Is the ‘New Normal’ here?
Presentation by Dr. V. Anantha Nageswaran
Chief Investment Officer
Bank Julius Baer
Indian Association of Investment Professionals
Speaker Event, May 7, 2010, Mumbai
Agenda
 Introduction
 Trends observed between 1982 and 2002
 Trends observed from 2003 onwards
 Crisis
 The new financial normal
 Conclusion
2
1982-2000: The golden era for
financial assets. Why?
Gold prices, 1982 – 2002
As of April 06, 2010 in USD
Chart: Gold price, dollar per ounce, London PM fix
550
500
USD
450
400
350
300
250
4
Source: World Gold Council (2010)
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Jan-88
Jan-87
Jan-86
Jan-85
Jan-84
Jan-83
Jan-82
200
Long-term interest rates, 1982 – 2002
As of April 06 2010
Chart: US ten year government bond yields
16.0
14.0
Percent
12.0
10.0
8.0
6.0
4.0
5
Source: Bloomberg
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Jan-88
Jan-87
Jan-86
Jan-85
Jan-84
Jan-83
Jan-82
2.0
6
Source: Bloomberg
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
Jan-92
Jan-91
Jan-90
Jan-89
Jan-88
Jan-87
Jan-86
Jan-85
Jan-84
Jan-83
Jan-82
Index
Global commodity index, 1982 – 2002
As of April 06 2010
Chart: Reuters/Jefferies CRB index
290
270
250
230
210
190
170
Oil prices, 1983 – 2002
As of April 06 2010
Chart: West Texas Intermediate (WTI) cushing crude oil spot price
45
40
USD per barrel
35
30
25
20
15
10
5
Nominal
7
Source: Bloomberg and US Bureau of Labor Statistics (2010)
Real
May-02
May-01
May-00
May-99
May-98
May-97
May-96
May-95
May-94
May-93
May-92
May-91
May-90
May-89
May-88
May-87
May-86
May-85
May-84
May-83
0
Government public debt and fiscal balance
As of February 12 2009
Graph 1
Government gross public debt and primary fiscal balance in industrial economies
1, 2
As a percentage of GDP
Shaded areas represent forecast.
1
Weighted average based on 2005 GDP and PPP exchange rates of economies cited and data availability. 2 Australia, Austria,
Belgium, Canada, Denmark, France, Finland, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, the United Kingdom and the United States.
Sources: OECD; BIS calculations.
8
Source: Cecchetti (2010)
Population structure and age-related spending
As of February 12 2009
Graph 2
Projected population structure and age-related spending
Old-age population (ratio to working-age population)
1
Working-age population is between 15-64.
2
1
Estimated increase in age-related government
2
expenditure from 2011 to 2050
As a percentage point of GDP.
Sources: IMF April 2007 WEO; United Nations Secretariat European Commission; Congressional Budget Office.
9
Source: Cecchetti (2010)
Wage and education
10
Source: Philippon T, Reshef A, Wages and human capital in the US financial industry: 1909-2006, December 2008
Financial wage and deregulation
11
Source: Philippon T, Reshef A, Wages and human capital in the US financial industry: 1909-2006, December 2008
Actual and benchmark relative wages
12
