SYZ & CO - SYZ Asset Management - Market Outlook 18 January 2013

This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses, caused by using the information supplied in this document.

18 January 2013

The main points at a glance

• This year 2013 is starting under favourable auspices while leaving a special impression in the minds of all the operators. The unanimously optimistic consensus that is prevailing about the economic and financial outlook is, paradoxically, making everyone fear that an unpleasant surprise is imminent. Yet after two years of a descent into hell in Europe, growing systemic fears, demystification of China’s growth and questions being asked about the US economy’s ability to one day get out of the mire caused by the financial crisis, everything seems to be coming together so that things at last improve in 2013.

• There is no reason to jump for joy either, since growth in the United States or the emerging world will be far from on a par with its pre-crisis levels and Europe will probably still hover between recession and stagnation. But the (apparent) disappearance of the systemic risks that had undermined the financial markets in recent years, combined with a return of a positive dynamic for global growth, are helping to create a favourable environment which the markets had not seen for a long time.

• And as the western central banks, led by the Fed, continue to flood still-convalescent economies with liquidity, it appears difficult today not to reach the conclusion that 2013 will be a more favourable year than the two previous ones. And the fact that this analysis is very consensual does not necessarily mean it is wrong…

• The markets are in fact continuing to reflect capital re-allocation, with share indices that are still well-oriented and assets that have acted as safe havens losing some of their attractiveness.

This document is based on informationcollected until the Monday precedingpublication.

A publication of the Research & Analysis team Banque SYZ & CO SA Tel. +41 (0)22 819 09 09 [email protected] Authors: Yasmina Barin Adrien Pichoud Fabrizio Quirighetti

Economy United States ...........................................................................2 A last-ditch agreement that leaves several elements unresolved

Europe.....................................................................................3 “Back in a normal situation, from a financial viewpoint”

Japan.......................................................................................4 While hopes are high for 2013, the end of 2012 was still weak

Emerging economies................................................................4 A (moderately) positive dynamic at the start of 2013

Markets Equities ...................................................................................5 A decrease in systemic risk

Bonds ......................................................................................5 The interest rate on Italian 10-year bonds at its lowest level since the end of 2010

Exchange rates ........................................................................6 Mario Draghi causes the euro to leap up

Asset allocation Allocation grid .........................................................................7 Increase in equities, decrease in gold

Bonds Equities Hedge funds

Projections at 6 months


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Economy

United States

The consensus is not always wrong… As expected by the vast majority of investors, Republicans and Democrats waited until the final hours of 2012 (even overshooting slightly into 2013), but reached an agreement that averts the abrupt tightening of budgetary policy that was threatening to plunge the US economy into recession. As is fitting, this agreement is only partial, as it concerns only the fiscal part of the set of measures that make up the now-famous fiscal cliff. As they were probably under time pressure (wanting to celebrate the New Year with their families?), the members of Congress and the President postponed until the end of February the resolution of the other two “major issues”: the public spending cuts and the raising of the debt ceiling.

A potential Fiscal cliff 2.0 is thus looming in the short term, with its batch of telling sentences and taking of stances. Yet this time the suspense appears to be less unbearable, first of all owing to a degree of familiarization with the dramaturgy of last-minute agreements after the episodes of August 2011 and December 2012, but also owing to a genuine lack of room for manoeuvre on at least one point: the raising of the debt ceiling, which must imperatively be adopted, failing which the United States will be in a situation of payment default. Indeed, the public debt exceeded the legal ceiling of USD 16,394 bn in December, compelling the Treasury to resort to special measures to continue to meet payments. As in 1995 or 2011, the raising of the debt ceiling – which is inescapable - is in fact being used as a tool to exert pressure in other negotiations, this time concerning the public spending cuts.

Debt ceiling and public debt as a percentage of GDP since 1930 The aim of the ongoing negotiations, which have to be wrapped up by the end of February, is to stabilize debt at around 100% of GDP.

