 2013 deadline EU E EU commitment to set up a banking union

31 Jan 2014 US CB Federal Reserve Chairman’s term expires

There are several emerging markets elections taking place in 2013 including Georgia, Ecuador, Iran, Kenya, Jordan, Tunisia, Cyprus and Argentina.

1: Single supervisory mechanism. 2: Brazil, Russia, India, China and South Africa. 3: Communist Party of China

Source: HSBC Global Asset Management, as of November 2012

P Political E Economic CB Central Bank

14

Will rates and yields stay ultra-low?To recap, while we are not expecting a descent into global recession we believe that growth rates in key economies will remain weak in 2013 relative to the pre-crisis trend. This in turn will help to keep inflation in check – one reason why we expect rates and yields on core government bonds to remain very low in 2013. As the charts below show, inflation fell, in some cases sharply, in 2012 and we expect inflation pressures to remain contained in 2013. Labour markets are loose in the developed world with unemployment still rising in much of Europe; this should limit follow-through moves in wages and salaries in response to commodity price rises. In such an environment inflation ‘shocks’ are unlikely to turn into ongoing inflation ‘processes.’ For this reason, other than temporarily, elevated oil and some agricultural commodity prices are not likely to push up global inflation in 2013. But the size of the weights of food and fuel in Consumer Price Index (CPI) baskets mean there is a higher inflation risk in EMs than

developed economies, which would also be aggravated by tighter labour markets in a number of these economies.

A consequence of this muted growth and inflation outlook is that monetary policy in the developed world will likely remain very loose (see table above) in 2013 – although we continue to believe that it will have only a minimal effect on economic activity in core developed markets. The Fed has committed to keep its policy rate at an exceptionally low level until mid-2015 and continues to depress longer-term yields. It has also committed to inject additional liquidity through mortgage-backed securities (MBS) purchases until unemployment falls. This should help to keep financial markets flush with dollar liquidity in 2013 and beyond. Other developed market central banks are also likely to keep interest rates at historically low levels and liquidity conditions very loose.

Bottom line, our central scenario is for interest rates in the US, Europe and Japan to stay very low for at least another two years and probably longer. The risk to this view is that activity responds more positively than anticipated or else inflation picks up more aggressively, but both risks appear low at present. For now, EM central banks are also mostly still in easing mode or on hold, although inflation could force a change in the monetary cycle in a number of these economies in 2013. As things stand the markets are currently pricing higher policy rates in a number of countries that include Brazil and Turkey in the course of 2013.

Excess capacity will limit inflation pressures in the US…

Source (charts above): Bloomberg, OECD, as of November 2012

-2

0

2

4

6

Dec

-02

Jun-

03

Dec

-03

Jun-

04

Dec

-04

Jun-

05D

ec-0

5Ju

n-06

Dec

-06

Jun-

07D

ec-0

7Ju

n-08

Dec

-08

Jun-

09D

ec-0

9Ju

n-10

Dec

-10

Jun-

11D

ec-1

1Ju

n-12

-6-5-4-3-2-101234

US inflation (lhs) US output gap (rhs)

-2

0

2

4

6

Dec

-02

Jun-

03D

ec-0

3

Jun-

04D

ec-0

4Ju

n-05

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06D

ec-0

6Ju

n-07

Dec

-07

Jun-

08D

ec-0

8Ju

n-09

Dec

-09

Jun-

10D

ec-1

0

Jun-

11D

ec-1

1Ju

n-12

-6-5-4-3-2-10123

Eurozone inflation (lhs) Eurozone output gap (rhs)

…and the eurozone% %

%

Per

cent

age

yoy

Per

cent

age

of G

DP

Per

cent

age

yoy

Per

cent

age

of G

DP

%

Current Q4 2012 Q1 2013F Q2 2013F

Fed 0.13 0.12 0.12 0.13

ECB 0.75 0.74 0.74 0.77

BoE 0.50 0.45 0.42 0.41

BoJ 0.10 0.10 0.10 0.10

Brazil 7.25 7.20 7.26 7.48

India 8.00 7.59 7.26 6.96

Korea 2.75 2.71 2.65 2.63

Mexico 4.50 4.52 4.58 4.60

South Africa 5.00 4.80 4.72 4.75

Taiwan 1.88 2.13 1.99 1.87

Turkey 5.75 5.87 6.23 6.37

Source: HSBC Global Research, Morgan Stanley Research, as of November 2012

Any forecast, projection or target, where provided, is indicative only and is not

guaranteed in any way

What markets are pricing for interest rates (%)

Q1 2013 15

Investment themes for a low return world

EM inflation moderated in 2012 but commodityprice pressures are a risk

-4

-2

0

2

4

6

8

10

12

14

16

05/0

6

11/0

6

05/0

7

11/0

7

05/0

8

11/0

8

05/0

9

11/0

9

05/1

0

11/1

0

05/1

1

11/1

1

05/1

2

China Brazil Russia India (WPI series )


%

Infla

tion

(yoy

)

Food and fuel prices dominate EM CPI baskets


0

10

20

30

40

50

60

Bra

zil

Mex

ico

Sou

th A

fric

a

Chi

na

Indi

a

Indo

nesi

a

Thai

land

Rus

sia

Food Energy/fuel related items

%

Per

cent

age

of t

otal

CP

I bas

ket

Reverting to long-term trends?As the table on the next page demonstrates, over the very long run equities have significantly outperformed fixed income in terms of average real returns. The problem is that this conclusion has not held over the past 10 years, a period in which fixed income returns have exceeded equity returns in many markets, in some cases by a considerable degree.

Are there lessons for future prospective returns from Japan’s experience over the past 30 odd years? Japan’s experience certainly has relevance but there are big differences as well as similarities. During the initial period following the onset of Japan’s crisis, government bond yields were high and falling and in real terms returns were also boosted by deflation. By contrast, companies did not pay sizeable dividends and given the very high starting valuations were not seen as an investment alternative. As a result they were penalised in terms of price action with a sharp fall in valuations. Japan was also the odd man out in the sense that peer group markets continued to grow relatively rapidly. Following this period of outperformance, bond yields became unattractive and investors were forced to look to other markets to generate returns. In our view, government bond markets in much of the rest of the developed world have already reached the equivalent of Japan’s second stage of financial markets adjustment, where yields are extremely low and unattractive on a long-term basis.

Most investment theories are based on the idea of ‘mean reversion’ where above average returns for a period are generally followed by below average returns as valuations tend to long-run levels over time. We believe that this is still the way to think about the investment universe and that following a period of excess returns relative to long-term trends, core government bonds are likely to underperform equities over the coming 10-15 years. This has clear implications for the construction of balanced, multi-asset portfolios but is there value in fixed income securities?

Fixed income portfolios – responding to the challenge of low yieldsThe big question is how long yields will remain low. This will clearly depend on underlying global economic conditions and the extent to which inflation remains benign, plus factors like the level of risk appetite, the desire for liquidity and the longevity of central bank bond buying programmes. Central bank purchases are an ongoing market distortion and one of the reasons why yields have been so low, and not just

16

in markets where QE originated. A study by the Federal Reserve Bank of St. Louis (‘Large scale asset purchases had large international effects’) looks at the Fed’s asset purchase programmes and concludes that announcements of these programmes not only impacted US bond yields but also had an important impact on international markets, significantly reducing 10-year nominal bond yields in Australia, Canada, Germany, Japan and the United Kingdom (see charts to the right) and also depreciating the US dollar versus the currencies of those countries.