Source: Philippon T, Reshef A, Wages and human capital in the US financial industry: 1909-2006, December 2008
13
13
1.0
-2.0
-3.0
Dec-07
-1.0
Jun-07
1.5
Dec-06
0.0
Jun-06
2.0
Dec-05
1.0
Jun-05
2.5
Dec-04
2.0
Jun-04
3.0
Dec-03
3.0
Jun-03
3.5
Dec-02
4.0
Jun-02
Real Federal funds rate
Dec-01
5.0
Nov-07
Nov-06
Nov-05
Nov-04
Nov-03
Nov-02
Nov-01
Nov-00
Nov-99
Nov-98
Nov-97
Nov-96
Nov-95
Nov-94
Nov-93
Nov-92
1.0
Nov-91
3.0
Nov-90
Nov-89
Nov-07
Nov-06
Nov-05
Nov-04
Nov-03
Nov-02
Nov-01
Nov-00
Nov-99
Nov-98
Nov-97
Nov-96
Nov-95
Nov-94
4.0
Jun-01
-3.0
Nov-93
4.0
Dec-00
-2.0
-2.0
Nov-92
5.0
Jun-00
-1.0
-1.0
Nov-91
5.0
Dec-99
0.0
Nov-90
Swiss real rate
Jun-99
Nov-89
6.0
Dec-98
Nov-07
Nov-06
Nov-05
Nov-04
Nov-03
Nov-02
Nov-01
Nov-00
Nov-99
Nov-98
Nov-97
Nov-96
Nov-95
Nov-94
Nov-93
Nov-92
Nov-91
Nov-90
Nov-89
Response to 2000-2002 - ultra low real rates – delayed the
inevitable
6.0
Japan 3-M LIBOR real rate
3.0
2.0
2.0
1.0
0.0
4.0
ECB Real Rate
0.5
0.0
Post-2003: Markets begin to respond to
fiat money debasement and lower
funding costs
Gold prices, 2003 onwards
As of April 06, 2010 in USD
Chart: Gold price, dollar per ounce, London PM fix
1,200
1,100
1,000
USD
900
800
700
600
500
400
300
Jan-03
15
Jan-04
Source: World Gold Council (2010)
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Long-term interest rates, 2003 onwards
As of April 06 2010
Chart: US ten year government bond yields
5.5
5.0
Percent
4.5
4.0
3.5
3.0
2.5
16
Source: Bloomberg
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
Sep-05
May-05
Jan-05
Sep-04
May-04
Jan-04
Sep-03
May-03
Jan-03
2.0
Global commodity index, 2003 onwards
As of April 06 2010
Chart: Reuters/Jefferies CRB index
500
450
400
Index
350
300
250
200
150
Jan-03
17
Source: Bloomberg
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Oil prices, 2003 onwards
As of April 06 2010
Chart: West Texas Intermediate (WTI) cushing crude oil spot price
160
140
USD per barrel
120
100
80
60
40
20
0
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Nominal
18
Source: Bloomberg and US Bureau of Labor Statistics (2010)
Jan-08
Real
Jan-09
Jan-10
Leverage
Chart: LCFIs’ trading portfolios and financial leverage - 2007
19
Source: Haldane (2009), http://www.bis.org/review/r091111e.pdf
Leverage
 The previous chart suggests that “efforts to expand balance sheets through
higher leverage were focussed on trading assets. In the first part of this
decade, rising asset prices delivered mark-to-market gains on banks’
expanding trading assets. This boosted their profitability and returns on equity.
As long as asset prices rose, this created an Alice in Wonderland world in
which everybody had won and all had prizes.”
20
Source: Haldane and Alessandri (2009), http://www.bis.org/review/r091111e.pdf
Consequence of low cost of debt
21
It was not just a US sub-prime problem – German banks
expanded their balance-sheets
Source: Germany: 2010 Article IV Consultation—Staff Report, IMF, March 2010
22
An experienced investor saw this