President Obama and the Democrats are proposing a combination of public spending cuts and tax increases in order to stabilize the ratio of debt to GDP at its current level, i.e. around 100%. The Republicans, for their part, intend to achieve this result solely through public spending cuts, in particular in welfare programmes. Once an agreement has been reached, the debt ceiling should be raised by USD 2,000 bn, an amount sufficient for the next two years if the stabilization of the debt/GDP ratio is ineffective (that is, if the debt does not increase faster than GDP in current dollars).

ISM composite and year-on-year change in GDP

After a soft patch in the middle of the year and the quelling of some of the fears over the fiscal cliff, the outlook is clearer: growth should remain at around 2% in 2013. Thus while the debate about budgetary policy is not completely over, the prospect of a fiscal shock and growth coming to a halt appears to have been ruled out. Now that the US economy has been freed from the burden of uncertainty that weighed on corporate expenditure in particular during the second half of last year, the U.S. economy appears set to regain a growth rate of about 2%, after what was probably a soft patch at the end of 2012. The activity index in manufacturing industry returned to the growth zone in December, while the services index recorded a clear-cut increase. It is significant that the indicator of employment in services increased strongly, suggesting an upcoming strengthening of the encouraging dynamic observed in 2012.

Thus in summary, the negative impact of the moderate tightening of budgetary policy should, in 2013, be offset by a good performance of domestic demand: consumption will be driven by rising employment and the return to growth of the real-estate market (construction and prices of existing houses), and corporate investment should recover. This should be sufficient to fuel GDP


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growth of the order of 2% over the year. With perhaps - unlike in 2011 and 2012 - more “risks” of pleasant surprises than of disappointments. Europe

In the Euro zone, the beginning of the year was marked by the monthly meeting of the European Central Bank, which ended on a much more encouraging note than that which had been held only one month ago. Mario Draghi and his colleagues now consider that “We are now back in a normal situation, from a financial viewpoint”! It is true that the central bank did not spare any effort in 2012 to contain the threat of the monetary union breaking up: injection of liquidity into the banking system via the LTRO, a cut in the Refi rate, a commitment to defend the single currency whatever the cost, putting in place a lender-of-last-resort mechanism for governments deprived of market access, drawing up a draft plan for a banking union supervised by the ECB...

This resulted in a significant narrowing of interest-rate spreads on government bonds (leading to "positive contagion" according to Mr. Draghi) and to incipient stabilization of the leading credit indicators. Consequently, the members of the ECB did not even discuss the possibility of a further cut in interest rates at their January 10 meeting, as the subject had been widely debated in December and such a move was taken for granted in 2013 by a number of investors.

Economic sentiment index and change in the unemployment rate over 12 months

While activity is still likely to remain weak in 2013 in the euro zone, the worst of the deterioration now appears to be behind us. In terms of economic activity, however, the central bank acknowledges that there is not yet any sign of a recovery of activity and that we should not expect to see one before the second half of this year. But, after one and a half years of continuous deterioration, the incipient stabilization of the activity indicators – albeit at a still-low level synonymous with recession - is already in itself

an encouraging development: the worst does indeed appear to be behind us for Europe… And if the unemployment rate continues to rise and reach new highs, if industrial production is still downwardly oriented and if fiscal austerity continues to weigh on domestic demand in 2013 - particularly in Spain - the rate of deterioration now looks set to slow down, which means that questions are now justified about the date on which growth will return rather than about the likelihood of the euro surviving…

Trade balances in peripheral Europe

The foreign balances of the peripheral European economies are being re-balanced and gradually becoming a source of growth. The stabilization of the various activity indicators has been joined by the significant improvement in the foreign balances of the peripheral European economies. This re-balancing is taking place with some pain (via a drop in imports), but is creating the conditions for a positive and growing contribution from foreign trade to GDP growth. This will probably not be enough to counterbalance, in the short term, the weakness of domestic demand, but it bodes well for the medium-/long-term outlook… Italy has thus posted trade surpluses for the first time since the first half of the previous decade, while the Spanish trade deficit is today only one third of what it was at its peak (half for the Greek and Portuguese deficits). As for Ireland, the dynamism of its exports makes it one of the countries with the strongest growth prospects in the Euro zone in 2013 (+1.1% expected by the European Commission, bettered only by Estonia, Slovakia and Malta).