Source: 10 year government bond yields sourced from Bloomberg.Data as of November 2012

US

Extremely low yields in core government bond markets

-4

-2

0

2

4

6

8

10

12

14

16

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Nominal yield Real yield

%

Source: 10 year government bond yields sourced from Bloomberg.Data as of November 2012

UK


-4

-2

0

2

4

6

8

10

1219

92

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

%

NB: 10-year government bond yields. Real yield defined as nominalyield minus inflation. Source (charts above): Bloomberg, as of November 2012

Germany


-2

-1

0

1

2

3

4

5

6

7

8

9

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

%

In USD unless stated 10yrs 20yrs 50yrs 75yrs

US cash -0.7 0.6 1.1 0.1

US TIPS 7.3

US treasuries 6.1 6.0 3.3 1.9

US corporate bonds 5.4 5.4

US high yield 5.6 5.6

EM debt 8.2 7.4

US real estate 5.4 11.1

US equities 1.8 5.6 5.2 6.2

Global developed equities 1.6 3.7

EM equities 11.4 6.4

Private equity 9.4 11.9

Hedge funds 3.3 7.8

UK gilts (£) 3.9 5.9 3.1 1.1

UK index-linked (£) 4.0 5.0

UK equities (£) 1.2 4.8 5.3 5.2

UK real estate (£) 3.6 5.6

Total returns in real terms, gross income reinvested (%)

Source: HSBC Global Asset Management, Barclays equity-gilt study,

Datastream, Bloomberg, Cambridge Associates, IPD, as of November 2012

Long-term real returns by asset class (%)

Pecking order of long-term expected future real returns by asset class

Source: HSBC Global Asset Management, Barclays equity-gilt study,Datastream, Bloomberg, Cambridge Associates, IPD, as of November 2012

-0.4

0.00.6 0.7

1.9

3.34.0 4.4 4.5

6.5

9.5

-2

0

2

4

6

8

10%

Cas

h

US

Tre

asur

ies

US

IG C

redi

t

EM

Deb

t (U

SD

)

US

HY

Cre

dit

Eur

o H

Y C

redi

t (U

SD

)

US

Rea

l Est

ate

Eur

opea

n E

quity

US

Equ

ities

GE

M E

quity

Priv

ate

Equ

ity

Q1 2013 17

In this context central bank buying of core government bonds has contributed to so-called ‘financial repression’– measures by which governments (or their agents) channel funds to themselves, in this case through the effective capping of interest rates payable to the holders of government bonds. There are clear implications of lower yields for investors, particularly pension funds. Firstly, the low level of yields will tend to increase funding gaps that are in many cases already problematic. This is partly because of the drag that they introduce on the return side but also because in many markets actuarial values placed on liabilities will also have risen as government bond yields are generally used to set discount rates for valuations. In addition, many pension schemes hold fixed interest government bonds but most of their liabilities are inflation-linked. Falls in implied inflation levels have led many such funds to look into swapping from fixed interest into inflation-linked securities to take advantage of this and improve the match with their liabilities.

There is always a natural tension between protecting the capital of investments versus the running income return on those investments. It is self-evident that in a low yielding environment, hitting preconceived levels of return from a portfolio will necessitate taking increased risk. The challenge will be toughest in markets used to a historically high risk-free rate, eg Australia. There have been alternative approaches taken in response to this problem. Some fixed income investors have extended duration in an effort to push up returns – however marginally – on the view that yields will remain low for the foreseeable future. Others have decided to suffer the short-term pain of staying at the short maturity end of government bond curves to avoid locking into the risk that yields could rise sharply in the future. Indeed, in the current environment one of the key risks for investors in core government bonds is that yields rise in the future leading to capital losses.

Traditionally, many pension funds and insurance companies have been considered to be ‘forced’ holders of core government bonds but in the current environment many of these traditional fixed income investors – pension funds and insurance companies included – are actively considering alternative assets including corporate debt, real estate and equities as ways to spice up prospective returns (see individual assets sections below).

On the negative side such assets will generally have poorer liquidity and come with higher potential default risk. One way around this problem is for pension funds to adopt a ‘buy and hold’ strategy for these types of assets. This means that the ‘mark-to-market’ risks associated with lower liquidity become less problematic and the ultimate return more certain. Beyond liquidity considerations, there will be other consequences of adopting alternative asset allocations – in particular the mismatch between assets and liabilities for pension funds. Core government bonds generally have the longest maturities and most complete maturity structure in the fixed income world. Reducing the allocation to these assets in favour of corporates or emerging market government bonds could increase the maturity mismatch

problems because the maturity of these assets tends to be shorter in duration.

‘Core’ government bonds look expensiveIn general we consider core government bonds (US treasuries, UK gilts, Japanese government bonds, German bunds, etc) to be significantly overvalued on a long-term basis given the extremely low level of nominal and real yields currently on offer. The risk in the end is that central bank actions generate asset bubbles in core government bond markets with valuations failing to reflect fundamentals. However, in 2013, governments at the safer end of the bond spectrum that are able to restore public finances without excessive recessionary measures will likely continue to trade at low or negative real yields, supported by benign inflation and accommodative monetary policies. Over this horizon, any upward correction in these yields is likely to prove either minimal or temporary. Triggers for a sustained move up in yields are hard to identify. In terms of geography, we favour the core and semi-core of Europe over the US, based on expected continued economic underperformance in the eurozone and the UK relative to the US, which should lead to outperformance of those bond markets.

We expect these markets to trade in relatively tight ranges in 2013 and phases in the market’s direction are likely to be the main driver of the shape of yield curves. If longer-term inflation fears are triggered by any reappraisal of the inflationary implications of loose monetary policy they are likely to cause bear steepening phases (where longer-term yields move higher), while expectations of additional QE will likely cause bull flattening phases. The bias for spread curves to bull steepen in Europe as the ECB buys the 1y-3y segment remains in place. Intermediate maturities will likely benefit from MBS purchases by the Fed and any reduction in volatility. Longer-term inflation fears have risen on the back of easier policy stances from the Fed and the ECB and breakeven curves should steepen over time as weak growth keeps inflation risks under control in the short term but future inflationary fears increase.


Peripheral eurozone yield curves are still steep

Spanish government bond curve

6

%

5

4

3

2

1

0

1M 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 15Y

20Y

25Y

30Y

US Treasury bond curve

18

Emerging market sovereign debt and currenciesLonger term we are still big believers in the emerging markets debt story but tactically, given recent strong performance, we have become more cautious. Fund flows into the asset class remain very supportive (see chart below) but credit quality shows signs of deterioration. Furthermore, supply is abundant which, coupled with tighter spreads, will likely constrain further spread tightening, particularly in high quality but tight external debt sovereigns.

Still bullish on corporate creditEasy money has fuelled investment in sound corporates down to the high quality end of high yield. Since the end of May, credit spreads have tightened. Valuations remain attractive for better quality corporate names in investment grade and BB/B+ categories. European assets have outperformed but we believe they remain the most attractive segment of the asset class. The value in European fixed income is more visible in high yield than in investment grade. Many European banks still offer value. We prefer to focus on more robust profiles: liquid balance sheet, cash-flow generative rather than speculative, cyclical positions. While we are not expecting global recession, 2013 is unlikely to prove to be a very friendly environment for weak corporate credits. In terms of financials, our focus will be on the more resilient national champions in the core of Europe and the Nordic countries.

Credit risk premia will likely continue to diminish and while default rates will probably rise from the current low levels we do not expect a dramatic increase. Liquidity also remains ample, with no severe credit tightening in sight. But issuer selection is paramount and we aim to avoid low quality and speculative situations. In Asia, corporate, bank and sovereign spreads remain at tight overall levels but we still see value in certain sectors.

Where is the value in equity markets?Despite a strong bounce for most markets in 2012 we believe that equities still offer compelling investment opportunities as part of a balanced portfolio. Companies, in contrast to governments and consumers, have managed themselves relatively prudently over recent years. While governments and households were building up debt to unsustainable levels, companies were mostly paying down their liabilities and building up cash balances and this has helped to protect them in the recent, difficult environment.

Assessing equity market value based on ‘price to book’On a number of valuation metrics many equity valuations are currently attractive relative to their previous trading history in most regions. Many companies, particularly in cyclical sectors, have substantially depressed valuations relative to history. There are many ways to appraise equity valuations. Our favoured approach, particularly for emerging markets, is ‘price to book’. This is a way of valuing shares by looking at the current share price relative to the value of shareholders’ equity on the company’s balance sheet – the ‘book’ value. It is a measure favoured by many strategists as a common sense check on equity prices given that the volatility of earnings can sometimes result in misleading price to equity (PE) ratios.

