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The Institutional Strategist
GLOBAL MARKETS
EQUITY & FIXED INCOME MARKETS
MARKET THEMES AND STOCKS
Featured This Month:
AMERICA’S EQUITY—EQUITY OUTLOOK FOR 2013
EUROPEAN EQUITY STRATEGY—TIME TO TAKE SOME MONEY
OFF THE TABLE
ASIAN EQUITY STRATEGY—THAILAND ECONOMY WELL POSITIONED TO
BENEFIT FROM RISING CONSUMERISM AND REGIONAL TRADE
COUNTRY SUMMARIES
January 2013
by TIS Group, Inc.
Editor, Larry Jeddeloh
Copyright 2013
TIS
TIS Group, Inc.
100 Village Center Dr, Ste 260
North Oaks, MN 55127
Contact: ............ Larry Jeddeloh
E-Mail: ............. tis@tisgroup.net
Telephone: ..... (651) 379-5070
Toll free within U.S./Canada
............................... 866-527-8698
Fax: ..................... (651) 379-5080
GLOBAL MARKETS TABLE OF CONTENTS
January 2013
I.
GLOBAL INVESTMENT STRATEGY (EXECUTIVE SUMMARY) ........................................ 1–26
Global Asset Allocation
USD Reference Currency – as of January 8
Conventional Allocation
Unconventional Allocation
% of
Total
USD (Up 10%)
U.S. (10%)/Japan (15%)/Hong
STOCKS
Kong (10%)/European (15%,
Down 10%,)
20% Crude Oil,
ALTERNATIVES 10% Gold/PM Shares
10% CRB
CASH
15%,
45%
40%
0%
TOTAL 100%
BONDS
% of
Total
CASH
STOCKS
ALTERNATIVES
BONDS
USD (Up 10%)
Hong Kong
Japan
Europe (Down 10%)
CRB
Gold/PM Shares/Silver
Short 10 Year French OATS
TOTAL
10%
10%
15%
15%
10%
30%
10%
100%
II. GLOBAL EQUITY STRATEGY ............................................................................................... 27-47
A. U.S.—MILD UNDERWEIGHT IN CONVENTIONAL ALLOCATION
————————————
PURPOSE:
The Institutional Strategist is a
third party, monthly publication,
covering geonomics, global stock
markets, interest rates, market
themes, and currency trends. Our
purpose is to present nonconsensus, timely analysis designed
to call major “turns” and to assess
various forms of global risks.
COVERAGE:
Each month we assess investment,
economic, risk and political
developments in the world’s top
financial markets.
————————————
► AMERICA’S EQUITY STRATEGY—EQUITY OUTLOOK FOR 2013 ..................................... 27-31
► U.S. DOLLAR REVIEW—Long-term fundamental trends continue to be bearish for the
Dollar. Last year, deterioration in the U.S. government’s balance sheet and QE2
helped move the Dollar lower. Over the long run, the simple economic need for a
lower currency, and a policy which inflates away the debt may be the deciding factor
favoring further monetary ease and a lower Dollar. Official replacement of the Dollar
as the global reserve currency is unfolding as Russia, China and Iran accept other
currencies for energy and buyers such as China wish to pay for oil imports in other
forms than USD. A more likely scenario than full Dollar replacement is that
competitors to the Dollar will emerge, i.e. The Yuan-Yen, and a more multi-polar
currency will evolve. On a long term Coppock curve, the Dollar is a sale. But if the
Fed indicates QE will slow or be withdrawn, the Dollar will rally sharply.
B. EUROPE—UNDERWEIGHT IN CONVENTIONAL ALLOCATION
► EUROPEAN STRATEGY—TIME TO TAKE SOME MONEY OFF THE TABLE ................... 32-34
► EUROZONE CURRENCY REVIEW— Euro/Dollar is in a trading range for now between
1.27-1.32. The ECB continues to push Spain, Greece, and Portugal toward bailouts.
The numbers still do not add up in Greece, but Greece will be kept afloat for now.
Portugal is moving voluntarily toward a fiscal restructuring, while Spain is slowly
being forced to the bailout table. A majority of the ECB’s governing board, favors
another interest rate cut. If done in conjunction with further monetary tightening,
the Euro could go much lower against the USD.
C. JAPANESE OUTLOOK—OVERWEIGHT IN CONVENTIONAL ALLOCATION
All rights reserved. No part of this
publication may be reproduced
without consent. Permission is
granted for normal and limited
quotations.
► ASIAN EQUITY STRATEGY—THAILAND ECONOMY WELL POSITIONED TO BENEFIT
FROM RISING CONSUMERISM AND REGIONAL TRADE ................................................. 35-44
► JAPAN COUNTRY SUMMARY ........................................................................................... 45-47
► JAPAN CURRENCY REVIEW–YEN DECLINE AHEAD—We think Japan has an interest in
weakening the Yen. The BOJ eased monetary policy by intervening in the FX market in
recent months, so far with success. A new government led by the LDP will develop
policies which weaken the Yen further.
III. COUNTRY SUMMARIES ....................................................................................... 48–88
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
AUSTRALIA ............................................................................................. 48-49
BRAZIL ................................................................................................. 50-51
CANADA ................................................................................................ 52-53
CHINA .................................................................................................. 54-56
EUROZONE ........................................................................................... 57-58
HONG KONG ......................................................................................... 59-60
INDIA ................................................................................................... 61-62
INDONESIA............................................................................................. 63-65
ISRAEL ......................................................................................................... 66
JAPAN.................................................................................................... 67-69
MEXICO ............................................................................................... 70-71
NEW ZEALAND ....................................................................................... 72-73
RUSSIA .................................................................................................. 74-75
SCANDINAVIA.......................................................................................... 76-78
SINGAPORE ............................................................................................ 79-80
p.
q.
r.
s.
SOUTH AFRICA ....................................................................................... 81-82
SWITZERLAND ........................................................................................ 83-84
UK ....................................................................................................... 85-86
U.S. ..................................................................................................... 87-88
IV. MARKET THEMES..................................................................................................................... 89-95
A. Equity Themes – Perhaps the most important global themes are the three Ds:
deleveraging, demographics, and debt. With ultra-low interest rates around the
developed world, income-producing vehicles such as high dividend yield stocks are in
demand. The developed world is burdened by excessive debt loads, deleveraging out
of that debt and way too many unemployed people. Pensions, investment funds,
foundations, and endowments are being forced to re-allocate assets to income paying
instruments in order to earn a return.
Another major theme is the rise of agriculture as an investable asset class, as long term
changes in the climate will affect crop yields, global grain inventories are low, and ag
markets are being financialized.
Can resuming another round of QEs extend the credit (debt expansion) cycle again?
The developed world remains in the grip of a Kondratieff winter, making additional
QEs more likely, as deleveraging persists and demographics shift the demand curve.
There is a lack of demand in the developed countries. Rather than liquidating or
restructuring debt, governments are taking more debt on.
On the demographic side, China is about to enter years of falling population, just as
Japan has already done. Many European countries are in a similar situation. It is
America which will grow demographically, though slowly, so the U.S. which could show
the best growth among developed markets over the long term.
B. We have a 15% weight in European equities, have an underweight position in the U.S.
and have moved to overweight in Japan in a conventional allocation. We also closed
out an allocation to Canada and kept the allocation to Hong Kong. In an unconstrained
allocation, there is a net short position of 10% in French 10 yr. OATS, a 10% short in
U.S. Treasuries, and a 20% position in gold/silver/precious metals shares and a 10%
position in the CRB Index.
C. For long-term global relative return investors, Japanese equities, gold, silver, and
agriculture (especially interesting) should be overweighted. Tactically, crude oil and
gold are buyable on pullbacks and if you can take a three-year time frame, buy
European equities. I doubt the QEs are over, despite some Fed Governors looking to
end QE3 before year-end, so the hard asset trade should continue to work, though not
uniformly.
TIS THEMES:







Emerging Markets......................................................................................................................................89
Euro Debt-Free..........................................................................................................................................90
Global Energy .............................................................................................................................................91
Malthus Revisited.......................................................................................................................................92
Materials Extraction..................................................................................................................................93
Oil Transportation/Shipbuilding............................................................................................................94
Water............................................................................................................................................................95
V. CURRENCY OVERLAY ...................................................................................................................... 96-107
We would remain structurally long Norwegian Krone and the Singapore
Dollar against the U.S. Dollar. Yen/Dollar is in the process of a meaningful weakening
while Euro/Dollar was in a trading range, but could be pushed higher by Yen weakening.
OVERVIEW:






Canadian Dollar ........................................................................................................................... 96-97
Euro ................................................................................................................................................ 98-99
Japan Yen .................................................................................................................................. 100-102
Swiss Franc............................................................................................................................... 103-104
UK Pound Sterling........................................................................................................................... 105
U.S. Dollar ................................................................................................................................ 106-107
VI. TIS NEWS & WHAT'S NOT FIT TO PRINT, Including Larry's travel schedule ... 108-110
VI1. Bibliography..................................................................................................................... 111-113
Source Data
Barron’s, 1/7/2013, Investors Business Daily, 1/4/2013, The Economist, 1/5/2013
U.S. & THE AMERICAS EXECUTIVE SUMMARY
S&P 500
Courtesy Paul Nesbitt, 618034 Ltd
What The Bernank Did  In his post December 11th-12th Fed-meeting press conference,
So how should we look at this? The Bernank may get some
price action in the markets, which is unexpected. But if interest rates began to rise or the Dollar strengthen too much (or
both), two or three months of weaker unemployment numbers might well shift the market’s expectations about future
Fed policy. It may be I am reading too much into this shift in
how the Fed communicates. But they did so for a reason. I
would welcome feedback from readers as to what that purpose is.
If this economic environment is the new normal and structural
unemployment is not fixed, ZIRP will go on for years. And
think about this- the new normal is a $1 trillion expansion in
the Fed’s balance sheet in the next twelve months. One year
from now, the Fed balance sheet should total $4 trillion. And
what does the Fed do, if their balance sheet expansion does
not move risk assets higher? More to the point, what happens
if they buy $1 trillion in bonds, sell an offsetting $1 trillion in
2008-2009 positions, leaving the balance sheet flat?
the Bernank stated that moving from a date specific/time horizon oriented monetary policy to a policy, which is more numerically based. Markets like certainty and what he has done
is increased somewhat the level of uncertainty, by potentially
shortening the time remaining for ZIRP. Change the market’s
perception about ZIRP and funding costs will rise. Increased
funding costs are unlikely to be greeted by higher asset prices,
though the USD would benefit.
If the unemployment rate and inflation are now the principle
drivers of Fed policy, it is not an automatic that interest rates
are headed higher just yet. The U.S. unemployment figures
have been widely discussed as to how accurate they are, especially as the recent election approached and the unemployment rate fell to 7.7%. The U6 rate remains above 14% (see
chart). These types of numbers are a long way from a 6.5%
official rate. An interesting way to think about this is that if
Sources:
the unemployment rate can be “adjusted,” this could be a way
Bloomberg Data; Bloomberg News
Shadowstats.com
to keep ZIRP going, for as long as the Fed wishes. Changing
how an economic data point is presented, is not uncommon,
especially when it does not confirm an impression the authors World Monetary Boom Kicks In would like that number to convey. This of course is the ar-  There was much talk on Wall Street late in the trading day
gument that was made in the U.S. over the past several
recently, after a 300-point move in the Dow, of how some
months, that the manner in which the Unemployment rate was
traders thought the market should be sold now, while others
calculated gave the impression of an improving labor market,
forecast doom later. I lost count of how many pundits on
while in fact, it was not improving all that much.
Bubblevision warned us of the debt ceiling “cliff” in February.
They may be right about February being the next wall of worUnemployment – Total Labor Force
ry for the risk markets to climb. But there is another powerSeasonally Adjusted. Jan. 1994 – Nov. 2012 (BLS)
ful force at work which will have 30-60 days to work on the
markets before the U.S. reaches the next cliff. That force is a
sea change in monetary policy among some of the world’s
largest central banks.
The BOJ, the Fed, the BOE, the Swiss National Bank, the RBA
and several Scandinavian banks are all printing money at high
rates, in order to devalue their currencies. In some cases,
such as the SNB, it is nearly a matter of life or death for their
countries export sector as the currency (Swiss Franc) was being overwhelmed by inflows. As I stated in a recent MIR, this
massive monetary stimulus is forcing other nations' currencies
Source: Shadowstats.com
TIS Group January 2013 Global Markets
1
U.S. & THE AMERICAS EXECUTIVE SUMMARY
higher, i.e. the Euro and the RMB. China will be pushed to respond. And since the transmission, mechanism to the economy is not immediate, nor always as effective as policymakers
would like, there is significant risk of a flood of excess cash
moving into the financial markets.
China is a good example of the willingness of Central Bankers
to print money at a moment when in prior economic cycles,
they may not have done so. Since the onset of the 2008-2009
financial crisis, China has created $14 trillion in credit, an
amount about equal to the European or U.S. economies. A
$60 billion plus fiscal stimulus package is coming from Beijing.
No wonder the Chinese stock indices have made impulsive
moves higher, for they were pricing for recession and now a
replay of the last credit cycle looks to be unfolding.
Shanghai ‘A’ Index
The odd man out, at least initially in all this monetary largesse,
is Europe, which suggests the ECB risks a higher Euro. If the
Euro/Dollar trades above 1.40 and Euro/Yen strengthens any
further, the French and German car industries are going to be
walloped. South Korea’s Hyundai and KIA will not be the only
car companies to face much stiffer competition from Toyota,
Honda, Mazda, et al. Meanwhile, Italy remains in political turmoil, Spain has 55% youth unemployment, a housing crash still
in play and yet Prime Minister Rajoy goes along with Germany’s austerity drive. Will Spain be the country in 2013, to say
enough, and pull out of an EU monetary system which does
not work for them? Looking at Spain’s economic data is reminiscent of the U.S. in the 1930s. Madrid does not need more
austerity, it needs growth.
Spain Youth Unemployment @ 55%
Source: Bloomberg LP
Source: Paul Nesbitt, 618034 Ltd.
If China’s economic recovery gathers momentum and it
should, along with a rebound in Japan, Asia will be off to the
races. Add in what appears to be a trend toward nominal
GDP targeting, which is unfolding across a number of central
banks (BOE?) and the risk of inflation will grow rapidly in
2013. This will make holding bonds difficult as yields are
priced for deflation in the major markets and if deflation risk
suddenly dissipates, yields will rise. The early signs are equity
fund inflows in the U.S. have grown, perhaps a precursor of
where capital will flow. Also, the gold price has moved up
about $45 in two days, right at year-end, which is one of the
time periods when currencies become active and historically
change direction. Gold is money, that’s my view, so the price
action gold bullion has had in the past 72 hours, right at yearend, may be important.
Comex Gold
That brings me to the last point, the U.S. and how the Fed will
proceed in 2013. As incredible as this may sound, I do not think
the round of tax hikes which were agreed to on December 31,
are the end of it. I watched a number of Republican Congressmen in the media recently saying we just raised taxes, that’s
done. Then Democrat Congressmen would come on screen
and without a lot of probing, they were clearly talking about
more revenue increases to be discussed in February at the time
of the debt ceiling negotiations. It’s not over, the Administration wants more revenue. The U.S. economy just took a hit due
to multiple Obamacare taxes and the negotiated hike on high
earners to 39.6%. If another hike is added in on top of these
new taxes in sixty days, the U.S. will be headed for recession
this year and the Fed will respond, perhaps aggressively. It is interesting that according to the CBO, the fiscal cliff deal adds
$3.9 trillion the long-term deficit. There was no deficit reduction, taxes alone are not able to do that. The Administration, as
I said last month, has little interest in meaningfully reducing
spending. So the issue in February will be this. Will the Republicans be willing to stand up and say no debt ceiling increase unless meaningful spending cuts are adopted - perhaps something
along the lines of $4 in cuts for every $1 in revenue. The fiscal
cliff deal was upside down in this regard with $1 in cuts for every $10 in revenue according to the CBO. Are the House Republicans brave enough to say to the Democrats, show up with
spending cuts or we will not vote for a debt ceiling increase and we know a recession will occur as a result, but we are willing to live with that. We are willing to take a recession to stop
additional tax hikes. Can they sell that to themselves and to the
country?
Sources:
Bloomberg Data; Bloomberg News
Heintz, Jim and Hinnant, Lori. “Depardieu, In Tax Fight, Gets Russian Citizenship” AP 3 January 2013.
Paul Nesbitt, 618034 Ltd.
Source: Paul Nesbitt, 618034 Ltd.
2
TIS Group January 2013 Global Markets
U.S. & THE AMERICAS EXECUTIVE SUMMARY
 Ideas: I think commodities, which should have had a better
Ideas for the Start of 2013  Obviously, resolution of what tax rates will be in the U.S.
helps the markets. I suggested in the December 13th MIR that
a deal would be done because the administration did not wish
Federal spending to stop, let alone be cut. If you look at the
final results of the bill passed on December 31, the ratio of tax
hikes to almost invisible spending cuts, is incredible. The CBO
estimated there are $10 in tax increases for every $1 in
spending cuts. This is not the end of the spending, in my view,
nor the end of tax increases, but for now, some clarity is good
for markets. Meanwhile, Abe’s policy changes in Japan, are beginning to look like FDR in 1933. Europe is a bit more complicated, but essentially, credit markets are going to continue
to rally, producing a lower risk premium, which in turn helps
equities. But the big global story, I think, is how monetary
easing in Japan starts to move central bank policies across the
board.
I read a comment by Japan’s new Finance Minister, Taro Aso,
in which he apparently told the U.S. Treasury Secretary that
the U.S. should take steps to strengthen the Dollar. With the
right deal, the U.S. might be of help on the Yen/Dollar cross,
but what I found interesting is that if that Yen cross rates
moves, cross-rates across Asia will move. Asian central banks,
seeking to spur exports, seem like good candidates to step up
monetary easing. My Asian home away from home, Singapore,
is entering a recession and has a currency which is high due to
inflation, but this is an example of a central bank which I think
will change policy over the year. At 1.22 to the USD, the Sing
Dollar could easily sell-off, juicing the Sing equity market. That
theme of Asian currency depreciation, pushed by Asian CBs is
how I think the year starts.
USD/Singapore Dollar
year in 2012, will have a good year in 2013. On the models I
watch, there are buy signals on gold, silver, platinum, crude oil,
natural gas, sugar, copper is close and a copper ETF is launching and beans. Also, DBC, the commodity ETFs is in a good
position. Finally, a side note on copper. A copper ETF sponsored by JP Morgan has been approved, while Blackrock’s version has been delayed. On November 18, 2004, the gold ETF
launched and in the next graph and we can see the result as
the public had for the first time, a vehicle which made buying
gold easy. This was a bullish development for gold. It may
prove to be bullish for copper as well.
Crude Oil (Brent) Weekly
Source: Paul Nesbitt, 618034 Ltd.
GOLD (2004-2013)
November 18, 2004
Gold ETF Launched
Source: Bloomberg LP
There is no reason to think the Fed is about to adopt tighter
monetary policy, especially after the government just passed
tax hikes on personal income/capital gains and Obamacare
taxes kick in on January 1. The ECB is still nursing a fragile EU
economy, the Bank of England has a long period of slow
growth or no growth to address and the Swiss are struggling
with massive currency inflows which keep the printing press
running. According to Forex Flash, the majority of ECB Board
members favored a rate cut in December. (1) And with
Chancellor Merkel downplaying the European economy in
2013 ( lowering expectations for her election run), I expect
the ECB will move in a month or two.
TIS Group January 2013 Global Markets
Source: Bloomberg LP
Two further points on commodities. Hedge funds cut their
bullish exposure to commodities to six-month lows as of December 24th. Gold holdings reached a four-month low and
copper holdings fell for the first time in five weeks. Investor
bearishness on natural gas is the most extreme level since
May. This much bearishness I would interpret as bullish.
Last, the COMEX reduced margin requirements on gold by
11% as of January 1 trading. This is bullish as it tells me the
exchange wants more volume and there are few things that attract higher volume, than higher prices.
3
U.S. & THE AMERICAS EXECUTIVE SUMMARY
Comex Gold Weekly—Target $2,031-$2,109
Source: Paul Nesbitt, 618034 Ltd.
*TIS Group managed accounts own gold, silver, precious
metals shares and natural gas
Sources:
(1) “Forex Flash: Majority of ECB Board Favoured December Rate Cut—BBH”
FXstreet.com 2 January 2013.
(2) Donahue, Patrick. “Merkel Election Year Starts With Warning on Growth:
Euro Credit” BN 2 January 2013.
Bloomberg Data; Bloomberg News
Paul Nesbitt, 618034 Ltd.
casts is factoring in a surge in lending. Is another credit bubble
operation about to be launched?
I was also told in SF that due to the recent increases in state
taxes, not a few California families are buying homes in nowheresville Nevada in order to change domicile and escape
the tax hikes, which incidentally were made retroactive to
2012. This is a lesson France is learning now and the UK has
learned over the past two years. When the rich have their
taxes raised too much, they move and tax collections can fall
rather than rise, which defeats the purpose of the tax rate increase. California is going to short of revenue again and I
wonder if opening up state land for oil and gas development
via fracking will not be the answer. I understand that California has larger reserves of shale oil and gas than the Bakken
field does. Sooner or later, economics is going to overtake
the environmentalists as the primary determinant of state government and when that happens, California will boom again.
Finally, on the other side of the world, I see Credit Suisse is
beginning to charge customers for leaving deposits at the bank.
In fact, the bank seems to have 23% more deposits than loans,
so once again negative interest rates have arrived in Switzerland. Where will that money go or will it simply accept a penalty for holding cash? Bonds yield little and cash is now a cost,
Swiss property has gone through the roof, so what asset class
is left? Stocks.
Swiss SMI Index—The Next Bull Market?
Market Observations  A recent stop in San Francisco on the way to Asia proved to
be very helpful. Not everyone was home this time, but several of my long time confederates were in town and we had very
active discussions, as always. A couple things come out of the
meetings which I believe are worth thinking about. The backdrop is SF has always been a very equity-oriented town, in my
opinion.
The Silicon Valley entrepreneurship/innovation
streak runs through the investment community and so being
bearish on stocks here has not been a winning position to
take. SF also faces Asia, so there is generally more interest
here and in Los Angeles in China etc. than almost anywhere
else I go in America, except for NY/Boston.
One of the most interesting talks I had was with an old friend
who is thinking about the possibility of a liquidity-led equity
rally which takes stocks to new highs, significant new highs
over the next few years, based on PE expansion rather than
higher profits. Increased liquidity would be necessary for that
to happen and interestingly that is what I learned recently is
coming from several major U.S. banks. I think expansions in
lending are going to take place in the U.S. mortgage market
because that is where spreads are available for U.S. banks.
Buying the 10-year Treasury will not cut it. Is this why Obama
recently stated that the U.S. is about take -off? Everyone
seems aware that the price of housing is rising faster than the
price of interest rates which fund housing. Defaults should
diminish rapidly. Mortgage bonds become even better quality.
Investment demand for housing should rise and home prices
should also rise, lifting the net worth of American consumers.
The economy benefits, bank earnings get a second wind and
while housing stocks seemed to have predicted this, I don’t
believe the rest of the equity market has adjusted for a surge
in home prices. I also doubt a consensus of economic fore-
4
Source:
Bloomberg Data; Bloomberg News
Source: Bloomberg
TIS Group January 2013 Global Markets
U.S. & THE AMERICAS EXECUTIVE SUMMARY
Conventional Allocation
Change In Asset Allocation  I closed the position in Canadian equities in the Conventional
and Unconventional models in December and replaced it with
a position in China. The Chinese economy is not likely to see
significant stimulus until Q1 or even Q2, 2013, but the market
will move ahead of the government. The Shanghai Index has
room to run from roughly 2,000 to 2,400 within weeks. So
my equity exposure in the unconventional model now is in Europe, Japan, Hong Kong, China, and in commodities/commodity shares.
Shanghai Index
Unconventional Allocation
Bloomberg LP
TIS Group January 2013 Global Markets
5
COMMODITIES, ENERGY AND THE MIDEAST
Gold (2005-2012)—Still in A Bull Market
Source: Bloomberg LP
Gold—Ready To Make a Run  The price of gold has been correcting, along with silver
sinceQ3, 2011. Lately, gold’s price action has turned into a
streak. The metal traded down five of seven days going into
Christmas and is off nine of the past eleven weeks. Sentiment
is so bad, that according trade-futures.com, gold bulls are
down to 5% and Silver bulls are at 6%. For silver, that is the
lowest bullish sentiment reading since September 2008, when
silver traded below $10. (1)
Technically, gold held at $1,647 and should have enough sellers
who are finished due to redemptions and tax related transactions that the deluge should lift. The fundamentals still seem
fine. Central banks are easing everywhere, even the BOJ is set
to join the cheap money/print at all costs club. When political
leaders start calling for central banks to print money, fight deflation, charge up their economies and be competitive with
other central bank policies, many of which are reflationary, inflation must be coming. This factor should drive the next
move in gold.
Perhaps alone for the moment, central banks see what is coming. An expanding list of central banks (including Brazil, Turkey, and Russia) are buying gold as a portion of their official reserves. The latest devotee is Iraq’s central bank which recently
purchased 25 tonnes. This was Iraq’s first gold purchase in
years and it may have been used to bolster official reserves or
to facilitate trade. Neighboring Iran is using gold to settle import-export transactions, some with Turkey. This is the first
Mideast buyer to be reported in some time, so if the veil is
about to be lifted, it will be interesting to see what the Saudis
have done or how the SWFs spread across the Mideast, may
have adjusted their gold holdings. Once again, gold is being
used as money.
Sources:
Bloomberg Data
Bloomberg News
Universal Economics. 24 December 2012.
Philadelphia Gold & Silver Index (XAU)
Courtesy of Paul Nesbitt, 618034 Ltd
switching into Japanese equities. So far, this has been the right
move and while I am not calling for a halt to Japan’s impulsive
move higher, this is the time of year when it normally pays to
buy the new low list. Precious metals miners certainly fit that
description, though gold bullion is still positive for the year.
In recent MIR’s I have mentioned the possibility that forced liquidation may be the culprit for weakness in mining shares. So,
I was intrigued by stories that appeared in the media recently,
which reported that Morgan Stanley had placed the Paulson
Advantage and Advantage Plus Funds in the “redeem” category,
down from “watch.” According to Bloomberg, MS may have
$100 million invested in those funds. In August, Citigroup
dropped the same funds and according to reports is pulling
about $410 million. This could be the beginning of a flush in
the underlying securities. Or due to the calendar year nature
of redemption patterns, the selling may abate right about here.
That would be true for mining shares and also for bullion. See
the next chart of XAU Index. There is support at 154.
The new market, which is turning, is natural gas. At the forefront of the 15% gain in natural gas this year, is a 49% decline in
the number of U.S. rigs drilling for gas. The Baker Hughes
Natural Gas Rotary Rig Count is shown next. This is surprising given the alleged boom in fracking activity. What was even
more surprising was a larger than expected drawdown in gas
supplies fueled by very cold weather in the Midwest. But those
types of weather moves are temporary. What is of more interest is that given 50% of all U.S. households use gas for heat,
what effect will growth in U.S. housing units have on demand?
This point seems to be missed in the commentary I read on nat
gas, but it seems to me is quite important. Fewer rigs, more
housing units, more people, and cheap gas driving demand
seem like a good mix to produce more than a trading move.
For now, I would take the trade, as Nat Gas is set up for a
pop. The nat gas stocks should move as well.- EQT, SWN.
Natural Gas, Gold, and Oil  Over the past six weeks, I have made calls on all of these mar-
kets. Probably the most important being a move out of half
our exposure to precious metal miners in mid-November,
6
TIS Group January 2013 Global Markets
Baker Hughes Gas Index (BAKEGAS)
COMMODITIES, ENERGY AND THE MIDEAST
be unavailable from new taxes. Once Obamacare taxes/fees
kick in next year, it will become more difficult to pass additional state tax increases. Fracking may be the financial salvation
for some states.
Sources:
(1) Chazan, Guy and Blas, Javier. “Saudis Cut Oil Output to Lowest in a Year”
FT 12 December 2012.
Bloomberg Data
Bloomberg News
Paul Nesbitt, 618034, Ltd.
Drought and the Mississippi  The worst drought in the U.S. in 50 years is having a severe
Source: Bloomberg LP
Sources:
Bit, Kelly. “Morgan Stanley Said to Suggest Paulson Redemptions to Clients”
BN 19 December 2012.
“Hedgeworld: Morgan Stanley Urges Redemptions From Paulson Funds” Reuters Hedgeworld/BN 19 December 2012.
effect on the water level, and therefore the transportation viability of our nation’s rivers. The Mississippi River alone is responsible for handling around $7 billion in cargo every year, so
a reduction or stoppage of barge traffic could have severe effects on grain prices and truck and railway transportation
costs.
USDA Weekly River Barge Grain Movements
Crude Oil  The Saudis are reported to be producing the least amount of
oil in a year as U.S. oil production is seeing the largest oneyear gain since commercial production began in 1859. (1) The
rapid increase in U.S. production is intriguing for several reasons. The possibility of a collapse in prices exists now unless
the world economy picks up and/or there is a Mideast event.
Even a temporary fall to $70 would put extreme pressure on
Iran's economy and on the budgets of a number of Mideast
countries - including the Saudis. At the same time, $70 oil
would be highly simulative for the economies of China, the
U.S., Japan and Europe and the UK. The UK has a near gasoline crisis on its hands, given the high price of petrol.
Crude Oil (Brent)
Source: Bloomberg LP
With nearly 60% of the U.S. experiencing drought conditions,
levels of the Mississippi are well below normal. This is having
an effect on the more than 100 million tons of products
shipped in barges on the river.
Around half of that bulk is soybeans and corn, so congressmen
from Iowa and Illinois are lobbying the Obama administration
to step up funds for dredging. Through the Army Corps of
Engineers, the federal government has already increased efforts
to remove rock formations and shoals which could impede
barge traffic, but this is not enough, says Iowa’s Tom Harkin
and Illinois’ Dick Durbin.
Corn Price (1 year)
Source: Paul Nesbitt, 618034, Ltd.
A case can be made for a rapid build-up in U.S. oil/gas production in 2013, based on an expansion of fracking technology
across a number of states. States need revenue, in part to fund
mandates from the Federal government for which no funding
was supplied. State governors are looking for revenue and
opening up state lands to fracking would produce new streams
of income, which will help get them the revenue, which might
TIS Group January 2013 Global Markets
Source: Bloomberg LP
7
COMMODITIES, ENERGY AND THE MIDEAST
They would also like the Corps to open dams in the Missouri
River to raise the water level in the Mississippi. The Army
Corps of Engineers is pushing back on this suggestion, citing a
lack of authority and a concern for the effects on the Missouri
River valley itself.
So, it would seem that with three consecutive years of smaller
U.S. corn harvests, a once-in-a-lifetime drought situation, and
now a transportation disaster imminent, a solid bottom for
corn and soy prices might be a safe bet. The risk for grains
certainly seems to be on the upside, as it will now take more
than one year of good weather and above average rainfall to
8
get U.S. crop harvests back to where they were just a few
years ago.
Sources:
Abbott, Charles. “UPDATE 2-Mississippi water low, but enough for river barges." Reuters.com 7 Dec. 2012.
Wilson, Jeff. “Tightest corn crop since ’74 as Goldman sees rally: commodities.” Bloomberg News 11 Dec. 2012.
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
+
Nikkei Index—Policy Driven, More Unfolding
Courtesy of Bloomberg LP
Japan—Policy Changes Unfolding  Shinzo Abe was sworn in as Japan’s new Prime Minister and
he is wasting no time in terms of policy shifts. The following
is what I think he will do and/ or attempt to do:
On defense policy, I believe Abe would like to re-write the
Constitution allowing the country to build a standing army.
This is not possible in the near term as the LDP controls 61%
of the Lower House seats and a 2/3 majority is needed. The
LDP’s partners, new Komeito party, are financed by a Buddhist foundation, so funding for a military build-up seems unlikely to be achievable for now. Still, I think Japan’s rearmament will quietly begin as an offset to China’s growing
military power. Abe spoke on the matter the other day, “For
the last ten years, Japan has reduced defense spending by 1%
per year, including during my administration, 2006-2007.
Meanwhile, China has been increasing its military spending by
more than 10% annually for two decades. This has created an
imbalance in the area of defense. The U.S. also plans to make
deep cuts to its defense budget in the coming years, which
could reduce its presence in the Pacific. I believe this has led
to the aggressive actions of China in the East China Sea and in
the South China Sea.” (1)
This statement should be read as a clear signal that Japan is
moving closer to the U.S. again in terms of foreign policy, defense policy and quite possibly, economic policy. It may be
that economic considerations are the principal factors which
drive many of Abe’s policies. Beating deflation and the strong
Yen are Abe’s top priorities. On December 27, Japan’s Finance Minister Taro Aso said he won’t necessarily stick to a
44 trillion Yen cap on new bond sales to pay for an extra
budget. Aso also stated that PM Abe asked for comprehensive steps to counter the strong Yen.
The new Cabinet, named hours after Abe’s swearing in, is
very telling in terms of policies which are coming. Akira Amari, Economy Minister, Akira Amari, has a role described by
Abe as the “control tower” for developing growth strategies
for the economy and specific industries. He is known as a
proponent of nuclear power, defending the nuclear industry
even after the March 2011 nuclear crisis. He worked at Sony
before entering politics. Toshimitsui Motegi, Trade Minister,
is Tokyo University/Harvard and ex-McKinsey. He will develop new offshore markets for Japanese goods and design a new
energy strategy. Kyodo News is already reporting that Japan
is set to resume using nuclear reactors deemed safe by the
regulator. Fumio Kishida, the foreign Minister dealt with is-
TIS Group January 2013 Global Markets
Shanghai Composite Index—Target is 2,400
Courtesy of Bloomberg LP
sues on Okinawa during the first Abe administration. This has
been a sticking point in U.S.-Japanese relations for years.
Resolution might unlock U.S. help in moving the Yen lower,
especially against the Korean Won. Taro Aso, the Finance
Minister, is 72-years old, a former Prime Minister and has experience in Cabinet positions. The fiscal stimulus package will
be his primary responsibility. The next step, in terms of
“people positioning,” will be the appointment of new Deputies at the BOJ as well as the Governor. If Ito or Iwata are
appointed to replace Shirakawa, I would expect Yen/Dollar to
move toward 90, stocks to move 20%-30% higher and the
BOJ will be back in the game as a major central bank player.
By the numbers, Japanese stocks are cheap.
Nikkei Dividend Yield is 2x the 10-year JGB Yield
Source: Bloomberg LP
While economic considerations are crucial, politics intersects
much of Japan’s trade patterns. For example, it appears that
the Chinese government has given tacit approval of a boycott
by Chinese consumers of Japanese cars and other Japanese
goods. This will not go on much longer as I expect to see Japan start moving production and FDI to Burma, Vietnam, India
and Indonesia. About 10 million Chinese are employed by
Japanese companies operating in China, while Chinese employment of Japanese workers in Japan, is minimal. Japan will
start locating FDI in new markets, big markets such as India
9
TIS EXECUTIVE SUMMARY—ASIA
and Indonesia. Export markets such as these, while always
important, will become a focus of policy attention. When the
Yen/Won drops as it has, pressure on Korean car companies
which sell into China, becomes pronounced. But if the Chinese are not buying Japanese cars despite the price drop, new
markets have to be opened up. This is Motegi’s job.
Finally, it is becoming clear the BOJ is being pushed to cooperate with the government. The days of complete BOJ independence are coming to an end. Amari recently stated that
he would consider attending BOJ meetings if needed. This
was taboo for years, but now the gloves seem to be off. Abe
calls this his “Crisis Beating Cabinet.” (2) So far, he has the
markets going his way. Where it will really get interesting is
when the BOJ Governor and Deputies are named. For the
first time in ages, Japan is moving. I have said this to some of
you over the years, but now it is time to put it in print. It
takes years, even decades for Japan to decide on a strategy.
Their development of the auto industry, which was done over
decades and took market share from America’s Big 3, is an
example. When the Japanese move, look out.
Nikkei 225 Index (1990-2012)—Target is 13,000
TSE REIT Index (TSEREIT)
Source: Bloomberg LP
Talking with institutional investors this week who invest in
Japan, the point was made that just to get back to the Koizumi rally levels, the Nikkei needs to trade up 60%-80% or
to 16,000-18,000 from the current 10,003. The Koizumi rally was also marked by policy changes, so even a minimum
50% retracement of that rally would target the 13,000 level.
My point is there is room for Japan to run from current
prices and institutional money has just started to move in.
Japan—Overweight and Bullish Kozumi Rally
Source: Bloomberg LP
Sources:
(1) “Land of the Rising Sun (and Falling Yen)” Halkin Services Limited 20 December 2012
(2) Nakamoto, Michiyo. “Abe reveals ‘Crisis Beating’ Japan Cabinet” FT 26
December 2012
Bloomberg Data; Bloomberg News
McPherson, Steven. “Japan to Resume Reactors Deemed Safe by Regulator,
Kyodo Says” BN 27 December 2012.
BOJ board member Koji Ishida has proposed scrapping interest paid on lenders deposits, potentially unleashing a flood
of money into the JGB market. BOJ Governor Shirakawa
rejected the plan, but he is a short termer now and so I expect this policy shift to surface again in April. $373 billion in
deposits are tied up at the BOJ, which is enough to move
the markets. Releasing those funds would be in addition to
the $119 billion recently added to the asset purchase program, which has driven 1 to 3 year JGB yields to 0.1%. Japanese investors are going to be forced to start purchasing
other income producing assets, such as REIT's, which have
had a stellar year in 2012.
10
 Abe-san won the election in a landslide and now Japan is ap-
proaching a Volcker like moment. A change in monetary policy may be imminent as the new PM’s lack of tolerance for deflation drove his election victory along with a new aggressiveness on defense policy. We may see the BOJ begin to shift its
approach to asset purchases as early as this week, but that
would be only the first of what could be a yearlong series of
changes at the BOJ. Immediately after the election Abe wasted no time in laying out what he intends to do. “We have to
get the economy out of deflation, correct the strong Yen,
create jobs and boost growth, that's our mission.” (1) By the
time current BOJ governor Shirakawa leaves office in April
2013, I expect stocks will have discounted a change in policy,
though they could have a long way to go if economic policy also becomes pro-growth.
Another area of interest in the Japanese stocks, is the defense
sector. Since 1995, Japan’s ratio of defense related expenditures to GDP have held constant at 1%. This is well below
China’s rate of defense expenditure and it is China, which has
been testing Japan’s defense systems on the water and in cyberspace. Jane’s Defence Weekly reported two years ago
that Japan planned to increase her submarine fleet from 16 to
22 vessels. In cyber space, Japan has been busily launching
new intelligence satellites. Expenditures on system across the
Japanese military should accelerate not because Japan intends
to become more offensive oriented, but because Tokyo recognizes that new threats are emerging. A more active defense system will be put in place and that should translate into
growth Japanese defense companies, such as Mitsubishi Electric and Melco, especially if the export ban on military hardware is lifted.
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
Nikkei 225
Hong Kong Housing & Real Estate Prices (+75% in 3 Yrs.)
Sources:
Bloomberg Data
Bloomberg News
Source: Paul Nesbitt, 618034, Ltd.
Sources:
(1) Fujioka, Toru. “Abe Shift on BOJ Signals Japan May Be Approaching
Volcker Moment” Bloomberg News, 18 December 2012.
Bloomberg Data; Bloomberg News
IHS Jane’s Defence Weekly, April, 2011
Hong Kong—Moving to an RMB Peg?  I mentioned several days ago that capital is pouring into Hong
Kong, pressuring the HKD/USD peg on the upside. The Hong
Kong Monetary Authority is intervening almost daily to keep
the peg in place. I do not think this will go on forever. I am
not sure when this will happen, but perhaps 2013 will be the
year when the HKD unpegs from the Dollar and re-pegs to
the RMB. This would make sense for other Asian countries
as well as trade patterns shift and the desire of Asian countries to endlessly accumulate Dollar reserves, wanes. China
will increase RMB convertibility over time and I expect HK to
become a major trading hub for the HKD. Linking to the
PBOC’s monetary policy may also make sense in terms of
abandoning the link to Fed policy. It is loose Fed policy, which
is feeding through to the HK real estate market, via cheap financing. Would the HKMA move to avoid the Fed's 2013
monetary policy?
One of things I have been thinking about is the possibility that
the Fed really steps on the monetary gas prior to Bernanke’s
end of term, mid-2014. He has to make this experiment in
monetary policy work prior to that date, because his successor would have little support for continuing a failed policy.
What do I mean by making it work? House prices and stock
prices have to go up in America during 2013 and the economy
must come back to 3-3.5% growth while unemployment falls.
That’s a prescription for higher long-term interest rates and a
boom in real estate prices. I am not sure HK is interested in
either outcome given the explosion in property prices they
have already had.
TIS Group January 2013 Global Markets
Source: Bloomberg LP
Hong Kong/China  I spent a week recently in Hong Kong/Singapore, talking most-
ly with clients and prospects, but also searching for investments. The outstanding feature of this trip was a rapidly developing view that China has turned the corner economically
and that further steps will be taken to accelerate growth in
2013. I would expect GDP growth in China to move towards
8% in 2013 and that perception is already having an effect on
Hong Kong property, Australian equities and the Aussie Dollar, as well as Japan, iron ore, coal, oil and base metals generally. This is a big deal, if Chinese GDP picks up. Chinese equities have just started to move after a 2.5 year bear market,
while the Australian market has gone sideways for 2 years.
These are markets that are especially interesting.
ASX Index—Close to a Breakout
Source: Bloomberg LP
Hong Kong is booming. The Fed's easy monetary policy is
pushing HK real estate higher just at the moment capital flows
from China into HK are accelerating. I heard numerous concerns from younger people in HK, who are simply being
priced out of the housing market. Stamp duty on real estate
transactions has been increased once, but I think other
measures will have to be taken to cool the property market.
The Hong Kong Dollar is experiencing so much upside pressure that the HKMA was intervening daily in the FX market
to keep it within the prescribed band. On one day, they in-
11
TIS EXECUTIVE SUMMARY—ASIA
tervened with roughly USD1 billion, no small sum for what is
essentially a city-state. At some point, possibly in 2013, I
think they will have to allow the HKD to float higher. This is
one of my top picks for currency markets next year.
In Singapore, the currency is also appreciating and is trading at
1.22, a little high, but as I have written earlier this year, the
SGD/USD will trade higher over time and should be bought
on every dip. This country is well run and as one friend noted, this government doesn't want your money- they have
plenty. That fact, along with an attractive business environment, good legal protection an orderly society, excellent infrastructure and education system (Yale is starting a new university in conjunction with the National University of Singapore) will continue to draw capital to Singapore. South Asia
looks more interesting to me than north Asia on a long-term
view and Singapore is in the center of southern/ west Asian
development.
Singapore Straits Times Index—Clear Breakout in Place
Source: Bloomberg LP
Finally a word on Japan. Sunday’s election may represent a
short- term top for the Topix and a brief respite in Yen
weakness. But I think if Abe-san wins and that seems likely,
Japanese stocks should be bought on dips and there are very
specific parts of the economy on which we should focus. One
of those groups is the defense industry, which I will write
more on next week. I think Japan is about to begin to re-arm.
I think the navy will expand, the cyber forces will grow and so
will air defenses. This build-up will help the Japanese economy.
Abe-san has an opportunity to force Yen depreciation. At
one recent Treasury auction, the Fed purchased about 90% of
the issue, so the Treasury needs more external buyers. With
auctions like that, it is no wonder the Bernank opted to buy
$45 billion per month of Treasuries with fiat money. Abe-san
can offer to fill in the funding gap between a lack of external
buyers and supply, as well as sopping up Treasuries owned by
China, which are not being rolled. He can do so by seeing
that Yen are printed to pay for those Treasuries and everyone should then be happy. Merry Christmas!
Major Foreign Holders of Treasury Securities
How Long Will Foreigners Continue Buying? (in billions $)
Nov
Nov
%
2012
2011
Change
75.5
59.2
24.7
13.1
58.9
93.3
65.3
75
194.4
29.3
94.3
51.6
27.3
30.6
258.5
137.2
201.6
58.2
22.2
27.5
36.7
1134.7
165.4
255.2
139.4
19.5
117.3
12.5
266.2
14.5
25.9
30
133.3
37
31
14.1
8.6
40.1
66.2
46.4
53.7
143.9
21.8
70.7
40.5
21.5
24.7
212.1
113.3
167.4
49.9
19.3
24
32.2
1006.1
147.5
229.4
126.5
17.7
106.5
11.5
248.4
13.6
24.6
28.6
132.4
104%
91%
75%
52%
47%
41%
41%
40%
35%
34%
33%
27%
27%
24%
22%
21%
20%
17%
15%
15%
14%
13%
12%
11%
10%
10%
10%
9%
7%
7%
5%
5%
1%
Korea, Sout
41.6
42.7
-3%
Germany
64.1
68
-6%
28.5
1161.5
30.8
1256
-7%
-8%
238.3
189.6
26%
5482.2
4918.3
11%
COUNTRY
Norw ay
Mexico
Spain
Peru
India
Ireland
Canada
France
Sw itzerland
Colombia
Singapore
Turkey
Italy
Chile
Carib Bnkng
Hong Kong
Taiw an
Thailand
Israel
Netherlands
Philippines
Japan
Russia
Brazil
Luxembourg
Malaysia
UK
South Africa
Oil Exporters
Denmark
Australia
Poland
Belgium
Sw eden
China, Main
All Other
Grand Total
1. Est imat ed f oreign holdings of U.S. Treasury market able and nonmarket able bills, bonds, and not es report ed under t he Treasury
Int ernat ional Capit al (TIC) report ing syst em are based on annual
2. Unit ed Kingdom includes Channel Islands and Isle of M an.
3. Oil export ers include Ecuador, V enezuela, Indonesia, B ahrain, Iran,
Iraq, Kuwait , Oman, Qat ar, Saudi A rabia, t he Unit ed A rab Emirat es,
A lgeria, Gabon, Libya, and Nigeria.
4. Caribbean B anking Cent ers include B ahamas, B ermuda, Cayman
Islands, Net herlands A nt illes and Panama. B eginning wit h new series
f or June 2006, also includes B rit ish V irgin Islands.
Depart ment of t he Treasury/ Federal Reserve B oard
17-Dec-12
Sources:
Bloomberg Data; Bloomberg News
Major Foreign Holders of Treasury Securities.” Department of the Treasury/Federal Reserve Board (http://www.ustreas.gov/tic/mfh.txt)
South China Morning Post 12-13 December 2102
Australia  I have spent the past few days down under and found summer
in Australia, very pleasing. On the economy, interest rates
are being cut by the central bank and the commercial banks,
yet nominal rates are still quite high which helps explain a
12
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
stubbornly high Aussie Dollar. But what is different is when
rates were cut earlier this week, the A-Dollar rose. How
does that work? Well my hunch is as an AAA credit and one
of the few left in that condition and with the term structure
of rates so high, Australia may be able to cut rates for a while,