Global fundamental economic conditions are nearly perfect and have been for some time.

Availability of global credit is generous and cheap and has been for some time.

Animal spirits and optimism are therefore high and feed on themselves through reinforcing results and
through being universally shared.

All global assets reflect this and are overpriced and show, probably for the first time, a negative return
to risk taking.

The correlation in global economic fundamentals is at a new high, reflected in the steadily increasing
correlation in asset price movements.

Global credit is more extended and more complicated than ever before so that no one is sure where
all the increased risk has ended up.

Every bubble has always burst.

The bursting of the bubble will be across all countries and all assets, with the probable exception of
high-grade bonds. Risk premiums in particular will widen.

Since no similar global event has occurred before, the stresses to the system are likely to be
unexpected.

All of this is likely to depress confidence and lower economic activity.
Source: It’s Everywhere, In Everything: The First Truly Global Bubble
(Observations following a 6-week Round-the-World Trip), GMO Quarterly Letter, April 2007, Jeremy Grantham
23
Peak valuation in 2007 even higher than in 1999 in Asia
MSCI Asia ex-Japan price-to-book ratio
3.5
3.0
2.5
2.0
1.5
1.0
0.5
MSCI Asia ex-Japan
24
Source: Bloomberg.
Nov-09
May-09
Nov-08
May-08
Nov-07
May-07
Nov-06
May-06
Nov-05
May-05
Nov-04
May-04
Nov-03
May-03
Nov-02
May-02
Nov-01
May-01
Nov-00
May-00
Nov-99
0.0
Consequences of the crisis, in
brief
General government financial balances, 2003 onwards
As of March 10 2010
Chart: General government balance as a percent of GDP
0
-2
Percent
-4
-6
-8
-10
-12
-14
2003
2004
2005
2006
2007
2008
Japan
Note: IMF estimates since 2007 for Japan and since 2008 for UK and US
26 Source: IMF
2009
UK
2010
US
2011
2012
2013
2014
Central bank balance sheets
27
Source: BIS (2009)
Government public debt and fiscal balance
As of February 12 2009
Graph 1
Government gross public debt and primary fiscal balance in industrial economies
1, 2
As a percentage of GDP
Shaded areas represent forecast.
1
Weighted average based on 2005 GDP and PPP exchange rates of economies cited and data availability. 2 Australia, Austria,
Belgium, Canada, Denmark, France, Finland, Germany, Greece, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, the United Kingdom and the United States.
Sources: OECD; BIS calculations.
28
Source: Cecchetti (2010)
Population structure and age-related spending
As of February 12 2009
Graph 2
Projected population structure and age-related spending
Old-age population (ratio to working-age population)
1
Working-age population is between 15-64.
2
1
Estimated increase in age-related government
2
expenditure from 2011 to 2050
As a percentage point of GDP.
Sources: IMF April 2007 WEO; United Nations Secretariat European Commission; Congressional Budget Office.
29
Source: Cecchetti (2010)
What needs to change?
 Spending habits
 Executive Compensation
 Importance of Finance
 Attitudes to investing
 Long-term thinking in public policy
 Acceptance of limitations of human brain
30
Scale of household de-leveraging needed
As of January 22 2009
31
Source: Global Economic Paper No 178, Goldman Sachs, 22 January 2009
US income excluding government transfer
As of March 26 2010
Chart: Real personal income excluding current transfer receipts
9,800
USD in billions
9,600
9,400
9,200
9,000
8,800
8,600
1
2
3
4
1
2
3
4
1
2
3
4
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
07 0 07 0 07 0 07 0 08 0 08 0 08 0 08 0 09 0 09 0 09 0 09
0
2
2
2
2
2
2
2
2
2
2
2
2
32
Source: BEA (2010)
US personal spending
As of March 26 2010
Chart: Real personal outlays
9900
USD in billions
9800
9700
9600
9500
9400
20
07
Q
1
20
07
Q
2
20
07
Q
3
20
07
Q
4
20
08
Q
1
20
08
Q
2
20
08
Q
3
20
08
Q
4
20
09
Q
1
20
09
Q
2
20
09
Q
3
20
09
Q
4
9300
Notes: Adjusted using implicit price index for personal consumption expenditure. 2009 nominal personal outlays are adjusted using 2008 index
33
Source: BEA (2010)
US income inequality
As of April 07 2010
Chart: CEO pay vs. Average wage income, 1970 – 2006
$1,000,000
Rank 10 CEO pay
Rank 50 CEO pay
Rank 100 CEO pay
Top 100 CEOs average pay
Salary+Bonus rank 10
Average Salary (right scale)
$10,000,000
$100,000
$1,000,000
34
Source: BEA (2009)
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
$10,000
Average Wage Income (2005 dollars)
CEO pay (2005 dollars)
$100,000,000
The ascent of finance – the damage it did
 “Highly leveraged financial firms became a dominant part of the economy.
Their profits allowed the firms to recruit many of the country’s most soughtafter employees — mathematicians, scientists, top college graduates and top
former government officials. Yet many of those profits turned out to be
ephemeral. So some of the best minds were devoted to devising ever-morecomplex means of creating money out of thin air, the proceeds of which then
drew in even more talent.”
 “It is worth remembering that Wall Street’s long boom has not exactly been
shared by much of the rest of the American economy. Wage growth for most
workers has been painfully slow over the past three decades. Economic
growth over the last decade was slower than in any decade since World War
II. Surely, one goal of re-regulation should be to loosen Wall Street’s grip on
the country’s resources, both financial and human, in the hope that they might
be put to more productive use.”
35
Source:The New York Times, “Heading off the next financial crisis“, 22 March 2010,
http://www.nytimes.com/2010/03/28/magazine/28Reform-t.html?ref=magazine&pagewanted=all
Attitudes to investing
 Investment portfolio:
 Need to accept time-lags – lengthening holding periods
 Need to optimise decisions over longer time periods (delayed
gratification)