Source: EPFR database, Bloomberg, as of November 2012

Emerging markets inflows have been robust

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Corporate spreads have compressed but remain attractive

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JP Morgan Investment Grade corporate spread (lhs)

Ratio of JP Morgan Investment Grade corporate spread over 5y US Treasury (rhs)

Barclays Capital High Yield spread Index (lhs)

Ratio of Barclays Capital High Yield over 5y US Treasury (rhs)

Valuations for developed equity markets

Note: Price to book and ROE data based on HSBC Global Asset Management universe for the respective marketSource (all): HSBC Global Asset Management, as of November 2012

Pric

e to

Boo

k

Return on Equity (%)

3.4

2.9

2.4

1.9

1.4

0.9

0.47 9 11 13 15 17 19 21 23 25

Japan

Italy

Australia

France New ZealandSpain Portugal

CanadaAustria

Hong Kong Belgium

SingaporeGermany

FinlandNorway

SwitzerlandUnited States Sweden

NetherlandsUK

Denmark

Valuations for developed market sectors



0.8

1.3

1.8

2.3

2.8

9 11 13 15 17 19

Health Care

Consumer Staples

Consumer DiscretionaryInformation Technology

Industrials

UtilitiesMaterials

Energy

Telecommunication Services

Pric

e to

Boo

k

Valuations for emerging equity markets

Note: Price to book and ROE data based on HSBC Global AssetManagement universe for the respective marketSource (all): HSBC Global Asset Management, as of November 2012


3.3

2.8

2.3

1.8

1.3

0.8

0.39 11 13 15 17 19 21 23 25

Poland

ChinaCzech Republic

Turkey

India Thailand

IndonesiaSouth AfricaMexico

Brazil

PhilippinesChile

Malaysia

RussiaHungary

South KoreaTaiwan

Pric

e to

Boo

k

Valuations for emerging market sectors



1.0

1.5

2.0

2.5

3.0

3.5

10 11 12 13 14 15 16 17 18 19 20

Health Care

Consumer Staples

ConsumerDiscretionary

Information Technology

FinancialsIndustrials

Utilities

Materials Energy

Telecommunication Services

Pric

e to

Boo

k

Q1 2013 19

20

Q1 2013 21 Q1 2013 21

So what looks attractive? There is a long-term relationship between valuation and profitability within equity markets. We believe it makes sense to identify companies that exhibit above average profitability (we use ‘return on equity’ (ROE) to show this) at below average valuations (we use ‘price to book’). The charts on page 19 show this by market and sector for developed and emerging markets. Markets and sectors that lie below the upward sloping line on the respective charts look relatively cheap on a ‘price to book’ (PB) basis compared to their profitability as measured by ROE.

In terms of developed markets, Japan, the US, the UK, Italy, the Netherlands and Australia fit into this picture. On a sector basis, not surprisingly, industrials, energy and materials sectors look cheap relative to the respective return on equity, whereas more ‘defensive’ sectors like consumer staples and telecommunications services look relatively expensive.

For emerging markets, China, Russia, Malaysia, Thailand, Turkey and Poland look cheap on a PB basis relative to profitability and Brazil, Mexico and South Africa look expensive on this basis. From a sector perspective, again the cyclical sectors like industrials, energy and materials look to offer the best trade-off between valuation and profitability at

this point, while defensive sectors like consumer staples and healthcare look relatively expensive. On a longer-term basis part of the return from EM investments will likely come from currency appreciation. For these reasons, on a long-term basis we believe our emerging equity exposure should remain un-hedged from a currency perspective.

Beyond current valuations we expect that ‘risk on, risk off’ behaviour is probably here to stay and our aim will be to identify longer-term investment themes as anchors around which portfolios can be constructed. Going back to the idea that developed world demand will be constrained by high debt loads and ageing populations, companies entirely dependent on such demand are likely to suffer. This applies to Europe where activity is likely to remain depressed in 2013. However, some European equity markets look attractively priced and in a range of sectors can also provide a way of accessing more positive EM themes, including emerging consumption and infrastructure spending.

Assessing value based on forward price-earnings multiples

Forward price-earnings ratios (P/Es)

20 yr average 15 yr average 10 yr average 5 yr average 2010 average Current

World 16.5 16.3 13.8 12.3 12.5 12.1

US 16.3 16.8 14.4 12.9 12.9 12.7

UK 14.5 14.9 12.7 10.1 10.1 10.5

Euro Area 12.3 12.3 11.8 10.5 10.8 10.8

Japan 28.6 22.3 16.6 15.6 15.4 11.7

Canada 15.3 15.5 13.7 13.0 14.0 12.7

Hong Kong 14.7 15.5 15.5 15.3 15.8 14.8

Brazil n/a n/a 8.5 10.0 10.6 9.8

China n/a 12.6 12.0 11.7 12.3 9.5

India n/a 13.8 14.6 14.8 16.4 13.6

Russia n/a n/a 7.9 6.6 6.4 5.0

Latin America 10.7 10.3 10.2 11.0 11.6 11.6

Emerging Asia 14.1 12.7 11.4 11.9 12.1 10.6

Asia ex-Japan n/a n/a 12.4 12.3 12.6 11.5

Emerging Europe n/a 8.9 8.6 7.2 7.3 5.8

Emerging Markets 12.7 11.5 10.7 10.8 11.3 10.2

Source: Datastream, IBES estimates, as of November 2012

22

Developed market forward PE relative to own valuation history(5 year average)

EM forward PE relative to own valuation history(5 year average)

Source: HSBC Global Asset Management, Datastream,as of November 2012

Source: HSBC Global Asset Management, Datastream,as of November 2012

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Many investors prefer to focus on price earnings multiples when thinking about equity valuations. In our view this can also be a useful valuation metric, particularly when looking at valuations relative to the market’s own trading history. As the charts above show, on this basis the Russian and Chinese equity markets look cheap (relative to their own trading history) while Mexico and Turkey, for example, look expensive, unless there is a re-rating story that justifies the current premium relative to history. For Russia and China, these results match up to the conclusions from the PB/ROE valuation framework.

We treat forward earnings estimates carefully as they can be very volatile and tend to react to changes in the economic environment with a lag which in some cases can be substantial. Reflecting the downward revisions of global growth prospects, earnings growth forecasts for 2013 were revised lower over the course of 2012. US earnings estimates for 2013 have been revised downwards since the beginning of the year – from a forecast earnings per share (EPS) growth rate of 15.3% to 6.6%. UK earnings estimates have been revised down substantially, from 13.3% to negative 7.2%. Not surprisingly, the eurozone has also seen downward revisions from a forecast EPS growth rate of 1.8% to negative 2.5%. Most EM earnings growth estimates have also been revised downwards. Earnings estimates in China have been revised

downwards from an expected EPS growth rate of 12.4% to 2.2%. Earnings estimates in Brazil have been revised downwards to negative 16.6%. The only key exception is India where earnings estimates have been revised upwards over the same period from 7.6% growth previously to 10.2% currently.

But what if earnings are further downgraded? Taking a more conservative view of earnings than the one currently embedded in prices, the table above calculates PE multiples for many major equity markets, factoring in an additional 10% and 20% fall in forecast earnings relative to current expectations. Even if profits were to slump 20% more than analysts currently expect a number of the larger emerging markets, including China and Russia, would still be trading on multiples that are at or below their five-year averages. This reinforces our attraction to these markets over the medium- to long-term.

Buying equities for incomeEquity dividend yields currently stand at attractive levels compared with government bonds, while in many cases company balance sheets are still supportive of paying increased dividends. This represents an attractive combination in the continuing low interest rate environment that we expect in 2013 and beyond. The gap between dividend yields and bond yields is historically high in Europe which makes equities look attractive relative to bonds from a running return perspective. A large part of the explanation for this is the very low level of nominal bond yields discussed above. This gap indicates strong prospects for equities relative to bonds in the long term for many equity markets globally. Historically,

12m forward PE Ratio

5yr Avg Latest

Earningsrevised

down by 10%

Earnings revised

down by 20%

US 12.9 12.7 14.1 15.9

UK 10.1 10.5 11.6 13.1

Japan 15.6 11.7 13.0 14.6

EU 10.5 10.8 12.0 13.5

France 10.2 10.2 11.4 12.8

Germany 10.5 10.1 11.2 12.6

China 11.7 9.5 10.5 11.8

India 14.8 13.6 15.1 17.0

Russia 6.6 5.0 5.6 6.3

Brazil 10.0 9.8 10.9 12.3

Indonesia 12.5 13.9 15.5 17.4

Turkey 8.8 10.5 11.6 13.1

Mexico 13.3 17.1 19.0 21.4

Source: HSBC Global Asset Management, IBES estimates, Datastream,

as of November 2012

What if earnings expectations are further downgraded?

Q1 2013 23

Real estateFor our portfolios, we remain broadly positive on real estate as an asset class. Property yields – both listed and unlisted – provide a healthy margin over government bond yields in this ultra-low yielding environment. This is likely to remain a supportive factor in an environment of continued low interest rates. Regular rent reviews in property leases also provide investors with some degree of protection against inflation. For our portfolios, we have a preference for listed over unlisted property, mainly on valuation grounds as many markets stand at a discount to underlying net asset values. Because of its generally weak correlation with other assets, real estate also provides helpful diversification in our multi-asset portfolios.

the size of the valuation differential represented by the yield gap has been a strong driver of subsequent relative long-term market price performance.