yet see little effect on the currency. Everyone I spoke to
thinks the A-Dollar is too high, real estate too expensive and
the country too exposed to the Chinese economy. Aussie
shares have traded sideways for a couple years, but I think will
have a better year in 2013, especially if China begins to reflate.
Australia Stock Index (ASX)
Over the past 22 years, as Japan’s economy withered, Australia and New Zealand restructured their finances and their
economies, leaving them well-positioned to benefit from China's growth. I am wondering what happens to Australia if Japan’s economy finally kicks in at the same time China reflates
in 2013? Synchronized Asian growth is not something we
have seen in a long time. Could 2013 be the start of a new
cycle of broad based Asian expansion? Would not Australian
equities be one of the main beneficiaries? Would not oil be
another beneficiary?
I would count Australia among the unloved. I have had virtually no questions about this market in 2012, yet the long term
dynamics for investing are quite interesting. One group I met
with told me the Super-Annuation schemes which currently
invest 9% of payroll income will be boosted to 12% shortly
and this is mandatory saving. I had the impression that within
2-3 years, Aussie investment managers would be forced to
start investing overseas as local investments would be saturated. Forced savings plan, have a way of boosting asset values. Australia may be on the verge of another boost.
Sources:
Bloomberg Data
Bloomberg News
Source Bloomberg, LP
COUNTRY SUMMARIES
Australia—In the third quarter of 2012, Australia's seasonally
adjusted real GDP contracted marking the second consecutive
quarter of falling growth. GDP fell to a 3.1% YoY growth rate
and a modest 0.5% QoQ rate. The growth risk is on the
downside from weak external demand for Australian
commodities and the lower prices for those commodities. The
slowdown in China was a big problem for Australia, however
China’s growth rate should re-accelerate now. The uncertain
future of the EU and its sovereign debt bailouts remain a risk
factor.
Australia has largely recovered from the damaging floods of
2010 and 2011. With its resource infrastructure mended,
natural products, coal and ores are flowing unimpeded to ports
for export market delivery. While mining output has returned
to trend, we note that demand for that output is sluggish. The
RBA stepped in to lower the benchmark by 25-bps in
December taking the rate to 3%. This targets a weaker A$
which will work to the advantage of the resource sector by
increasing export competitiveness. However, even armed with
a weaker A$, exporters can do little to stimulate external
demand or the weak prices for their commodities, goods and
services.
In the mining sector, the squeeze on profits is
particularly hard felt due to the imposition of Ms. Gillard’s tax
on profits which came into force on July 1st 2012. The net
effect is a slowdown in the sector that is putting plans for
expansion projects on hold and jeopardizing jobs and wages.
Outside of the resources sector we note that Australian
business confidence is very weak. Business confidence indexes
fell in the fourth quarter as did corresponding indexes for
production, new orders employment and inventories. While
confidence in primary industries is being sapped by the decline
in global commodity prices, confidence in secondary and
TIS Group January 2013 Global Markets
tertiary industries are stifled by weak internal and external
demand for goods and services.
Despite the decline in business sentiment, consumer confidence
has held up well. Confident consumers have been buoyed by
low unemployment and low borrowing costs. Consumer
demand has provided much needed support for the economy as
external demand flags. The RBA rate cut gives consumers
access to low cost credit and a weaker A$ rebalances
consumer spending away from imports to domestic goods and
services. While we believe consumer demand will continue to
support the economy this year, we feel that consumers will
begin to feel the fiscal pinch during the first half and they will
adjust spending habits to become more cautious. We believe
that consumer demand will trend lower in 2013.
Inflationary pressure is modest and we expect CPI to fall within
the RBA’s 2% to 3% target band this year. This gives the bank
some flexibility in managing monetary policy to emphasize
economic stimulus. The bank cut the benchmark to 3% in
December but in its policy statement warned that without a
pickup in global commodity demand that the peak of investment
in the resource sector is approaching which will cap economic
gains from the sector. The bank’s cut also targets the
Australian Dollar which has been too strong for the export
sector’s good. The strength of the A$ has been putting
significant adjustment pressures on the manufacturing which
imposes limitation on widespread growth in the secondary
sector. The downside to the RBA’s decision is that by
weakening the currency, the bank will lose a hedge against
inflation and accelerate lending in the already hot property
sector potentiating a bubble.
We note that despite her razor thin majority in parliament, Ms.
Gillard’s coalition was cohesive enough to pass her three main
13
TIS EXECUTIVE SUMMARY—ASIA
bills in 2012: the carbon tax, the mining tax, and the national
broadband bill. These political successes aimed at balancing the
state budget may cost jobs and lowered wages. The result has
been a steady decline in Labor’s polling numbers. Labor faces
re-election later this year. Given the razor thin majority that
holds her government in power and the unpopularity of the
legislation that Ms. Gillard has championed, we believe that it is
possible that she could be replaced ahead of the election to
allow a more popular candidate to stand for election against a
growing tide of vocal Liberal opposition. Labor will struggle to
hold its government together and could well be unseated in
2013 by a Liberal candidate.
Australia’s natural resource based economy is subject to weak
external demand coupled to weak prices. The mining sector
has absorbed the brunt of this slowdown and Labor’s onerous
mining tax. We believe that the RBA’s rate cuts will help
weaken the A$ and give the export sector some relief but until
external demand increases, the resource sector will be under
increasing pressure. An associated decline in private demand
will undercut the economy in 2013. We hold a neutral weight
in the Australian market mindful of the risks associated with
slower growth this year.
China—China's economy is undergoing a sharp deceleration.
Third quarter, real GDP expanded at a 7.4% YoY rate after
slowing from 8.1% YoY growth in the first quarter to 7.6% YoY
in the second quarter. Growth in the mainland economy is
forecast to fall below 8% this year following a 9.3% YoY rate in
2011. We expect the new leadership team to inject stimulus in
2013 that could exceed one trillion Renminbi.
China’s outgoing Fourth Generation leaders added proactive
fiscal stimulus amounting to roughly one trillion Renminbi. The
central government stimulus was bolstered by local provincial
governments that pledged additional money for use in their
regions. The multi-trillion Renminbi fiscal stimulus program was
directed to infrastructure projects that will benefit the
construction and engineering sectors. We believe that the fiscal
stimulus package will gather speed in early 2013 while the new
leadership team engineers a second stimulus program that will
be implemented later in the year. Early indications concerning
the forth-coming stimulus suggest that it will be larger than the
2012 package. The expected consequence of proactive fiscal
stimulus is a large state budget deficit. Early estimates of China’s
2012 budget deficit project a RMB800 million gap, the central
government deficit target for 2012 is RMB 550 billion and the
local governments’ target is RMB250 billion. These numbers are
designed to fall inside the government’s 1.5% of GDP deficit
limit. The new leaders anxious to avert a hard landing for the
economy are expected to deliver a 2013 stimulus package that
will be close to RMB1.2 trillion, some 2.2% of GDP. This will
force the government to increase the debt limit and take steps
to limit the cap local government debt issuance. The state’s
economists think that deficits in excess of 3% of GDP are a notto-exceed threat threshold. The government’s insistence on
growth supported by debt cannot substitute for strategic
structural reforms that would set China’s economy on a path to
stable, sustainable growth.
The economic tug of war between exports and domestic
spending is tipping in favor of emphasis on domestic spending.
This is the emphasis that China always promoted with rhetoric
but never realized in practice. There is no longer a choice. The
days of double-digit export growth are gone replaced by erratic
weak single digit gains contingent on demand from a debt
14
ridden EU, slow improvement in the U.S. and a Japanese
economy in dire need of help. What we find to be of greater
interest is that import demand collapsed in August 2012.
Import demand contracted to a minus 2.5% YoY rate and a
more recent 0% YoY rate in November. This deceleration
marks a turning point in consumer demand that we feel may
not be easily corrected by a government injection of stimulus to
promote domestic consumption of goods and services
produced in the local economy. We observe that fourth
quarter business conditions reflected by the seasonally adjusted
manufacturing PMI moved above the 50-level threshold
indicating a shift to optimism. The new orders PMI was also
above the 50-level. Government stimulus supported optimism
in China’s manufacturing sector is welcome news that
businesses are realizing benefits. A corresponding uptick in
consumer sentiment and improved gains in retail spending data
measured against little or no import growth supports the
notion that the pattern of growth is shifting to domestic
spending.
We observe that Chinese producer prices were negative during
the March to November period. While private consumption
has increased deflationary PPI data suggest that manufactured
output is not yet matched to demand. If the fiscal stimulus and
credit easing do not result in an acceleration in demand, the
loss of pricing power will trigger a prolonged period of weak
profit margins for corporations. In this scenario, the PBoC
action to ease credit could become a vehicle to replace
corporate profits with debt. In a corporate sector notorious
for inefficiency, increasing debt for any reason sets the stage for
a sharp increase in nonperforming loans. The bet that China’s
state run capitalists are placing is that the timing of the U.S. and
EU recovery takes place before the domestic economy is
irreparably damaged by mismatched consumer demand and
factory output.
With import growth nil, China is not heavily exposed to
imported inflation. China’s headline consumer price inflation
rate moderated during 2012 but is showing signs of increase. In
November, headline CPI rose 0.3% to a 2% YoY rate. Behind
the increase was an increase in food prices due early fall frosts
that reduced vegetable and produce yields and transferred
consumer demand to expensive meats. We look for headline
CPI to run close to 3.5% in 2013. This is still inside the 4% goal
set by Premier Wen Jiabao in March 2012. The People’s Bank of
China faces slower economic growth, rising inflation and the
assumption of more government debt. Executing monetary
policy through the benchmark rate has never been extremely
effective in controlling inflation, housing bubbles or credit
bubbles. Through December, the PBoC’s 1-year lending rate
stood unchanged at 6% and the reserve ratio stood at 20%.
We note that in December the associated SHIBOR yield curve
moved higher at the short and long ends of the curve. As the
interbank rate is the benchmark rate in China's domestic
financial activities and loan activities, we expect that the PBoC
will act more effectively to control liquidity and inflation with
the SHIBOR. We see little evidence of pressure for the PBoC
to ease off the 6% benchmark rate in the near term but the
central bank may adjust its accommodative benchmark rate
policy outlook later in 2013.
The Fifth Generation political leadership of China will installed
this spring. The installation of Xi Jinging as president and Li
Keqiang as Premier marks a change that we expect will endure
for the next decade. The new leadership cadre inherits a China
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
with unprecedented economic potential and an equally
unprecedented list of problems that have no apparent
immediate solution. We believe that the overarching focus of
this leadership team will be to rescue economic growth with
debt driven fiscal spending and hope that the stimulus is enough
to prevent wide-spread civil unrest. The era of dependable
export driven, double-digit growth is over. China’s new Fifth
Generation leaders need to recognize this fundamental change
in China’s economic landscape and institute reforms that steer
the economy along a new path for lower, but sustainable
growth.
We note that risk adverse foreign investors with a strategic
outlook have begun to retrench into less risky, defensive
markets in Europe, Japan and the U.S. Government support of
economic growth emanating from domestic companies points
to selective buying opportunities for shares of companies
engaged in infrastructure development projects supported by
fiscal stimulus. These opportunities may be better exploited in
Hong Kong’s equity market or as offshore ADRs where
exposure to China’s domestic capital markets is minimized.
With political uncertainty out of the way, we feel that a neutral
weight in this market is appropriate. There is significant value
appearing selectively in stocks. A massive monetary reflation
would point us to increase an overweight position. Chinese
equities tend to trade more on politics than economies.
Politics and policies are turning more bullish.
Hong Kong—Economic growth in the SAR accelerated in the
third quarter with the rate real quarter-on-quarter GDP
increasing from the weak second quarter -0.1% rate to 0.6% in
the third quarter. Year-on-year growth ticked up slightly to
1.3% in 3Q12. Prospects for robust growth in this exportdominated economy are not good. The economy is highly
depended on global export demand for domestic manufactured
goods and re-exports that move through the SAR’s port
facilities which flagged in 2012. With the Eurozone and North
American economies struggling, and China slowing, we expect
that exports and re-exports will be slow in 2013.
We note that Hong Kong has run trade deficits since January
2009. The record deficit of HK$48.9 billion in December 2011
is not significantly lower early in the fourth quarter of 2012.
Fourth quarter deficits remained above HK$40 billion We
foresee no sharp recovery in Europe well into 2013 and the
U.S. will struggle to right itself next year. In addition to China’s
economic slowdown, which is decreasing re-export volume
through SAR port facilities, we also note that Hong Kong’s
long-term export picture is clouded by the growing importance
of mainland port facilities. As the mainland economy evolves,
the need for the SAR’s ports and its role as a financial
intermediary will progressively decline. Shanghai is now China's
biggest port and stockmarket operator. The SAR is also seeing
significant competition from Singapore as a re-exporter and as a
financial services center. A potential bright spot for exports is
the recent election of Shinzo Abe as Japan’s prime minister. Mr.
Abe promises aggressive action to return Japan’s economy to
growth. If he succeeds, Hong Kong stands to be a major
beneficiary of increasing trade volumes to and from Japan. In
this regard we note that the November, the HSBC PMI
increased to an optimistic 52.2 reading from October’s 50.5
reading. The optimism reflects expectation that China’s fiscal
stimulus will drive new order growth from the mainland
As exports trend lower, private consumption assumes greater
importance for the SAR economy. Unfortunately, we observe
TIS Group January 2013 Global Markets
that SAR consumer sentiment remains weak. The consequence
is a corresponding downturn in retail spending. While retail
spending showed year-on-year gains each month in the second
half through November, the gains are well off the double-digit
increases seen in the first half. We look for domestic spending
to remain weak in 2013.
Hong Kong consumer price inflation has been moderate. In the
fourth quarter, consumer price inflation remained steady as
external inflationary pressures from rising food costs in the
mainland economy moderated and global commodity prices
remained subdued. However, we believe that CPI will increase
in 2013 due to the SAR’s buoyant property market, a wage
increase planned for May 2013 and rising CPI on the mainland.
The wage increase is noteworthy because the SAR’s minimum
wage has been comparatively low compared to other
economies. While the increase is overdue, it will contribute to
inflationary pressures. To cool the property market, the
government imposed new measures to contain the market
including raising the down payment for some mortgages,
accelerating land sales and imposing a tax on real estate resold
within six months of purchase. However, these have not
proved to be very effective and we look for the property
market to be a major inflation driver in 2013. We also note that
the local property market is subject to significant inflationary
momentum derived from foreign capital inflows. The real estate
bubble will be exacerbated by the U.S. Fed’s QE-III program
that increases US$ liquidity looking for offshore opportunities.
In addition to its inflationary impact we look for the SAR real
estate bubble to be a test for the HK$ peg to the U.S. Dollar.
With inflationary running under 4%, the HKMA has been able
to maintain its historically low interest rate. The low
benchmark lending rate in the SAR, 0.5% set in December
2008, and high liquidity, the M1 was up 13.1% in October and
the M2 and M3 were both up 10%, are poised to defend growth
in 2013. The unfortunate consequence of HK$ peg to the US$
and the low borrowing rates is that the Hong Kong property
bubble is being supported by low lending rates.
Since assuming the reigns as Chief Executive in July, Leung
Chun-ying has had a bumpy ride. Mr. Leung faces an
unprecedented attempt to impeach him. We harbor strong
doubts that Mr. Leung will or can be impeached. In his
December visit to Beijing, during which Mr. Leung met China’s
new leadership team, he received not only support but orders
to address the SAR’s problems with employment, high cost of
living, housing, poverty, the environment and the SAR’s shift to
an ageing population. Mr. Leung is a student of the mainland’s
“mentored” approach to governing the SAR by proxy. We
expect that Mr. Leung is well suited to endure local dissent and
deliver on the mainland’s expectation for obedience to its
authority.
As a proxy for the mainland’s capital markets, international
investors can find buying opportunities in Hong Kong
correlated to mainland shares. Because Hong Kong’s markets
historically follow the U.S. more closely than the mainland and
with the U.S. economy showing signs of improvement, the
Hong Kong market may further decouple from the mainland. It
should also be noted that risk adverse investors, particularly
those in the Eurozone, are retreating from emerging Asia
markets in favor of less risky defense markets on the continent.
For risk tolerant investors the SAR offers buying opportunities
that may become more coupled to the North American market
than to the mainland and other regional Asian markets.
15
TIS EXECUTIVE SUMMARY—ASIA
Overall, we feel that now isn’t the time to enter the Hong Kong
equity market in other than a selective, opportunistic manner.
From a long-term/intermediate viewpoint, we hold our neutral
stance in Hong Kong.
India—The political or economic development that could have
the biggest positive impact on India would be surrounding land
development. As of now, miners, industrialists, or developers
have mountains of regulations and red tape to get through
before they can even consider expanding. It is extremely
restrictive and causes unnecessary bottlenecks in supply and
employment.
This is why we are particularly excited about India’s recent push
for land reform. We recognize that easing restrictions on land
development will be a long process filled with protests and legal
challenges, but the fact that the process is beginning is a huge
positive for the slow-moving Indian system.
Under a new draft bill, the government would need approval
from 80% of landowners for private sector projects and 70%
for public/private joint ventures. This is even higher than what
the Congress Party’s president pushed for, but we are positive
to see movement, no matter what the first stage looks like.
Realty stocks in India seem to agree. They have taken off, and
we expect a secular bull market in this sector, as well as related
and supporting sectors. Construction and industrial equipment
stocks are buys, too. We recommend an overweight position
in Indian equities.
(“Indian land bill faces hurdles despite Cabinet nod.” Oxford
Analytica 14 Dec. 2012)
Indonesia—Indonesia’s GDP expanded by 6.3% YoY in the
first quarter of 2012, 6.4% YoY in the second quarter and by
6.2% YoY in the third. These form a pattern of strong growth
amidst the financial problems in the EU, a struggling U.S.
economy, China’s slowdown and Japan’s ongoing struggle with
deflation. We expect that 2013 GDP growth will follow trend
and remain above 6%.
The linchpin for this economy is private consumption.
Indonesia’s consumer confidence and domestic spending
remained buoyant in the fourth quarter. We note the Bank of
Indonesia’s consumer confidence index rose each month during
the July through November period with a corresponding
double-digit increase retail sales each month. We expect that
private consumption will remain robust in 2013 outweighing a
growing but smaller contribution from exports. Indonesian
consumers are shielded from external price shocks by many
government subsidies. In 2012, the Yudhoyono government
backed away from reducing the fuel subsidy when civil protests
grew violent. This subsidy costs the government an estimated
US$15 billion each year that could be redirected into improving
the transportation system so less fuel was wasted by the
country’s inefficient transportation systems and used to target
many other infrastructure projects needed to unlock the
country’s economic potential.
We note that Indonesia’s economy has been resilient largely
because of its dependence on domestic spending rather than
external demand and export trade for its excellent growth.
While small, Indonesia’s export sector includes forest products,
minerals and energy resources in the form of coal, gas and oil.
We believe that Indonesia’s crude oil, natural gas and coal are
important energy resources to China despite the mainland’s
economic slowdown. We feel that Indonesian energy resources
are an important future cornerstone for Asia-centric energy
16
demand especially with persistent turmoil in the Middle East.
The major impediment to exploiting the country’s natural
resource base is a widespread lack of infrastructure. Without
highways, railways, airports and ports, getting to these
resources and bringing them to global markets is difficult. In
December 2011, the government enacted law to acquire land
necessary to develop critical infrastructure under eminent
domain. However, implementation has been extremely slow. It
has been estimated indicate that Indonesian companies spend
roughly one third of total production costs on the
transportation of goods to domestic and foreign market outlets.
The infrastructural tasks are daunting because Indonesia is an
archipelago of 17,000 islands. The need for infrastructure is
enormous and we feel that Indonesia is one of the world’s
largest markets for infrastructure development. With little time
left in his presidential term, Mr. Yudhoyono needs to accelerate
investment to give a PD successor a good chance to win in the
looming 2014 election.
Headline inflation has been tame giving the Bank Indonesia
latitude to remain on the sidelines. In its December policy
meeting, BI held the benchmark rate at the historic low 5.75%
maintaining its policy focus on growth. BI’s rate position has
diminished speculative interest in the Rupiah but this has been
largely offset by the bank’s high relative interest rate differential
to other key global benchmark rates. In concert with ample and
growing FDI flows, the rate differential attracts carry trade
money inflows. In this regard we note that the Rupiah
remained one of Asia’s worst performing currencies last year
largely because of the country’s weak current account position.
The currency depreciated against the US$ by roughly 6.5% in
2012. This helps the fledgling export sector but increases debt
service costs. We expect the Rupiah will depreciate in 2013
which will make it difficult to limit Rupiah volatility and maintain
a stable currency regime as foreign capital inflows increase.
We note that the government of President Yudhoyono remains
stable and appears likely to survive until the next election is
2014. Government cronyism and corruption are major
problems facing Mr. Yudhoyono and his Democratic Party.
These limit the effectiveness of government programs to build
new infrastructure and deliver meaningful reforms to voters.
Elections will be held in 2014 and we foresee a rising tide of
opposition politics that in this Muslim nation that could acquire
a risky fundamentalist foundation if Mr. Yudhoyono does not
attack fundamental problems more aggressively. For now,
President Yudhoyono’s mandate to govern remains strong and
his government is stable but the massive protests over the fuel
subsidy are indicative of widespread frustration with the
government that lingers just below the surface. Cracks in the
armor of the ruling Democratic Party and Mr. Yudhoyono’s
political machine are evident and these are opportunities from
which new leadership will emerge in 2014.
We believe that the momentum of Indonesia’s economic
expansion will continue this year driving GDP growth to above
6%. We believe that the investment climate in Indonesia
remains structurally favorable and the government of President
Yudhoyono demonstrated that the country can deliver solid
economy performance under a stable democratic government.
Indonesia’s growth potential is an opportunity but until the
government takes aggressive steps to reform the economy and
implement infrastructural development this potential will not be
fully realized. Indonesia is a resource rich country with
abundant timber, minerals and fossil fuels. We feel that the lack
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
of strong dependence on exports will help maintain the
economy this year in the face of slowing demand from China
and considerable uncertainty over the fate of EU and North
American demand. We feel a slight overweight is appropriate
for Indonesia.
Japan—The election of Shinzō Abe as Prime Minister may be
the tonic needed to set Japan’s ailing economy on a path to
recovery. Mr. Abe, elected on December 16th, wasted no time
announcing the triadic framework for what must be done; apply
pressure on the Bank of Japan to lift its inflation target,
depreciate the Yen and boost job creating growth. Mr. Abe’s
task is daunting. Japan’s economy has languished for so long that
robust, sustainable growth is lost from common economic
memory. The macro environment is uniformly stacked against
him.
On an annualized, seasonally adjusted basis, Japan’s real GDP
contracted sharply in the third quarter, falling 3.5% QoQ. The
former Noda government injected significant fiscal stimulus to
rebuild infrastructure damaged in the 2011 earthquake-tsunami
but this failed to boost growth in the broad economy. For Mr.
Abe, the reconstruction is a foundation upon which to build.
Mr. Abe will have little control over the external environment
that has been a debilitating brake on exports. An increase in
demand from EU member states wallowing in sovereign debt
problems is unlikely and the U.S. import picture in the second
half has been characterized by sub-1% month-over-month gains.
To address foreign market penetration Mr. Abe tasked
Toshimitsui Motegi, his Trade Minister, with increasing Japan’s
competitiveness in external markets. We think that an
immediate focus will be Japan’s Asian trading partners. This
brings China to the fore. China’s boycott of Japanese
merchandise over disputed territorial claims in the South Chain
Sea is potential damaging to Japan but China is not immune to
Japanese retaliation. Japanese corporations have manufacturing
facilities in China that employ millions of Chinese workers. We
believe that Mr. Abe’s choice of foreign minister, Fumio Kishida,
and Mr. Motegi will leverage Japan’s hold on Chinese jobs to
point out that there are other low cost labor pools in Asia and
other large markets in India and Indonesia that offer Japan
attractive offshore opportunities. Japan’s biggest manufacturing
competitor in Asian markets is South Korea. A key aspect of
Mr. Abe’s directives to depreciate the Yen is diminished export
competitiveness of South Korean goods and services when the
Yen-Won cross rate falls. Overall, we see Japan holding far
more economic power over China than China has over Japan.
Adding to Japan’s export debacle is the decision made by the
former Noda government to idle Japan’s fleet of nuclear power
stations. This shifted the burden for electrical energy
production to fossil fuel fired generation stations that need to
import fuel to spin the turbines. Energy imports are a growing
problem for Japan’s trade deficit. Again, Mr. Abe’s choice of
Nobuteru Ishihara as his Environmental Minster will be
instrumental in addressing this matter. Mr. Ishihara is a
proponent of nuclear power and we believe that he will use his
cabinet position to rescind the former DPJ controlled Diet’s
ban on nuclear power generation. This will involve a new
energy policy that will exploit the existing fleet of nuclear
power stations, perhaps adding more generating capacity, and
rejuvenating Japan’s renewable energy sector. This high tech
sector was once a flagship for Japanese industry that can be
restarted to create jobs. Restarting Japan’s fleet of nuclear
power stations is not without risk. The occurrence of another
TIS Group January 2013 Global Markets
Fukushima-Daiichi event would have severe consequences for
Mr. Abe’s economic recovery strategy.
The effects of a strong Yen on trade are a particular concern
for Mr. Abe. The Bank of Japan is a linchpin in Mr. Abe’s plan to
increase inflation. In the BoJ’s December meeting, the policy
committee adopted an interim 1% inflation target. The bank
plans to “consider” carefully Mr. Abe’s request for the bank to
set a 2% CPI target. We expect the new governor will oversee
and insure that the central bank is aligned with Mr. Abe’s plans
to increase the inflation target to 2%. We believe that the BoJ
will outpace the U.S. Federal Reserve this year in printing
money. This will put the Yen on a path to depreciate to
US$1:JPY90 and eventually a target of 99.
On foreign policy, Mr. Abe is a hawk. We believe that Mr. Abe
will resume what he began in his first term as prime minister in
2006. When Mr. Abe took the reins of power as Junichiro
Koizumi’s successor, Mr. Abe set about to rearm Japan. This
included a nuclear weapons capability. A pacifist nation by
constitutional declaration since World War II, Mr. Abe set his
cabinet to work to determine the legality of nuclear weapons
capability. The legal test focused on Article Nine of Japan’s
constitution which lays the foundations for Japan’s pacifism. The
key legal finding by the Cabinet Ministry was that Article Nine
does not bar Japan from possessing nuclear weapons that could
be used defensively in matters of national security. This opened
the matter to public debate but the first term Abe government
established that a redraft of Japan’s constitution would be
necessary if Japan was to remilitarize in a manner that
accommodated enhanced military capability beyond those
deemed strictly defensive, including nuclear weapons. In so
doing the stage would was to be set for Japan to become a
military power capable of independent action. This debate was
abruptly ended when Mr. Abe resign his position in September
2007, less than one year after taking office. We feel that Mr.
Abe will soon resume his quest for remilitarization and do so
without the timid approach that he took in his first term. This
forebodes a rewriting of Japan’s constitution and the emergence
of a remilitarized Japan as a threat to Chinese aggression in the
region. Re-militarization has significant ramifications for
increased defense budgets as a tool for creating jobs and as a
economic growth engine.
We note that many advisors accustomed to Japan’s economic
pathologies have maintained small positions in Japan equities.
The newly elected LDP government led by Shinzō Abe
promises to change the face of Japan’s economic future. We
believe that with the Mr. Abe and the LDP in power an
overweight stance in Japan is appropriate.
New Zealand—In the third quarter, New Zealand’s seasonally
adjusted GDP grew 2% YoY and a weak 0.2% QoQ. This
represents a sharp contraction following 2.5% YoY growth in
the second quarter. The local, export dependent economy will
struggle in 2013 on weak export demand and sluggish private
consumption. The major downside risk to growth is weak
demand for natural resource and agricultural exports. The
bright side for the economy remains earthquake
reconstruction.
Expenditure on fixed investment will be a key growth driver in
2013. Fiscal spending to repair earthquake damage is far from
complete in many areas and reconstruction activities will
accelerate in 2013. Spending on fixed investments is projected
to grow by 7.4% this year. The construction sector will be a
main beneficiary providing employment and bolstering domestic
17
TIS EXECUTIVE SUMMARY—ASIA
consumption as industries return to full production. In part
because of extensive earthquake damage and slow
reconstruction, New Zealand’s property and rental markets
have been strong. Building permits trend series data show
month over month gains into the fourth quarter. While the
central bank has been on the sidelines holding the benchmark at
2.5%, New Zealanders have taken advantage of relatively low
borrowing costs for homes and household credit spending.
We note that New Zealand’s balance of payments has slid into
deficit due to the effect of declining commodity prices coupled
to weak demand from Asian trading partners. We expect that
weak external demand will continue to put pressure on export
growth this year emphasizing the impact of reconstruction on
the domestic manufacturing sector. The central bank’s policy is
permissive support for the NZ$ which was strong in the
second half of 2012. NZ$ strength clearly affects export
competitiveness and gives consumers leverage in purchasing
imported goods and services which imports inflation. As the
current account deficit grows, pressure will mount to
depreciate the currency but this runs counter to the policy bias
of the RBNZ. We note that in its December policy meeting, the
Reserve Bank of New Zealand held the benchmark at 2.5%
citing moderate CPI and an unwillingness to ease in an effort to
contain the property market. We expect the bank to be on the
sidelines during the first half as Governor Graeme Wheeler
continues the bank’s wait and see watch on the economy.
Against weak external demand for exports, we note that New
Zealand consumer confidence has held up relatively well. The
reserve Bank of New Zealand has played an important role in
supporting domestic consumption by holding the benchmark at
a relatively low 2.5%. We expect that the central bank will
remain the sidelines as Governor Graeme Wheeler continues
to advocate a wait-and-see approach to managing monetary
policy. We believe that the RBA is content with the inflation
outlook and has held rates at 2.5% expressing concern that it
does not want to inject more stimulus into the hot property
markets. Consequently, believe that the central bank’s inaction
will support the NZ$, allowing it to remain relatively strong in
the first half of 2013.
Investor sentiment has historically gravitated toward
maintaining a stronger NZ$ on the basis of the country’s low
risk profile which makes the NZ$ a surrogate safe haven
currency. This points to some level of risk that the Kiwi will be
subject to overvaluation, which will hurt export
competitiveness and give consumers leverage in purchasing
imported goods.
In November 2011, New Zealand held general elections that
returned the National Party government led by Prime Minister
John Key. Mr. Key quickly formed a coalition to secure a 64seat majority in the 121-seat parliament. The next scheduled
election is scheduled for 2014. In power since 2011, the
popularity of Mr. Key’s Nations fell in recent polls while
support for the Nationals has gained. We expect that the next
election will be tighter than the 2011 election and much
depends on how Mr. Keys handles the economy and job
creation. Overall, we see little change in New Zealand politics
in the near term and expect that Mr. Key’s Nationals will
continue to govern but a referendum is possible and the
National coalition could face difficulty retaining their fragile hold
on power.
We observe that growth in New Zealand’s economy is slowing.
A bleak export picture is partially offset by domestic
18
reconstruction activity. The RBNZ is holding the benchmark
rate at 2.5% creating a significant rate differential to the U.S.,
Japan and ECB. This turns investor attention to fixed income at
the expense of equities. In comparison to Russia and South
Africa, New Zealand carries low risk for investors that want
exposure to a natural resource based economy. We hold our
neutral position in New Zealand.
Singapore—Singapore's economy contracted sharply in the
third quarter of 2012. Real GDP fell to a 0.3% YoY growth rate
from 2.5% YoY in the second quarter. On a quarter-on-quarter
basis, GDP contracted by -5.9% following contractions in the
first and second quarters. The impact of weak external demand
for exports will push 2012 growth to a three-year low near
1.5%. Sluggish export demand will continue to impeded growth
in 2013 with full year growth showing only slight improvement.
With China and India slowing and the EU bogged down with
debt bailout costs we expect the external demand will remain
subdued. Although Singapore's merchandise trade balance
remains in surplus, holding a relatively stable S$80 billion in the
second half of 2012. Never-the-less, we see persistent
weakness in the non-oil export picture this year noting that
pharmaceuticals demand has been good but the dominant
electronics export sector contracted sharply in the fourth
quarter. With China and India slowing and the EU bogged
down with debt bailout costs we expect the external demand
will remain weak. Against weak performance in the
manufacturing sector, Singapore’s oil exports rebounded early
in the fourth quarter. Moderate strengthening of crude prices in
2013 will benefit Singapore but energy alone cannot entirely
compensate for weak external demand for goods and services.
Overall, business sentiment is very weak and we do not feel
that global conditions are favorable for a near term pick-up in
external demand so the near term trend in manufacturing will
reflect continued pessimism. This shifts much of the economy’s
growth emphasis to domestic spending. This shifts much of the
economy’s growth emphasis to domestic spending which is
problematic on weak consumer sentiment.
We do not believe that the economy can expect much help
from domestic spending in the first half of 2013. Consumer
sentiment is weak. This is reflected in retail sales data that
shows consumer purchases fell from an annualized growth rate
of 19.9% YoY in February to a to a 1% YoY contraction in
October. This is primarily due to consumer caution in
purchasing big-ticket items. Ex-autos, retails sales rose each
month during the August to October period. We look for
consumers to remain cautious about big-ticket discretionary
items as the economy remains sluggish this year. One bright
spot for consumerism is the job market. Singapore’s labor
market is currently very tight, running at a low unemployment
rate of 1.9% in the third quarter. Demand is high for skilled IT
applicants in the financial sector where continued expansion is
draining the pool of the skilled applicants. A factor that irks
Singaporeans is the large number of foreign immigrant workers
in Singapore. Estimates put the number jobs held by foreigners
at roughly 30%. This has ramifications for the political process
in Singapore. In this regard we note that the government’s
FY12/13 budget targets this problem with provisions designed
to reduce in the dependence on foreign workers and to attract
and retain citizens in the workforce. Low unemployment
underpins consumerism but puts inflationary upward pressure
on wages.
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—ASIA
The Monetary Authority of Singapore must simultaneously
contend with rising CPI and slowing growth. This combination
complicates its currency management policy. The central bank
continues to use a managed S$ as its main monetary tool, not
benchmark interest rate policy. The MAS strategy has been to
allow the S$ to appreciate to fend off rising CPI. The MAS
reviews its currency stance in October and April. We note that
in its October policy meeting the MAS unexpectedly refrained
from slowing the Singapore Dollar’s appreciation despite signs
of a rapid deceleration in GDP growth. Consequently, we
expect that the MAS will maintain a modest and gradual
appreciation of its currency in April when it next meets to
consider policy. Through December, the MAS held the prime
lending rate at 5.38% and has the overnight rate at 0.3% and the
3-month deposit rate 0.31%. While the MAS is constantly on
guard for inflationary containment, the static interest rate
environment has done very little to curb activity in Singapore’s
property markets. Growth in Singapore REITs, driven by asset
acquisitions and rental appreciation, outpaced gains in the
regional Asian markets, the U.S., U.K. and Japan. The property
market remains a source of inflationary pressure in this
economy acting to counter the MAS currency management
actions.
In politics, Singapore’s PAP led by Prime Minister Lee Hsien
Loong is entrenched and is in firm control of parliamentary
process with a commanding majority holding 81 of 87 seats.
However, there is an undercurrent of political discontent
among younger Singaporeans that poses a strategic problem for
the PAP’s dominance of politics. The willingness of voters to
TIS Group January 2013 Global Markets
vote for the opposition was evident in the recent May byelection that saw an opposition candidate hold his parliamentary
seat despite strong campaigning by the PAP. We feel that
demographics are working against the PAP and its future
control of the political process in Singapore. This is reflected in
a growing trend toward opposition politics displayed by
younger, digitally enabled voters who find the opposition more
to their liking. The next election scheduled for 2016 could
mark the beginning of a period in which the political opposition
forms a credible framework from to challenge the incumbent
PAP.
Singapore’s export dominated economy slowed in 2012 and will