Thus at the beginning of 2013 the Euro zone no longer necessarily poses the same threat to global growth as it did in early 2011 or at the beginning of 2012. Among the major zones, it will probably continue to post the weakest economic performance but the trend towards deterioration appears to have been halted. And if the diagnosis made by the ECB of a return to normal in financial terms proves to be accurate and sustainable, it is possible that the surprises may be positive ones this


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So urce: SYZ A sset M anagementBRA CHI IND

year, in view of the low level of expectations. The potential for disappointment has in any case significantly diminished… In the United Kingdom, the trend in the activity indices in December clearly illustrates the current situation of the British economy: the manufacturing sector index has risen and has returned to positive territory for the first time since last April, supported by the signs of an improvement in the global growth cycle. But its counterpart for the services sector, for its part, has fallen to its lowest level since April 2009, a sign of the persistent weakness of domestic demand at a time when budgetary austerity continues to stifle activity on the island… Thus although the Bank of England did not alter its monetary policy at its first meeting of 2013, a further easing appears to be inevitable. Before or after July 1st this year, the date on which Mark Carney, the successor to Sir Mervyn King as governor of the Bank of England? In Switzerland as well, the positive dynamic of the global cycle has driven up the index of activity in industry, even though the latter has not yet returned to a zone synonymous with expansion. As far as the SNB is concerned, the decrease in tensions over the Euro zone has, in parallel, reduced the upward pressures on the Swiss franc. Thus defending the floor rate no longer requires any intervention by the central bank, as is borne out by the stability of the institution's foreign-exchange reserves since the end of the summer. Japan

While the election of Mr. Abe and the prospect of a reform of the Bank of Japan’s monetary policy are arousing optimism on the Japanese financial markets, the latest activity indices for 2012 are still conveying the image of a Japanese economy in recession. The tensions with China since the end of the summer have significantly impacted Japanese industry. Thus the industrial activity index has fallen to its lowest level since April 2009, counter to the improvement observed in the rest of the major world economies. The economy appears to be in dire need of the reforms promised by Mr. Abe and it is to be hoped that they will prove sufficient to genuinely revive growth in the Archipelago.

Emerging economies

The encouraging trend that has appeared since the end of the summer in the emerging economies and in particular in China has been confirmed by the statistics published at the beginning of the year. The industrial activity indices - a measure of the cyclical dynamic - have returned to the expansion zone in China, India and Brazil. The exports of most of the Asian economies (excluding Japan) have begun to increase again, a sign of a revival of dynamism in the region and of global demand.

In China, inflation rebounded under the influence of an increase in food prices, but at 2.5% it remains well below the limit of 4% set by the authorities. The central bank, which had resisted the temptation to overly ease its monetary policy in 2012, does not appear set to tighten it again in the near future, even though growth is becoming stronger and inflation is increasing slightly.

PMI manufacturing indices in Brazil, China and India

After the slowdown in the first half of the year, growth has regained a positive dynamic in the emerging world.


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Markets

Equities

The stock markets have begun the year on a favourable note. Good news on the economic front and an agreement in extremis on the US fiscal cliff right at the end of last year have helped to reassure the operators. Indeed, as the systemic threat has been dispelled following the measures taken last summer by Mr Draghi, visibility is increasing and encouraging the operators to move with a higher risk profile in their portfolios.

Trend in the European sectors

The return of a risk appetite has resulted in a sharp appreciation in the share prices of the cyclical and financial sectors. On the sectoral front, the trends observed last winter have been confirmed. Shares that offer more strongly cyclical results (Automotive, Industrial) and financial stocks have continued to outperform the market. Defensive shares, which are still quite widely held, have tended to stagnate. The luxury sector has taken advantage of an improvement in the trends in Asia and of an upturn in mergers and acquisitions transactions in the past few weeks.