Dividend yield by market

Note: The chart above shows 12-month forward dividend yields Source: IBES, Datastream, as of November 2012

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Global property yields attractive relative to coregovernment bonds

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Q1 2013 23

24

Currency exposure and diversification

Spot (vs USD) PPP (vs USD)Under/Over

Valuation (%)

Interest rate differential

vs USD

Developed Markets

Eurozone EUR 0.78 0.84 7.60 0.50

United Kingdom GBP 0.63 0.67 7.70 0.25

Switzerland CHF 0.94 1.64 74.30 -0.25

Canada CAD 0.99 1.25 25.60 0.75

Japan JPY 80.22 103.9 29.50 -0.15

Australia AUD 0.96 1.57 64.00 3.00

New Zealand NZD 121.0 1.73 42.80 2.25

EM-Asia

Hong Kong HKD 7.75 5.54 -28.50 0.25

China CNY 6.27 4.24 -32.40 5.75

India INR 54.45 20.08 -63.10 7.75

Malaysia MYT 3.06 1.94 -36.60 2.75

South Korea KRW 1091 806.4 -26.10 2.50

Taiwan TWD 29.26 15.42 -47.30 1.625

Philippines PHP 41.23 25.49 -38.20 3.25

EM-Latam

Brazil BRL 2.03 1.88 -7.60 7.00

Colombia COP 1817 1343 -26.10 4.50

Mexico MXN 12.99 8.96 -31.10 4.25

EM-EMEA

Russia RUB 31.49 23.80 -24.40 8.00

South Africa ZAR 8.67 5.67 -34.60 4.75

Turkey TRY 1.78 1.33 -25.10 5.50

Under/over valuation based on IMF purchasing power parity (PPP) estimates expressed versus USD

Source: Bloomberg and IMF World Economic Outlook, as at November 2012

It is notoriously difficult to forecast currencies which respond to a range of economic and political factors and quite often the direction of change to events can vary over time. This picture has been further complicated by the assertive nature of recent central bank action which seems by design to be intended to weaken currencies. As with other asset classes, currencies responded to ‘risk on, risk off’ moves and changes in monetary policy by central banks such as the Fed and the ECB in 2012. In 2013 we expect to see similar, although probably less extreme, shifts in sentiment. The euro may benefit in 2013 as the risk of EU break-up recedes and given that QE from the Fed is unsterilised, unlike ECB intervention. Longer-term prospects for the euro could be hurt by the weak eurozone growth outlook.

If the ‘green shoots’ of recovery in the global economy really do take root (even if it is not dramatic growth) we believe that higher yielding currencies should benefit from investor inflows. The currencies we favour have two characteristics – they tend to be undervalued on a real purchasing power basis and also have a positive interest differential relative to developed world currencies. These currencies tend to be in the EMs where measures of real purchasing power of currencies suggest that, over the longer term, exposure to EM currencies should help to capture appreciation. Beyond this view, more generally we will continue to ensure that currency diversification is part of our overall strategies for building diversified global investment portfolios.

Q1 2013 25

Investment preferences as part of a balanced portfolioThe eurozone crisis, the prospect of US fiscal tightening and China’s slowing rate of sustainable growth are likely to continue to constrain global growth in 2013 and beyond. But while we expect growth to be below what was previously regarded as the trend we expect economic stabilisation rather than global recession. Given weak demand and stubbornly high unemployment, in this environment inflation is unlikely to be a problem in developed markets and monetary policy is likely to remain very loose (conventional and unconventional) but largely impotent. In other words, the world is likely to be locked in a low rate environment for 2013 and probably several years to come.

Bonds look expensive relative to equitiesUpside to core government bonds (US treasuries, UK gilts, Japanese government bonds, German bunds, etc.) is likely to be capped by very low current yields with downside more significant if the incipient recovery evident in the US and China gathers momentum. This makes the return profile look asymmetric. Equity markets appear attractive relative to core government bonds.

Markets and sectors that are at deep valuation discounts are particularly interesting (for example Russia and China in EM) as are stocks that deliver decent yield in terms of regular dividend payments.

Lock in high yield corporate and EM debt liquidity and risk premiaHigh yield corporate and EM credit fundamentals are generally strong, but in certain cases spreads are still relatively wide. These are less liquid markets when compared to core government bond markets but this remains an opportunity, particularly if our strategies can lock in these yields via ‘a buy and hold’ approach.

Broadly positive on real estateProperty yields provide a healthy margin over core government bond yields in this ultra-low yielding environment. In addition, because of its generally weak correlation with other assets, real estate provides helpful diversification in our multi-asset portfolios.

Diversifying currency exposureThe euro could benefit in 2013 as the perceived risk of EU break-up recedes and given that quantitative easing from the Fed is unsterilised, unlike ECB intervention. Over the longer term, exposure to EM currencies should help to capture appreciation versus developed market currencies, supporting EM equity and local currency bond returns.

Q1 2013 25

26

Special report (part 2):

Julien Seetharamdoo Senior Macro and Investment Strategist

to USD 95bn. An equally important element of the ‘fiscal cliff’ is the expiration of emergency unemployment benefits also introduced as part of the fiscal stimulus after the credit crisis. Other key components of the ‘fiscal cliff’ are automatic spending cuts, called ‘sequestration’, due to kick in 2013, equivalent to around USD 65bn.

Fortunately, on many elements of the ‘fiscal cliff’, the Democrats and Republicans are more or less in agreement about what should be done. For example, both accept that the Obama payroll tax cuts should be allowed to expire, as should the extensions to unemployment benefits. Democrats and Republicans also agree that the Bush tax cuts for lower- and middle-income US households should be allowed to continue.

It is on the issue of raising tax rates for higher income households that there is most disagreement. Although this represents a relatively small part of the total ‘fiscal cliff’, it is the most politically contentious issue. Republicans would like to keep the Bush income tax cuts for all households including the highest income earners. In essence they are opposed to higher marginal tax rates for the wealthy, whereas the Democrats including President Obama himself have argued for higher marginal tax rates for the rich.

However, even here there could be room for compromise. For example, by raising marginal tax rates only for the very wealthiest US households (say those earning above USD 1mn per year instead of above USD 250,000 per year), or closing loopholes and tax breaks for higher income households to raise their average tax rates rather than their marginal tax rates.

Either way, an agreement simply over how to deal with the ‘fiscal cliff’ is unlikely to be far-reaching enough to stabilise debt levels in the long term. Indeed, as well as dealing with the ‘fiscal cliff’, Congress will also need to agree to raise the US debt ceiling within the next few months; under US law, Congress sets a debt ceiling beyond which the Treasury cannot borrow. A failure to raise the debt ceiling would result in the administration being unable to fund all its planned spending for the year. At that point, the government might need to cancel or delay some spending, effectively shutting down some

With the elections out of the way, investor attention has swiftly focused on another US political issue, the so-called ‘fiscal cliff’. The ‘fiscal cliff’ refers to the fact that on current legislation a large amount of automatic tax increases are due to occur from January 2013 and spending cuts kick in as well, totaling around USD 600bn. If left unaddressed, the tax increases and spending cuts are so large that they would probably tip the US economy back into recession in 2013. Because of concern about the ‘fiscal cliff’, by the end of the first trading day after the US election result, the S&P500 was down 2.4%, its biggest daily percentage drop since 1 June, whilst US 10-year treasury yields fell 10 bp and treasury prices rose, as investors fled riskier assets such as equities in search of ‘safe havens’ assets.

Both the Democratic and Republican parties have announced their willingness to compromise to reduce the size of the ‘fiscal cliff’, but negotiations could go down to the wire, creating further volatility for risk assets in the meantime.

The largest elements of the ‘fiscal cliff’ are the expiration of the so called ‘Bush income tax cuts’ introduced in 2001 and 2003. Expiration of the Bush tax cuts for US households earning less than USD 250,000 per year would represent around USD 160bn coming out of the US economy, while expiration of Bush tax cuts for households earning above USD 250,000 per year represents another USD 60bn approximately.

Another large element of the ‘fiscal cliff’ is the expiration of the Obama payroll tax reduction introduced in 2011 as part of a stimulus programme after the credit crisis, equivalent

With the US elections over, all eyes are now on dealing with the ‘fiscal cliff’

The US ‘fiscal cliff’

Q1 2013 27

government activity. In an extreme situation it could even default on its debt repayment obligations.