struggle with modest improvement in 2013. Singapore offers
foreign investors a stable market relatively free from political
risk. The government’s strong budget surplus prompted S&P
and Moody’s to give the city state strong credit ratings that
underscore its ability to withstand global financial shocks. We
also see Singapore growing in importance as a hub for Asian
financial transactions. However, the risk of slower growth will
put pressure on corporate earnings this year. We feel that
Asian’s general slowdown and rising inflation will take a toll on
Singapore’s market in the near term. We see the economy
improving slowly this year and adopt a slight overweight
position in Singapore.
19
TIS EXECUTIVE SUMMARY—EUROPE & AFRICA
DJ Euro Stoxx 50—Time For A Breather
Source: Paul Nesbitt, 618034
P
Europe  European equity indices performed quite well over the second
half of 2012 with European Financials acting exceptionally well.
Germany is at risk of entering a recession. For German
stocks, this may well matter as the DAX Index was up 27%
last year and has broadly outperformed other Euro markets.
The DAX may be too high. But other markets in Europe may
well be at the other end of the spectrum, too low. I pointed
out the dynamics in the Swiss market recently, which are
quite good and I think will improve further. But it is southern
Europe, where the values are and at this point, I would say
the near term risks of a funding problem blowing up Greece
are diminishing while in Italy spreads have come in to manageable levels.
Euro Stoxx Financials (SXFE)
Could it be that the pipeline which will be run out of the
Leviathan field south of Turkey, will have a terminus in Greece,
rather than Turkey? Would NATO prefer it that way? How
about Israel, which is developing the field along with American
company Noble Energy and Woodside Petroleum (Australia),
which is working on the LNG side of the project. If Greece
were to exit the Euro, would it remain in NATO? Keeping
Greece and certain other European countries in the fold, has
implications beyond the financial aspects.
Leviathan Field
Source Bloomberg, LP
Greece is worth a comment. After Angela Merkel's trip to
Washington this summer, she did a remarkable about face. A
trip to Greece followed, her Germanic charm was unleashed
on an unsuspecting Greek population and suddenly all the stops
were pulled out to keep Greece inside the Euro tent. Athens
has been given one break after another in the past 6 months, as
the government struggled to restructure its finances. Why?
20
Sources: Dabbour, Haitham. “Brotherhood Would Cancel Camp David Agreement
Says Hezbollah Official” egyptindependent.com 30 Jan 2012
European equities could have a pretty good 2013, in relation to
what is unfolding in Japan and Hong Kong, European shares
have a different set of factors driving them, though valuations
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—EUROPE & AFRICA
are similar to those in Tokyo. Hong Kong is a Fed story. The
leakage of liquidity from the Fed's quantitative easings is driving
property prices in HK and as property goes, so goes the
economy. As to Japan, Abe-san has spoken so openly and so
widely about easing monetary policy, this election must be
viewed now as a referendum on monetary policy. 2013 could
be a very interesting year for Japanese equities.
Nikkei
EUROPEAN COUNTRY SUMMARIES
Eurozone—A huge shift in power has taken place in Europe
away from elected officials, and toward the ECB. This occurred
when Mario Draghi stood up and promised the world that he
would back Spain’s debt. He didn’t have the legal authority to
do so, but the markets like it, and as a result, the EU is working
on giving him his legal authority retroactively. The election of
Francois Hollande in France is a sign that austerity in Europe is
a long way off, but his losses in the recent by-elections give us
some hope. Germany and the EU will continue to give good lip
service to austerity, but sentiment is clearly moving the other
way across the Eurozone. With Spain and Italy talking austerity,
yields on their government debt have come off their highs. This
is providing somewhat of a respite to the markets, and allowing
the fear trade to come off. The snap elections called in Italy,
however, is going to bring their recently-ignored fiscal situation
to the fore. This will likely begin to lift rates again, and put
pressure back on the enormous debt service levels. This is
where we begin to get skeptical. Growth is the only hope for
Europe, but prospects are grim. We are also skeptical of the
long-term commitment of the PIGS to their new “austere”
pledges, as set forth in what is now known as the “fiscal
compact.” (“Spain rescue could determine market view of
Italy.” Oxford Analytica 18 Dec. 2012)
Russia—Russia’s GDP growth continues to slow. GDP growth
slowed in the third quarter to a 2.9% YoY rate. This is well below
the 4.9% YoY rate in 1Q12 and the 4% YoY rate in 2Q12. We
look for this energy and natural resource dependent economy to
get a boost from the rebound in commodity prices in 2013.
Deputy Economy Minister Andrei Klepach projects that growth
will slow to 3% this year. While this growth rate would make
many EU states very happy, it is going to make it very difficult for
President-elect Putin to deliver on the many economic promises
that he made during his campaign. We also note that if growth
slips below 3%, Mr. Putin will be faced with an increasingly risky
political environment in which he could be forced to
acknowledge that his aggressive economic growth campaign has
failed. In this environment, it is likely that demonstrations against
the Putin government would intensify.
Weak external demand lowered output from Russia’s manufacturing sector. Output from Russia’s manufacturing sector slid in
TIS Group January 2013 Global Markets
the fourth quarter. After a peak increase of 3.4% YoY in July,
output fell below 2% in October and November. Business confidence numbers in the manufacturing and mining sector were negative in November. The data reflect weaker demand from the
external and domestic economies. While global demand for
commodities will slowly improve in 2013 we do not believe that
there will be a corresponding rebound in manufacturing in the
near future for Russia’s factories and businesses. China, now
Russia’s main trading partner is slowing, propped up by government stimulus and EU member state economies encumbered by
sovereign debt problems remain fragile and harbor significant risk
to member state economies.
We also note that the decision by the United States Federal reserve to implement a third cycle of quantitative easing effectively
devalues the U.S. Dollar. This increases the cost of imported
Dollar based commodities and triggers inflation. For Russia this is
a mixed bag, as a net energy and hard commodity exporter higher US$ based commodity prices add to receipts but rising input
costs will be inflationary.
After a sharp increase in September, Russian headline CPI fell
back to a 6.5% YoY rate in October and November. The annualized core rate ran 6%. Against the backdrop of a slowing economy, Russia’s headline inflation is still running above the Russian
Central Bank upper 6% target band which makes loosening to defend growth problematic. Another downside to rising energy
prices is the end of sharp Ruble depreciation that began in the second quarter. Ruble appreciation works against export competitiveness and gives Russian consumers to buy imported goods rather than goods produced domestically. We note that in December, Bank Rossii held the benchmark at 8.25% citing inflationary
risks to the economy. However, the central bank raised the rate
on fixed-term deposit operations by 25bps to 4.5% and reduced
the rate on the Ruble leg of the Bank of Russia FX swap transactions by 25bps to 6.5%. By narrowing the interest rate corridor
the bank holds a neutral monetary policy stance but is set on reducing money market volatility and increasing Ruble liquidity by
lowering the swap rate. The bank’s decision to defend against CPI
rather than to accommodate growth directly with monetary policy through a rate cut exposes the Ruble to appreciation. We believe that a rebound in commodity prices and energy prices this
year will underpin Ruble appreciation. Ruble appreciation works
21
TIS EXECUTIVE SUMMARY—EUROPE & AFRICA
against export based manufacturing and makes imported goods
less costly for Russian consumers.
The private sector has been relatively strong despite weak consumer confidence. Russian consumer confidence fell 2-points to 6 in the third quarter which extends the string of negative numbers that began in the third quarter of 2008.We note that while
confidence is subdued, domestic spending has held up reasonably
well showing above 4% YoY gains in October and November. In
this regard we note that following his presidential election victory, President Putin promised to create 25 million jobs by 2020
fueled by a new round of privatization to decrease the number of
inefficient state monopolies. This rhetoric resonates with Russians but with the economy slowing and manufacturing under
pressure from weak demand, it is going to be impossible for President Putin to deliver on many economic promises that he made
during his campaign. With the economy slowing, and manufacturing unable rebound we expect employment to soften in 2013.
In May, Vladimir Putin was installed as Russian President after his
resounding March 2012 election victory. We believe that Mr.
Putin remains a hardline politician with a strong sense of possession when it comes to strengthening his hold on power. Reforms
sufficient to silence his critics and quell demonstrators will be
slow to emerge from his presidency. We do not believe that Mr.
Putin will make significant concessions to the West. He will resume the hardline foreign policies that characterized his first and
second terms as president. Relations with the U.S., Britain and
NATO are in for a bumpy ride and defense spending may be in
vogue during Mr. Putin’s term. This is especially noteworthy as
U.S. President Obama enters his second term and promises to
implement an Asia-pivot as a key foreign policy objective. With
U.S. policy focused on Asia, European disengagement will give Mr.
Putin new opportunities to make inroads that were formerly absent.
The Russian economy is still performing well relative to many EU
member states. We expect that demand for Russian energy and
natural products will begin to slowly recover in 2013. Investors
able to tolerate the risks inherent in Russia can benefit from this
growing economy and rising commodity prices. However, the
risks in Russia remain substantial compared to natural resource
based economies in Canada and Australia. We hold our slight
overweight position in Russia as Russian stocks are cheap.
Scandinavia—Economic growth in Scandinavia slowed in each
of the four economies covered in this report. Only Norway’s energy dependent economy is weathering the Eurozone storm reasonably well. Sharp growth contractions in Denmark, Finland and
Sweden are reason for concern contracted. These were subject
to weak external demand from Eurozone trading partners and
weak domestic demand.
Consumer price inflation will be subdued across the region this
year as growth slows. CPI has been subject to weak commodity
prices and weak energy prices. In Sweden and Norway, strong
currencies provided a shield against CPI by lowering the cost of
goods and services sourced from external suppliers. Sweden’s
Riksbank cut its benchmark rate by 25bps to 1.0% in December.
We also note that Denmark’s Nationalbanken cut the benchmark
by 25bps in August to 0.2% where it remained through the end of
the fourth quarter. Norway’s Norges Bank has been on the sidelines holding its benchmark at 1.5% in December but noted that
its policy bias is for tightening to combat rising inflationary pressure. Finland’s benchmark rate is tied to the ECB which stood at
0.75% in December. Despite Norges Bank’s policy bias, Scandinavian consumer price inflation is being held at a very low rate by
Eurozone sovereign debt problems and weak global growth.
As we note that strong domestic currency in Norway is due primarily to the energy dependent strength of the economy acting as
an attractant for investors seeking a safe-haven and for speculative
22
money inflows. This will serve to support a stronger Krone even
with Norges bank on the sidelines. In Sweden, the Riksbank’s rate
cut will ease pressure on the Krone which has weakened against
the Euro. Finland is in the Eurozone and Denmark’s Krona is
pegged to the Euro which will support a weaker currency.
Demand for goods and services from Scandinavia’s major export
markets in the EU remains very weak due to the persistence of
the Eurozone’s debt problems. The potential for other member
state sovereign debt defaults looms as an ongoing concern and
dissolution of the EU remains a strategic concern. The acute
phase of the crisis may be over but the EU’s main growth drivers
are in disarray and Eurozone economies are in no position to experience a turnaround recovery in short order that boosts demand for Scandinavia’s exported goods and services. We foresee
little help for export demand from outside the EU. Growth in India and China, Asia’s two main growth drivers have slowed and
the U.S. economy is not well positioned for a sharp increase in
export demand this year.
Scandinavia’s economies continue to support some of the world’s
most robust social welfare programs. Welfare programs are addictive alternatives to private sector jobs that contribute to
productivity and economic growth. Across Scandinavia, governments faced with the choice of curtailing fiscal spending to contain
budget deficits are also facing the prospect of increasing taxes to
pay for the stimulus monies that have already been doled out on
public programs. As domestic economies contract, governments
have few options but to maintain stimulus. Consequently there
are no easy solutions to the social welfare/future tax problem.
We note that in Denmark, unemployment benefits ended on January 1st for the long-term unemployed. Attempts to lure these
workers into new “acute jobs” has not worked well. This underscores the difficulties facing these benefits oriented economies.
We expect Scandinavia’s elected governments to try to choose a
middle ground, preserving the social welfare programs and avoiding tax reform while they bide time hoping that the EU recovers
enough to support economic expansion in their respective domestic economies. We do not believe that this option will exist
for several years and Scandinavia’s economies will continue to
struggle under debt burdens attributable to social welfare systems.
We note that sentiment in Scandinavia’s manufacturing sector
remains generally weak even in Norway where the energy sector
is the cornerstone of the economy. Consequently, broadly based
employment growth will be nil again this year with job opportunities confined to key industries such as Norway’s booming energy
sector and construction industry driven by a robust property
market. The unemployed and those unwilling to work will continue to seek benefits under government social benefit programs
which exacerbates the welfare problem that these governments
are trying to solve. Scandinavia’s welfare programs are robust,
entrenched, very costly to government budgets and unlikely to
disappear anytime soon.
Political sentiment in Scandinavia underwent a shift from support
for the conservative right in favor of centrist politics. This was
mainly based on the tragic Utoya Island shootings by a Norwegian
ultra-conservative nationalist citing resentment over a rising tide
of immigrants. While the shift away from politically conservative
nationalism is still evident, deterioration in economic conditions
are a hardship for many voters many of whom are the beneficiaries of social benefit programs. This makes anti-immigration sentiment difficult to avoid. We believe that a return to the conservative right within the urban workforce is now underway rebalancing political support to the conservative right. Quick economic recoveries are out of the question this year and agonizingly
slow recoveries may not become apparent until late 2013 or
2014. We believe that economic frustration directed at immigrant
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—EUROPE & AFRICA
workers may actually become an element of economic recovery
and a strategic foundation for a resurgence in nationalistic politics
that will become evident in the September 2013 election in Norway.
Scandinavian economies will struggle this year as the Eurozone’s
debt problems weigh heavily on all member state economies. We
hold a slight overweight position in Norway where the energydependent economy will benefit from ongoing energy demand despite weak prices. We are neutral in Denmark were the market’s
reputation as one of Europe’s most defensive equity markets and
some energy support will help it weather the Eurozone turmoil.
We expect that growth in Sweden will slow and hold a slight underweight. We also maintain an underweight position in Finland
where Euro membership marks the economy for greater exposure to the ongoing EU sovereign debt problems.
Switzerland—In the third quarter, the Swiss economy rebounded from its second quarter contraction. Third quarter real,
seasonally adjusted growth rose to 1.3% YoY and 0.6% QoQ.
Growth was underpinned by the SNB’s Franc cap and export
gains. The fourth quarter KOF economic barometer remained in
positive territory with a reading of 1.5 in November. Since March
when the indicator first turned positive, the KOF has been pointing to a slow increase in business sentiment. While the KOF has
been increasing, there is little reason for immediate optimism that
the economy is about to turn the corner and resume pre-debt
crisis growth. Switzerland’s key export market in Germany has
yet to show significant improvement in demand. The German PMI
has been below 50 since March.
Swiss National Bank cap on the Franc has proved to be instrumental in supporting growth by curbing imports, aiding exports
and diminishing speculative interest in the Franc as a safe haven
currency. The SNB has been obliging advocates of a weaker Franc
by using foreign currency reserves to defend the Franc. This activity is beneficial for exports but it cannot completely overcome
the demand deficit in EU member states that continues to constrain external demand. We expect that demand from Germany
and other key Euro denominated economies will remain weak as
the continuing saga of the sovereign debt crisis and bailout package evolves among the 27-member states. This will continue to
sap vitality from these economies resulting in weak export demand for Swiss goods and services.
We note that inflationary pressure is virtually absent in Switzerland. Inflation has been negative and the immediate risk is deflationary. This translates into loss of pricing power for corporations. An uptick in inflation is likely to come from energy and
food. Food prices are subject to increase due to drought conditions in many producing regions. Global crude oil prices have
been stable in upper US$80 per barrel range but geostrategic tensions are not absent from the market. We note the December
election of Shinzo Abe as Japan’s prime minister. Mr. Abe is a
hawk who promises to advocate standing up to China’s expansionary plans to acquire valuable energy resource in the South
China Sea. The Swiss government’s looming phase out of nuclear
energy will only serve to increase Swiss exposure to external energy suppliers.
With export demand weakening, we do not expect the economy
to get help from domestic consumption. While seasonally adjusted unemployment remains near a relatively low 3%, we believe
that the economy is not poised for a sharp increase in job creation. We expect that as the economy slowly improves, corporations that can spend on capex items will shift to protecting margins with measures to create production efficiencies, not more
jobs. We also note that consumer sentiment is sentiment showed
no significant improvement in the fourth quarter. Although retail
sales showed modest gains each month in 2012 through October,
TIS Group January 2013 Global Markets
the impact of such gains cannot bring domestic spending to a level
that will completely offset external demand.
In the October 2011 elections, Swiss voters moved political power away from the right to more moderate, centrist politics. Importantly, Switzerland’s most powerful party, the right-wing Swiss
People's Party (SVP) lost votes in comparison to its 2007 showing
but remains the most powerful political bloc in government. We
believe that the move to the center will slow legislative progress
on key issues that are inherently contentious. We expect that
Swiss politics will be relatively quiescent in the near term. The
next election is scheduled for late 2015 and we do not see significant perturbations to the current coalition of the five major parties in the near future.
We note that the Swiss economy has improved but indicators
remain weak in support of sustainable recovery. The domestic
Swiss Franc denominated capital markets will continue to offer investors a defensive, safe haven from global turbulence characterized by ongoing problems in the Middle East, North Africa and the
South China Sea. The Swiss equity market is top heavy with financials that are generally exposed to the EU debt problems, lingering
global financial problems and looming insurance claim risks attributable to global weather anomalies. Investors should note
that Switzerland is not in the Eurozone and it is a defensive market, which will offset some of the disadvantages of other EU markets. It is however, still affected by macro risk factors that are influencing the EU. Overall, we believe that a neutral position in
Switzerland is appropriate.
United Kingdom—The UK benefits greatly from its perception
as a safe haven, for investments as well as Pound Sterling. This is
why we are growing increasingly concerned about Scotland’s independence movement. A smaller and weaker UK simply cannot
back the same amount of trade. The Scottish National Party
(SNP), which leads Scotland's government plans to hold a referendum on independence from the United Kingdom in 2014. The
SNP maintains that an independent Scotland would remain in the
EU and would continue using Sterling as its currency. However,
the EU requires new member states to promise to introduce the
euro "eventually". A smaller and weaker UK would only further
diminish its global influence. (“Scotland independence would test
UK-EU relations.” Oxford Analytica 11 Dec. 2012)
23
TIS EXECUTIVE SUMMARY—INTEREST RATES
DXY–Is The USD Ripe For A Major Upturn?
AND
FX
JGB 10 Year Yields—Still Falling
Courtesy of Bloomberg
CANADIAN DOLLAR
Courtesy of Bloomberg
EURO/DOLLAR
JAPAN YEN/USD
REAL INTEREST  Real short rates are -0.25%. In the U.S.,  Euro short rates will become less compet-  Japan's deflation disappears and then reRATE
real short rates are -2.11%. Nominal
itive against many other developed counappears, depending on the latest CPI numDIFFERENTIALS
short rates in Canada are 0.95% vs. 0.09%
try currencies as the ECB is forced to adber. With inflation at -0.2%, Japan's CPI is
in the U.S.
just to deteriorating economic conditions.
the lowest among the major markets and
likely will remain that way.
 Canadian real long rates are slightly higher
 Real long rates are positive at 1.03%, dethan real U.S. long rates. More important,
the C-Dollar has a high correlation to
pending on where you think CPI actually is
gold. If gold trades above $2,000 and stays
(currently -0.2% on a year-over-year bathere, the C-Dollar will move higher.
sis). But if the BOJ is successful in creating
1% inflation, the real yield will become zero - that should lead to a sell-off in JGBs
and in the Yen.
INFLATION
 On a year-over-year basis, current CPI is  Fighting inflation, the ECB’s mandate, is  Japan's inflation rate calculation was reDIFFERENTIALS
1.2%. Official U.S. inflation is 1.8%.
not going to be the main issue for monecently restated by the Bank of Japan. Evetary policy over the next year. Fighting
ry 5 years, the BOJ overhauls the inflation
recession, deflation, credit downgrades,
measure. The upshot is that the assessand a bank/sovereign debt-funding crisis
ment that Japan escaped deflation last year
are Europe’s main problems. Tighter fiscal
was premature. The long-term battle
policies and high levels of unemployment
against deflation is not over, but until the
should keep inflation in check. Deflation is
2011 earthquake, very mild inflation was
Europe’s risk.
emerging. There appears to have been
sufficient disruption to the economy that
inflation will not be a problem for some
time.
 Demographics (baby bust, lower consumer demand) will help keep inflation in
check generally, though the items which a
generation of retirees demand, i.e. health
care, may begin to see price increases.
 The BOJ recently set a target for inflation
of 1%. The LDP wants a 2%-3% target.
 We think the new government will push
the BOJ to create at least 2% inflation.
GDP
 Year-over-year GDP growth is about  We think Europe is well behind the U.S.  Without a change in its immigration policy,
DIFFERENTIALS
1.1%. Almost three-fourths of Canada's
in the economic cycle and in recapitalizJapan's demographics will prove to be a maexports go to America, so if the U.S.
ing the banking system. That suggests a
jor challenge for the economy in the long
economy accelerates, so should Canada's
weak Euro is needed as an offset to a
run.
economy, though Asia is becoming an inweak and uncompetitive (in the south)
creasingly important trading partner. If
European economy. Either southern  Among the G-7 nations, Japan's economy
has the best potential to surprise on the upthe U.S. goes into recession early in 2013,
European countries must lower costs by
side due to fiscal/monetary policy changes.
Canada will need a lower CAD. The Bank
20%-30%, or the Euro must fall by 20%of Canada is aware of the problem and
30%. Parts of Europe, such as Spain,
should intervene if the cross rate trades
Youth unemployment in Spain is at 55%.
too high. Home prices in Canada are beItaly and Greece are in near depresing viewed as too expensive now. This desions. Wages have fallen by 25% in
velopment plus the CMHC reduction in
Greece, improving competitiveness.
24
TIS Group January 2013 Global Markets
TIS EXECUTIVE SUMMARY—GLOBAL INTEREST RATES
mortgage purchases may usher in a decline
in the real estate market. Toronto area
real estate is expensive. Existing Vancouver property as well as future projects are
being snapped up by Chinese buyers, putting upside pressure on prices.
AND
FX
This type of adjustment must occur
across southern Europe.
 Canada's economy is highly correlated to
gold, oil and other commodity prices the
U.S. and Chinese economies, which are in
long-term bull markets. Many ag commodities are very cheap relative to their
inflation-adjusted highs, which also argue in
Canada's favor over the long run. Demand for real assets will underpin the CDollar/U.S. Dollar in the intermediate
term.
 The macroeconomic picture for Canada is
in a generally strong position. Canada ran
huge surpluses for years until 2008 and
could do so again in a couple years, so the
C-Dollar should continue to strengthen
over the long term. At 0.93-0.95 to the
USD, we think the BoC will intervene and
attempt to slow down C-Dollar appreciation. At 1.05-1.06, the CAD/USD may be
too weak and will begin to strengthen naturally. Canada's strong fiscal position gives
the government flexibility to reflate the
economy. Canada's recent budget deficits
reverse years of budget surpluses, but
Canada can afford it, and unlike many other countries, Canada's credit rating should
not be appreciably damaged by recent deficit spending.
 Canada has some of the best economic
fundamentals in the G-8. However, if the
base metals mining boom has ended; or if
China's economy fails to pick up, Canada's
growth rate will slow.
TARGETS
 I think the BoC will be sensitive to keeping  Euro/Dollar is in a trading range for now  When the Japanese move, look out. Our
the CAD from strengthening too much
between 1.27-1.32. The ECB continues to
Yen Dollar target is moved from 90 to 99.
verses the USD. Over the long term, the
push Spain, Greece, and Portugal toward
CAD should rise along with commodity
bailouts. The numbers still do not add up
prices, reaching its peak at the conclusion
in Greece, but Greece will be saved; Porof a long-term commodity cycle, which
tugal is moving voluntarily toward a fiscal
could be as late as 2017-2018. I believe the
restructuring, while Spain is slowly being
world is about two-thirds of the way
forced to the bailout table, in fact, Spain’s
through this bull market, commodity cycle
recent request for funds to help its banks
with agriculture taking the lead over the
should accelerate the process. A majority
next 4-5 years. When the bull phase in
of the ECB’s governing board, favors ancommodities ends, the bull market in the
other interest rate cut. If done in conC-Dollar will probably end as well. Our
junction with further monetary tightening.
near-term CAD/USD target is 0.95-0.96.
The Euro could go much lower.
If the agricultural markets kick into high
gear, which is possible given low global inventories, drought conditions in the U.S.,
growing condition in South America which
are deteriorating and financialization of the
ag markets, the C-Dollar could enter another period of strength. Gold and the CDollar are highly correlated. Gold looks
higher in H1, 2013; the C-Dollar should
trade up as well. Buy the C-Dollar on any
dips.
REAL INTEREST
RATE
DIFFERENTIALS
 Switzerland’s real short rates are no long-  Real short rates are -2.28% and nominal
er the lowest in the developed world, in
rates have fallen to multi-century lows.
fact, they are one of the highest. But nominal SF rates do not have much room to
decline further, on either the short or
long end of the yield curve. Pushing interest rates up may strengthen the SF –
SWISS/USD
TIS Group January 2013 Global Markets
UK/DOLLAR
USD
25
TIS EXECUTIVE SUMMARY—GLOBAL INTEREST RATES
AND
FX
which is not what the SNB wants.
INFLATION
DIFFERENTIALS
 CPI on a year-over-year basis is -0.4% thru  Official CPI is 2.7%. PPI is at 3%. A build-  "Official" CPI in the U.S. is at 1.8%. We
November. PPI is at 1.54% on a Y-o-Y baup inflation has pretty much been ignored
believe CPI is underreported and may be
sis thru November.
by the BoE. There is a credible fiscal plan
well above 1.8%.
to address the budget deficit, so the funding outlook could improve. But, will Europe’s recession, and the knock-on effect
of deleveraging of UK banks eventually
sink the UK into deflation? For how long
will the BoE keep short-term interest
rates negative?
GDP
DIFFERENTIALS
 GDP was 1.3% Y-o-Y in Q3.
TARGETS
 The SF is still too strong against the Euro  Against the Euro, Sterling should strength-  Financial repression is in full swing in
and Dollar. This experiment being underen over the intermediate term and in the
America and that means years of money
taken by the SNB to peg the Swiss
long-run, which does not help the econoprinting and Dollar debasement lie ahead,
Franc/Euro and limit the Swissie’s apprecimy. The UK has already set out its fiscal
unless the Feds change their policy and/or
ation, may determine the economy’s fate.
policy shingle, austerity, long before
the U.S. government radically reduces its
Greece and the rest of Europe did. Thus,
borrowing requirement. Sell Dollars on
How long can the SNB continue on its
the possibility of rate hikes, which would
strength.
current policy path? Currency pegs such
continue to push GBP/USD higher is dim.
as this one tend to be temporary, but this
policy effort has lasted for over one year.
However, the ECB may be catching up to
Will the market eventually target the
the BOE on the QE front. Euro:Sterling
SF/Euro peg and attempt to break it? I
could well sell-off when the ECB starts to
think Mr. Market will do just that. Does
expand its balance sheet, unless the BOE
the SNB have the staying power to see
responds with a new QE. Sterling/Dollar
this through? The SNB says it does, but it
should trade higher on any pullback – to
was political pressure, which ended for1.58-1.59. Sterling and Euro/Dollar are
mer SNB leader Hillenbrand’s career.
being pushed higher by a weakening Yen.
Will political pressure force President Jordan to end the peg? Or will the SNB be
forced by Mr. Market to end this innovation in SNB currency policy? For now,
buy Swiss Franc on every dip against the
USD and the Euro. Over the intermediate
term, the Swiss Franc should continue to
rise.
 Changes in EU regulations may restrain  Problems in the housing market are easing
London's role as a world financial center
in some areas (lower-end housing and
and change how banks operate. Ring fencapartments). House builders’ traffic is rising the banks retail operations from ining and housing affordability is at a multivestment banking is one example. This
decade high. Household formation is still
could significantly alter London's longrising and new building is not keeping up.
term banking and economic outlook, as
Housing could be the surprise part of the
would the threat of moving Europe's fieconomy this year, especially if mortgage
nancial center away from London. Contirates continue to decline and mortgage
nental European GDP is in recession,
availability improves.
which will pressure the UK economy this  The Fed is fighting the credit criyear.
sis/economic contraction hard, so the re The UK unemployment rate is at 7.8%
ally steep fall in the economy could come
(November). This is lower than the rest
later, perhaps even in 2014. The next fiof the Eurozone, where some western
nancial/credit crisis is more likely to be
banking countries still have unemployment
debt/currency/derivative/CDS
centered
figures in the high single digits and are
and may not come until 2014.
moving toward double digits, while East-  The Labor Department’s unemployment
ern Europe is already well into double digfigures have improved recently, falling to
its. But with the economy still under so
7.8%. The U6 number remains well in
much stress, the UK's unemployment rate
double-digits at 14.4%.
may go on rising for a while. The UK government has limited room to reflate fiscal
policy, while monetary policy is running
out of bullets. The BOE's asset purchase
program just added another GBP 50 billion to the system.
Barron’s (1/7/2013);
Bloomberg;
Investor’s Business Daily (1/4/2013);
Pew Research Center. “Millennials: A Portrait of Generation Next – Confident. Connected. Open to Change.” Reported edited by P. Taylor and S. Keeter. February 2010. <http://www.pewresearch.org/millennials>
The Economist (1/5/2013)
United States Census Bureau. International Data Base (IDB).<http://www.census. gov/population/international/data/idb/informationGateway.php>
26
TIS Group January 2013 Global Markets
U.S. EQUITY STRATEGY
Equity Outlook for 2013
S&P 500
.
Source: Paul Nesbitt, 618034 Ltd.
In the U.S., the stock market is overbought thanks to the post “cliff” rally. But in the U.S., a case can be
made for equities which is better than Europe. U.S. companies are cash heavy with corporate cash as a
percentage of current assets at 30%, a twelve-year high. By some measures, large cap U.S. companies are
in the best balance sheet condition of the past thirty years. Meanwhile, the earnings yield is 8% while 10year Treasuries yield only 1.9%, a huge gap. I am really starting to wonder when the M&A business is
going to take-off in America, because the alternative of holding cash bears little return. On the demand
side, consumers are cashed up, with household debt service at 30+ year lows. And consumer wealth is
back- Americans’ balance sheet wealth is up $13 trillion since 2009, to $78 trillion.
U.S. Financial Obligations Household Debt Service Ratio Total
Consumer
Balance Sheet
in Better
Shape
TIS Group January 2013 Global Markets
27
U.S. EQUITY STRATEGY
U.S. Corporate Profits with IVA & CCA Net Cash Flow
Profits Near
Record Highs
Source for above two charts: Bloomberg LP
What is missing for the equity market to move higher is clarity on taxes, (tax reform or no tax reform)
and a resolution on how the country will pay for entitlement programs as currently constructed. Will the
country have to re-jigger how it pays for health care, social security and other programs? I urge everyone
to read Stephen Moore’s column in the January 7th WSJ (U.S. version) in which he describes Speaker
Boehner’s interactions with Democrats during the fiscal cliff issue. At one point, the President told
Boehner, we don’t have a spending problem. The President correctly sees a spending problem in America’s health care system, but seems oblivious to spending issues anywhere else - except perhaps defense.
After reading the full text of the column, I had to wonder how long it will take before Boehner understands the viewpoint of the President. No amount of spending on social programs, no amount of tax
hikes will be too much for them. There is no spending problem in the Democrats’ view - which is what I
argued in December was the case. Now we have it in print, courtesy of the WSJ.
Basel III Helps U.S. Financials
The banking industry won another round when the Basel committee agreed to soften capital requirements and delay full implementation until 2019. The banks argued that lending would be crimped and
the news regulations were overkill anyway and once again, the banks swayed regulators to their side.
Each country must decide, in the end, whether or not to fully implement Basel III requirements, so at
least in the U.S., I expect the banks now will accelerate lending, start pushing for permission to buy back
stock and raise dividends. I would think the price of bank debt other bank securities, especially bank
stocks, would get a boost from this latest regulatory backdown.
If bank stocks are supported in the U.S., it will be more difficult to take the market lower. As I said in
the prior paragraph, the S&P is overbought, but that does not mean the trend has changed. If a debt cliff
led decline starts about now and ends with resolution of the debt ceiling issue, one of the first places I
would look for new buys, is U.S. financials.
The Bear's View
On technical measures, the U.S. market is not positioned for an advance during the early part of 2013. A
high number of sentiment stocks have gapped up in early January, producing an overbought condition.
On some of the technical work I watch, an unusually high percentage of U.S. stocks are position at the
top of the intermediate trends and it would not take much of a decline to trigger outright sell signals.
This is somewhat curious given the market’s weakness in late December, however if we look at all of
2012 trading and then consider the low occurred in March 2009, it makes more sense. The equity market
has had a three year plus run which in its later stages, is likely to become choppier. Our own stock market model is calling for a near term correction, as of January 9th.
28
TIS Group January 2013 Global Markets
U.S. EQUITY STRATEGY
Short Term Stock Model Is Negative – Major Trend Is Neutral
W eek of
1/7/2013
R ating
R ate of Change
1)
5 2 -W eek Rate of Ch an g e, S& P, year-over-year
+8 .6 0 %
0
2)
52 -W eek Rate of Chan g e, 9 0- D ay T-B ills, year-over-year
-2 b ps
+
3)
5 2 -W eek Rate of Ch an g e, 1 0 -Year T-B on ds, year-over-year
+7 b p s
+
4)
IPO /Secon daries
Positive
+
5)
New Issues as Percen t of all NYSE
6)
Vicker's In sider Sell/B u y Ratio
Supply
0 .0%
0
– –
D em and
7)
Stock B u yb acks/M & A/Private Eq uity
8)
Accumu lation/D istribu tion Net (S& P 50 0)
9)
Neu tral
0
B
+
Mu tu al Fu nds/Cash, Money Market Cash $
3 .4%
0
10)
Mu tu al Fu n ds Pu rch ase/Redemp tion s (X-Mon ey Fu n ds)
1 .1 7 x
+
11)
Sh ort In terest Ratio
1 9 .6 8 x
+
Valuation
12)
S& P 5 0 0 P/E (Forecast)
1 3)
EPS S& P50 0 Q trly Positive Surp rises
1 4)
S& P 50 0 D ividen d Yield
1 4 .8 x
0
Neg ative
–
2.19%
0
Fundam entals
1 5)
CPI + S& P P/E (Forecast)
1 6)
Monetary Ph ase
1 7.5 x
0
Positive
+
17)
D ollar D irection al
Neu tral
0
1 8)
Earn in g s Mom en tu m
Neg ative
–
19)
P/E C om p ression /E x p an sion
Neu tral
0
2 0)
Liqu idity (Credit & Money Ex pansion)
Positive
++
2 1)
Credit Spreads/EMB I and TED
Positive
+
2 2)
CD S on Treasuries
Neg ative
–
– –
Technical/Sentim ent
23)
Market Van e (B u lls)
68%
24)
Pu t/Call Ratio
0 .7 3
–
25)
Percen t Stocks Ab ove 2 0 0 -D ay Movin g Averag e
76%
– –
2 6)
Stochastics (S& P)
– –
2 7)
MACD (S& P)
– –
28)
VIX
1 3 .8 1
+
B ond M odel
+1
Net Tec hnic al - Short Term
-6
T o ta l S co re - M a jo r T rend is N eutra l
11 P o sitives
9 N eutra l
14 N ega tive
All indicators have a possible rating range of -14
Data Sources:
Barron’s 1/7/2013– 21), 22)
Bloomberg – 1), 2), 3), 4), 11), 12), 13), 14), 18), 19), 20), 23), 26) 27)
Investor’s Business Daily 1/4/2013, – 5), 7), 8), 9), 10), 24), 25)
An overbought condition, falling earnings among several key stock groups, a Fed which has warned it
may back off quantitative easing, and the threat of another political debacle over the debt ceiling which
spills into the financial markets, are all conditions which need to be worked off before stocks can move
higher.
After thinking more about the quote taken from the WSJ column written by Stephen Moore about the
fiscal cliff negotiations, I had one further thought. When the President says to the Speaker of the House,
we don’t have a spending problem, he does not think spending is an issue. There is no problem in his
view. May I suggest he may have gained support for that view, from the Treasury - for that would be the
only convincing place from where it could have emanated. If the incoming Treasury Secretary has a similar view, then what we have is one side (the Republicans in the House), who see a problem, which the
President does not even think exists. How do you get a deal done when one side thinks there is no probTIS Group January 2013 Global Markets
29
U.S. EQUITY STRATEGY
lem and the other side may have their political future tied up in addressing the problem which observers
from Wall Street to the former Comptroller of the Currency, think does exist?
What I think is going to happen in the near term, is the House is going to return to its proper function
and start passing legislation, including a budget. For our foreign readers, appropriations bills, the budget,
by law are to start in the House. Then the Senate will receive the budget bill from the House and it is the
Senate which has failed to pass a budget for four years. This was intentional, as it kept spending responsibility off the Senate and the White House. By passing a budget bill, in good order, the ball will be in the
Senate’s court. That is where I think the House will leave it as that is the proper legislative procedure.
Then watch the screaming start for negotiations, how the House budget is a non-starter, dead on arrival,
don’t even send it over here - that will be the Senate leaders approach, as it has been in the past. That
approach buys time and increases the possibility of backing the Republicans into a corner, as they were in
December. If late February/early March is roughly the ending date when the Treasury runs out of options, that is the “date certain,” I would look for in terms of markets to move into the next phase and
price the next big thing.
Hindrance To U.S. Growth
If there is a hindrance to U.S. economic growth, it is anti-growth policies. Have a look at Regulations.gov on the Internet. This information came from Cycles Research, USA, which they gleaned from
that site, as of December 10, 2012.
The number of new regulations posted December 12, 2012 - 102