“JPMorgan Chase holds $3 billion of “model-uncertainty reserves” to cover mishaps
caused by quants who have been too clever by half. If you can make provisions for
bad loans, why not bad maths too?”

RBI treatment of securitization profits
 Election cycle vs. economic-sense cycle
Partial Source: Economist, “The gods strike back“, February. 13, 2010,
http://www.economist.com/specialreports/displaystory.cfm?story_id=15474137
36
Evolution of human brain happened during the Stone Age
 Evolution has not stopped, but most of the ‘modern’ areas of the human brain,
like the prefrontal cortex, developed largely during the Stone Age.
 Our brains are deeply rooted in the primeval environments in which our earlier
ancestors evolved, long before the Homo Sapiens arose.
 Formal markets with regular trading of stocks and bonds date back only about
four centuries. It took our ancestors more than 6 million years to progress to
that point;
 if you imagine all of hominid history inscribed on a scroll one mile long, the first
stock exchange would not show up until four inches from the end”.
Source: ‘Your money and your brain‘, Jason Zweig
37
What is the evidence so far?
US saving rates
As of March 26 2010
Chart: Personal saving as a percentage of disposable personal income
6.0
5.0
Percent
4.0
3.0
2.0
1.0
20
07
Q
1
20
07
Q
2
20
07
Q
3
20
07
Q
4
20
08
Q
1
20
08
Q
2
20
08
Q
3
20
08
Q
4
20
09
Q
1
20
09
Q
2
20
09
Q
3
20
09
Q
4
0.0
39
Source: BEA (2010)
S&P 500 valuations
As of April 07 2010
Chart: S&P 500 price-earning ratio
50
20
2000
45
40
14
1929
30
12
1901
1966
25
10
21.3
Price-Earnings Ratio
20
8
15
6
1921
10
5
0
1860
4
Long-Term Interest Rates
1880
1900
2
1920
1940
Year
Source: Shiller (2005), http://www.econ.yale.edu/~shiller/data.htm
1960
1980
2000
0
2020
Long-Term Interest Rates
Price-Earnings Ratio (CAPE)
16
1981
35
40
18
Singapore property price index – a “V-shaped” recovery
As of April 13 2010
Chart: Singapore residential price index (central)
180
160
Index
140
120
100
80
De
c01
Ju
n02
De
c02
Ju
n03
De
c03
Ju
n0
De 4
c04
Ju
n0
De 5
c05
Ju
n0
De 6
c06
Ju
n07
De
c07
Ju
n08
De
c08
Ju
n09
De
c09
60
41
Source: :Bloomberg
Hong Kong property price index
As of April 13 2010
Chart: Hong Kong Colliers international luxury residential price index peak
300
250
Index
200
150
100
50
0
1
2
3
4
5
6
7
8
9
0
1
2
3
4
5
6
7
8
9
- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0 r- 0 p- 0
r
a
a
a
a
a
a
a
a
a
a
M Se M Se M Se M Se M Se M Se M Se M Se M Se M Se
42
Source: Bloomberg
What have shareholders learnt? – very low pain
threshold
 “It has cost a lot to learn how little we really knew,” says a senior central
banker. Another lesson was that managing risk is as much about judgment as
about numbers. Trying ever harder to capture risk in mathematical formulae
can be counterproductive if such a degree of accuracy is intrinsically
unattainable.”
 “Performance is usually judged relative to rivals or to an industry benchmark,
encouraging banks to mimic each other’s risk-taking, even if in the long run it
benefits no one. In mortgages, bad lenders drove out good ones, keeping up