During the debt ceiling crisis in mid-2011, Republicans and Democrats only reached agreement at the eleventh hour to raise the ceiling from USD 14.3 trillion to USD 16.4 trillion. Standards & Poor’s, the credit rating agency, cut the US sovereign credit rating a few days later, because the process was so messy. The US will hit this new ceiling some time in January or February 2013.

We would expect bi-partisan negotiations or a commission over the next few months, to come up with a set of proposals to attempt to stabilise long-term US debt dynamics and raise the debt ceiling at the same time. The credit rating agencies may give the US the benefit of the doubt for a few more months, but if these proposals are not made and adopted soon, further rating downgrades for the US could follow.

There is a lot of pressure on US politicians to deal convincingly with the ‘fiscal cliff’, debt ceiling and long-term US debt dynamics, suggesting a compromise agreement will be found. However the clock is now ticking for a resolution and until the fine details are agreed, investors are likely to remain nervous and asset markets volatile. The good news is that if and when the ‘fiscal cliff’ and debt ceiling uncertainty is resolved, investors will once again be able to focus on the economic fundamentals. In the US, at least, these are improving.

Households are gradually deleveraging. Average US household debt as a percentage of disposable income is currently 113% compared to 134% at its peak in 2007. The banking sector has largely recovered from the credit crisis through aggressive recapitalisation and recognition of losses, and is now able to support the recovery through increased lending. The US housing and labour markets are also gradually picking up.

Source: Congressional Budget Office, as of November 2012, HSBC Global Asset Management

Size of ‘fiscal cliff’ elements for fiscal year 2013

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Market focus: Korea

Market fundamentals Key growth driversThe Korean economy has developed remarkably well since the 1997-98 Asian financial crisis, following financial and corporate restructuring and trade/market liberalisation. Per capita GDP has nearly tripled from USD 7,723 in 1998 to USD 22,424 in 2011 and Korea has become one of the major G20 economies. The country is at the centre of north-east Asian global value chains and is home to some of the most competitive and well-known multinational companies in the world. Korean companies produce and export high-end electronics, mobile communication products, automobiles and ships, and many of the companies involved are leaders in the area of technology and innovation. Korea has signed numerous free trade agreements (FTAs) with its major trading partners, including the US, EU, Asean and several Latin American countries among others, and is negotiating a trade pact with China while a FTA with Japan is also under consideration.

A well-educated workforce has also contributed to Korea’s economic success as its high-quality human capital has played a key role in absorbing advanced technology from developed countries. The country’s economy has showed resilience in a volatile global environment – it did not fall into a recession in the 2008-09 global financial turmoil despite its export-driven growth – thanks to a number of factors: 1. persistent current account surplus and large foreign currency reserves; 2. strengthened banking and corporate balance sheets since the Asian financial crisis; 3. diversified export products and markets and 4. overall predictable, effective and decisive policy making, with a sound fiscal position and low level of government debt giving policy flexibility. Korea also benefits from a stable government and healthy infrastructure.

That said, Korea’s economic growth has slowed since late 2011 amid difficult global market conditions. A slow recovery into 2013 is expected, supported by the effects of monetary policy easing and modest fiscal stimulus amid an expected stabilisation of the global economy. The competitiveness of Korea’s export sector should help lead a rebound as global demand recovers. The domestic labour market has been steady with an unemployment rate of around 3-4% over recent years, lower than in many other Asian peers and major countries. However, a large part of the recent rise in employment has been an increase in unpaid workers (self-employed and family workers).

Key economic risks Korea’s openness and export-driven growth does create vulnerability to external shocks. Domestic private investment is heavily tied to global cyclical factors. Persistent global economic weakness and/or renewed financial turbulence is the main risk to the country’s outlook. Korea’s inflation and economic outlook are sensitive to supply-side shocks, such as crude oil; it is the world’s fifth largest net oil importer, relying on imports for all of its oil needs.

The high level of household debt has been holding back consumer spending at a time when the export-driven economy has suffered from slowing global demand. In the medium to long term, this could potentially lead to a decline in the household savings rate, limiting the accumulation of productive capital and thus weakening the economy’s growth potential.

The housing market has been in the doldrums since the 2008 global financial crisis, adding to concern that heavily-indebted households may have trouble repaying mortgage loans, particularly as many self-employed already face tough business conditions. Despite the government’s measures to reinvigorate the property market, the abundant market liquidity and low interest rates, the rise in unsold homes, tepid economic growth, high household indebtedness and the unfavourable demographics (a fall in the population of major home buyers aged 35 to 54) do not bode well for the housing market in our view.

A diversified economy with a competitive export sector, high-quality workforce and sound external and fiscal positions

High household indebtedness and North Korea remain key risk factors

No significant economic policy change is expected under the new government

Renee Chen Macro and Investment Strategist

Q1 2013 29

30

Korean banks have a solid capital buffer against a possible rise in household debt defaults. The loan portfolio of Korean banks have structurally superior asset quality – the mortgage portfolios have lower loan-to-value ratios and banks tend to lend to households with above-average income and credit standings. However, the portion of lending from non-bank institutions has been increasing, even after regulators tightened their lending criteria in 2011, and the number of households that borrowed from multiple financial firms has also been on the rise. Non-bank financial institutions are subject to looser regulatory control than that imposed on banks and have targeted poorer borrowers and smaller businesses.

Longer term, the Korean economy faces the challenge of an ageing population. Compared to other advanced countries, retirement ages are low, the national pension payable is small and a large percentage of the workforce is self-employed. Sustaining growth potential against demographic headwinds will require boosting labour force participation and productivity, particularly in the service sector where productivity is only about half of that in manufacturing.

Politics The upcoming presidential election on 19 December is a two-way race between Park Geun-Hye of the ruling Saenuri Party and Moon Jae-In of the main opposition Democratic United Party. President Lee Myung-bak will remain in office until February 2013. Both candidates have pledged to make ‘economic democratisation’ a policy priority, to restrain the concentration of ‘chaebols’ economic power, enhance economic fairness and support smaller businesses

to create jobs, redistribute wealth and reduce income inequity. Chaebols are Korea’s large, mostly family-owned, conglomerates, some of which have become well-known multinationals. The two rivals’ pledges are similar to each other but Moon has urged a higher degree of restrictions on the chaebols’ dominance. Both candidates have called for investing more in a social safety net – Korea’s public spending on social programmes as a percentage of GDP is one of the lowest among OECD countries.

Regime collapse or military escalation in North Korea is an ongoing political risk although the smooth leadership transition in North Korea with Kim Jong-un having firmly established himself as the leader may have reduced the near-term risk. Both presidential candidates have pledged to pursue a more conciliatory approach towards North Korea than the current administration to secure more peaceful bilateral relations.

Outline of key events in the next 12 months Rapid economic policy changes or reforms are unlikely under the new government, but some change to the tax system is possible to broaden tax base or raise tax revenue from the wealthiest to help fund social welfare spending. The election results may have some impact on the government’s chaebol policy, but is unlikely to change the dominance of the big conglomerates and their export focus significantly over the medium term. If the growth outlook fails to improve visibly, the new government may consider more stimulus measures, eg via a supplementary budget, particularly to support construction and business investment, on top of the measures already announced.

Rising household indebtedness

Note: Chart based on household credit data, as published by the Bank ofKorea. According to OECD statistics however, the ratio could be as highas 156% for 2011, including non-credit household liabilities. Source: CEIC

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Financial marketsCurrencyThe Korean won has been one of the strongest performing currencies in the region this year. Monetary policy accommodation by major central banks has supported capital flows into Korea where economic fundamentals are relatively sound. In the near term, the ‘risk on, risk off’ environment may result in volatile won exchange rates, while further strength of the won could induce the authorities to act to support exports and growth. However, further prudential measures are likely aimed at reducing excessive market volatility rather than impacting the won’s value. The fundamentals and medium-term prospect for the won remains positive. The currency is undervalued on a purchasing power parity (PPP) basis.

Equity marketThe Korean equity market valuation looks reasonably low, in terms of forward price-to-earnings and ‘price to book’ ratios, as compared with its own history and regional peers. The Korean economy is reasonably balanced with solid fundamentals and its exporting sector is highly competitive and set to benefit from a global economic recovery.

Monetary policy and fixed income marketMonetary policy will likely remain accommodative through most of 2013. The Bank of Korea (BOK) cut interest rates twice this year by a cumulative 50bp. While inflation is likely to pick up in 2013 after decelerating this year, it is likely to remain within the BOK’s target range of 2.5-3.5% given tepid domestic demand.