Last 3 days - 103

Last 7 days - 540

Last 15 days - 1,067

Last 30 days - 1,831

Last 90 days - 5,863
Regulations are not necessarily a bad thing. Some are helpful, businesses run better when they know
what the rules are. But the sheer number and rate of growth in regulations in America, must be at or
near the point of restraining the economy. What struck me was these numbers were tabulated before a
wide range of new regs are launched in 2013. From Dodd-Frank to fracking, another round of regulation is coming, which does divert resources and restrain growth. I look at this and I wonder, how does
the Fed factor this into their thinking that the economy will grow at 2.3% this year? Are regulations a
factor in their models?
Will The Fed Stop QEs?
I have real doubts the Fed can do so or that the inner circle at the Fed wants to. Having said that, what
the Fed has said and what the Fed has done over the past 18 months, had varying effects on risk assets.
When the Fed announced QE2 and QE3, the assumption was the Fed's balance sheet would expand.
That expansion would have a salutory effect on risk assets. In fact the Fed's balance sheet did not expand as we see in the next graph.
30
TIS Group January 2013 Global Markets
U.S. EQUITY STRATEGY
Fed Balance Sheet
3500000
3000000
2500000
2000000
1500000
1000000
500000
0
1/4/2006 1/4/2007 1/4/2008 1/4/2009 1/4/2010 1/4/2011 1/4/2012
Assets: Other Factors Supplying Reserve Balances: Total factors supplying
reserve funds: week average
Liabilities and Capital: Other Factors Draining Reserve Balances: Total factors,
other than reserve balances, absorbing reserve funds: week average
Liabilities and Capital: Other Factors Draining Reserve Balances: Reserve
balances with Federal Reserve Banks: week average
Data Source: http://www.federalreserve.gov
Stocks did benefit from QEs, as did the Treasury and mortgage markets, but commodities generally did
not, especially gold which should have been the obvious winner. Now we have a better idea as to why
gold topped in Q3, 2011 and has treaded water ever since. What it appears the Fed has been doing is
buying Treasuries/MBS, but then selling other positions in other securities, such as short term securities
and old 2008-2009 holdings, i.e. Maiden Lane holdings. What I am beginning to think about is the possibility that most of those 2008-2009 holdings are gone now and as Twist comes to a close and short
term securities are not sold, the balance sheet actually will, start expanding - and commodities do begin to
rise, as do inflation expectations.
How Does It All Stack Up?
Near term, I would buy some protection, as it is cheap and the probability of a smooth outcome to the
debt ceiling discussions, is not high. The alternative is to raise some cash now, or if you must own stock,
rotate into the healthcare sector which looks increasingly interesting.
Sources:
Barron’s 1/7/2013
Bloomberg Data
Bloomberg News
Federal Reserve Data
Investor’s Business Daily 1/4/2013
Moore, Stephen. “The Education of John Boehner” WSJ 7 January 2013.
Paul Nesbitt, 618034 Ltd.
TIS Group January 2013 Global Markets
31
EUROPEAN STRATEGY
.
European Equity—Time To Take Some
Money Off The Table
On January 8th, I reduced our allocation to European equities by 10%, moving to an underweight position in the global models. This was done primarily on a price basis. The position was entered in stages
over the summer/early fall of 2011 and has performed well., but the recent run-up in prices leaves the
European indices vulnerable to a correction.
Euro Stoxx 50
Source: Paul Nesbitt, 618034 Ltd.
Whether or not a correction turns into another significant decline, depends on several factors. The
ECB and Mr. Draghi remain the key players in Europe's economy and markets. Draghi is now Europe's leader, as a central banker and as a political leader. He is the deal maker/ring leader who decides
which European states will be funded and which won't. He will be the arbiter of which banks survive
and which don't. And in terms of 2013 and the election cycle, he may have much to say about Chancellor Merkel’s re-election. A recession at this particular point in time would be inconvenient for Mrs.
Merkel, but the possibility might give the ECB significant leverage over how Germany behaves during
the run-up to the September elections.
Greece Saved
For the time being, thanks to the ECB, German co-operation and perhaps a nudge from the
U.S./NATO, the Greek government will be funded, vastly reducing the possibility of a financial meltdown led by Athens. This development has helped reduce credit spreads across Europe. Those
spreads could have further to come in.
The locus for the next round of stress in the European system may be in Spain. So far, Prime Minister
Rajoy has avoided an ECB led bailout, but over the intermediate term, the pressure of a near depression
and a reversal in funding costs, may do the trick. That parts of the Spanish economy are in depression
may be an understatement. Youth unemployment is 55%, a number which almost beggars description.
Social stresses as a result of unemployment levels like this are unlikely to attract capital and once additional austerity hits, the Spanish economy may have another downleg.
32
TIS Group January 2013 Global Markets
EUROPEAN STRATEGY
Spain Youth Unemployment @ 55%
Source: Bloomberg LP
The Spanish credit markets will help us time the next round of trouble in European equities. Spreads
to German Bunds can come in a bit further, but there is not a lot of room for additional gains. In the
next chart, we can see how the Spanish 10 year bond is approaching target yields. There is a possibility
of one more quick drop in yields, but the bulk of the move, which reflated Spanish equities, appears to
be over.
Spanish Bond Yields
So while Greece may have been saved, Spain has not. Funding has been Europe's principle problem
over the past three years, and the funding problem for European governments has not been resolved.
Europe's secondary problem is the depression like economic conditions which exist in Spain, Portugal,
and Greece and to a lesser extent Italy. Germany and France may well enter recessions this year and
that should be the end of the descent into economic contraction, across Europe. I do not expect
France and Germany to enter deep economic declines. But something in the neighborhood of 1-2
quarters of contraction with declines of 0.5% seems possible.
Have Core European Stocks Discounted Recession?
In Germany, I would have a hard time believing that as the Dax rose about 25% last year. Across Europe, stocks are not expensive. The EuroStoxx 50 trades at 9.8X the 2013 estimate of $275 earnings.
The price/cash flow ratio is 4.98x is nearly equal to the dividend yield of 4.58%. That is an unusual set
of numbers and must represent some measure of value.
TIS Group January 2013 Global Markets
33
EUROPEAN STRATEGY
EuroStoxx 50 Earnings Estimates – Europe Is Cheap/9x PE, 5x CF, 4.5% Yield
European Stocks are Cheaper than 2008
Measure
Actual
EarningsPerShare
EPSPositive
CashFlowPerShare
DividendsPerShare
BookValuePerShare
SalesPerShare
EBITDAPerShare
LongTermGrowth
NetDebtPerShare
EnterpriseValuePerShare
ValuationMeasure
Price/EPS
Price/EPSPositive
Price/CashFlow
DividendYield
Price/Book
Price/Sales
Price/EBITDA
EV/EBITDA
NetDebt/EBITDA
F12Est Growth Y+1Est Growth Y+2Est Growth
142.6 250.13 75.40% 275.54
213.91 252.59 18.08% 275.54
665.6
510.5 ‐23.30% 544.28
118.31 128.02
8.20% 124.17
2207.03 2361.86
7.02% 2503.78
3685.24 3636.31 ‐1.33% 3757.86
601.36 637.95
6.08% 665.33
8.45%
4958.63 882.74 ‐82.20% 822.72
4404.98 3864.2 ‐12.28% 3688.66
Actual
19.01
12.67
4.07
4.36
1.23
0.74
4.51
7.33
8.25
10.16% 296.47
9.09% 296.47
6.62% 590.07
‐3.01% 133.67
6.01% 2520.42
3.34% 3790.36
4.29% 670.83
7.60%
7.60%
8.41%
7.65%
0.66%
0.86%
0.83%
‐6.80% 735.94 ‐10.55%
‐4.54% 3582.04 ‐2.89%
F12Est Y+1Est Y+2Est
10.84
10.73
5.31
4.72
1.15
0.75
4.25
6.9
7.77
9.84
9.84
4.98
4.58
1.08
0.72
4.08
6.62
7.45
9.15
9.15
4.59
4.93
1.08
0.72
4.04
6.57
7.39
The Euro/Dollar should be set to fall, further helping European exports and corporate earnings. A
majority of ECB governors were prepared to cut interest rates at the December ECB board meeting.
With the Fed virtually unable to cut short-term rates further, a change in relative interest rates should
begin to lower Euro/Dollar. The target level is 1.20-1.21, a 7%-8% downleg against the Dollar.
Against the Yen, as the BOJ ramps up monetary easing, I would expect the Euro to appreciate, as most
other major currencies are expected to do.
Euro/Dollar—Is the Low in Place?
More Monetary Easing Coming
Source: Paul Nesbitt, 618034 Ltd.
All things considered, I have reduced our weighting in European equities to an underweight position in
the conventional model and to 15% in the unconventional model. In the unconventional model, I will
reduce the holding in European equities further on any additional price strength. The ECB's next monetary easing may give us that opportunity.
Sources:
Bloomberg Data
Bloomberg News
Paul Nesbitt, 618034 Ltd.
34
TIS Group January 2013 Global Markets
FAR EAST EQUITY STRATEGY
Global Markets Equity Weighting Based On Fully Invested Model
 Japan—Overweight
 Taiwan—Slight Underweight
 China, Shenzen & Shanghai—Overweight
 Hong Kong—Overweight
Japan Nikkei
Starting A New Bull Market
 Singapore—Underweight
 Malaysia—Underweight
 Thailand—Underweight
 Korea—Slight Underweight
China Shanghai Composite Index
Is The PBOC Starting To Reflate The Chinese System?
Courtesy of Bloomberg L.P.
Courtesy of Bloomberg L.P.
Thailand Economy Well Positioned To Benefit From
Rising Consumerism And Regional Trade
Thailand is often lost amidst discussions of Asia’s two biggest developing economies,
China and India. However, Thailand is staging an aggressive comeback from devastating
floods that brought the economy to a standstill in the fall of 2011. After a year of reconstruction and supply chain repairs, manufacturing sector output is poised to deliver goods to meet growing domestic demand and export trade with regional partners. These will help fill the gap attributable to
the weak demand emanating from Europe and the United States. We also believe that a key element of
Thailand’s strategic growth picture is the plan that newly elected Japanese Prime Minister Abe is putting
into place to restore Japan’s economy to growth. Japan is investing heavily in Thailand and the advantages of robust bilateral trade will ensue. We also note that Thailand is of increasing importance to
the United States as a geostrategic ally and Bangkok has developed close ties with the Association of
Southeast Asian Nations. In this regard we note that immediately following his reelection in November,
Thailand was the first country that President Barack Obama visited during his diplomatic mission to Asia
(1). Thailand is also the beneficiary of strong economic ties to mainland China. China is Thailand’s largest trade partner. We believe that China’s new Fifth Generation leaders will continue to apply fiscal
stimulus to support growth in the mainland economy which will benefit Thailand’s manufacturing sector.
We also note that the attractiveness of Thailand as a destination for foreign investment is increasing.
This poses potential problems for the Bank of Thailand management of monetary policy but the central
bank appears sound and able to provide exchange rate stability. Our overall assessment is that Thailand’s
economy is well positioned to benefit from rising consumerism and regional trade.
Thailand Economy Staging Aggressive Comeback from Devastating Floods
Thailand & Indonesia
Thailand Export Trade Concentrated in Asia
Highest Regional MSCI Rankings
Japanese recovery will be major factor
INDIA
2.4%
TOP 10 TRADE PARTNERS
Per Cent of Total Export Value
VIETNAM
AUSTRALIA
4.8%
INDONESIA
4.9%
MALAYSIA
U.S.A.
JAPAN
CHINA
TIS Group January 2013 Global Markets
4.2%
SINGAPORE
HONG KONG
Source Data: Bloomberg, LP
( November 2012 data )
2.9%
5.3%
5.7%
9.9%
10.3%
11.7%
Source Data: Bloomberg, LP
35
FAR EAST EQUITY STRATEGY
The Thai Economy
During 2012, Thailand’s economy staged a sharp recovery from two unrelated events that caused significant contractions in GDP growth the previous year. In March 2011, Japanese industry was crippled by
the Tohuku earthquake and tsunami that caused global supply chain disruptions in critical manufacturing
industries. The second event was severe domestic flooding in the fall of 2011 that shutdown Thai manufacturing and imposed significant limitations on domestic commerce. The extent of the flooding resulted
in 65 of the country’s 77 provinces being declared disaster zones causing the domestic economy to come
to a standstill. In response, GDP contracted sharply in the second half of 2011. On an annual basis
GDP growth fell from 7.8% in 2010 to a mere 0.1% in 2011. To accelerate recovery the newly elected
government implemented a triadic framework of measures that consisted of: 1) direct compensation to
households and businesses affected by the flood augmented by debt moratorium and tax concessions; 2)
an estimated 300 billion Baht in infrastructure spending on a comprehensive national water management
plan that mitigates the risk of future flooding; 3) aggressive government borrowing to accommodate 1.05
trillion Baht over the 2013 – 2014 period and a five year commitment to fund reconstruction investment
with an estimated 2.3 trillion Baht in total spending. The Bank of Thailand acted synergistically by halting its gradual normalization policy and cutting the benchmark interest rate by 75-bps to the current
2.75% rate. Full year growth in 2012 is forecast to be above 5%, somewhat below pre-flood trend.
Thailand Economy Recovering from Significant Disruptions In 2011
Japanese earthquake & domestic flooding
80
60
Capacity Utilization Rate
(2000 = 100)
300
Motor Vehicle Prodution
(x1,000)
Motor Vehicle Production
250
THAILAND
Domestic Flooding
JAPAN
Earthquake/Tsunami
40
200
20
150
0
100
Capacity Utilization Rate
50
-20
-40
Jan-11
Mar-11 May-11
Jul-11
Sep-11
Nov-11
Jan-12
Mar-12 May-12
Jul-12
Sep-12 Nov-12
0
Source Data: Bloomberg, LP
Economic Decomposition by Expenditure. Thailand’s pre-2011 flood economic expansion was
principally an export story supported by private consumption. A number of convergent factors, the 2011
floods in concert with Eurozone sovereign debt problems and the slowdown in China conspired to blunt
the contribution of exports to GDP. The basis for 2012 growth was highly dependent on government
fiscal stimulus and private consumption. We believe that this will continue to be the case in 2013.
Thailand Economy by Expenditure
Component Expenditure
Value
Non-Seasonally Adjusted
Q3 2012
(THB mlns)
Nominal GDP by Expenditure
GDP Final Expenditure
Private Consumption
Government Consumption
Gross Fixed Capital Formation
Changes in Inventories
Exports
Goods
2,799,862
THB mlns
% Final GDP
2,855,624
100%
1,560,874
54.7%
438,638
15.4%
831,620
29.1%
-94,701
-3.3%
2,225,272
77.9%
1,858,665
Services
366,607
Goods
2,106,079
1,892,246
Imports
Services
Trade Balance (exports - imports)
Statistical Discrepancy
-73.8
213,833
119,193
-55,762
Year – over – Year %
Non-seasonally Adjusted
Q3 2012
Q2 2012
Q1 2012
4.2
6.0
1.9
4.5
8.8
10.4
18.7
—
0.2
-2.5
6.5
7.8
9.0
15.5
—
4.2
2.2
2.0
6.6
6.4
10.9
—
-1.0
-2.6
17.0
16.7
7.0
1.9
1.6
13.6
14.1
12.0
12.7
4.3
9.3
7.0
—
-24.6
0.7
4.2%
Source Data: Bloomberg, LP
36
TIS Group January 2013 Global Markets
FAR EAST EQUITY STRATEGY
The impact of the 2011 floods on private consumption was broadly realized in the manufacturing sector
and the household sector. Flood damaged industries could not get the inputs needed to produce and deliver because of damage to supply chain infrastructure and the flooding directly damaged production machinery and facilities. Many households were either severely damaged or destroyed by flooding. The impact on households shifted the composition of private consumption away from the purchase of goods
and services to investment in home reconstruction. For much of 2012, the investment nature of private
consumption limited domestic demand for manufactured goods and services while reconstruction activities in manufacturing improved supply side dynamics. We believe that during 2013, consumption will revert to a merchandise and services demand pattern as home investment spending matures.
Contribution By Industry To GDP
Third quarter 2012 – real, non-seasonally adjusted
12.2%
Mining and quarrying
11.7%
Agriculture, hunting and forestry
9.8%
Construction
8.0%
Transport, Storage & Communications
6.9%
Restaurants & Hotels
4.9%
Electricity, Gas and Water
Cleaning, sizing, grading, pulverizing, compressing of coal
4.7%
Private households with employed persons
4.6%
4.4%
Real Estate, Renting And Business Activities
Financial Intermediation
4.2%
Wholesale and Retail Trade & Personal and Household Goods
4.1%
4.1%
Public administration and defence; compulsory social security
3.6%
Education
2.7%
Nonagriculture
1.0%
Other service activities
Manufacturing
-2%
-1.1%
0%
2%
4%
6%
8%
10%
12%
14%
Source Data: Bloomberg, LP
The Paddy Pledging Scheme. We note that agriculture in Thailand represented the second largest
contribution to GDP in the third quarter of 2012. This emphasizes Thailand’s rice crop. Rice is a staple
food in Thailand and is the country’s major export crop. As part of the government’s efforts to overcome flood damaged rice crop, a parry rice pledging scheme was introduced in October 2011. Under the
scheme the government pays a premium for unmilled rice (paddy rice) that is roughly 50% above the
global spot commodity price per metric ton. Under the scheme, the government buys the rice at a price
well above market prices and adds it to inventories which are ultimately sold off at a significant loss.
This subsidy scheme is estimated to cost the government 376 billion Baht during the 2011/2012 harvest
season and is expected to cost 450 billion for the 2012/2013 harvest (2). This amounts to roughly 1% of
GDP each year. Because the government stores the rice and does not release it on world markets, Thailand’s net rice exports have fallen significantly. Concerns are mounting that in the absence of competitive incentives to improve rice growing practices, Thailand’s rice producers are at risk of producing large,
but globally substandard crops in the future. The World Bank estimates that roughly one third of rice
farmers, mainly medium and large producers are in the subsidy program and that the majority of smaller
producers do not benefit from the program. This program is based on a campaign promise of the Pheu
Thai Party which was elected to power in July 2011 largely on the basis of rural voter support. We believe that this is a flawed program that is becoming an entrenched agricultural practice. It works to the
detriment of small subsistence farmers and Thailand’s overall agricultural production. Implemented ostensibly to aid flood ravaged farmers, which is questionable in practice, the paddy pledging scheme is far
too costly to the government to be maintained indefinitely. Never-the-less, it is entrenched and rescission will be politically costly to the ruling Pheu Thai Party and seems unlikely in the near term.
Import Emphasis. We also note that during 2012, the trade balance was skewed to imports. We believe that this reflects the need for industries to spend down Capex accounts to replace flood damaged
machinery and other equipment to reinstate production lines to full operational status. This will continue
into 2013 but progressively lessen as manufacturing output returns to per-flood trend and domestic consumption resumes its former pattern of goods and services with supportive government compensation
TIS Group January 2013 Global Markets
37
FAR EAST EQUITY STRATEGY
and tax reductions. We feel that this is a strong indication that firms are rebuilding in Thailand and do
not plan to relocate manufacturing outside Thailand. In this regard we note that on January 1st, 2013, the
government raised the minimum wage for all workers introduction of a national daily minimum wage by
9.7% to 35.3% (2). This move legally entitles all workers to a minimum daily wage of at least 300 Baht.
For workers at the lowest wage scale, the new minimum wage is very significant, representing as much as
a 90% increase in pay. However, the new minimum wage scale is primarily associated with urban workers in Thailand’s formal labor pool. The increase in wages will aid consumption but it will have a negative impact on many of Thailand’s labor intensive small and medium industries where labor costs will rise
sharply, increasing the cost of production. To offset the wage increase, the government is expected to
continue to offer tax breaks to firms. In 2012, the government reduced the corporate tax rate from 30%
to 23% and is going to cut the rate to 20% this year. For small firms hardest hit by the wage increase, the
government is expected to lift the tax threshold level from 150,000 Baht to 300,000 Baht as well as offering these firms reduced tax rates.
International Trade Balance And Balance Of Payments
Imports high during reconstruction – capital inflows high
THB 800
Thai Baht Billions
THB 750
THB 700
THB 650
IMPORTS
THB 600
EXPORTS
THB 550
THB 500
THB 450
THB 400
2011
2012
2013
US$ Millions
$4,000
$3,000
$2,000
$1,000
$0
-$1,000
-$2,000
-$3,000
-$4,000
CAPITAL ACCOUNT
FINANCIAL ACCOUNT
2011
2012
2013
Source Data: Bloomberg, LP
Commercial Banks. A critical element of Thailand’s economic future performance is the soundness of
the country’s commercial banking sector. We feel that the country’s banks are structurally sound and
have good balance sheets at the present time. In the third quarter of 2012, commercial bank profits increased by 21% year-over-year and deposits we up 29% year-over-year. We also note that total loans increased by 14.1% year-over-year in the third quarter and by 16.9% in the fourth quarter. Despite the increase in loan activity, commercial bank non-performing loans have declined from nearly 6% of total
loans in the first quarter of 2010 to 3.1% in the third quarter of 2012. We also note that the adequacy ratio for Thailand’s banking sector, a comparator of capital to risk, has been above 14 since 2010. The related Tier 1 capital ratio was above eleven during the second half of 2012. Thailand’s banks fare well
against the Bank of International Standards Basel III minimum Tier I capital ratio set at 4.5 and the BIS
adequacy ratio of minimum of 8% (3).
Thailand Commercial Banks
Sector comparatively sound and well positioned to support growth
THB 12,000
Deposits
Baht blns
Profit
Baht blns
Commercial Banks Net Profit
THB 9
Loan Value
Baht trillion
Adequacy Ratio
Total Loans
Tier 1 Capital Ratio
Total Non-Perfoming Loans
Capital Ratio
THB 50
16
THB 7
THB 8,000
THB 40
THB 6,000
THB 30
20
18
THB 8
Commercial Banks Deposits
THB 10,000
THB 60
14
THB 6
12
THB 5
10
THB 4
8
THB 4,000
THB 20
THB 3
6
THB 2
THB 2,000
4
THB 10
THB 1
THB 0
THB 0
Q1
Q2
Q3
2010
Q4
Q1
Q2
Q3
2011
Q4
Q1
Q2
Q3
Q4
2012
Source Data: Bloomberg, LP
38
2
THB 0
0
Q1
Q2
Q3
2010
Q4
Q1
Q2
Q3
2011
Q4
Q1
Q2
Q3
Q4
2012
Source Data: Bloomberg, LP
TIS Group January 2013 Global Markets
FAR EAST EQUITY STRATEGY
Inflation And The Thai Baht
We note that while headline consumer price inflation increased late in 2012 on higher food costs, CPI
averaged only 3% in 2012, down from 3.8% in 2010. The sharp rise in minimum wages will exert upward pressure on CPI but the overall impact will be blunted by Thailand’s large “informal” sector labor
pool located mainly in outlying rural areas where ages will remain below the national minimum (4). Thailand’s domestic labor pool is also augmented by an influx of migrant workers from neighboring countries, mainly Myanmar, Laos and Cambodia. The majority of these workers are employed in the informal
sector at below national minimum wage levels and often in sub-standard conditions (5). The core rate
minus food and energy remained 2% in the fourth quarter. Because the government continues to fix
food and energy costs, especially transportation fuels, we believe that headline inflation will remain near
or below the Bank of Thailand’s 3% upper band this year with the core rate near 2%.
Economic Output From Thailand’s Low Cost Labor Pool Lags
Minimum wage increase only for formal sector
Expensive for employers – could hurt output
160
GDP per Worker
Constant 1990 Purchasing Power Parity
2000 = 100
VIETNAM
150
INDONESIA
140
MALAYSIA
130
THAILAND
PHILIPPINES
SINGAPORE
120
110
100
90
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source Data: World Bank (6)
Japan Dominates FDI. The Thai Baht has been subject to appreciation in early 2013 on increasing
capital inflows. As the Thai economy expands we expect that global portfolio rebalancing will accommodate greater exposure to Thailand with an accompanying increase in capital inflows. We believe that
the political and economic changes transpiring in Japan will become a key driver for Thailand’s economy
and currency appreciation. The influx of Japanese capital stems in part from the March 2011 Tohoku
earthquake and tsunami. The damage to Japan’s manufacturing core and infrastructure pointed to the
necessity for Japanese industries to establish offshore holding that would mitigate the risk a future Tohoku type event. Much of this effort was directed at Thailand. In the first eleven months of 2012, Japan
invested a total of 312 trillion Baht, 66.7% of all FDI in the January to November period. The majority
of FDI from all sources was directed to transportation equipment machinery and metal products followed by electronics, services and utilities, chemicals, paper and plastics and agriculture.
Thailand FDI Increasing
Japanese investment dominates
(Data for approved FDI project applications only)
THB 500
Baht trillion
2009
2010
2011
2012
NOTE: 2012 data January to November period
THB 450
THB 400
THB 350
THB 300
THB 250
THB 200
THB 150
THB 100
THB 50
THB 0
Total
Japan
All ASEAN
USA
All Europe
Source Data: Thailand Investment Board (7)
TIS Group January 2013 Global Markets
39
FAR EAST EQUITY STRATEGY
Baht Sterilization. Capital inflows, while providing a highly desirable source of additional capital that
supports economic growth, job creation and investment opportunities, present potential risks for macroeconomic management by the Bank of Thailand. The risks posed by strong capital inflows are amplified
by the relatively small size of Thailand’s economy and the country’s modest monetary base. The rapid
depreciation of the Thai Baht and other regional currencies during the Asian financial crisis that transpired between June 1997 and January 1998 reinforces our view that the Bank of Thailand is cognizant of
the risks attendant to strong economic expansion coupled to a growing trade surplus, available credit and
FDI capital inflows. We note that the Baht exchange rate has been relatively stable. In both real (REER)
and nominal (NEER) terms, the Thai Baht is roughly 3% overvalued as of December 2012 (8). This is
directly linked to the higher domestic inflation observed during the fourth quarter. We also note that the
measured against Baht exchange rate volatility, Bank of Thailand intervention directed to smooth Baht
volatility appears to follow a muted trade weighted U.S. Dollar pattern despite the fact that the Japanese
Yen is the dominant source of capital inflows to Thailand. The recent sharp depreciation of the Yen
against the Dollar and Baht was not fully compensated for by central bank intervention. This gives Japanese investors significant leverage in Thailand but works against Thailand’s export manufacturing core.
We believe that Yen inflows may pose a growing problem for the Bank of Thailand as Prime Minister
Abe aggressively reflates Japan’s economy.
Thai Baht Currency Exchange Mechanism
Yen based capital inflows increasing - BoT intervention not following Yen FDI
41.0
Trade Weighted
U.S. Dollar (DXY)
Dollar Baht
Yen Baht
Cross Rate
84
104.00
Effective Exchange Rate
REAL
( REER )
103.50
US DOLLAR
trade weighted
(DXY)
39.0
82
NOMINAL
( NEER )
103.00
80
37.0
102.50
102.00
78
35.0
YEN:THB
Baht spot rate
(JPYTHB)
33.0
101.00
76
74
31.0
USD:THB
Baht spot rate
(USDTHB)
29.0
2011
2012
2013
101.50
100.50
100.00
99.50
72
Source Data: Bloomberg, LP
99.00
2011
2012
2013
Source Data: Bloomberg, LP
Absent persistent intervention by the central bank, significant capital inflows will effect a surge in liquidity. However, Bank of Thailand efforts to sterilize inflows and prevent Baht appreciation carries the associated risk of inflation, higher interest rates and a counterproductive appreciation of the Baht. How well
prepared is the Bank of Thailand to intervene to smooth Baht exchange rate volatility and insure exchange rate stability? We note that in general, since the Asian financial crisis that began with a sharp depreciation of the Thai Baht in 1997, Asian banks in general have used their balance sheets to intervene
aggressively in foreign exchange markets and accumulated foreign reserve assets. The Bank of Thailand
is no exception. The central bank finances the Forex accumulation, which appears as a liability on the
bank’s balance sheet, principally through the expansion of monetary liabilities (increased Bot reserves)
and of non-monetary liabilities (increased BoT issuance of securities). As a matter of bank practice, the
central bank has the option to use the bank reserve requirement or security issuance to execute sterilization. These have different costs to the bank. Increased bank reserve requirements incurs little cost (the
bank pays little or no interest) but removes liquidity on a more permanent basis than does the issuance of
securities which can be more acutely controlled to match need. In contrast to reserve ration manipulation, the issuance of sterilization securities is more expensive because it requires that the bank pay interest on the securities issued. If the central bank enjoys favorable credit ratings from international rating
agencies and maintains a favorable domestic rate environment, security issuance costs can be minimized.
40
TIS Group January 2013 Global Markets
FAR EAST EQUITY STRATEGY
Bank of Thailand Balance Sheet Summary and Sterilization
Central Bank Balance Sheet Expansion
Central Bank Sterilzation Instruments
Growing need to insure exchange rate stability
Reserve assets and security issuance
THB 1,000
Thai Baht (blns)
ASSETS
THB 800
LIABILITIES
EQUITY / RESERVE POSITION
THB 600
THB 400
THB 200
THB 0
-THB 200
-THB 400
-THB 600
-THB 800
-THB 1,000
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source Data: Bloomberg, LP
Source Data: Bloomberg, LP
Overall, we note that the Bank of Thailand has followed the general trend to expand its balance sheet to
better manage Baht exchange rate volatility and insure exchange rate stability. Evidence to date suggests
that this policy has been effective. The Bank of Thailand successfully weathered the 2008 global financial
crisis, the impact of Japan’s earthquake induced supply chain disruption and the consequences of severe
domestic flooding. The most immediate challenge facing the bank’s management of the Baht exchange rate
stem from what we believe will be increasing capital inflows as the country’s export manufacturing core returns to trend. Our expectation that Japan’s economy will return to growth under Prime Minister Abe’s aggressive management will provide a major boost to Thailand in the form of increasing trade and increasing
FDI. This will put greater pressure on the central bank to intervene. We assess that the bank is currently
well positioned to maintain flexibility for the Baht exchange rate in line with anticipated fundamentals. The
bank’s apparent costs for intervention have been relatively low, estimated to be roughly 0.1% of GDP (9).
However, increased intervention will cause costs to accumulate over time. This becomes of greater concern
if the bank pursues a policy of achieving sharply higher foreign currency reserve holdings. Even modest
Baht appreciation depreciates the value of the bank’s reserve currency assets and, increased issuance of interest bearing sterilization securities incurs costs that are likely to exceed revenue earned by the bank on its
international reserves. We believe that the Bank of Thailand will maintain an appropriate and flexible Baht
exchange mechanism as the economy continues to perform well and the trade balance moves to a strong
surplus. Never-the-less, we cannot completely disregard the risk that higher inflation, financial instability
and financial market distortions will accompany the observed expansion in the Bank of Thailand’s balance
sheet. These risks may become more apparent as the U.S. economic recovery accelerates and North American FDI pours into Thailand. President Obama emphasized this point in remarks made during a press
conference held during his November 2012 visit to Bangkok (1).
Political Stability
Political stability in Thailand is a relative term. The government is a constitutional monarchy currently
ruled by a titular head of state, King Bhumibol Adulyadej, and the head of government, Prime Minister
Yingluck Shinawatra (1). Thailand’s constitution has been rewritten seventeen times since the first document was crafted in 1932. Each new constitution variously reshaped the balance of power between
branches of government, the monarchy and the military to suite the immediate needs of the governing
authority. This is noteworthy. Governance that molds its constitution to its politic, and not its politic to
its constitution, is inherently predisposed to instability. In recent history, Thailand experienced a military
coup d'état in 2006 that overthrew the elected government of Prime Minister Thaksin Shinawatra (10).
The junta promptly rewrote the constitution in a manner that severely weakened the executive branch of
government and strengthened the authority of the judicial branch. This changed the power of the electorate by limiting the number of legislative seats determined by direct suffrage to 50% of the total seats.
The remainder were appointed by high-ranking political officials in the junta and high ranking judges.
Rule by military junta ended in July 2011 when the Puea Thai Party aligned with deposed, former Prime
Minister Thaksin Shinawatra won a convincing majority in the general election. The Puea Thai Party
leader, Yingluck Shinawatra, was appointed as the country’s first woman prime minister. We expect that
TIS Group January 2013 Global Markets
41
FAR EAST EQUITY STRATEGY
Ms. Shinawatra will at some point introduce her revisions to the Thai constitution to rescind those of the
junta. It warrants mention that Ms. Shinawatra is the sister of former Prime Minister Thaksin Shinawatra.
Opposition Politics and the Monarchy. Not surprisingly, Ms. Shinawatra, her Puea Thai Party colleagues and the party’s “Red Shirt” political support base want to negotiate a return for the self-imposed
exilic and former Prime Minister, Mr. Thaksin, to the country. This is increasing political tensions between the elected government, the political opposition, the monarchy and the military. The opposition
People's Alliance for Democracy (PAD) and a far-right, royalist group Pitak Siam are central to a rising
anti-Thaksin movement that has already staged mass street protests in Bangkok. However, we note that
while Mr. Thaksin exerts a strong behind-the-scenes influence on government, Ms. Shinawatra demonstrates considerable autonomy from her brother in conducting the affairs of government. Adding to the
mix of political tensions is the looming succession of the reigning monarch, King Bhumibol Adulyadej,
who is 85-years old. The King’s support base in the Privy Council is closely aligned with Thailand’s military. The Privy Council is headed by the former Prime Minister during the junta’s rule, Army General
Prem Tinsulanonda. The King’s only son, Prince Vajiralongkorn, is his designated successor. We note
that Prince Vajiralongkorn’s interest in politics and ruling as monarch appear to be quite limited. We believe that this points to increased political power being vested in the King’s pro-military Privy Council in
the aftermath of succession. We feel that the monarchy will remain a conservative opposition force in
politics that poses an ongoing risk to the government of Prime Minister Yingluck Shinawatra.
Insurgency. Thailand is plagued by a militant insurgency that operates primarily in four southern provinces (11). At its core, the insurgency is a Malay-Muslim insurgency that seeks to challenge and if possible, overthrow the authority of the Thai state. Despite its violent nature, this is a remote and unlikely
possibility. There is little clarity as to who leads the insurgents or what specific political objectives are
sought. The insurgency appears to be contained in only four southern provinces but it has proved refectory to political and military attempts to remedy the situation. The government of Prime Minister
Yingluck Shinawatra has asserted that some form of autonomy for the region could become part of a
larger peace plan but we do not believe that this is a practically achievable, or viable political option. A
more likely scenario is an escalation of military intervention against the insurgency. We note that the
Puea Thai Party’s state budget includes higher funding for regional security and national defense (11).
We believe that the government is intent on pursing a path of increased military intervention to mitigate
the insurgent threat. In terms of Bangkok politics, we believe that intensification of the insurgency conflict plays to the military’s political interests. In this regard, we note that the Thai government has the
support of Malaysia’s leadership to end the insurgency. This will remain an important brake on the conflict escalating from a Thai regional insurgency to an international cross-border conflict. Because the insurgency draws attention to the use of Thailand’s military in achieving regional stability, the effectiveness
of the ruling Puea Thai Party in remedying the insurgency is an important determinant of the government’s stability weighed against the political interests of the conservative pro-military politics and the allied monarchy and its royalist support base.
Thailand Defense And Internal Security Spending Increasing
Government seeks military solution to insurgency
Baht (blns)
Defense
THB 180
THB 160
Public Order and Safety
165
161
159
156
THB 140
THB 120
2012 YTD
Jan - Nov
129
114
120
118
THB 100
THB 80
THB 60
THB 40
THB 20
THB 0
2009
2010
2011
2012
Source Data: Bank of Thailand (12)
42
TIS Group January 2013 Global Markets
FAR EAST EQUITY STRATEGY
Stability. Prime Minister Yingluck Shinawatra is a populist leader that derives considerable support
from lower income, largely agricultural support base in rural areas. Her populist economic polices reflect
this rural bent and mirror those initiated by her brother, Thaksin, during his tenure as prime minister.
Since her election in July 2011, Ms. Shinawatra’s controversial economic polices included a minimum
wage increase, the paddy pledging scheme, debt relief programs and a significant expansion of rural credit. These target the lower income classes in both rural and urban areas but they are contentious and the
source of considerable political discord. We anticipate that Ms. Shinawatra’s government will try its hand
at amending the constitution to rescind the former military junta’s power sharing arrangements with the
judiciary. This will limit the risk that the legitimacy of her government could be challenged in Thailand’s
courts because as the constitution now stands it is possible that opposition political parties or the monarchy could enlist the Constitutional Courts to dissolve Ms. Shinawatra’s government. We note that the
four-year term of the Puea Thai Party’s control of the 500-seat lower house, the House of Representatives, will end in July 2015 when a national election will be called. An interim election to elect 76 of the
150 members of the upper house, the Senate, will take place in March 2014. Ms. Shinawatra will be well
served by efforts to forge coalition agreements with smaller parties to augment the Puea Thai Party’s parliamentary strength. Political instability is an ever present risk in Thailand and the current Puea Thai Party government is no exception. Ms. Shinawatra appears to us to be able to balance the opposition and
the monarchy but a legal challenge to her mandate or a sudden escalation in widespread insurgent violence pose risks that could trigger instability.
U.S. - Thai Relations
We note that Thailand is of increasing importance to the United States as a geostrategic ally. In this regard we note that immediately following his reelection in November, Thailand was the first country that
President Barack Obama visited during his diplomatic mission to Asia (1). We believe that during his second president term, Mr. Obama will strengthen his commitment to an Asia-centric foreign policy. This
has variously been described as an Asia Pivot strategy (13). The strategic intent embodied in the Asia
Pivot is a progressive shift of U.S. geostrategic emphasis from Europe, the Middle East and Central Asia
to South Asia and the South Pacific region. The Asia Pivot is broadly encompassing of geographies and
the resident sovereigns of East Asia, South Asia, Southeast Asia and oceanic geographies and resident
sovereigns of the South Pacific, East China Sea, the Sea of Japan, the South China Sea, and the Indian
Ocean. The geopolitics of the Asia Pivot hinge on Washington’s understanding that the region’s importance to the economic future of the U.S. has grown dramatically in the last decade and can be expected to continue to increase during this century (14). The traditional U.S. hegemons in the region,
Australia, Japan, the Philippines, South Korea and Thailand form the bedrock of the Asia pivot.
While it is clear that the U.S. views Thailand as a key participant in the Asia pivot, it is not clear that
Bangkok views Washington in the same manner. In the post-Cold War period, Thailand’s world view
has embraced an omnidirectional focus that while not excluding the U.S., does not embrace a U.S. centric
foreign policy. The dissonance in U.S. – Thai relations is a product of a decade of Washington’s neglect
while it focused on the Middle East and Central Asia and a number of policy missteps. We also note that
subsequent to finalizing a free trade pact between China and Thailand in 2003, China has become Thailand’s biggest trading partner. We believe that the current Shinawatra government has no qualms and
sees no policy contradiction in dealing opportunistically with the U.S. and simultaneously expanding economic and military cooperation with China. Washington will be hard pressed to restart U.S. - Thai relations and achieve the tight geostrategic alignment that characterized Vietnam era and Cold War era relations. We have doubts that Bangkok will fully embrace Mr. Obama’s concept of a tight knit community
of U.S. hegemons functionally descriptive of his Asia Pivot. We feel that because of Japan’s significant
investment in Thailand and expectations that bilateral trade will grow faster with Japan than China, Mr.
Abe’s government will have better odds of moving Bangkok to a (more) U.S. centric policy stance
than will anyone in the Obama administration.
Conclusion
We believe that Thailand’s economy is well positioned to benefit from rising domestic consumerism and
regional trade. The economy has rebounded from shocks in 2011 that brought growth to a standstill.
The country underwent significant reconstruction during 2012 that rebuilt flood damaged infrastructure
and repaired damaged manufacturing. To facilitate flood recovery, the government will continue to apply
stimulus measures that include tax relief measures to businesses and implement pro-business reforms
TIS Group January 2013 Global Markets
43
FAR EAST EQUITY STRATEGY
that attract foreign investment. Thailand’s financial sector remains sound and the central bank has
demonstrated effectiveness in managing capital inflows. We note that although Thailand’s labor force is
ample and wages are low by global standards, government action to subsidize the agricultural sector and
to increase the minimum wage are controversial and may work against Thailand’s international competitiveness. The government elected in July 2011 is a populist government that continues to benefit from
the economic expansion but faces many challenges going forward. Achieving sustainable political stability has historically eluded elected Thai governments. While the current government appears stable, political tensions attributable to opposition political parties and the conservative, pro-military monarchy are
growing. Despite known risks that bear on this developing Asian economy, our overarching assessment
of Thailand is favorable at this time.
Bibliography
44
1.
Council on Foreign Relations. Thailand. <http://www.cfr.org/region/thailand/ri300>
2.
World Bank. “Thailand Economic Monitor.” Publication #74575. December 2012. <http://www-wds.worldbank.org/external/default/
WDSContentServer/WDSP/IB/2012/12/27/000425966_20121227112519/Rendered/PDF/NonAsciiFileName0.pdf>
3.
Bank of International Settlements. “Basel III Rules Text and Results of the Quantitative Impact Study Issued by the Basel Committee.”
December 16, 2010. <https://www.bis.org/press/p101216.htm>
4.
Sasiwimon, W. “The Role of the Informal Sector in Thailand.” 2011 International Conference on Economics and Finance Research.
IPEDR 4, Page 450. November 2009. ACSIT Press, Singapore <http://www.ipedr.com/vol4/89-F10110.pdf>
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Human Rights Watch. “Thailand: From the Tiger to the Crocodile – Abuse of Migrant Workers in Thailand.” Publication 1-156432-6020. February 2010. <http://www.hrw.org/sites/default/files/reports/thailand0210webwcover_0.pdf>
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World Bank. Data Indicators - GDP per Person Employed (constant 1990 PPP $). <http://data.worldbank.org/indicator?display
=default>
7.
Thailand Investment Board Resource Center. Foreign Investment: Monthly Accumulated Statistics. <http://www.boi.go.th/index.php?
page=statistics_investment>
8.
Bank of Thailand. Effective Exchange Rate – Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER).
<http://www.bot.or.th/English/EconomicConditions/Thai/Index/Pages/eer.aspx>
9.
International Monetary Fund. “Thailand - 2012 Article IV Consultation.” IMF Country Report Number 12/124. June 2012.
<http://www.imf.org/external/pubs/ft/scr/2012/cr12124.pdf>
10.
McCargo, D. “Toxic Thaksin.” Foreign Affairs. September 27, 2006
11.
Abuza, Z. “The Ongoing Insurgency in Southern Thailand: Trends in Violence, Counterinsurgency Operations, and the Impact of National Politics.” National Defense University, Institute for National Strategic Studies, Washington, D.C. Strategic Perspectives No. 6. September, 2011. <http://www.ndu.edu/inss/docuploaded/Strategic%20Perspectives%206_Abuza%20.pdf>
12.
Bank of Thailand. Statistical Data – Economic and Financial Statistics. <http://www.bot.or.th/English/Statistics/EconomicAndFinan
cial/Pages/index1.aspx>
13.
Clinton. H. “America’s Pacific Century.” Foreign Policy. November 2011. http://www.foreignpolicy.com/articles/2011/10/11/ameri
cas_pacific_century
14.
TIS Group. “The Obama Second Term and European Disengagement.” The Institutional Strategist – Global Markets Edition. Pp:23-32.
December 2012.
TIS Group January 2013 Global Markets
JAPAN REVIEW
Eco no mi c F o r ecast
GDP Economic Forecast (QoQ)
—
St o ck M ar ket
F i xed I nco me
Q 1 2 0 13
-0.45%
C ur r ent
C ur r ent
Target Rate —
0.10%
Nikkei 225
CPI Economic Forecast (YoY)
—
-0.10%
6-M o Discount Bills —
0.10%
P/E Estimat e
Current Accnt %GDP Est
—
0.70%
2-Year Bond Yield —
0.10%
Dividend 12 M o Yield - Gross
Unemployment Rat e
—
4.20%
5-Year Bond Yield —
0.20%
*2013 EPS Growt h
Central Bank Rat e (%)
—
0.10%
10-Year Bond Yield —
0.83
10-Yr Spread/US Treas —
-107.71bps
Bloomberg Cont r ibut or Composit es
OVERVIEW
The Nikkei closed at 10,395 on December 31st. The market was up
22.9% YoY. On an annualized, seasonally adjusted basis, Japan’s third
quarter GDP contracted by 3.5% QoQ. Macro factors remain negative
and government stimulus programs are the main drivers for GDP
growth emanating from domestic spending in lieu of external demand
for exports. Consumer sentiment is weak as is consumer spending.
Manufacturing is subdued and industrial production contracted moving
into the third quarter. In the fourth quarter, the large manufacturer
Tankan fell 9-points from -3 to -12. The foundations for the Japanese
economy remain in a disinflationary state reflected by negative headline
and core CPI. The newly elected LDP government led by Shinzō Abe is
set to change this plethora of bad news. Mr. Abe’s triadic framework
for what must be done immediately is s to apply pressure on the Bank
of Japan to lift its inflation target, depreciate the Yen and boost job creating growth (exports). Easier said than done, but we believe that Mr.
Abe and Japan’s people will rise to the task. The newly elected LDP
government led by Shinzō Abe promises to change the face of Japan’s
economic future. We believe that with the Mr. Abe and the LDP in
power an overweight stance in Japan is appropriate.
POLITICAL
In November 2012, Japanese Prime Minister Noda dissolved the Lower
House Parliament setting the stage for a snap election that took place on
December 16th. The election resulted in a change of leadership as voters
ousted Mr. Noda and the DPJ in favor of an LDP government headed by
Shinzō Abe. This is not a surprise. Pre-election polls and Mr. Noda himself forecast the LDP win. Mr. Abe is no stranger to the prime minister’s
job. He held the position for a year between September 2006 and September 2007 before resigning his post. Mr. Abe is a foreign policy hawk
who will oppose China and rearm Japan as well as a fiscal hawk intent on
overcoming deflation and weakening the Yen. The days of frustrating inter-party wrangling in the Diet are not over but we expect that Mr. Abe
will become a force to be reckoned with. The composition of the Diet
gives Mr. Abe’s LDP a majority in the Lower House, but he faces a DPJ
majority in the Upper House. This will have an effect on the rapidity with
Mr. Abe can enact legislation.
Nikkei
Current M arket Cap (Yen/t rlns)
_
_
_
_
_
10599.01
19.6x
1.89x
+31%
203789 t ril
Bloomber g LP; * TIS Gr oup
We believe that Mr. Abe will immediately apply pressure to the Bank of
Japan to ease more aggressively and push the bank’s inflation target to 3%.
In short order, we also expect Mr. Abe to inject more fiscal stimulus.
Dealing with Japan’s ailing economy becomes the job for Mr. Abe’s Economy Minister, Akira Amari a former Sony executive. Mr. Abe tasked Toshimitsui Motegi, his Trade Minister, with increasing Japan’s penetration
and competitiveness in external markets. Taro Aso, is Mr. Abe’s Finance
Minister. Mr. Aso’s main focus will be engineering a fiscal stimulus package. Dealing with thorny geostrategic issues is Fumio Kishida, Mr. Abe’s
Foreign Minister. Mr. Kishida faces the difficult task of confronting Chinese aggression in the South China Sea where sparing over disputed territorial claims is likely to intensify. For his Environmental Minster and State
Minister for Nuclear Power Mr. Abe chose Nobuteru Ishihara. Mr. Ishihara is a proponent of nuclear power and will work with the cabinet and
LDP controlled Lower House to rescind the Diet’s ban on nuclear power
generation. Overall, we see Mr. Abe ushering in a new era for Japan that
has favorable ramifications for the economy and Japan’s relationship with
the United States. Mr. Abe’s election aligns nicely with the Obama administration’s Asia pivot geostrategic planning which will increase U.S.
presence and influence in Asia and the South Pacific. We look for Mr.
Abe to return to LDP hawkish politics on the economy and foreign policy. Politically, Mr. Abe must work quickly to win voters over to the
LDP ahead of the July Upper House election where the DPJ still holds a
majority.
MARKET POSITIVES
 In the December snap election, voters turned to the LDP and Shinzō
Abe to lead the government. This increases pressure on the BoJ to
adopt a more dovish policy stance and a likely increase in the inflation target to 3%, some 3-fold higher than the Noda DPJ government
target. Mr. Abe will pressure the bank to print Yen to meet his inflation target.
 Japan’s Yen appreciated to US$1:JPY77 in September before depreciating throughout the fourth quarter. The Yen hit US$1:JPY86 after
Mr. Abe’s election. Mr. Abe wants the Yen weaker. We expect that
Yen will move to US$1:JPY90 or above.
 Prior to the December election defeat, the DPJ controlled lower
house approved former Prime Minister Noda’s FY12/13 budget of
some ¥90.3 trillion. We expect that the Lower House under LDP
Topix Index
Charts courtesy of Bloomberg LP
TIS Group January 2013 Global Markets
45
JAPAN REVIEW