with aggressive competitors for fear of losing market share. A few held back,
but it was not easy: when JPMorgan sacrificed five percentage points of return
on equity in the short run, it was lambasted by shareholders who wanted it to
“catch up” with zippier-looking rivals.”
Source: Economist, “The gods strike back“, February. 13, 2010, http://www.economist.com/specialreports/displaystory.cfm?story_id=15474137
43
Petrol tax
 “Raising the federal petrol tax (which has remained at just 18.4 cents per
gallon since 1993) would spur conservation and reduce imports even if the
world oil price dropped.”
 “Unfortunately, any politician bold enough to try that is liable to be driven from
office. Americans may be getting used to expensive petrol, but that does not
mean they are grateful for it.”
44
Source: Economist, “A special report on American‘s economy: energetic progress“ 31 March 2010,
http://www.economist.com/specialreports/displaystory.cfm?story_id=15793084
This is not good news
4.0%
14.0%
3.5%
12.0%
3.0%
10.0%
2.5%
8.0%
2.0%
6.0%
1.5%
4.0%
1.0%
2.0%
0.5%
0.0%
1948 19511954 19571960 19631966 19691972 19751978 19811984 19871990 19931996 19992002 20052008
Financial Share of GDP (LHS)
45
Source: Bureau of Economic Analysis, USA and Bloomberg
Non-financial profit share of GDP (RHS)
0.0%
The missing key word - humility
 “I am inclined to think that, provided we do not become complacent and we
continue to work on the reform of the financial regulation, the answer may be
positive.”
 “The more we convince ourselves that we have mastered risk and uncertainty
and the more confident we are that we have learned the lessons of the past,
the more vulnerable we become to lethal overconfidence and the probability
that things will again go unimaginably wrong.”
 “So the best way to ensure that the next time really will be different is to
strengthen the financial system and remain vigilant, so as to avoid, at all costs,
the thought that this time is different.”
46
Source: Mr Jaime Caruana, General Manager of the BIS, at the 50th Anniversary Symposium of the Reserve Bank of Australia, Sydney,
9 February 2010, http://www.bis.org/speeches/sp100209.htm
47
Spot price of gold in USD per ounce. Source: Bloomberg
3/15/2010
9/15/2009
3/15/2009
9/15/2008
3/15/2008
9/15/2007
3/15/2007
9/15/2006
3/15/2006
9/15/2005
3/15/2005
9/15/2004
3/15/2004
9/15/2003
3/15/2003
9/15/2002
3/15/2002
9/15/2001
3/15/2001
9/15/2000
Therefore, this has a long way to go
1400.0
1200.0
1000.0
800.0
600.0
400.0
200.0
0.0
What if there is a new normal? – Investment implications
 Emphasis on Income-generating assets: stocks with dividend yields
 Weakening of global correlations
 Rising interest rates
 Importance of real assets
 Less leverage – and hence better performance of non-financials over
financials
48
Thank you very much
for your attention
"If contact between people
is based on trust and absolute integrity,
then it is of benefit for both sides."
Contact:
Dr. V. Anantha Nageswaran
+41 (0) 58 888 1122
Van@juliusbaer.com
49
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