Korea has a large and liquid fixed income market with many non-government bond issues (hence a variety of investment choices). Recent sovereign rating upgrades by major credit rating agencies (S&P, Moody’s and Fitch) have added to the attraction of Korean bonds and credit for foreign investors. The current valuation of Korean credit looks somewhat rich after the significant spread compression this year and further tightening of spreads could be limited. Korean government bond yields are sensitive to any possible re-pricing of US Treasury yields. Over the medium term, Korea’s fixed income markets remain attractive given the higher yield compared with the developed markets which have a similar-level of sovereign credit ratings, solid fundamentals and potential of won appreciation.

Q1 2013 31

32

EM corporate debt

Ask the expert:

The tables are turning in favour of Emerging Markets (EM) corporate debt While corporate debt has traditionally lingered in the shadows of sovereign debt within the EM debt universe, we expect EM corporate debt to move into centre stage and become the dominant EM hard currency asset class in terms of investor appetite and portfolio allocations. The dominance of EM corporate debt can now be seen both in terms of market capitalisation as well as new issuance. With corporate issuance at record levels, if current growth rates continue as we expect, this market segment could soon exceed the size of the US high yield market.

EM corporate issuance is driving new supply in EM debt Corporate debt issuance is likely to represent over 70% of total EM external debt issuance this year, with a forecast (by JP Morgan) to reach USD 255bn in 2012 versus an expected USD 83bn for EM sovereigns. An important milestone was reached in August this year when the size of the EM corporate debt index in terms of market capitalisation surpassed that of sovereign debt for the first time (USD 469bn versus USD 463bn in terms of debt outstanding).

The overall credit quality of the corporate debt asset class is often higher than investor perception. Although traditionally associated with higher risk investments, the EM corporate debt universe is comprised of more than 70% investment grade issues. The index (JPM CEMBI Diversified) for this high quality asset class currently has a higher average rating than the EM sovereign index (JPM EMBIG). At present, high credit quality will be further reinforced as more than 80% of new issuance has been rated investment grade in 2012 thus far.

High credit quality is supported by the strong balance sheets of EM companies as well as of the countries in which they operate EM countries are driving global growth and emerging economies will account for more than 70% of the contribution to global growth in 2012 (JP Morgan, September 2012) and are growing at a pace four times that of developed market economies. As a result of the growing economies, as well as populations and disposable incomes, many EM corporates also enjoy strong organic growth which further strengthens their balance sheets and keeps average leverage low despite increased issuance. Additionally, EM corporates continue to enjoy favourable cost structures compared to developed market corporates and are further sustained by more attractive labour force demographics.

The macroeconomic environment in many EM has been transformed over the past decade and now offers a more stable operating base for private companies Due to low debt to GDP ratios and high reserves, compared to their developed markets peers, the risks of a macro crisis has diminished in many EM countries, thereby reducing one of the major causes of default for EM corporates in past decades. In many ways, the comparison of EM corporates to their developed market peers mirrors the comparison of EM sovereigns to developed market sovereigns; in most cases displaying cases of lower leverage, better liquidity and a potentially stronger growth outlook.

Market size in terms of debt outstanding (USD trillion)

Source: JP Morgan, as of September 2012

10.2

4.7 4.2

1.3 1.2 1.06 0.97 0.68 0.6

0

2

4

6

8

10

12

US

Tre

asur

ies

Age

ncy

MB

S

US

HG

Cor

pora

tes

CM

BS

Non

-age

ncy

MB

S

US

HY

Cor

pora

tes

EM

Cor

pora

tes

EM

Sov

erei

gns

AB

S

Guillermo Osses Chief Investment Officer, Emerging Markets Debt

Q1 2013 33

Many EM corporates offer attractive valuations versus their global peersOn average, for similar credit quality, EM corporates offer higher yields and wider spread levels over their US peers

whilst having lower leverage and sounder balance sheets. Through September 2012, BBB-rated EM corporates have an average spread level of 331bp compared to 237bp for US BBB-rated corporates, with almost half the average net leverage, 1.06 versus 1.92 respectively (see graphs on left).

Though trends for EM corporates are positive, challenges remainChallenges are driven by market dynamics as well as investor perception. The unfamiliarity of the asset class leads to a perception of higher risk which in turn can cause short-term volatility, moving with market risk appetite. In addition, secondary market liquidity can be an issue, particularly during times of an overall market downturn.

We expect these issues to improve over time as the asset class develops, and we believe the positive benefits of investing in EM corporates far outweigh these challenges. In addition, if the current dynamics continue, spread levels of EM sovereigns and corporates should converge. Although these challenges may create volatility in the short term, current valuations and expected future convergence present an attractive entry point into the asset class for investors with medium- and long-term investment horizons.

Despite the growing prominence and positive outlook, EM corporate debt currently still remains under-owned and often overlooked Given the pace of growth of the EM corporate debt universe, its increasing dominance in the EM asset class and recent turbulence in a number of developed markets, we believe that we are approaching a turning point. Many investors are starting to take note of the positive trends in EM corporate credit and we believe it is poised to potentially exceed sovereign debt in investors’ EM allocations in the next five years. The increased investor interest combined with a growing number of dedicated EM corporate debt investment funds currently available are a sign of investors increasingly considering EM corporate debt on its own merits, as opposed to a marginal allocation within their global EM corporate debt or global credit portfolios.

EM corporate liquidity and leverage

NB: Turn of leverage refers to the company’s Debt-to-EBITDA ratio wherea 1:1 ratio translates into one turn of leverageSource (both charts): Bank of America, Merrill Lynch and BarclaysNet leverage is measured as debt to EBITDA, as of September 2012.

0.0

0.3

0.5

0.8

1.0

1.3

1.5

1.8

2.0

2.3

2.5

2006 2007 2008 2009 2010 2011 2012

Net

Lev

erag

e (N

et D

ebt/

LTM

EB

ITD

A, x

)

EM Corp Net Leverage US Corp Net Leverage

2006 2007 2008 2009 2010 2011 2012

Spr

ead

per

turn

of

Leve

rage

, bps

/x

EM Corp Spread per turn of LeverageUS Corp Spread per turn of Leverage

0

200

400

600

800

1000

1200

1400

34

Global data watch

Key highlights Growth: GDP growth for the US has stabilised in the past

couple of quarters while growth rates in Japan have fallen. In the eurozone, GDP growth continues to be sluggish and remains in negative territory. Emerging markets have not been immune to the slow down in the developed world and as a result have also seen their growth rates continue to fall.

Inflation: The slowdown in the global economy has helped to reduce inflationary pressures this year. However, in the past couple of quarters, inflation in a few key economies has started to turn back up.

Industrial production: Industrial production growth continues to soften in both developed and emerging markets with key economies in both regions now showing a contraction in industrial production.

Labour market: Although unemployment rates in the US have fallen, they remain at high levels. In Europe, unemployment rates have risen even further. However, in key EM economies labour markets remain relatively healthy.

Developed markets headline inflation

-3

-2

-1

0

1

2

3

4

5

6

-3

-2

-1

0

1

2

3

4

5

6

US UK Eurozone Japan

%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Headline inflation in the BRIC economies

-4

-2

0

2

4

6

8

10

12

14

16

-4

-2

0

2

4

6

8

10

12

14

16

China Brazil Russia India (WPI)

%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

GDP growth for the US has stabilised in the past couple of quarters while growth rates in Japan have fallen. In the eurozone, GDP growth continues to be sluggish and remains in negative territory. Growth in the UK has rebounded in the past quarter and the UK is now out of recession.

GDP growth in the BRIC economies has continued to weaken. Although the Chinese economy has cooled, growth still remains at a high level relative to the other BRIC economies.

Annual global real GDP growth

-12-10

-8-6

-4-2

0

24

68

%

-12-10

-8-6

-4-20

24

68


9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Real GDP growth, BRIC economies

China Brazil Russia India

-15

-10

-5

0

5

10

15

-15

-10

-5

0

5

10

15%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Source (all): Bloomberg, Datastream, ThomsonReuters, as of November 2012

There was a downward trend in inflation in 2012, but data in the past quarter indicates an uptick in inflation for the US and the eurozone. Latest monthly data (October) for the UK also indicates a rise in inflation.

Inflation in Brazil and China has continued to fall, while in Russia inflation has started to turn back up and as a result the Central Bank of Russia (CRB) unexpectedly hiked its policy rates in September.

Paras Patel Associate, Macro and Investment Strategy

Q1 2013 35

Industrial production (IP) for the developed world is mixed. For the US and UK growth has been relatively unchanged in the past quarters. Japanese IP growth has fallen sharply and turned negative while IP in the eurozone continues to contract albeit modestly.