control will revise this and drive a ¥10 trillion supplemental budget
through the Diet. The money will target public works projects.
All bets are on the new BoJ governor to quickly revise the banks polies to align with Mr. Abe’s wishes.
In May 2012 Japan shutdown the last of nuclear power stations. By
July, the government began to restart reactors to alleviate power
shortages and in October construction resumed on a new nuclear
plant in Aomori prefecture. We believe that Mr. Abe will act quickly
to restart nuclear power stations.
Consumers have been shielded from rising prices in Japan’s deflationary environment but his must change if the economy is to grow. In
the BoJ’s December meeting the policy committee adopted an interim 1% inflation target. The bank plans to “consider” carefully Mr.
Abe’s request for the bank to set a 2% CPI target.
Crude oil prices remained moderate in the fourth quarter. This is
providing relief to the Japanese petroleum energy landscape which
has assumed greater importance since the Fukushima disaster. Near
term, Japan’s energy import risk is primarily from sharp, event driven
increases that will come from rising tensions with Iran.
MARKET NEGATIVES
 In the third quarter, Japan’s seasonally adjusted real GDP contracted
sharply. Third quarter GDP contracted by an annualized 3.5% QoQ
and showed weak 0.1% YoY growth. The rapid deterioration points
to a recessionary period for this economy that will make Prime Minister Abe’s job difficult.
 In the fourth quarter, the large manufacturer Tankan fell 9-points from
-3 to -12. The Medium Business Tankan also plunged, shedding 6
points to a -12 reading and the Small Business Tankan fell 4-points to
-18. The decline in sentiment across small, medium and large manufacturers reflects pervasive pessimism as the outlook for export demand remains weak and domestic spending has been in retreat. We
expect that first quarter Tankan results may look very different as
Mr. Abe’s commitments to right the economy gain traction with
businesses.
 Evidence of the weakness in the external sector is contained in the
trade deficit numbers. The merchandise trade balance has been in
deficit since March 2011. Exports showed month-over-month declines each month in the June to November period.
 Anti-Japanese protests and boycotting of Japanese goods in mainland
China over territorial disputes is a major problem for Japan’s export
manufacturing core. This is reflected in industrial production numbers
that have been negative in the June to October period. China’s boycott could backfire because Japanese automakers and other corporations employ millions of Chinese workers in plants located in China.
Japanese corporations could retaliate by moving production to other
Asian countries with cheap labor.
 Japan’s coincident index dropped 2.3-points in September to 91.2 and
shed half a point to 90.7 in October. October data showed another
contraction when released in December compelling the Cabinet Office
to downgrade its view for a second straight month stating that the index shows deterioration an implicit recognition of recession.
 Consumer confidence showed no improvement into the fourth quarter. The confidence index levels for household and Tokyo dipped in
to the 30’s with the November confidence index at 39 and the Tokyo confidence number a tick better at 39.2. Retail spending faded
from YoY gains near 3% in the March-April period to a weak -1.2%
YoY decrease in October.
 Japan’s import trade receipts are bearing a heavy debt from energy
to replace the country’s loss of the majority of its nuclear electrical
generation capacity. This energy trade deficit is now a fixture in the
overall merchandise trade balance. If the Abe cabinet restarts the
fleet of nuclear reactors this situation will change quickly.
46
 June, Mr. Noda finally succeeded in getting the LDP opposition to
support his consumption tax increase. The 5% consumption tax level
will increase to 8% in April 2014 and to 10% from October 2015.
This ultimately cost him his position as prime minister. Despite the
Diet’s approval under Mr. Noda, Mr. Abe has hinted that he might
delay the increase until the economy improves. We believe that the
consumption tax carries significant risks for Japan’s economic recovery.
 Japan’s overall unemployment rate remained largely unchanged at
4.2% into the fourth quarter. The employment picture isn’t going to
improve quickly and consumers acclimated to deflation, weak employment, and stagnant wages will continue to express weak sentiment and limit domestic spending.
 Reconstruction and Mr. Abe’s aggressive spending plans will significantly exacerbate Japan’s public debt. If Mr. Abe gets his wishes to
sharply increase spending, public debt already headed to 250% of
GDP will go higher. This is the highest public debt level of any developed country. Japan’s citizens face high taxes in the post-recovery
period and Japan may need external assistance to service its debt in
the future if the economy does not improve.
VALUATION
Japanese stocks have an average P/E of 19.60x, the lowest level in
years. Compare that to the U.S.’s P/E of 13.14x, Singapore’s
14.49xand EPS -15%, and Hong Kong’s 11.33x and +6%.
INVESTMENT STRATEGY
The election of Shinzō Abe as Prime Minister may be the tonic needed
to set Japan’s ailing economy on a path to recovery. Mr. Abe, elected
on December 16th, wasted no time announcing the triadic framework
for what must be done; apply pressure on the Bank of Japan to lift its
inflation target, depreciate the Yen and boost job creating growth. Mr.
Abe’s task is daunting. Japan’s economy has languished for so long that
robust, sustainable growth is lost from common economic memory.
The macro environment is uniformly stacked against him.
On an annualized, seasonally adjusted basis, Japan’s real GDP contracted sharply in the third quarter, falling 3.5% QoQ. The former Noda
government injected significant fiscal stimulus to rebuild infrastructure
damaged in the 2011 earthquake-tsunami but this failed to boost
growth in the broad economy. For Mr. Abe, the reconstruction is a
foundation upon which to build.
Mr. Abe will have little control over the external environment that has
been a debilitating brake on exports. An increase in demand from EU
member states wallowing in sovereign debt problems is unlikely and the
U.S. import picture in the second half has been characterized by sub-1%
month-over-month gains. To address foreign market penetration Mr.
Abe tasked Toshimitsui Motegi, his Trade Minister, with increasing Japan’s competitiveness in external markets. We think that an immediate
focus will be Japan’s Asian trading partners. This brings China to the
fore. China’s boycott of Japanese merchandise over disputed territorial
claims in the South Chain Sea is potential damaging to Japan but China
is not immune to Japanese retaliation. Japanese corporations have manufacturing facilities in China that employ millions of Chinese workers.
We believe that Mr. Abe’s choice of foreign minister, Fumio Kishida,
and Mr. Motegi will leverage Japan’s hold on Chinese jobs to point out
that there are other low cost labor pools in Asia and other large markets in India and Indonesia that offer Japan attractive offshore opportunities. Japan’s biggest manufacturing competitor in Asian markets is
South Korea. A key aspect of Mr. Abe’s directives to depreciate the
Yen is diminished export competitiveness of South Korean goods and
services when the Yen-Won cross rate falls. Overall, we see Japan
holding far more economic power over China than China has over Japan.
TIS Group January 2013 Global Markets
JAPAN REVIEW
Adding to Japan’s export debacle is the decision made by the former
Noda government to idle Japan’s fleet of nuclear power stations. This
shifted the burden for electrical energy production to fossil fuel fired
generation stations that need to import fuel to spin the turbines. Energy imports are a growing problem for Japan’s trade deficit. Again, Mr.
Abe’s choice of Nobuteru Ishihara as his Environmental Minster will be
instrumental in addressing this matter. Mr. Ishihara is a proponent of
nuclear power and we believe that he will use his cabinet position to
rescind the former DPJ controlled Diet’s ban on nuclear power generation. This will involve a new energy policy that will exploit the existing
fleet of nuclear power stations, perhaps adding more generating capacity, and rejuvenating Japan’s renewable energy sector. This high tech
sector was once a flagship for Japanese industry that can be restarted
to create jobs. Restarting Japan’s fleet of nuclear power stations is not
without risk. The occurrence of another Fukushima-Daiichi event
would have severe consequences for Mr. Abe’s economic recovery
strategy.
The effects of a strong Yen on trade are a particular concern for Mr.
Abe. The Bank of Japan is a linchpin in Mr. Abe’s plan to increase inflation. In the BoJ’s December meeting, the policy committee adopted an
interim 1% inflation target. The bank plans to “consider” carefully Mr.
Abe’s request for the bank to set a 2% CPI target. We expect the new
governor will oversee and insure that the central bank is aligned with
Mr. Abe’s plans to increase the inflation target to 2%. We believe that
the BoJ will outpace the U.S. Federal Reserve this year in printing money. This will put the Yen on a path to depreciate to US$1:JPY90 and
eventually a target of 99.
On foreign policy, Mr. Abe is a hawk. We believe that Mr. Abe will resume what he began in his first term as prime minister in 2006. When
Mr. Abe took the reins of power as Junichiro Koizumi’s successor, Mr.
Abe set about to rearm Japan. This included a nuclear weapons capability. A pacifist nation by constitutional declaration since World War II,
Mr. Abe set his cabinet to work to determine the legality of nuclear
weapons capability. The legal test focused on Article Nine of Japan’s
constitution which lays the foundations for Japan’s pacifism. The key legal finding by the Cabinet Ministry was that Article Nine does not bar
Japan from possessing nuclear weapons that could be used defensively
in matters of national security. This opened the matter to public debate
but the first term Abe government established that a redraft of Japan’s
constitution would be necessary if Japan was to remilitarize in a manner
that accommodated enhanced military capability beyond those deemed
strictly defensive, including nuclear weapons. In so doing the stage
would was to be set for Japan to become a military power capable of
independent action. This debate was abruptly ended when Mr. Abe resign his position in September 2007, less than one year after taking office. We feel that Mr. Abe will soon resume his quest for remilitarization and do so without the timid approach that he took in his first
term. This forebodes a rewriting of Japan’s constitution and the emergence of a remilitarized Japan as a threat to Chinese aggression in the
region. Remilitarization has significant ramifications for increased defense budgets as a tool for creating jobs and as a economic growth engine.
We note that many advisors accustomed to Japan’s economic pathologies have maintained small positions in Japan equities. The newly elected LDP government led by Shinzō Abe promises to change the face of
Japan’s economic future. We believe that with the Mr. Abe and the LDP
in power an overweight stance in Japan is appropriate.
Source: Bloomberg LP Data
TIS Group January 2013 Global Markets
47
AUSTRALIA REVIEW
Eco no mi c F o r ecast
St o ck M ar ket
F ixed Inco me
C ur r ent
GDP Economic Forecast
—
Q1 2 0 13
3.00%
RBA Cash Target Rate —
C ur r ent
3.00%
AS30 Index —
CPI Economic Forecast
—
2.60%
2-Year Bond Yield —
2.80%
P/ E Estimat e —
14.5x
Current Accnt %GDP Est JPM *
—
-3.85%
5-Year Bond Yield —
2.97%
Dividend 12 M o Yield - Gross —
4.37%
Unemployment Rate JPM *
—
5.40%
10-Year Bond Yield —
3.43%
*2013 EPS Growt h —
+23%
Bank Rat e (%)
—
3.00%
10-Yr Spread/ US Treas —
152.29bps
Current M arket Cap (Aus$/ blns) —
1375.47
Aust ralian $ AUD/ USD Forecast
—
1.04
Bloomberg Cont ribut or Composit es unless not ed above
Bloomberg LP; * TIS Gr oup
ASX All Ordinaries Index
U.S. $ to Aussie $ Exchange Rate
Bloomberg LP
Bloomberg LP
OVERVIEW
The S&P ASX 200 closed at 4,649 on December 31st, up 14.6% YoY. In
the third quarter of 2012, Australia's seasonally adjusted real GDP contracted marking the second consecutive quarter of falling growth. The
main driver for growth remained the resource sector, mining and agriculture. We believe that external demand will remain weak this year
and that mining sector will suffer from diminished demand, weak commodity prices and the impact of the mining tax. We note that consumer
sentiment has held up well but business confidence is weak. CPI has
been modest, and will remain within the RBA’s 2% to 3% band this year.
The RBA cut the benchmark rate to 3.0% in December. We expect this
to support a weaker A$ which will aid export competiveness. We note
that Ms. Gillard’s fragile coalition hangs by a razor thin majority in parliament. Performing poorly in recent political polls, we feel that Labor
will face an uphill battle to fend off the Liberal opposition in 2013 elections. We hold a slight overweight in the Australian market mindful of
the risks associated with slower growth this year.



MARKET POSITIVES
 After two cuts in the second quarter and one in the third, the RBA
cut the benchmark rate by 25 bps to 3.00% in December. With inflation tame and the economy still expanding, RBA Governor Stevens is
taking a cautious view reflecting uncertainty over the ultimate state of
the Euro-zone and its sovereign debt problems and slower growth in
China. With export commodity prices weak, the bank is moving to
protect the downside risk of slower growth and poised to move
rates lower again to stimulate growth.
 Outside of the booming resource sector, the only other bright spot
for the Australian economy is the property markets. Housing prices
continue to increase, rents are up and building approvals are rising.
Lower RBA rates will help this sector and act as a stimulus for the
construction industry but there is the potential for a bubble to form.
 Fourth quarter consumer confidence ticked up in October and November before edging downward in December. Early fourth quarter
consumer demand showed a decline from September’s 3.5% YoY gain
to a lower 3.1% YoY gain in October. We believe consumer demand
bolstered by the low RBS borrowing costs will continue to support
the economy this year but consumers will become increasingly cautious and domestic spending cannot fully compensate for weak external demand for exports.
 Through the end of the third quarter, the Westpac leading index held
gains made in the first half. The October leading index was flat at
285.7 and the corresponding coincident index moved up 0.8-points
to 275.5. Both reflect a stability but the plateaus in both leading indi-
48
4738.07

cators suggest that economic trend may have peaked and risk is shifting to the downside.
Australia's November unemployment rate fell 0.2-points to 5.2% on
employment gains of 13,900 jobs. However, the gains were entirely in
part-time employment, which grew by 18,100, more than offsetting a
4,200 fall in the number of full-time jobs. We also note that the decline was also attributable to a small decline in the labor force participation rate, which fell to 65.1%, from 65.2% in October. We look for
the job creation to be weak as employers shift to part time workers
and use low borrowing costs to fund capex spending to acquire machinery and devices to effect efficiency gains.
Consumer price inflation will remain within the RBA’s 2% to 3% band
for the near-term. However, rising food price pressures from
drought damaged, lower crop yields seen in many food exporters,
rising property prices and a weaker A$ will fuel CPI this year.
The government announced new rules for individual tax returns that
will allow a standard deduction of A$500 for work-related and taxadvice expenses, which began on July 1st, 2012. The standard deduction will rise to A$1,000 on July 1st 2013.
Persistent drought conditions that affected agricultural production
have lifted. In April, the government declared Australia drought free
for the first time in a decade. Despite the apparent absence of official
drought, the winter weather has been dry, pointing to lower wheat
production level for the crop.
MARKET NEGATIVES
 In the third quarter of 2012, Australia's seasonally adjusted real GDP
contracted marking the second consecutive quarter of falling growth.
GDP fell to a 3.1% YoY growth rate and a modest 0.5% QoQ rate.
 Australia’s current-account deficit expanded by A$2.5 billion to
A$14.9 billion in the third quarter of 2012. Merchandise exports
slumped by A$4.3 billion QoQ but failed to offset an A$1.5 billion
decline in imports of goods. The trade balance has been in deficit
since December 2011. With global commodity prices weak, we anticipate that the outlook for exports in 2013 will remain subdued. The
services sector may see gains from increased tourist visits who will
benefit from a weaker A$.
 Australian business confidence is very weak. In November, the NAB
Business Confidence Index plunged to a -9.2 reading. Corresponding
indexes for production, new orders employment and inventories
were all off. Confidence in primary industries is being sapped by the
decline in global commodity prices and secondary and tertiary industries are stifled by weak internal and external demand for goods and
services.
TIS Group January 2013 Global Markets
AUSTRALIA REVIEW
 The AIG production PMI remains weak with readings in the low 40
range through November. We note that all purchasing manager indexes including orders, employment inventories and deliveries were
below 50 reflecting weak sentiment and pessimism in the business
sector.
 Ms. Gillard’s promised Minerals Resource Rent Tax was approved in
both houses and came into force in July 2012. The government plan
to levy this tax is based on capturing a larger share of the profits
from mineral extraction. The treasury forecasts the tax will bring in
some A$11 billion in its first three years but other, third party independent projections projects cast doubt on this figure suggesting it
could be closer to A$2 billion annually.
VALUATION
At 14.5x, the P/E for the Australian market remains high relative to regional and other commodities-based markets. The impact of the strong
currency reduces earnings, while Australia’s markets are attracting the
attention of global investors seeking a low risk market and who are willing to overlook the high P/Es while enjoying the market’s 4.37% dividend yield.
POLITICAL
Australia’s Labor government led by Prime Minister Julia Gillard is a
fragile government susceptible to scandal and persistent Liberal-National
opposition attack. Public opinion polls have not been kind to the Gillard
government.. The mining tax that she championed went intro effect in
July 2012. The timing of the tax couuldn’t be much worse for the
natural recources sector. Global commodity prices have been in decline
as demand from China slows. With profits eroding corporate plans for
expansion, projects in mining sector are on hold. Workers are angry
and striking adding to the turmoil. We feel that the combined economic
effects of Ms. Gillard’s tax on mining and a tax on greenhouse gas
emissions are a recipe for stifling productivity within Australia’s
corporate sector at a time when the economy needs all of the help that
politicians can provide. Ms. Gillard’s government faces re-election in late
2013. Given the razor thin majority that holds her government in power
and the unpopularity of the legislation that she has championed, we
believe that it is possible Ms. Gillard could be replaced ahead of the
election to allow a more popular candidate to stand for election against
a growing tide of vocal Liberal opposition. Labor will struggle to hold
its government together and could well be unseated in 2013 by a Liberal
candidate.
INVESTMENT STRATEGY
In the third quarter of 2012, Australia's seasonally adjusted real GDP
contracted marking the second consecutive quarter of falling growth.
GDP fell to a 3.1% YoY growth rate and a modest 0.5% QoQ rate. The
growth risk is on the downside from weak external demand for Australian commodities and the lower prices for those commodities. The
slowdown in China was a big problem for Australia, however China’s
growth rate should re-accelerate now. The uncertain future of the EU
and its sovereign debt bailouts remain a risk factor.
Australia has largely recovered from the damaging floods of 2010 and
2011. With its resource infrastructure mended, natural products, coal
and ores are flowing unimpeded to ports for export market delivery.
While mining output has returned to trend, we note that demand for
that output is sluggish. The RBA stepped in to lower the benchmark by
25-bps in December taking the rate to 3%. This targets a weaker A$
which will work to the advantage of the resource sector by increasing
export competitiveness. However, even armed with a weaker A$, exporters can do little to stimulate external demand or the weak prices
for their commodities, goods and services. In the mining sector, the
squeeze on profits is particularly hard felt due to the imposition of Ms.
Gillard’s tax on profits which came into force on July 1st 2012. The net
effect is a slowdown in the sector that is putting plans for expansion
projects on hold and jeopardizing jobs and wages.
Outside of the resources sector we note that Australian business confidence is very weak. Business confidence indexes fell in the fourth quarter as did corresponding indexes for production, new orders employment and inventories. While confidence in primary industries is being
TIS Group January 2013 Global Markets
sapped by the decline in global commodity prices, confidence in secondary and tertiary industries are stifled by weak internal and external demand for goods and services.
Despite the decline in business sentiment, consumer confidence has
held up well. Confident consumers have been buoyed by low unemployment and low borrowing costs. Consumer demand has provided
much needed support for the economy as external demand flags. The
RBA rate cut gives consumers access to low cost credit and a weaker
A$ rebalances consumer spending away from imports to domestic
goods and services. While we believe consumer demand will continue
to support the economy this year, we feel that consumers will begin to
feel the fiscal pinch during the first half and they will adjust spending
habits to become more cautious. We believe that consumer demand
will trend lower in 2013.
Inflationary pressure is modest and we expect CPI to fall within the
RBA’s 2% to 3% target band this year. This gives the bank some flexibility in managing monetary policy to emphasize economic stimulus. The
bank cut the benchmark to 3% in December but in its policy statement
warned that without a pickup in global commodity demand that the
peak of investment in the resource sector is approaching which will cap
economic gains from the sector. The bank’s cut also targets the Australian Dollar which has been too strong for the export sector’s good.
The strength of the A$ has been putting significant adjustment pressures
on the manufacturing which imposes limitation on widespread growth in
the secondary sector. The downside to the RBA’s decision is that by
weakening the currency, the bank will lose a hedge against inflation and
accelerate lending in the already hot property sector potentiating a
bubble.
We note that despite her razor thin majority in parliament, Ms. Gillard’s
coalition was cohesive enough to pass her three main bills in 2012: the
carbon tax, the mining tax, and the national broadband bill. These political successes aimed at balancing the state budget may cost jobs and
lowered wages. The result has been a steady decline in Labor’s polling
numbers. Labor faces re-election later this year. Given the razor thin
majority that holds her government in power and the unpopularity of
the legislation that Ms. Gillard has championed, we believe that it is
possible that she could be replaced ahead of the election to allow a
more popular candidate to stand for election against a growing tide of
vocal Liberal opposition. Labor will struggle to hold its government
together and could well be unseated in 2013 by a Liberal candidate.
Australia’s natural resource based economy is subject to weak external
demand coupled to weak prices. The mining sector has absorbed the
brunt of this slowdown and Labor’s onerous mining tax. We believe
that the RBA’s rate cuts will help weaken the A$ and give the export
sector some relief but until external demand increases, the resource
sector will be under increasing pressure. An associated decline in private demand will undercut the economy in 2013. We hold a neutral
weight in the Australian market mindful of the risks associated with
slower growth this year.
Source:
Bloomberg LP Data
49
BRAZIL REVIEW
growth rate is predicted for 2013. (“Reserve requirements cut to boost
lending in Brazil.” Oxford Analytica 28 Dec. 2012)
Bovespa Index
STOCK MARKET
Bovespa___
P/E Estimate___
Dividend 12 Mo Yield -Gross ___
2013 EPS Growth* ___
Current Market Cap (Br Real/blns)___
Courtesy of Bloomberg LP
CURRENT
61927.83
11.55x
4.05%
+65%
1615.12
Data: Bloomberg LP; *TIS Group
OVERVIEW
The Bovespa rose 8.87% in Q3, bringing ytd 2012 performance to +4.3% in local
currency. Market returns for the years 2004-2011 have been, +17.8%, +27.7,
+32.9%, +43.6, -41.2%, +82.7%, +1.0%, and -18.1% respectively. The World
Cup coming in 2014 and the Olympics in 2016 will certainly boost domestic
spending in the short-run. Brazil is in a financial position to make some of
these concessions because of the stable state of their fiscal house. Unlike
Western households and governments, Brazil has record reserves and room
on the balance sheets for growth. The government and the central bank are
in full stimulus mode now, with room to spare on their inflation targets. The
new Rousseff administration has been effective in remaining fiscally prudent,
and global credit ratings agencies are noting the improvements. (Bloomberg
Data)
MARKET POSITIVES

The central bank has cut rates again in December, this is the 6th
consecutive quarterly cut. The central bank is in full stimulus mode.

The central bank is now less focused on curbing inflation and more
concerned with spurning growth. In their Q3 report, they increased their
2012 inflation forecast from 4.7% to 5.2%, which we think they will
continue to be comfortable with, as long as it remains within their 2.5%6.5% target range. It is likely they will continue to stimulate until that
number bumps up against that upper limit. (“Brazil Central Bank cuts
growth forecast, again.” Oxford Analytica 28 Sept. 2012)


The long-term demographics in Brazil are turning against it. Similar to
developed markets, the population is aging rapidly. In the past 40 years,
the average number of children per mother dropped from 6.0 to 1.8. At
the same time, in another 40 years, the number of retirees over 60 is
expected to triple. While the effects of this trend are quite a ways off, it
stresses the importance of the current administration’s fiscal
responsibility. (“Brazil’s demographic dividend set to be short-lived.” Oxford
Analytica 23 May 2011)

We are getting closer to the auctions for the huge pre-salt oil reserves
found off the country’s coast in 2008. However, the minimum 30% stake
by Petrobras in any and all operations may have a strong deterrent effect
on bidders. The expense of extracting the deep water, 100 billion barrel
reservoir will be significant, and investors may require a higher stake in
the spoils. (“New oil auctions in Brazil may not include pre-salt.” Oxford
Analytica 20 Sept. 2012)

Consumers in Brazil are heavily indebted, and are beginning to pay their
bills late at an increasing rate. In the last year, the percentage of indebted
households in the country rose from 54% to 64%. Also, 23% say they are
unable to pay their debt on time, with 8% saying they cannot pay at all.
Of the households with debt, 73% have credit card debt, while only 3%
have mortgage debt. (“Growing indebtedness could undermine Brazilian
Growth.” Oxford Analytica 17 June 2011)
CURRENCY
The Real has been trading sideways (roughly 2:1 USD) essentially since May
of this year. Barring any global meltdowns, we think the next move for the
Real would be on the upside. We cannot stress enough the importance of
Brazil’s fiscal responsibility in our positive view of the country as an
investment destination. Not only is it a dramatic change from its own
history, it is a stark contrast to the current, and worsening fiscal policies in
developed nations around the world.
This distinction is providing
opportunities for smart investors in the U.S., Europe, and Asia to reallocate
capital away from increasingly risky markets. Fitch and Moody’s have
upgraded the country’s credit rating, as they have been downgrading much
of the rest of the world. For investors, this is an important trend to follow.
VALUATION
The Brazilian equity market continues to represent value when compared to
internal growth. On a valuation basis, Brazil's P/E (11.55x) is well below that
of Mexico (15.90x), but with a stronger currency, and good relative value
comparable to the U.S. at (13.14x). Brazil remains the most attractive equity
market in the Western Hemisphere.
The weaker Real should help exporters. Weakness is being driven by
central bank cuts, but the Real traded sideways in Q4, 2012.
POLITICAL

President Dilma Rousseff’s approval rating is rising steadily (78% in
December). Much of this success is being attributed to the popularity of
her efforts to rout out corruption. So far, the efforts have yielded four
ministerial resignations. Her support is also stemming from her economic
policies, which are focused on strengthening the middle class. These
policies have worked well, and now estimates show that nearly 52% of
the population can now be considered “middle class.” (“Brazil’s Rousseff
rides high despite economy, Lula.” Oxford Analytica 17 Dec. 2012)
President Rousseff is breaking approval records. In a recent Ibopr poll taken
Dec. 6-9 and published Dec. 14, her 78% approval rating is the highest on
record for a president halfway through their first term. This is surprising
considering GDP growth figures are plummeting, and 2012 year-end
numbers appear to be close to only 1%. Despite this, 62% approve of
government policies. If an election were held today, she would win in a
landslide. (“Brazil’s Rousseff rides high despite economy, Lula.” Oxford Analytica
12 Dec. 2012)

While ratings agencies are downgrading European sovereign debt, they
are upgrading Brazil’s. This is a good sign for interest rates and stimulus
options for the Brazilian government.
MARKET NEGATIVES

50
The economy grew just 1% in 2012, lower than most forecasts, including
those of the central bank. This has led to more cuts in the benchmark
rate, and more hopes that stimulus is just around the corner. A 4%
INVESTMENT STRATEGY
The services sector, along with agribusiness, continue to be bright spots for
the economy. FDI confirmed this outlook as multinationals around the globe
snapped up Brazil’s service companies en masse in 2012.
With the Rousseff administration clearly focused on boosting demand, the
consumer sector is being seen as the growth engine. UnitedHealth acquired
Amil this year, a company which covers 10% of the population with private
TIS Group January 2013 Global Markets
health insurance.
Japan’s Kirin acquired Brazil’s 3rd largest brewer,
Schincariol. Also, Diago bought one of the largest producers of a sugar cane
alcohol.
We believe the consumer trend will continue throughout 2013, and
investment allocations should be focused on these areas versus
manufacturing. Agriculture still has a big upside, however, as we continue to
see China and U.S.-based companies like International Paper making large
capital investments in the country.
(“FDI focus shifts to service sectors in Brazil.” Oxford Analytica 2 Jan. 2013)
We would be overweight Brazilian equities, especially in the consumer and
ag spaces, which seem to be doing well regardless of internal interest rate
levels or the value of the Real.
TIS Group January 2013 Global Markets
51
CANADA REVIEW
Eco no mi c F o r ecast
F ixed I nco me
St o ck M ar ket
C ur r ent
GDP Economic Forecast
—
Q 1 2 0 13
1.70%
CPI Economic Forecast
—
1.35%
3-M ont h Treasury Rate —
0.92%
P/ E Est imate —
13.18x
Current Accnt %GDP Est
—
-3.40%
2-Year Bond Yield —
1.21%
Dividend 12 M o Yield - Gross —
2.97%
Unemployment Rat e
—
7.30%
5-Year Bond Yield —
1.50%
*2013 EPS Growth —
+16%
Canada Central Bank Rate (%)
—
1.00%
10-Year Bond Yield —
1.96%
Current M arket Cap (Cn$/blns) —
1686.21
Bloomberg Cont ribut or Composit es
Prime Rat e —
C ur r ent
3.00%
S&P/ TSX Comp. Index —
12462.98
10-Yr Spread/ US Treas
5.69bps
S&P/TSX Comp Index


Bloomber g LP; * TIS Gr oup
.
more acres of wheat which could be a windfall for Canadian producers if
global crop yield are hit by another year of weather anomalies.
After weak crude oil prices in much of 2012, Canada’s energy producing
Western provinces will benefit from rising energy prices this year. However, Canadian producers dependent on transmission to the U.S. market
will continue to face a competitive environment that is skewed to favor
output from U.S. shale producers.
With economic growth still tenuous, the Harper majority government
will not enact legislation that will deliberately hurt corporations. A capand-trade scheme is unlikely to pass with a Conservative majority in parliament and government will continue to support the decision to abandon
the Kyoto protocol.
MARKET NEGATIVES
Bloomberg LP
OVERVIEW
Canada’s S&P/TSX Composite Index closed at 12,434 on December 31st, up
4% YoY. Canada’s seasonally adjusted QoQ GDP contracted in the third
quarter. After first quarter and second quarter growth rates of 1.7% YoY,
GDP fell to a mere 0.6% QoQ rate in 3Q12. The economy was beset by a
decline in business investment and a sharp decline in exports. The current
account remains in deficit and weak external demand from the U.S., Europe
and Asia will continue to limit profitability in the export manufacturing sector. CPI and PPI moderated, both under the BoC 2% target band. The Bank
of Canada held the benchmark at 1% through the fourth quarter and maintains a bias toward tightening despite downside risk to the economy. This
supports a strong Canadian Dollar that works against export competitiveness and contributes to import consumption. Consumer sentiment weakened in the fourth quarter and the pace of retail spending growth slowed. As
a pro-business leader with a majority government, Mr. Harper’s Conservatives will continue to support economic growth. With the opposition Liberals in disarray, Mr. Harper’s Conservative government is set complete its full
five-year term. We continue to like the Canadian market from the standpoint of its potential to benefit from demand for crude oil, agricultural
commodities and forest resources. We are slightly overweight in the Canadian market.