This resolutely more favourable environment encourages us to gradually increase the weight of equities in our portfolios. The valuation levels in absolute terms, but also compared with sovereign bonds, remain very attractive. Facilitated access to credit and a stabilization or even slight re-acceleration of growth in the emerging zones should translate into some good results in 2013. But the path will remain stony, at a time when the discussions about the debt ceiling in the United States are still ongoing and the elections in Italy are approaching. The corporate earnings season might also take us back to greater

volatility, after having risen virtually without interruption since last summer. Bonds

The beginning of the year has been marked by the continued narrowing of interest-rate spreads on sovereign bonds between the peripheral and the core countries of the euro zone: Spanish 10-year rates thus briefly fell below the 5% mark before returning to just above this level, while their Italian counterparts were reaching their lowest level since autumn 2010, at 4.15%. An illustration of the “back to normal” in financial terms mentioned by Mario Draghi.

At the same time the long-term interest rates of issuers perceived as safe havens have firmed up, penalized by investors’ regained risk appetite: German 10-year rates thus rose from 1.31% at the end of 2012 to 1.58%. The rate on 10-year US Treasuries has risen from 1.76% to 1.86%, while French and British 10-year rates were returning to above 2%.

Government bond 10-year rates in the Euro zone The lack of any differentiation between issuers before 2008 was probably not “normal”. Nor were the levels reached by Spanish or Italian interest rates in summer 2012, once the ECB took on the role of lender of last resort. At the beginning of this year, the situation does indeed appear to be returning to normal… Among the “corporate” issuers, non-financial corporate bonds have also suffered from the decrease in risk aversion, while financial corporate bonds, buoyed by the peripheral European issuers, have kept up the momentum they had in 2012 (best segment of the European Investment Grade market) with a continued narrowing of spreads.


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Exchange rates

Mario Draghi’s declarations at the end of the ECB meeting, which ruled out the prospect of an interest-rate cut and emphasized a return of confidence and capital flows in the Euro zone, have lent significant support to the European single currency. The euro has thus reached its highest level since February 2012 against the dollar (at 1.3382). Against the Swiss franc, the European currency has attained its highest level since May 2011, above EUR/CHF 1.24. With the decline in risk aversion and the adoption by several Swiss banks of negative interest rates on deposits in CHF, the capital flows “seeking a safe haven” in the Swiss franc appear to have begun to decline.

Euro against dollar and Swiss franc since September 2011

The receding prospect of a further interest rate cut by the ECB and the positive comments made by its president caused the euro to rise suddenly in early January.

This document has been produced purely for the purpose of information and does not therefore constitute an offer or a recommendation to invest or to purchase or sell shares, nor is it a contractual document. The opinions expressed reflect our judgement on the date on which it was written and are therefore liable to be altered at any time without notice. We refuse to accept any liability in the event of any direct or indirect losses, caused by using the information supplied in this document

18 January 2013

Asset allocation Given the factors described above, we have decided to reduce the weight of gold in all the portfolios, in favour of the “equities” portion. For a “medium” risk profile, the weight of gold has been reduced from 6% to 4 % (-2%) and re-invested in equities, the weight of which has risen from 38% to 40% (+2%). The allocation grid for a “medium” risk profile in euros, as at 14 January, is given below.

Allocation grid for a “medium” risk profile in euros

Bonds 32% Short-term bonds 25% Long-term bonds 7% Equities 40% Europe 17% United States 15% Japan 2% Emerging countries 6% Alternative investments 14% Gold 4% Cash 10%

Total 100%

“LOW” RISK PROFILE The weight of gold has dropped by -1% to 3% and that of shares has risen, from 7% to 8% (+1%). In addition, the proportion of alternative investments has increased by +2% to 14%, financed by an equivalent reduction of cash (-2% to 15%). “MODERATE” RISK PROFILE The proportion of gold has been lowered from 5% to 3% (-2%). Half of the proceeds of these sales has been re-invested in equities, the weight of which has risen by +1% to 18%, and half in alternative investments (+1%), taken up to 18%. “HIGH” RISK PROFILE The weighting of gold has been reduced by 50% (-3%, from 6% to 3%). The weight of shares has been increased in proportion (+3% to 68%).

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SYZ & CO - SYZ Asset Management - Market Outlook 18 January 2013