IP for the BRIC economies has also been mixed with Russia and China posting falls in industrial growth. In Brazil and India industrial production continues to contract.

Growth in retail sales in much of the developed world fell from already low levels with retail sales growth in the eurozone turning negative in the last quarter. On a positive note, retail sales growth for the US has rebounded since the last quarter.

Consumer spending continues to slow for many emerging economies. Chinese spending has also cooled in the past year but latest figures indicate retail sales growth has rebounded slightly from the prior quarter.

Although the unemployment rate in the US has come off its credit crisis high, it still remains stubbornly high. In the eurozone, low confidence and fiscal tightening have weakened labour markets.

Labour markets in Asia remain relatively healthy despite slowing growth, reflecting stronger economic fundamentals and better sentiment when compared to developed world counterparts. Unemployment rates in Russia and Brazil continue to fall.

Developed markets retail sales

-10

-5

0

5

10

15


%

-10

-5

0

5

10

15

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Emerging markets retail sales

-15

-10

-5

0

5

10

15

20

25

-15

-10

-5

0

5

10

15

20

25

China Brazil Russia Taiwan

%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Unemployment in emerging markets

2

3

4

5

6

7

8

9

10

11

2

3

4

5

6

7

8

9

10

11

China Brazil Russia

%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Unemployment rates in the developed world


%

0

2

4

6

8

10

12

14

0

2

4

6

8

10

12

14

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Industrial production – developed markets

-40

-30

-20

-10

0

10

20

30

40

-40

-30

-20

-10

0

10

20

30

40


%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Industrial production – BRIC markets

-20

-15

-10

-5

0

5

10

15

20

25

-20

-15

-10

-5

0

5

10

15

20

25

China Brazil Russia India

%

9/06

1/07

5/07

9/07

1/08

5/08

9/08

1/09

5/09

9/09

1/10

5/10

9/10

1/11

5/11

9/11

1/12

5/12

9/12

Source (all): Bloomberg, Datastream, ThomsonReuters, as of November 2012

36

August 2012 consensus Latest2012 F 2013 F 2012 F 2013 F

Developed markets

United States 2.2 2.1 2.2 1.9

Canada 2.0 2.0 2.0 2.0

Japan 2.4 1.3 1.8 0.8

UK -0.3 1.3 -0.1 1.3

Eurozone -0.5 0.2 -0.5 0.0

France 0.1 0.4 0.1 0.2

Germany 0.8 1.0 0.8 0.8

Spain -1.6 -1.4 -1.5 -1.6

Italy -2.2 -0.6 -2.4 -0.7

Emerging markets

Brazil 1.6 4.0 1.6 3.9

China 7.7 8.1 7.7 8.1

India 5.9 6.9 5.6 6.6

Mexico 3.9 3.5 3.9 3.6

Russia 3.8 3.7 3.7 3.6

South Africa 2.6 3.4 2.6 3.2

South Korea 2.6 3.5 2.3 3.3

Turkey 2.9 4.3 2.9 4.0

World 2.6 2.8 2.5 2.7



Economic forecasts for 2012 and 2013 Growth: The consensus forecasts for global growth for

2013 and 2012 have been revised slightly lower to 2.7% and 2.5% respectively, compared to 2.8% and 2.6% three months ago. The most notable downward revisions in growth for 2013 are in the US, Japan, the eurozone and India.

Inflation: Consensus data forecasts for inflation remain unchanged for 2013. However the recent rebound in inflation data for several key economies has resulted in forecasts for 2012 being revised upwards slightly. Global inflation in 2012 is now expected to come in at 3%, compared to 2.9% three months ago.

Consensus growth forecasts

Q1 2013 37

Consensus inflation forecasts

August 2012 consensus Latest2012 F 2013 F 2012 F 2013 F

Developed markets

United States 2.0 2.0 2.1 2.0

Canada 1.8 1.9 1.8 1.9

Japan 0.1 0.0 0.0 -0.2

UK 2.7 2.1 2.7 2.3

Eurozone 2.4 1.8 2.5 1.9

France 2.0 1.7 2.0 1.7

Germany 2.0 1.9 2.0 1.9

Spain 2.3 2.2 2.5 2.4

Italy 3.1 2.2 3.2 2.2

Emerging markets

Brazil 5.2 5.3 5.3 5.3

China 2.8 3.4 2.7 3.3

India 8.9 7.4 9.3 7.6

Mexico 4.0 3.7 4.2 3.7

Russia 6.6 5.9 6.7 6.0

South Africa 5.6 5.2 5.5 5.4

South Korea 2.3 2.9 2.3 2.7

Turkey 8.9 6.4 9.0 6.9

World 2.9 2.9 3.0 2.9



38

Policy rates Monetary policy: Market implied short-term interest rates

for the US, UK, eurozone and Japan indicate that policy rates are likely to be on hold at least until mid-2013.

The market implied policy rates suggests further easing is likely in India but rates are now expected to move higher in Brazil, Turkey and Taiwan from current levels by the second half of next year.

What markets are pricing for interest rates (%)

Central Bank interest rate setting meetings for Q1 2013

Current Q4 2012 Q1 2013F Q2 2013F

Fed 0.13 0.12 0.12 0.13

ECB 0.75 0.74 0.74 0.77

BoE 0.50 0.45 0.42 0.41

BoJ 0.10 0.10 0.10 0.10

Brazil 7.25 7.20 7.26 7.48

India 8.00 7.59 7.26 6.96

Korea 2.75 2.71 2.65 2.63

Mexico 4.50 4.52 4.58 4.60

South Africa 5.00 4.80 4.72 4.75

Taiwan 1.88 2.13 1.99 1.87

Turkey 5.75 5.87 6.23 6.37

Source HSBC Global Research, Morgan Stanley Research, as of November 2012


Date Region Central Bank Event

Jan 09-10 UK Bank of England (BoE) holds Monetary Policy Committee meeting, followed by interest rate decision

Jan 09-10 ECB ECB Governing Council meeting, followed by interest rate announcement

Jan 21-22 Japan Bank of Japan (BoJ) Monetary Policy Meeting, followed by interest rate decision

Jan 29-30 US Federal Open Market Committee (FOMC) holds two-day meeting, followed by interest rate decision

Feb 06-07 UK BoE Monetary Policy Committee holds meeting, followed by interest rate decision

Feb 06-07 ECB ECB Governing Council meeting, followed by interest rate announcement

Feb 13-14 Japan BoJ Monetary Policy Meeting, followed by interest rate decision

Mar 06-07 Japan BoJ Monetary Policy Meeting, followed by interest rate decision

Mar 06-07 UK BoE Monetary Policy Committee holds meeting, followed by interest rate decision

Mar 06-07 ECB ECB Governing Council meeting, followed by interest rate announcement

Mar 19-20 US FOMC holds two-day meeting, followed by interest rate decision

Source: HSBC Global Asset Management, Bloomberg, as of November 2012

Q1 2013 39

Currency expectations (quoted versus USD)