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MARKET POSITIVES

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
52
Canadian consumer demand was the mainstay for growth in the third
quarter as it was in the first half. Seasonally adjusted annualized retail sales
showed gains increased every month through the October period. However, we note that the rate of growth in private consumption spending
slowed from above 2% MoM rates to under 2% MoM in September and
October. We believe that consumer demand will slow in coming months
and until the export sector gains momentum there is appreciable downside risk to economic growth dependent on consumer demand.
Canadian CPI is moderating. Headline inflation declined to 0.8% YoY rate
in November and the core rate ex-food and energy fell to 0.9% YoY. On
a month-over-month basis headline was a deflationary -0.2% and the core
rate was 0%. We believe that headline inflation will pick up in 2013 but a
weak first half should hold the annual rate below the BoC's 2% target.
Canadian producer prices were negative in the three months August
through October period. This disinflationary period should end in 2013 as
global commodity price stage a slow comeback. As producers see input
costs rise, consumers will be paying more for goods.
In December 2011, the Canadian government ended its 70-year monopoly of domestic wheat trading. With the fall harvest nearly completed, Canadian farmers can now sell wheat directly on open markets. From a
strategic standpoint, less government participation in the market will lead
to greater profits for producers and is likely to result in the planting of



On a seasonally adjusted, quarter-over-quarter basis the Canadian economy went from stagnation to contraction in the third quarter. After first
quarter and second quarter growth rates of 1.7% YoY, GDP fell to a
mere 0.6% QoQ rate in 3Q12. The economy was beset by a decline in
business investment and a sharp decline in exports
Business sentiment is very weak. Through the end of the third quarter,
Statistics Canada's Leading Indicator Index for the economy was pegged
flat at 110. The Ivey PMI fell 12 points from 58.3 to 46.4 in November and
the Business Leading Balance of Opinion dropped 5-points to a negative
15.8 reading. These weak third quarter and early fourth quarter numbers
could be near the bottom and we expect slow improvement in the first
half of 2013.
The stagnant economy and debt-burdened consumers are not showing
interest in the property market. November housing starts fell to 196,000,
the lowest level since November 201. We note that the value of building
permits staged a modest come back in October but we do expect that
property market to rebound sharply in the near term.
Despite moderating CPI and PPI the Bank of Canada held the benchmark
at 1% through the end of the fourth quarter. The central bank’s main
concern has been the bubble in Canada’s property market but this risk is
abating. Holding at 1% with a below inflation benchmark rate, posies a risk
for a consumer debt bubble is bank left policy language in place that its
next action will be to tighten, not loosen.
In its December policy brief, the BoC noted that Canadians are holding
record levels of household debt. In the second half of 2012, the ratio of
household debt to disposable income rose to 163%, up 1.5% points from
the bank’s June report. With the housing market cooling, the bank forecasts that consumer credit growth will moderate.
While the U.S. economy is showing signs of improvement which will
increase demand for Canadian exports, the EU economy remains subject
to severe downside risks. If Europe slips further, Canadian consumers
would be exposed to higher unemployment at the same time their house
prices are falling. A decline in consumer spending and consumer debt
servicing problems could become a significant downside risk to the economy.
The Bank of Canada’s December statement pointing to a bias toward
tightening supports a stronger Canadian Dollar in the long-run. With
BoC’s overnight rate at 1%, policy bias toward tightening and the high relative benchmark rate to the U.S. we note support a stronger C$. We
look for the Canadian Dollar to appreciate in 2013.
Canada's current account deficit widened in the third quarter. The overall
seasonally adjusted merchandise trade balance went into deficit in April
2012 and remained in deficit through the October reporting period. Exports to the United States have kept the U.S. balance of payment in surplus but U.S. demand cannot compensate for weak demand from the EU
and Asian trade partners.
TIS Group January 2013 Global Markets
CANADA REVIEW


Canada’s labor market held steady above 7% unemployment through
November. Average weekly earnings fell 2.8% YoY in October. We look
for full time job creation to remain weak in the near term.
As delivered, the Conservative's FY12/13 budget envisioned annual savings of C$5.2 billion to get to a balanced budget by 2015 and a surplus
budget in 2016. In November, Mr. Flarherty projected a deficit of C$26
billion and until FY16/17 to balance the budget.
VALUATION
At 13.18x earnings, the Canadian market is priced consistently with other
commodities-oriented markets in Australia (14.46x) or New Zealand
(15.62x). However, each of these markets is expensive relative to the more
risky South African market with its P/E of 13.69x and expected EPS of +3%.
POLITICAL
Following the May 2011 election that gave Mr. Harper the long sought majority of 166 seats in parliament, the Conservative government continues to
enjoy a firm mandate to govern. We look for the Conservatives to serve the
full five year term. With its Parliamentary majority the Conservatives focused on their list of reforms in 2012 passing corporate tax cuts, a law ending the monopoly on control of wheat exports by the Canadian Wheat
Board, several bills that together toughened Canada’s crime laws, abolish the
long-gun registry unpopular with right-to-bear-arms voters and passed provisions that lighten the regulatory burden on large energy projects. With
the economy limping along Mr. Harper will focus additional energies on fiscal
spending to boost the economy. Early indications are that the Conservatives
are planning a new round of infrastructure spending to begin in 2014 when
the current “Building Canada” program ends this year. The new stimulus
cycle could earmark roughly C$5 billion each year a year over a 10-year to
15-year period. The source of the funds would in part come from proceeds
from an excise tax the Canadian government already collects on gasoline.
The benefits to construction sector beginning in 2014 would be significant. It
is clear that the Conservatives want to redirect spending to stimulate economic growth in the private sector where jobs need to be created. We
note that The Liberal opposition has been reasonably quite in Mr. Harpers
first year with a sound parliamentary majority. We look for the Liberals to
regroup but be unable to mount significant opposition to the Conservatives
this year. We look for the Harper government to be stable and stand a
good chance to complete their full five year term to the next general election.
main concern has been the bubble in Canada’s property market. We note
that this risk is abating and the bank’s focus is shifting to consumer debt. In
the BoC’s mid-year November report the bank note that Canadians are
holding record levels of debt. We feel that the bank is unwilling to risk inflaming the debt bubble and will be on the sidelines in early 2013 with the
potential for tightening growing as inflationary pressure increases. Canada’s
annualized headline inflation rate declined to under 1% during the fourth
quarter and the core rate ex-food and energy fell was also under 1%. We
believe that headline inflation will pick up in 2013 but a weak first half should
hold the annual rate below the BoC's 2% target. Holding the benchmark
rate at 1% supports a stronger Canadian Dollar. With BoC’s policy bias
toward tightening and the high relative benchmark rate to the U.S. add to
interest in the C$ as a global safe-haven currency supporting an appreciating
Canadian Dollar in 2013.
Absent support from external merchandise trade, Canadian consumer
spending assumes much greater importance to economic growth. Seasonally
adjusted annualized retail sales showed gains increased every month in 2012.
However, we note that the rate of growth in private consumption spending
is slowing. Canadian consumer confidence fell in the fourth quarter and debt
burdened consumers looking at a weak economy have reason to spend
more cautiously. We believe that consumer demand will slow in coming
months and until the export sector gains momentum there is appreciable
downside risk to economic growth dependent on consumer demand.
Now one year into his term, Prime Minister Steven Harper enjoys a solid
parliamentary majority. Fortunately for Canada’s carbon intense industries,
the Conservatives have backed away from their cap-and-trade carbon emission-trading scheme and abandoned the Kyoto protocol. The forthcoming
FY13/14 budget is expected to continue strong government fiscal support
for infrastructure projects. Mr. Harper’s reform legislation aimed at tax cuts
and stimulus measures will keep the Canadian economy out of recession.
This means that plans to attack the budget deficit are on hold and the stated
objective of balancing the budget by FY14/15 will be delayed. We look for
the Conservatives to serve the full five year term of the mandate.
We continue to like the Canadian market from the standpoint of its clear
potential to benefit from long-term demand for crude oil, agricultural commodities, and forest resources. We are slightly overweight in the Canadian
market.
Source:
Bloomberg LP Data
INVESTMENT STRATEGY
On a seasonally adjusted, quarter-over-quarter basis the Canadian economy
went from stagnation to contraction in the third quarter. After first quarter
and second quarter growth rates of 1.7% YoY, GDP fell to a mere 0.6%
QoQ rate in 3Q12. The economy was beset by a decline in business investment and a sharp decline in exports. The economy will improve this year
with export demand from the U.S. increasing. The debt situation in the
Eurozone remains a major downside risk to growth.
Canadians business sentiment is very weak. We note that the Ivey PMI remained negative as was Business Leading Balance of Opinion indicator.
Through the end of the third quarter, Statistics Canada's Leading Indicator
Index for the economy was pegged flat at 110 showing no near term data
that would suggest that growth is returning to trend. However, these weak
third quarter and early fourth quarter numbers could be near the bottom
and we expect slow improvement in the first half of 2013. Weak demand
from the external sector continues to weigh heavily on growth. The current
account deficit widened in the third quarter and the seasonally adjusted
merchandise trade balance remained in deficit through the October reporting period. Exports to the United States have kept the U.S. balance of payment in surplus but U.S. demand cannot compensate for weak demand from
the EU and Asian trade partners. Higher demand from mainland China due
to its stimulus targeted infrastructure development programs and the US
QE-3 stimulus program are both positive for higher global commodity prices. This will help offset Canada’s weak export picture but it is demand from
the U.S. that must improve to completely remedy Canada’s ailing export
picture. While we believe that the export picture will improve, Canada’s
export trade dynamic will struggle in 2013.
In its December 2012 policy brief, the Bank of Canada held the benchmark
rate at 1%. The December statement pointed to a bias toward tightening.
Despite tame headline inflation and low producer prices, the central bank’s
TIS Group January 2013 Global Markets
53
CHINA REVIEW
Shanghai Composite Index


Bloomberg
S T O C K M A R KE T
C UR R E N T
Shanghai B Share Index___
255.96
P /E Estimate___
7.41x
Dividend 12 M o Yield -Gro ss ___
2.02%
2013 EP S Gro wth* ___
+78%
Current M arket Cap (billio ns)___
13.89
OVERVIEW
China’s Shanghai B index closed at 245 on December 31st, up 13.8%
YoY. China's real GDP fell to a 7.4% YoY growth rate in the third quarter. The economy is rapidly decelerating and in need of government
stimulus if it is to meet former Premier Wen’s 7.5% growth target.
Government stimulus from Beijing and local provincial government is on
the way and the PBoC will maintain an accommodative stance with the
benchmark and reserve requirement. Manufacturing sentiment turned
optimistic in the fourth quarter with the PMI rising to above 50 level
readings. We expect that external demand for Chinese exports will
remain weak emphasizing domestic private consumption as the main
economic growth driver going forward. Producer prices were negative
pointing to a lack of final demand that will affect pricing and squeeze
business profit margins until domestic demand matches factory output.
We expect that pressure on the Renminbi to appreciate will grow.
Formal installation of Xi Jinping as China’s next president and Li Keqiang
as premier will take place this spring. We feel that investor risk remains
high in China and the possibility of a hard landing for the economy is
possible. With political uncertainty out of the way and more stimulus
about to be injected, we feel that neutral in this market is appropriate,
and we are alert to either significant value appearing selectively in stocks
or a massive monetary reflation begins.
MARKET POSITIVES
 Fourth quarter business conditions reflected by the seasonally adjust-
ed manufacturing PMI moved above the 50-level threshold indicating
a shift to optimism. The new orders PMI was also above the 50-level.
After hitting a 2012 low of 8.9 in August, Chinese industrial production gains rose to a 10.1% YoY rate in November.
 China’s National Bureau of Statistics data indicated that in the first
11-months of 2012, China sold 917.05 million square meters of
commercial housing, up 2.4% YoY. The Real Estate Climate Index hit
a 2012 low of 94.4 in September and showed gains in October and
November, hitting 95.7 in November.
 China’s consumer price inflation rate moderated during 2012 but is
showing signs of increase. In November, headline CPI rose 0.3% to a
2% YoY rate. Behind the increase was an increase in food prices due
early fall frosts that reduced vegetable and produce yields and transferred consumer demand to expensive meats. We look for headline
CPI to run close to 3.5% in 2013. This is still inside the 4% goal set by
Premier Wen Jiabao in March 2012.
 Chinese producer prices have been deflationary since February 2012.
In November, the PPI was running at a minus 2.2% YoY rate. The
producer data support lower consumer prices and a brake on head-
54


line CPI which will protect the purchasing power of household wage
earners. However, we expect that input prices will begin to increase
this year as commodity prices firm up.
Consumer sentiment rose in the fourth quarter. Moving off a 2012
low of 99.4 set in July, the Consumer Confidence Index rose to 105.1
in November. Retail sales data also showed year-over-year gains in
the quarter. Sales grew 14.9% YoY in November following above 14%
gains in September and October. We look for sentiment to improve
and private consumption to increase in 2013 as government stimulus
works to offset weak external demand.
The People’s Bank of China faces slower economic growth and rising
inflation. Executing monetary policy through the benchmark has never been extremely effective in controlling inflation or credit bubbles.
Through December, the PBoC’s 1-year lending rate stood unchanged
at 6% and the reserve ratio stood at 20%. We note that in December the associated SHIBOR yield curve moved higher at the short
and long ends. As the interbank rate is the benchmark rate in China's
domestic financial activities and loan activities, the PBoC could act
more effectively to control liquidity and inflation with the SHIBOR.
In September, the China’s National Development and Reform Commission announced plans for fiscal outlays for new infrastructure
amounting to roughly one trillion Renminbi, some 2.1% of current
GDP. We also note that China’s local provincial governments
pledged an additional 11.6 trillion Renminbi for infrastructure located
in their respective regions. We believe that the 13 trillion Renminbi
fiscal stimulus program will gather speed in early 2013 while the new
leadership team engineers a second stimulus program that will be implemented later in the year.
Lower prices for imported crude oil and refined products are a huge
benefit to China as the economy slows. China’s demand for imports
was affected by sanctions against Iran but spare capacity in the market due to a combination of Saudi production increases and lower
demand from the EU should help met China’s import demand and
keep prices low.
MARKET NEGATIVES
 Mainland China's economy continued to slow in the third quarter.
Third quarter, real GDP expanded at a 7.4% YoY rate after slowing
from 8.1% YoY growth in the first quarter to 7.6% YoY in the second
quarter. Growth in the mainland economy is forecast to fall below
8% this year following a 9.3% YoY rate in 2011. We expect the new
leadership team to inject stimulus in 2013 that could exceed one trillion Renminbi.
 The installation of Shinzō Abe as Japanese prime minister ushers
in a new era of geostrategic relations between Asia’s two powerhouse economies. Mr. Abe is a hawk who will not back down
from China’s aggressive sabre rattling in the South China Sea.
Moreover, China’s implicit boycott of Japanese cars is likely to
backfire and cost China Jobs.
 Proactive fiscal stimulus is driving the state budget deeper into deficit.
Early estimates of China’s 2012 budget deficit projected a RMB800
million gap, the central government deficit target for 2012 is RMB
550 billion and the local governments’ target is RMB250 billion. These
numbers are designed to fall inside the government’s 1.5% of GDP
deficit limit.
 With economic growth tethered to fiscal stimulus, we expect that
the 2013 stimulus package will be close to RMB1.2 trillion, some 2.2%
of GDP. This will force the government to increase the debt limit and
take steps to limit the cap local government debt issuance. The
state’s economists think that deficits in excess of 3% of GDP are a
not-to-exceed threat threshold.
 During 2012, year-over-year cumulative growth in urban fixed asset
investment, a key GDP growth driver, began to decline from mid-20
level readings in 2011plateauing at a 20.7 YoY rate in October and
November. During the January-November period, investment was
not evenly distributed with investment in central China growing fast-
TIS Group January 2013 Global Markets
CHINA REVIEW
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est at 26.2% YoY, followed by 24.2% YoY in the Western provinces
and more slowly, at 18% YoY in Eastern provinces.
China export picture isn’t rosy but export demand hasn’t altogether
collapsed. The days of double-digit export growth are gone but exports grew at a 2.9% YoY rate in November flowing 9.8% YoY and
11.6% YoY gains in September and October. What we find to be of
greater interest is that import demand collapsed in August. Import
demand contracted to a minus 2.5% YoY rate and a more recent 0%
YoY rate in November. This deceleration marks a turning point in
consumer demand that we feel may not be easily corrected by a government injection of stimulus.
The PBoC has been active in lowering the Renminbi fixing rate which
allows spot cross-rate to move 1% on either side of the PBoC rate.
The central bank wants the Renminbi to reflect and to the extent
possible overcome limitations imposed on domestic export manufacturing by weak external demand.
The debt driven government spending and PBoC policy of loose
credit constitute the fulcrum on which economic growth rests. By injecting loose consumer credit to boost domestic consumption, the
bank adds increasing inflationary pressure if the manufacturing sector
does not follow with increased output of domestic goods.
The election of Shinzō Abe as Japan’s prime minister who is intent on
reflating Japan’s ailing economy can offer many economic benefits to
China. However, Mr. Abe is a foreign policy hawk who will confront
China on matters of territorial disputes in the South Chain Sea. Also,
China’s boycott of Japanese goods and services is risky because Japanese corporations have manufacturing plants in China that employ
millions of Chinese workers. If Japan relocates these plants China will
be unable to easily replace the lost jobs.
The U.S. Federal Reserve decision to implement a third cycle of
quantitative easing effectively depreciates the U.S. Dollar. This causes
Renminbi appreciation and, it increases the price of Dollar denominated commodities. We expect that the Dollar’s response to QE will
increase speculative interest in the Renminbi. The government has
indicated that it will take steps to limit the ability of offshore hedge
funds to inject speculative, short-term liquidity into China’s markets.
China's official and somewhat predictable urban unemployment rate
remained at 4.1% during the first, second and third quarter. This
clearly underestimates the actual number of workers without jobs in
the total labor pool and doesn't address the rural labor force. We
feel that the slowdown in external demand coupled to weak domestic demand will slow manufacturing. This will slow urban job creation
and put a brake on creating the unskilled jobs China needs to bring
the remaining unskilled workforce to bear on productive economic
growth. A consequence of is social unrest, which is the main driver
behind the government’s priority on injecting stimulus to salvage
economic growth.
China has an established middle class of wage earning urban consumers that want higher wages, more leisure time and more government
services including income protection in the form of state sponsored
health insurance. The government ignores these demands at great
risk of civil unrest and political stability. The rise of the middle class
will be China’s undoing as the world’s low cost manufacturing center
as it progressively undermines the competitiveness of China’s goods
and services in the global market.
VALUATION
The Chinese market is carrying a current P/E of 7.41x and earnings
growth of +78% which compares to Hong Kong 11.33/+6%), and Singapore (14.49/-15%). The perception of investor risk has increased in
China with the prospects of problems at the big four state owned
banks, North Korea and Taiwan. Meanwhile, the market is becoming
cheap.
POLITICAL
The Chinese Communist 18th Nation Congress convened in November
to formally name Xi Jinping to succeed President Hu Jintao and Li
Keqiang as successor to Premier Wen Jiabao. When installed to their
announced positions this spring, the Fourth Generation leadership cycle
TIS Group January 2013 Global Markets
is ended and the new Fifth Generation cycle of Chinese leaders takes
over. This is probably the team that will govern China until 2022. These
leaders face challenges wrought by China’s rapid economic gains and rising prominence on the world stage. The people’s cadre to be led is demographically diverse. The aged population wants stability and greater
government services to ease their transition trough retirement. The
emergent middle class wants more of what got them into the middle
class in the first place so they get what the nouveaux rich have. Rural
families want the same opportunities that urban families have. A population bulge of young Millennials want interesting and influential jobs that
give them the opportunities to be transformational including the creation of stronger opposition politics.
Fulfilling this list of wants will finally make China harmonious but it will
not happen in the next decade. China’s Fifth Generation leaders face the
difficult task of introducing to 1.3 billion people the fact that China’s era
of sustainable double-digit economic growth is over. As underlying
conditions drive China’s economy toward a slower growth path, the
government’s approach to this “problem” is, as it has always been, to
force the economy into a higher growth path by increasing investment.
China’s historic successes in doing so were predicated on growth in the
U.S. and European economies that absorbed the output from Beijing’s
investment and financed the next investment cycle with current account
deficits. Presently, these two economies are unable to be of great service to China and the die is cast for China to solve its own problems
with its own money.
The turning point in the economy requires a new model for growth that
is based on labor dynamics directed to employing the growing pool of
college-educated workers. China’s traditional export manufacturing
growth model based on an abundant supply rural unskilled work is coming to an end and the economy must finds the means to create sustainable employment for the middle class that export manufacturing built.
The current means of applying government debt to drive growth is not
the long term answer. The incoming Fifth Generation leaders face the
task of changing the internal machinations of the CCP to shift its centralized state run management of the quasi-capitalistic economy to an
much more liberal open form of capitalism that promotes the types of
individual entrepreneurialism that can exploit the university trained
workforce to drive and innovation and job creation. For the new leadership team, managing a rapidly decelerating economy to a soft landing
while simultaneously making fundamental changes in the CCP are daunting challenges. The massive economic imbalances deeply embedded in
the economy have the potential to cause explosive social unrest and a
broken state.
Adding to the list of problems facing the Fifth Generation leaders is a
growing resistance to China’s desire to expand its geostrategic influence
in Asia. The United States’ acknowledgement of the need for a greater
foreign policy presence in Asia is President Obama’s Asia Pivot strategy.
The pivot rebalances U.S. geostrategic interests to Asia at the expense
of Europe. This shift is welcome news for Japan’s new Prime Minister,
Shinzō Abe. Mr. Abe is a hawk who is intent on rearming Japan in a
manner that forms a credible regional military resistance to China. Mr.
Abe is joined by strong U.S. hegemons in Australia, South Korea and
Taiwan. The foreign policy direction set by China is for growing confrontation in Asia and increased military spending that will absorb portions of GDP that could be better used in the interests of social reform.
At home, trust in the party is very low and the rural and urban, middle
class proletariat is variously frustrated, angry and disenfranchised from
its government. The government’s time tested formula for massive fiscal
spending will channel money into infrastructure projects. The rich will
get richer but this is not necessarily where the white-collar middle class
works. The lag period between blue collar jobs and white collar jobs
will be risky for China’s precariously balanced social stability. There is
55
CHINA REVIEW
no oppositon party in China and the only means by which the people
can impose their will on the political process is through expression of
dissent in the streets.
The Fifth Generation leaders govern at a pivotal moment in China’s history. We believe that civil unrest will grow, not recede, from the list of
problems facing the new leaders.
INVESTMENT STRATEGY
China's economy is undergoing a sharp deceleration. Third quarter, real
GDP expanded at a 7.4% YoY rate after slowing from 8.1% YoY growth
in the first quarter to 7.6% YoY in the second quarter. Growth in the
mainland economy is forecast to fall below 8% this year following a 9.3%
YoY rate in 2011. We expect the new leadership team to inject stimulus in 2013 that could exceed one trillion Renminbi.
China’s outgoing Fourth Generation leaders added proactive fiscal stimulus amounting to roughly one trillion Renminbi. The central government stimulus was bolstered by local provincial governments that
pledged additional money for use in their regions. The multi-trillion
Renminbi fiscal stimulus program was directed to infrastructure projects
that will benefit the construction and engineering sectors. We believe
that the fiscal stimulus package will gather speed in early 2013 while the
new leadership team engineers a second stimulus program that will be
implemented later in the year. Early indications concerning the forthcoming stimulus suggest that it will be larger than the 2012 package. The
expected consequence of proactive fiscal stimulus is a large state budget
deficit. Early estimates of China’s 2012 budget deficit project a RMB800
million gap, the central government deficit target for 2012 is RMB 550
billion and the local governments’ target is RMB250 billion. These numbers are designed to fall inside the government’s 1.5% of GDP deficit
limit. The new leaders anxious to avert a hard landing for the economy
are expected to deliver a 2013 stimulus package that will be close to
RMB1.2 trillion, some 2.2% of GDP. This will force the government to
increase the debt limit and take steps to limit the cap local government
debt issuance. The state’s economists think that deficits in excess of 3%
of GDP are a not-to-exceed threat threshold. The government’s insistence on growth supported by debt cannot substitute for strategic structural reforms that would set China’s economy on a path to stable,
sustainable growth.
The economic tug of war between exports and domestic spending is
tipping in favor of emphasis on domestic spending. This is the emphasis
that China always promoted with rhetoric but never realized in practice. There is no longer a choice. The days of double-digit export
growth are gone replaced by erratic weak single digit gains contingent
on demand from a debt ridden EU, slow improvement in the U.S. and a
Japanese economy in dire need of help. What we find to be of greater
interest is that import demand collapsed in August 2012. Import demand contracted to a minus 2.5% YoY rate and a more recent 0% YoY
rate in November. This deceleration marks a turning point in consumer
demand that we feel may not be easily corrected by a government injection of stimulus to promote domestic consumption of goods and services produced in the local economy. We observe that fourth quarter
business conditions reflected by the seasonally adjusted manufacturing
PMI moved above the 50-level threshold indicating a shift to optimism.
The new orders PMI was also above the 50-level. Government stimulus
supported optimism in China’s manufacturing sector is welcome news
that businesses are realizing benefits. A corresponding uptick in consumer sentiment and improved gains in retail spending data measured
against little or no import growth supports the notion that the pattern
of growth is shifting to domestic spending.
We observe that Chinese producer prices were negative during the
March to November period. While private consumption has increased
deflationary PPI data suggest that manufactured output is not yet
matched to demand. If the fiscal stimulus and credit easing do not result in an acceleration in demand, the loss of pricing power will trigger a
prolonged period of weak profit margins for corporations. In this scenario, the PBoC action to ease credit could become a vehicle to replace
corporate profits with debt. In a corporate sector notorious for inefficiency, increasing debt for any reason sets the stage for a sharp increase
56
in nonperforming loans. The bet that China’s state run capitalists are
placing is that the timing of the U.S. and EU recovery takes place before
the domestic economy is irreparably damaged by mismatched consumer
demand and factory output.
With import growth nil, China is not heavily exposed to imported inflation. China’s headline consumer price inflation rate moderated during
2012 but is showing signs of increase. In November, headline CPI rose
0.3% to a 2% YoY rate. Behind the increase was an increase in food
prices due early fall frosts that reduced vegetable and produce yields
and transferred consumer demand to expensive meats. We look for
headline CPI to run close to 3.5% in 2013. This is still inside the 4% goal
set by Premier Wen Jiabao in March 2012. The People’s Bank of China
faces slower economic growth, rising inflation and the assumption of
more government debt. Executing monetary policy through the benchmark rate has never been extremely effective in controlling inflation,
housing bubbles or credit bubbles. Through December, the PBoC’s 1year lending rate stood unchanged at 6% and the reserve ratio stood at
20%. We note that in December the associated SHIBOR yield curve
moved higher at the short and long ends of the curve. As the interbank
rate is the benchmark rate in China's domestic financial activities and
loan activities, we expect that the PBoC will act more effectively to control liquidity and inflation with the SHIBOR. We see little evidence of
pressure for the PBoC to ease off the 6% benchmark rate in the near
term but the central bank may adjust its accommodative benchmark
rate policy outlook later in 2013.
The Fifth Generation political leadership of China will installed this
spring. The installation of Xi Jinging as president and Li Keqiang as Premier marks a change that we expect will endure for the next decade. The
new leadership cadre inherits a China with unprecedented economic
potential and an equally unprecedented list of problems that have no
apparent immediate solution. We believe that the overarching focus of
this leadership team will be to rescue economic growth with debt driven fiscal spending and hope that the stimulus is enough to prevent widespread civil unrest. The era of dependable export driven, double-digit
growth is over. China’s new Fifth Generation leaders need to recognize
this fundamental change in China’s economic landscape and institute reforms that steer the economy along a new path for lower, but sustainable growth.
We note that risk adverse foreign investors with a strategic outlook
have begun to retrench into less risky, defensive markets in Europe, Japan and the U.S. Government support of economic growth emanating
from domestic companies points to selective buying opportunities for
shares of companies engaged in infrastructure development projects
supported by fiscal stimulus. These opportunities may be better exploited in Hong Kong’s equity market or as offshore ADRs where exposure to China’s domestic capital markets is minimized. With political
uncertainty out of the way, we feel that a neutral weight in this market
is appropriate. There is significant value appearing selectively in stocks.
A massive monetary reflation would point us to increase an overweight
position. Chinese equities tend to trade more on politics than economies. Politics and policies are turning more bullish.
Source:
Bloomberg LP Data
TIS Group January 2013 Global Markets
EUROZONE REVIEW
Economic Forecast
Fixed Income
Q1 2013
Stock Market
Current
GDP Economic Forecast
—
-0.60%
ECB Main Ref Rate —
0.75%
Stoxx 50
CPI Economic Forecast
—
2.30%
3-Month Euro Rate —
0.02%
P/E Estimate
Unemployment Rate
—
11.75%
2-Year Bond Yield —
0.08%
Dividend 12 Mo Yield - Gross
Central Bank Rate (%)
—
0.75%
5-Year Bond Yield —
0.52%
Current Market Cap (Euros)
Euro EUR/USD Forecast
—
1.3
10-Year Bond Yield —
1.52%
*2013 EPS Growth
10-Yr Spread/US Treas —
-38.61bps
Bloomberg Contributor Composites
__
__
__
__
__
Current
2695.38
10.87x
4.4%
1995.90
+20%
Bloomberg LP; * TIS Group
with a sub-40 hour work week and limited executive pay, we imagine a
flood of companies and citizens leaving the country. The brain drain from
France will have significant long-term effects on the country, and will most
certain add to their budget woes going forward. Indeed, we are beginning
to see this trend already, as 400 homes in Paris worth more than 1 million Euro have been put on the market in a matter of a month. High-paid
bankers are fleeing to London and other places where their income won’t
be virtually completely cleaned out. (Sparks, Ian. “More than 400 1 million Euro homes put on the market in Paris since socialist Francois Hollande
elected to power.” DailyMail.co.uk 8 Oct. 2012)
 Francois Hollande lost the by-elections, even with the opposition party in
disarray. This is a clear testament to the unpopularity of Mr. Hollande’s
Courtesy of Bloomberg
policies. This will also undermine his pro-inflationary sway in EU negotiaOVERVIEW
tions. (“French Socialists lose by-election despite UMP feud.” Oxford AnaThe Euro Stoxx 50 Index was up 8.4% in Q3, bringing 2012 ytd perforlytica 17 Dec. 2012)
mance to +5.9%. This follows returns of +4.3%, +20.7%, +10.4%, +6.8%,  The financial crisis has exposed weaknesses in the loose alliance that is
-44.4, +21.1%, -5.8%, -17.1% in 2004-2011, respectively. Following the
the EU. Individual countries have been unwilling to cede national authoriU.S. model, Europe is shifting more and more power to its central bank.
ty to a central EU power. As a result, the EU system has weak oversight
As fewer solutions come to the fore, printing money is all that is left. As
and an inability to swiftly work in a coordinated fashion with member
a result, Mario Draghi and the ECB are taking control of the EU bailout
states. Voluntary cooperation is a slow process, and possibly not fast
programs. The legal authority for this shift is being added post hoc, as
enough to react to fast-moving markets.
EU members of parliament have no other choice. Systemic risk in EuMONETARY AND FISCAL POLICY
rope is not completely gone, but the willingness of EU citizens to tolerAt
the
EC
meeting
on Dec. 13-14, the terms of the single supervisory mechate bailouts and even defaults appears to be more substantive than what
anism
(SSM)
for
banks
were completed, but they fell far short of the commarkets thought previously.
plete economic and monetary union intended by President Barroso, along
with the president of the Commission, the Eurogroup, and the EU. We beMARKET POSITIVES
 There appears to be some acceptance among German and wider EU lieve this put the earliest possible complete union at least 15-24 months out.
citizens that losses from Greek debt will be inevitable. This is per- It appears instead, the effort will be made to standardize policies in different
haps a sign that their tolerance for bailouts is greater than the market countries, rather than unify them under one authority. (“EU summit fails to
once thought possible. This is important to factor in as we approach push political union as solution.” Oxford Analytica 17 Dec. 2012)
DJ Euro Stoxx 50
the Italy question.
Mario Draghi took over the presidency of the ECB in November, 2011 and
 Greece is effectively using the funds from the EFSF to buy all Greek since then we are witnessing a dramatically different approach than Trichet.
bonds from private holders. What this does is take the debt out of
the hands of any party that can claim default. Soon, the only holders
of Greek debt will be the other European, who are ‘safe’ investors,
and will not put up much of a fight when further concessions are
needed in the future regarding time and price. (“Greek banks sell back
most of their GGB holdings.” Oxford Analytica 12 Dec. 2012)
 The one positive we can see coming out of this global financial crisis
for the EU is that it will make very clear the need for these disparate
governments to cede fiscal and monetary control to a single body. It
is also likely that the strict inflation-only focus of the ECB will eventually be relaxed, and they will be allowed to have a broader mandate
for keeping markets healthy and credit wheels greased.
Whereas Trichet was conservative and slow to act, Draghi is stimulating in a
similar fashion to his counterparts in the U.S. and the U.K. The ECB Governing Council cut the benchmark interest rate to its now low 0.75% level.
In addition, the ECB has also announced an increase in their QE program of
50 billion Euros. (“Euro-area, UK monetary easing does not ensure growth.'”
Oxford Analytica 5 July 2012)
POLITICS
A huge shift in power has taken place in Europe away from elected officials, and toward the ECB. This occurred when Mario Draghi stood up
and promised the world that he would back Spain’s debt. He didn’t have
the legal authority to do so, but the markets like it, and as a result, the
EU is working on giving him his legal authority retroactively. The elec European equities are cheap relative to the U.S. and Japan. At 9x tion of Francois Hollande in France is a sign that austerity in Europe is a
earnings, 5x cash flow and a 5% yield, big cap European equities are long way off, but his losses in the recent by-elections give us some hope.
attractive.
Germany and the EU will continue to give good lip service to austerity,
but sentiment is clearly moving the other way across the Eurozone.
MARKET NEGATIVES
With Spain and Italy talking austerity, yields on their government debt
 The new French government has already announced they will tax the
have come off their highs. This is providing somewhat of a respite to
“rich” at 75% to attempt to close budget shortfalls in 2012. Combined
TIS Group January 2013 Global Markets
57
EUROZONE REVIEW
the markets, and allowing the fear trade to come off. The snap election
called in Italy, however, is going to bring their recently-ignored fiscal situation to the fore. This will likely begin to lift rates again, and put pressure back on the enormous debt service levels. This is where we begin
to get skeptical. Growth is the only hope for Europe, but prospects are
grim. We are also skeptical of the long-term commitment of the PIGS to
their new “austere” pledges, as set forth in what is now known as the
“fiscal compact.” (“Spain rescue could determine market view of Italy.” Oxford Analytica 18 Dec. 2012)
INVESTMENT STRATEGY
In the first quarter of 2013 we will likely see a test of the ECB’s new
power called “outright monetary transactions.” This test will come as
the markets begin to react to political rhetoric coming out of Italy before the February elections.
With Spain, Greece, Portugal, and Ireland all in financing arrangements of
one kind or another, it seems likely the next target for market focus will
be Italy. With that country’s elections coming up, the world’s sights will
be particularly focused here. The sheer size of a potential problem in
Italy also demands attention. We suspect with attention, rates may
begin to rise again in Italy. If this is the case, troublesome events begin
to develop across the continent.
Unfortunately, the internal numbers of Italy don’t support a positive fiscal outlook. Investment spending contracted 11% in Q2, household and
business spending fell dramatically in November 2012, and GDP growth
actually fell by 2% at the end of the year. (“Spain rescue could determine
market view of Italy.” Oxford Analytica 18 Dec. 2012)
On the positive side, the citizens of Europe appear to be holding steady
behind the bailout packages to date, even with writedowns coming from
Greece. This could change the dynamics of yield calculations, and the
confidence the ECB can act with moving forward.
We recommend a neutral weighting in EU equities.
58
TIS Group January 2013 Global Markets
HONG KONG REVIEW
Hang Seng
 The SAR’s Securities and Futures Commission proposed new rules in
December that will make investment banks criminally liable for information in IPO prospectuses. The proposed SFC rules require legislative approval but strengthening investor protection is a priority
and the rules are likely to go into effect in 2013.
 If newly elected Japanese Prime Minister Abe can right the Japanese
economy and steer it to recovery, Hong Kong stands to be a beneficiary of increasing trade volumes to and from Japan.
MARKET NEGATIVES
 Consumer confidence continued to flag in the third quarter with a
Bloomberg LP
S T O C K M A R KE T
C UR R E N T
Hang Seng___
23329.75
P /E Estimate___
11.33x
Dividend 12 M o Yield -Gro ss ___
3.03%
2013 EP S Gro wth* ___
+6%
Current M arket Cap (HK $ /trln)___ 13625.60 tril
Data Source: Bloomberg ;*TIS Group
OVERVIEW
Hong Kong’s Hang Sang index closed at 22,657 on December 31st, up
22.9% YoY. In the third quarter, Hong Kong’s real quarter-on-quarter
GDP increased to 0.6% in the third quarter. Year-on-year growth ticked
up slightly to 1.3%. The SAR economy is highly leveraged to exports and
re-exports which have been weak. Consumer sentiment is weak and
gains are not being seen in spending. We note that in November, the
HSBC PMI increased to an optimistic 52.2 reading from October’s 50.5
reading. The optimism reflects expectation that China’s fiscal stimulus
will drive new order growth from the mainland. Inflationary pressure is
moderate but we expect that the impact of a buoyant local property
market and rising inflation in the mainland economy will produce upward inflationary pressure in the SAR this year. Leung Chun-ying Hong
Kong’s new chief executive is not popular in Hong Kong but we believe
that he is well suited to endure local dissent and deliver on the mainland’s expectation for obedience to its authority.
Overall, we feel
that now is not the time to enter the Hong Kong equity market in other
than a selective, opportunistic manner. We hold our neutral stance in
Hong Kong.