3 months ago

6 months ago

12 months ago

2-month forward

6-month forward

9-month forward

12-month forwardSpot

Developed world

Eurozone (EUR) 1.28 1.23 1.27 1.35 1.28 1.28 1.28 1.28

UK (GBP) 1.59 1.58 1.60 1.58 1.59 1.59 1.59 1.59

Japan (JPY) 81.27 78.99 80.18 77.03 81.18 81.10 81.00 80.88

Sweden (SEK) 6.76 6.68 7.17 6.74 6.78 6.79 6.80 6.81

Norway (NOK) 5.76 5.95 6.00 5.75 5.78 5.80 5.82 5.83

Switzerland (CHF) 0.94 0.98 0.94 0.92 0.94 0.94 0.94 0.94

Australia (AUS) 1.03 1.05 0.99 1.02 1.03 1.02 1.01 1.01

Canada (CAD) 1.00 0.99 1.01 1.02 1.00 1.01 1.01 1.01

New Zealand (NZD) 0.81 0.81 0.77 0.77 0.81 0.80 0.80 0.79

Asia

China (CNY) 6.23 6.36 6.32 6.35 6.29 6.30 6.32 6.34

Hong Kong (HKD) 7.75 7.76 7.77 7.78 7.75 7.75 7.75 7.75

India (INR) 54.69 55.66 53.80 50.67 55.65 56.42 57.17 57.90

Indonesia (IDR) 9629 9513 9274 8995 9668 9766 9883 10006

Malaysia (MYR) 3.07 3.13 3.08 3.15 3.08 3.10 3.11 3.12

Philippines (PHP) 41.25 42.22 42.70 43.42 41.20 41.19 41.20 41.19

Singapore (SGD) 1.22 1.25 1.26 1.29 1.22 1.22 1.22 1.22

South Korea (KWR) 1087 1133 1154 1126 1093 1097 1101 1105

Taiwan (TWD) 29.08 29.98 29.48 30.20 28.88 28.78 28.70 28.62

Thailand (THB) 30.72 31.53 31.35 30.81 30.89 31.02 31.16 31.29

EEMEA

Czech Republic (CZK) 19.99 20.28 20.16 19.03 19.97 19.95 19.93 19.92

Hungary (HUF) 222.4 226.6 231.4 233.0 225.0 227.2 229.0 230.8

Poland (PLN) 3.25 3.32 3.43 3.28 3.29 3.31 3.33 3.36

Russia (RUB) 31.66 31.87 30.60 30.69 32.16 32.60 33.07 33.53

Turkey (TRY) 1.80 1.80 1.83 1.80 1.82 1.84 1.86 1.89

South Africa (ZAR) 8.96 8.24 8.31 8.17 9.08 9.19 9.30 9.41

Latam

Argentina (ARS) 4.79 4.61 4.44 4.27 5.16 5.56 5.96 6.41

Brazil (BRL) 2.08 2.03 2.00 1.77 2.09 2.12 2.14 2.17

Mexico (MXN) 13.24 13.13 13.84 13.6 13.36 13.48 13.61 13.74

Source: Forward currency rates sourced from Bloomberg, as of November 2012

40

Global equity market performance (MSCI indices)

Total return (% in USD terms)-MSCI indices -1M -1Q -1Y YTD

Developed World 1.6 3.1 18.8 14.3

Emerging World 1.5 5.8 13.7 12.7

North America 0.7 1.2 20.2 14.4

Europe 3.3 7.5 20.2 16.6

Eurozone 4.4 9.9 19.4 17.9

Europe ex UK 4.1 9.2 21.5 18.6

Asia Pacific ex Japan 2.2 6.2 22.7 21.2

Australia 1.9 5.0 20.0 18.1

Austria 8.2 19.7 26.0 19.6

Belgium 3.9 7.5 40.7 37.3

Brazil -2.9 -0.5 -3.2 -6.4

Canada 0.4 2.5 11.5 8.0

Chile -2.8 -1.6 8.9 4.1

China 1.8 11.9 17.6 16.4

Colombia -3.6 7.7 33.5 25.5

Czech Republic -6.2 -5.8 6.1 -0.1

Denmark -0.1 3.6 31.3 28.5

Egypt -17.8 -9.9 23.1 36.0

Finland 7.2 13.5 6.5 11.4

France 5.2 9.1 20.6 18.5

Germany 3.6 9.8 25.4 26.6

Greece 8.0 16.3 0.3 1.7

Hong Kong 3.9 12.1 28.8 27.3

Hungary -4.6 9.4 19.5 24.0

India 2.5 12.6 16.3 23.7

Indonesia -1.0 5.5 10.0 5.2

Ireland 0.0 2.2 15.0 0.5

Israel 3.5 6.6 6.2 2.1

Italy 4.3 10.4 10.5 9.9

Japan 2.6 0.7 3.8 2.8

Korea 4.4 5.3 13.4 15.8

Malaysia -2.6 0.9 16.1 9.5

Mexico 1.5 8.0 28.6 24.4

Morocco 3.2 -0.6 -11.6 -9.3

Netherlands 4.7 8.9 24.2 18.4

New Zealand 2.2 11.6 36.5 27.7

Norway 0.8 2.0 20.6 17.2

Peru 3.2 10.9 16.0 14.5

Philippines 6.1 14.9 48.7 43.5

Poland 6.0 13.2 26.9 29.8

Portugal -1.9 7.6 -4.6 -4.2

Russia -1.6 -0.3 -0.1 6.5

Singapore 1.1 2.4 25.2 26.3

South Africa 0.9 0.9 15.3 9.6

Spain 4.2 13.8 3.0 0.2

Source: ThomsonReuters Datastream, HSBC Global Research, as of November 2012

Q1 2013 41

Global equity markets equity valuations

Global equity market performance (MSCI indices) – continued

End year PE (x) End year EPSg (%) PEG2011e 2012e 2013e 2011e 2012e 2013e 2012e

Asia

China 10.4 9.5 8.6 2 9 11 0.9

India 14.8 13.0 11.4 10 14 14 0.9

Indonesia 15.3 13.5 11.7 6 13 16 0.9

Korea 9.5 8.2 7.3 34 17 12 0.7

Malaysia 15.3 14.1 12.9 11 8 9 1.5

Philippines 18.0 16.1 14.6 12 12 10 1.6

Taiwan 17.0 13.7 12.0 5 24 14 1.0

Thailand 12.5 10.6 9.6 14 18 10 1.0

EEMEA

Czech Republic 10.5 10.6 10.5 1 -1 2 7.1

Hungary 9.8 8.1 6.8 -17 21 20 0.4

Poland 10.1 10.8 10.2 -12 -6 6 1.9

Egypt 8.4 7.6 7.2 31 9 6 1.3

Russia 4.9 5.0 4.9 -13 -1 1 4.2

South Africa 13.8 11.8 10.5 14 17 12 1.0

Turkey 11.7 10.4 9.3 10 12 13 0.8

Latam

Argentina 3.3 3.1 2.9 -19 8 5 0.6

Brazil 12.0 10.0 9.0 -18 20 11 0.9

Chile 18.0 15.5 14.0 -1 16 11 1.4

Colombia 16.8 14.3 15.9 12 17 -10 -1.4

Mexico 19.1 16.4 14.4 36 16 14 1.2

Peru 12.7 11.4 11.0 -4 12 3 3.4

Global emerging markets 11.4 10.1 9.1 4% 13% 10% 1.0

PE – price earnings; EPSg – earnings per share growth; PEG – price/earnings to growth ratio. Data is for end year.

Source: IBES estimates, ThomsonReuters Datastream, HSBC Global Research, as of November 2012

Any forecast, projection or target, where provided, is indicative only and is not guaranteed in any way.

Total return (% in USD terms)-MSCI indices -1M -1Q -1Y YTD

Sweden 3.2 5.0 25.8 18.0

Switzerland 4.4 10.1 26.0 19.8

Taiwan 6.7 6.7 17.6 14.9

Thailand 2.2 7.0 30.6 25.8

Turkey 2.7 12.0 48.3 52.8

UK 1.9 4.4 17.7 13.1

US 0.7 1.1 21.1 15.0

Source: ThomsonReuters Datastream, HSBC Global Research, as of November 2012

42

This document is prepared for general information purpose only and the opinions expressed are subject to change without notice. The opinions expressed herein should not be considered to be a recommendation by HSBC Global Asset Management (Singapore) Limited to any reader of this material to buy or sell securities, commodities, currencies or other investments referred to herein. It is published for information only and does not have any regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors may wish to seek advice from a financial adviser before purchasing units in the fund. In the event that the investor chooses not to seek advice from a financial adviser, he should consider whether the fund in question is suitable for him.

The past performance of any fund and the manager and any economic and market trends/forecast are not necessarily indicative of the future or likely performance of the fund. Value of investment and units may go down as well as up, and the investor may not get back the original sum invested. Investors and potential investors should read the Singapore prospectus (including the risk warnings) which is available at HSBC Global Asset Management (Singapore) Limited or its authorised distributors, before investing. Changes in rates of currency exchange may affect significantly the value of the investment.

HSBC Global Asset Management (Singapore) Limited, or its ultimate and intermediate holding companies, subsidiaries, affiliates, clients, directors and/or staff may, at anytime, have a position in the markets referred herein, and may buy or sell securities, currencies, or any other financial instruments in such markets. HSBC Global Asset Management (Singapore) Limited has based this document on information obtained from sources it believes to be reliable but which it has not independently verified. Care has been taken to ensure the accuracy and completeness of this presentation but HSBC Global Asset Management (Singapore) Limited and HSBC Group accepts no responsibility for any errors or omissions contained therein. HSBC Global Asset Management (Singapore) Limited 21 Collyer Quay #06-01 HSBC Building Singapore 049320 Telephone: (65) 6658 2900 Facsimile: (65) 6225 4324 Website: www.assetmanagement.hsbc.com/sg Company Registration No. 198602036R

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