MARKET POSITIVES
 Economic growth in the SAR accelerated in the third quarter with




the rate real quarter-on-quarter GDP increasing from the weak second quarter -0.1% rate to 0.6% in the third quarter. Year-on-year
growth ticked up slightly to 1.3% in 3Q12.
In the fourth quarter, consumer price inflation remained modest as
external inflationary pressures from rising food costs in the mainland
moderated and global commodity prices remained subdued. Headline
CPI increased at a 3.7% YoY rate in November. However, we believe
that CPI will increase in 2013 due to the buoyant property market, a
wage increase planned for May 2013 and rising CPI on the mainland.
The SAR government will implement a 7.1% increase in the minimum
wage on May 1, 2013. This is overdue based on the SAR’s low rate
compared to other economies but it will contribute to inflationary
pressures.
In November, the HSBC PMI increased to an optimistic 52.2 reading
from October’s 50.5 reading. The optimism reflects expectation that
China’s fiscal stimulus will drive new order growth from the mainland
The U.S. Fed’s QE-III program effectively devalues the US$ against
the Renminbi. With the HK$ pegged to the US$, a weak HK$ makes
mainland Renminbi based investment in the SAR cheaper and more
attractive for Chinese firms and gives Chinese consumers and tourists added purchasing power for Hong Kong’s goods and services.
QE3 is bullish for Hong Kong shares but also contributes to a looming bubble in the property market.
TIS Group January 2013 Global Markets


2.1% decline in the already weak confidence index that suffered a 5point decline in the second quarter. While retail spending showed
year-on-year gains each month in the second half through November,
the gains are well off the double-digit increases seen in the first half.
We look for domestic spending to remain weak in 2013.
Hong Kong’s overall export trade contracted 2.8% YoY in October
with re-exports contracting 2.7% and domestic exports down 8.2%
YoY. The SAR’s current account which measures capital inflows fared
better, increasing from a HK$7.8 billion deficit in the second quarter
to a HK$29.2 billion surplus in the third quarter. We believe that
Hong Kong’s export dominated economy will continue to suffer from
weak external demand that will limit economic growth.
Momentum derived from foreign capital inflows continued to inflate
Hong Kong’s property market. Homes sales volumes were up each
moth by double digits during the August to November period. The
real estate bubble will be exacerbated by the U.S. Fed’s QE-III program that increases US$ liquidity looking for offshore opportunities.
The SAR real estate is a bubble is testing the HK$ peg to the U.S.
Dollar.
The SAR’s seasonally adjusted rate of unemployment increased by
0.1% to 3.4% in the October – November period as the headline rate
begins to suffer from the impact of the weak external environment
on manufacturing and port facilities. We note that employment is a
lagging indicator and is likely to move higher as economy growth remains sluggish this year.
With the HK$ pegged to the US$, the Hong Kong Monetary Authority can’t use rates to adjust monetary policy. The HKMA has held
the SAR’s benchmark rate at 0.50% since December 2008 which is
not helping the real estate bubble. While the benchmark is at the
lowest level since the HKMA established the base rate in September
1998, banks are holding their lending rates higher and adding bps to
protect profit margins and minimize the risk of increasing their nonperforming loan positions.
Although the net government fiscal position showed a budget balance
of 1.1% of GDP at the end of the third quarter, increased fiscal
spending for stimulus drove the budget into deficit in the May – September period with the first monthly surplus, HK$21.5 billion, coming in September.
As the mainland economy evolves, the need for a financial intermediary like Hong Kong will progressively decline. Shanghai is now China's biggest port and stock-market operator and we note that its
economy has surpassed that of Hong Kong. The SAR is also seeing
increased competition from Singapore in the financial services sector.
VALUATION
At 11.33x PE earnings, the Hong Kong market is comparative to regional
counterparts: China (7.41x), Singapore (14.49x), Australia (14.46x), New
Zealand (15.62x) and Japan (19.60x).
POLITICAL
Chief Executive Leung Chun-ying visited Beijing in December to meet
China’s new leadership team. By most accounts, Mr. Leung has the support of the mainland CCP but in the SAR it is a different story. Mr.
Leung faces an unprecedented attempt to impeach him. Whatever the
legislation may plan, Mr. Leung and SAR have their political agenda set
by the CCP in Beijing. We harbor strong doubts that Mr. Leung will or
59
HONG KONG REVIEW
can be impeached. In Beijing, Mr. Leung received not only support but
orders to address the SAR’s problems with employment, high cost of
living, housing, poverty, the environment and the SAR’s shift to an ageing population. While we harbor no illusions that Mr. Leung’ political
agenda is set by Beijing, we cannot ignore the problems facing Mr. Leung
and the lack of support that that he enjoys from the people. Street rallies are not new or unusual in Hong Kong but the massive New Year’s
Day rally seeking to impeach or otherwise reverse Mr. Leung’s appointment to the office of CE are noteworthy by dint of scale. On the
mainland, the CCP is no stranger to protests some of which have been
violent, but the SAR’s pro-democracy movement, deep-seated middle
class expectations and liberal worldview are not well aligned with Beijing’s authoritarian policies and procedures. How much patience China’s
incoming leadership team will have with the SAR remains to be seen but
we believe that it is finite. We doubt that democracy has a future in the
SAR but we also doubt that the SAR’s resentment of the mainland’s intrusions will soon subside. Mr. Leung is a student of the mainland’s
“mentored” approach to governing the SAR by proxy. We expect that
Mr. Leung is well suited to endure local dissent and deliver on the mainland’s expectation for obedience to its authority.
INVESTMENT STRATEGY
Economic growth in the SAR accelerated in the third quarter with the
rate real quarter-on-quarter GDP increasing from the weak second
quarter -0.1% rate to 0.6% in the third quarter. Year-on-year growth
ticked up slightly to 1.3% in 3Q12. Prospects for robust growth in this
export-dominated economy are not good. The economy is highly depended on global export demand for domestic manufactured goods and
re-exports that move through the SAR’s port facilities which flagged in
2012. With the Euro-zone and North American economies struggling,
and China slowing, we expect that exports and re-exports will be slow
in 2013.
We note that Hong Kong has run trade deficits since January 2009. The
record deficit of HK$48.9 billion in December 2011 is not significantly
lower early in the fourth quarter of 2012. Fourth quarter deficits remained above HK$40 billion We foresee no sharp recovery in Europe
well into 2013 and the U.S. will struggle to right itself next year. In addition to China’s economic slowdown, which is decreasing re-export volume through SAR port facilities, we also note that Hong Kong’s longterm export picture is clouded by the growing importance of mainland
port facilities. As the mainland economy evolves, the need for the SAR’s
ports and its role as a financial intermediary will progressively decline.
Shanghai is now China's biggest port and stock-market operator. The
SAR is also seeing significant competition from Singapore as a reexporter and as a financial services center. A potential bright spot for
exports is the recent election of Shinzo Abe as Japan’s prime minister.
Mr. Abe promises aggressive action to return Japan’s economy to
growth. If he succeeds, Hong Kong stands to be a major beneficiary of
increasing trade volumes to and from Japan. In this regard we note that
the November, the HSBC PMI increased to an optimistic 52.2 reading
from October’s 50.5 reading. The optimism reflects expectation that
China’s fiscal stimulus will drive new order growth from the mainland
gages, accelerating land sales and imposing a tax on real estate resold
within six months of purchase. However, these have not proved to be
very effective and we look for the property market to be a major inflation driver in 2013. We also note that the local property market is subject to significant inflationary momentum derived from foreign capital
inflows. The real estate bubble will be exacerbated by the U.S. Fed’s
QE-III pro-gram that increases US$ liquidity looking for offshore opportunities. In addition to its inflationary impact we look for the SAR real
estate bubble to be a test for the HK$ peg to the U.S. Dollar.
With inflationary running under 4%, the HKMA has been able to maintain its historically low interest rate. The low benchmark lending rate in
the SAR, 0.5% set in December 2008, and high liquidity, the M1 was up
13.1% in October and the M2 and M3 were both up 10%, are poised to
defend growth in 2013. The unfortunate consequence of HK$ peg to
the US$ and the low borrowing rates is that the Hong Kong property
bubble is being supported by low lending rates.
Since assuming the reigns as Chief Executive in July, Leung Chun-ying
has had a bumpy ride. Mr. Leung faces an unprecedented attempt to
impeach him. We harbor strong doubts that Mr. Leung will or can be
impeached. In his December visit to Beijing, during which Mr. Leung met
China’s new leadership team, he received not only support but orders
to address the SAR’s problems with employment, high cost of living,
housing, poverty, the environment and the SAR’s shift to an ageing population. Mr. Leung is a student of the mainland’s “mentored” approach
to governing the SAR by proxy. We expect that Mr. Leung is well suited
to endure local dissent and deliver on the mainland’s expectation for
obedience to its authority.
As a proxy for the mainland’s capital markets, international investors
can find buying opportunities in Hong Kong correlated to mainland
shares. Because Hong Kong’s markets historically follow the U.S. more
closely than the mainland and with the U.S. economy showing signs of
improvement, the Hong Kong market may further decouple from the
mainland. It should also be noted that risk adverse investors, particularly
those in the Euro-zone, are retreating from emerging Asia markets in
favor of less risky defense markets on the continent. For risk tolerant
investors the SAR offers buying opportunities that may become more
coupled to the North American market than to the mainland and other
regional Asian markets. Overall, we feel that now isn’t the time to enter the Hong Kong equity market in other than a selective, opportunistic manner. From a long-term/intermediate viewpoint, we hold our
neutral stance in Hong Kong.
As exports trend lower, private consumption assumes greater importance for the SAR economy. Unfortunately, we observe that SAR
consumer sentiment remains weak. The consequence is a corresponding downturn in retail spending. While retail spending showed year-onyear gains each month in the second half through November, the gains
are well off the double-digit increases seen in the first half. We look for
domestic spending to remain weak in 2013.
Hong Kong consumer price inflation has been moderate. In the fourth
quarter, consumer price inflation remained steady as external inflationary pressures from rising food costs in the mainland economy moderated and global commodity prices remained subdued. However, we believe that CPI will increase in 2013 due to the SAR’s buoyant property
market, a wage increase planned for May 2013 and rising CPI on the
mainland. The wage increase is noteworthy because the SAR’s minimum
wage has been comparatively low compared to other economies. While
the increase is overdue, it will contribute to inflationary pressures. To
cool the property market, the government imposed new measures to
contain the market including raising the down-payment for some mort-
60
Source:
Bloomberg LP Data
TIS Group January 2013 Global Markets
INDIA REVIEW
125
125
India BSE 30 Sensitive Index
(“INDIA: Education provision hampers manufacturing.” Oxford Analytica
2 January 2009)
MARKET NEGATIVES
 Since Palaniappan Chidambaram was reappointed to head the Ministry
of Finance in October, he has made attempts to get the RBI to loosen
its conservative fiscal policies. The pushback we’ve witnessed has
been an eye-opening lesson in just how difficult it is to move that political organization. It is unlikely the RBI will lower rates anytime
soon. (“RBI resists Delhi’s line on policy, despite slowdown.” Oxford Analytica 10 Dec. 2012)
 Water is becoming a threat to Indian economic growth. Not only are
Bloomberg LP
S T O C K M A R KE T
C UR R E N T
B SE30 Sensitive Index___
19691.42
P /E Estimate (no t B SE)___
15.58x
Dividend 12 M o Yield -Gro ss ___
1.58%
2013 EP S Gro wth* ___
+6%
Current M arket Cap (Rupee/billio ns)___ 32407.34 tril
Data Bloomberg LP; *TIS Group
OVERVIEW
disputes with Pakistan over the Indus River problematic, but the increasing prevalence of drug-resistant bacteria in the water supply is
threatening the health and welfare of the population. Eventually, it
could threaten tourism, as well. (“INDIA: Study point to risks to public
health, tourists.” Oxford Analytica 7 April 2011)
 One of the biggest concerns we have for India’s future growth, is the
sheer size of its government bureaucracy. The effects of government
on industry’s ability to grow, which is absolutely critical right now, are
serious and concerning. Indian consumers are demanding more of
everything right now, and if significant barriers are put in place to
keep industry from fulfilling these demands, serious economic consequences will result.
The Mumbai Stock Exchange Sensitive Index (Sensex) was up 7.6% in Q3,
making ytd 2012 performance +21.4% in local currency. This follows returns of +46.7%, +38.1%, -53.7%, +77.5%, +16.3%, and -25.8% for the years
2006-2011, respectively. Inflation and bureaucratic impediments continue
to be the largest risks to steady growth in India. Reforms, which have only
CURRENCY
been talked about, are actually starting to get some traction. We would be
The Rupee finished 2012 around 55:1 USD. We suspect the currency
strategically overweight India, with an eye on bureaucratic reforms and
will strengthen throughout 2013, assuming pro-market legislation
land development.
continues to make its way through the political chains. Slowing growth
is convincing the government to make pro-business changes in policy,
MARKET POSITIVES
which we see as positive. Allowing prices to fluctuate more freely could
 Some key pro-market reforms are making their way through the push up inflation even further, which had already been trending up. The
slow-moving Indian political apparatus, which we view as positive signs central bank decreased its repurchase rate to 8.00% in April, 2012, but
for both the political and economic directions of the country. The has not adjusted it since. The governor of Reserve Bank of India, Y V
2008 Insurance Laws Bill and the 2011 Pension Fund Regulatory and Reddy, has stated that the central bank's policy is to allow a marketDevelopment Authority Bill aim to raise the ceiling on foreign determined exchange rate.
ownership in these industries.
For insurance companies, the
percentage would go from 26% to 49%, and for the pensions sector it
VALUATION
would increase to 26%. These market-opening moves follow closely
The SENSEX carries a current P/E of 15.58x. The market is expensive
behind similar reforms for an expansion of foreign ownership in the
when compared with other regional markets in Singapore (14.49x),
multi-brand retail space (up to 51%) and lowered subsidies in the
Hong Kong (11.33x) and China (7.41x). It is somewhat more expensive
diesel industry. (“Parliamentary constraints blunt India’s reform drive”
than emerging markets in Mexico (15.90x) and Brazil (11.55x).
Oxford Analytica 5 Oct. 2012)
 Bond markets, which represent a much larger potential pool of funds,
are also being liberalized. The need for infrastructure in India is intense, therefore bonds tied to these projects are being opened to
foreigners. Limits to foreigners were raised from $5 billion to $10
billion on government bonds this year, and from $15 billion to $20 billion on corporates. This is an important development, as demand for
emerging market bonds is intense. China, Mexico, and the Philippines
have all issued 100-year bonds recently, and each of them has been
oversubscribed. Yields in the 6% range are in high demand as investors moving toward retirement are scrounging for yield. India will
certainly want to take advantage of this key source of funding.
POLITICAL
The ruling Congress Party is voluntarily making leadership changes
before the 2014 elections. Pro-business policies are being touted as the
economy falls precipitously. This is a positive change, but we are
somewhat skeptical. We’d like to see some real reform occur before
we jump on the bandwagon.
Maoist insurgents have been causing problems for years in all provinces,
but especially in the natural resource-rich areas in central and eastern
India. The good news, however, is the danger they pose appears to be
weakening. Deaths caused by their attacks has fallen for 3 straight years,
 India produces 240,000 engineering graduates each year. This total is with 1005 in 2010, 611 in 2011, and 409 in 2012. We suspect that
greater than those of the U.S., the U.K, Japan, Germany, and South industrial development with rise in proportion to these falling numbers,
Korea, combined, yet manufacturing accounts for just 25% of GDP. and access to these natural resources are badly needed with stiff import
restrictions and tariffs still in place.
TIS Group January 2013 Global Markets
61
INDIA REVIEW
(“INDIA: Maoists present risks, despite lower fatalities.” Oxford Analytica 3
January 2013)
INVESTMENT STRATEGY
The political or economic development that could have the biggest
positive impact on India would be surrounding land development. As of
now, miners, industrialists, or developers have mountains of regulations
and red tape to get through before they can even consider expanding. It
is extremely restrictive and causes unnecessary bottlenecks in supply
and employment.
This is why we are particularly excited about India’s recent push for land
reform. We recognize that easing restrictions on land development will
be a long process filled with protests and legal challenges, but the fact
that the process is beginning is a huge positive for the slow-moving
Indian system.
Under a new draft bill, the government would need approval from 80%
of landowners for private sector projects and 70% for public/private
joint ventures. This is even higher than what the Congress Party’s
president pushed for, but we are positive to see movement, no matter
what the first stage looks like.
Realty stocks in India seem to agree. They have taken off, and we
expect a secular bull market in this sector, as well as related and
supporting sectors. Construction and industrial equipment stocks are
buys, too. We recommend an overweight position in Indian equities.
(“Indian land bill faces hurdles despite Cabinet nod.” Oxford Analytica 14 Dec.
2012)
62
TIS Group January 2013 Global Markets
INDONESIA REVIEW
Jakarta Composite Index
 Foreign investors continued to invest in Indonesia during 2012. FDI in-


Bloomberg LP
S T O C K M A R KE T
C UR R E N T
Jakarta Co mpo site Index___
4392.38
P /E Estimate___
13.96x
Dividend 12 M o Yield -Gro ss ___
2.06%
2013 EP S Gro wth* ___
+25%
Current M arket Cap (IDR/trillio ns)___ 3926936.32
Data Source: Bloomberg LP
OVERVIEW
The Jakarta Composite index closed on December 31st at 4,317 up 12.9%
YoY. Indonesia’s GDP expanded by 6.2% YoY and 3.2% QoQ in the third
quarter. BI held the benchmark rate at 5.75% in December and we expect
the back to be on the sidelines. CPI is tame and should remain within the BI
3.5% to 5.5% target band this year. Consumer demand is the linchpin for this
economy and it is holding up well. A looming problem is the high level of
government subsidies that shield consumers from the real prices of goods
and services. The government has withdrawn from withdrawal of subsidies
because of street protests. Subsidy money can be better used elsewhere in
the economy and this situation can’t go on indefinitely. The country needs
new infrastructure for the economy to reach its output potential and we
believe that efforts to accelerate land acquisition and build infrastructure will
take place this year. High unemployment remains a problem for Indonesia’s
large, unskilled labor force and government efforts to remedy this problem
have not been effective to date. For now, President Yudhoyono’s mandate
to govern remains strong but the Democratic Party is exposed to loss of
voter support ahead of the 2014 elections. Indonesia is a resource rich country with abundant timber, minerals and fossil fuels. We feel that the lack of
strong dependence on exports will help maintain the economy this year in
the face of slowing demand from China and considerable uncertainty over
the fate of EU and North American demand. We hold a slight overweight.



MARKET NEGATIVES
 While exports are less important to Indonesia than many other Asian


MARKET POSITIVES
 Indonesia’s GDP expanded by 6.3% YoY in the first quarter of 2012, 6.4%
YoY in the second quarter and by 6.2% YoY in the third. These form a
pattern of strong growth amidst the financial problems in the EU, a struggling U.S. economy, China’s slowdown and Japan’s ongoing struggle with
deflation. We expect that 2013 GDP growth will follow trend and remain
above 6%.
 Indonesia’s consumer confidence and domestic spending remained buoyant in the fourth quarter. BoI’s consumer confidence index rose each
month during the July through November period. There was a corresponding double-digit increase retail sales extending into the fourth quarter. We expect that private consumption will remain robust in 2013
outweighing a growing but smaller contribution from exports.


 Following two weak months in July and August, industrial produc-
tion rebounded in September. The manufacturing Purchasing Managers’ Index rose to 51.9 in September from 50.5 in August.
 The rate of producer price inflation decreased from 4.1% YoY rate in
October to a 3.8% YoY rate in November. Global commodity prices have
been weak and although crude oil is driving the cost of refined products
higher, Indonesian businesses are shielded from inflationary price shocks
by government subsidies.
TIS Group January 2013 Global Markets
creased by US$2.3 billion to US$5.5 billion in the third quarter. As the
government becomes more aggressive about building infrastructure we
expect that the pace of FDI will accelerate as resource development increases.
Consumer price inflation continues to hold in the middle of the BoI’s
target band of 3.5% to 5.5%. Headline CPI ticked down slightly in November to a 4.3% YoY rate. We expect CPI to remain within the Bank of Indonesia’s target band this year.
In December, Bank Indonesia held the benchmark rate at 5.75%. This
historic low rate reflects BI policy outlook for tame inflation and downside
risk to growth from the Euro-zone debt problems and weak demand from
Asia. We believe that that BI will maintain its loose monetary stance in
2013.
In December 2011, the government finally passed legislation for land acquisition but implementation was slow in 2012. We expect that the pace
will quicken this year as President Yudhoyono pushes harder to increase
spending on roads, ports and airports to $140 billion and increase economic growth by an average 6.6% each year by the end of his term in
2014.
The government’s laws to cap real estate prices on open lands that are
important for infrastructural investment opens these areas for infrastructure development. Landowner price gouging has been a major problem
that constrained much-needed investment in infrastructure.
The November 2012 reelection of U.S. President Obama to a second
term emphasizes his foreign policy rebalancing to focus on Asia and
less on Europe. Greater U.S. interest in Asia has benefits for regional
stability.


economies, they have been a growing source of GDP growth. Exports
contracted every month since April 2012 sending the trade balance into
deficit. The October trade balance deficit was US$1.5 billion. The current
account deficit increased from a US$3.2 billion deficit in 1Q12 to US$5.3
billion at the end of the third quarter. The deficits reflect weak external
demand and the inability of Indonesia to overcome internal infrastructural
limitations to take full advantage of its domestic natural resource base.
The Rupiah remained one of Asia’s worst performing currencies last year.
The currency depreciated against the US$ by roughly 6.5% in 2012. This
helps the fledgling export sector but increases debt service costs. We expect the Rupiah will depreciate in 2013 which will make it difficult to maintain stability as foreign capital flows increase.
Despite the structural soundness of the economy, the government of
President Susilo Bambang Yudhoyono persistently underspends the state
budget. Chronic under-spending in response to prior corruption scandals
is a deterrent to the potential to develop infrastructure and bring economic output to capacity.
President Yudhoyono backed down from implementing the fuel subsidy
reduction in 2012 and is likely to avoid the issue again this year. The fuel
subsidy issue is a politically charged issue that will cost Indonesian’s more
to transport themselves and put added pressure on CPI. We feel that the
need for some level of subsidy reduction is great because it is the centerpiece obstacle in dealing with other subsidies to avert exceeding the legal
budget deficit limit capped by law at 3% of GDP.
President Yudhoyono is a populist leader whose term will in in 2014. Many
political cronies and wealthy individuals that expose his government to
charges of corruption back him. We feel that this is diagnostic of an entrenched weakness that will continue to produce slow progress on many
economic reforms necessary to bring the country to its full economic potential. Voter frustration is building and could undermine the Yudhoyono
government and Indonesia’s political stability.
While unemployment remains low by official measures, high unemployment by unofficial metrics remains a problem for Indonesia’s large unskilled labor force. The government’s efforts to remedy this problem have
not been effective. This is underscored by labor unrest and strikes protesting low wages and working conditions.
Indonesia’s Muslim population was largely silent as the Arab Spring revolts
swept across North Africa. However, the world’s largest Muslim popula-
63
INDONESIA REVIEW
tion, is reactive as demonstrated by its response to an insulting anti-Islamic
film created in the U.S. last year. Like their counterparts in Africa and the
Middle East, Indonesian Islamic sentiment is volatile and when awakened, a
potential risk to the stability of the country’s secular government.
VALUATION
The Jakarta Index has a P/E ratio of 13.96x, a dividend yield of 2.06%, and an
estimated EPS growth of +25%%. These numbers compare relatively well to
its regional counterparts. P/E and dividend yield comparative figures are:
Hong Kong (11.33x, +6%) and Japan (19.60x, +31%.).
POLITICAL
The government of Indonesian President Susilo Bambang Yudhoyono remains stable and appears to be well positioned to remain in power until the
next national election in 2014. Support for Mr. Yudhoyono has generally
been good due in large part to his fiscal stimulus measures that served to
shield Indonesians from the full onslaught of the financial crisis and his management of the economy which continues to perform very well despite financial crises that have engulfed the EU. Since coming to power in 2004, Mr.
Yudhoyono has managed the country and its economy in a manner that has
appealed to foreign investors. As the leader of a secular government of the
world’s largest Muslim population, Mr. Yudhoyono has proved to foreign
investors that Indonesia is a stable democracy underpinned by an economy
that can deliver top global growth rates. The main problem facing the President is that he is surrounded by cronies and wealthy individuals that undermine his government with corruption and scandal. Foreign investors have
been confident in Indonesia and rewarded by the country’s ongoing economic expansion. A major attraction for foreign investment is the government’s
commitment to build infrastructure. In December 2011, Parliament finally
passed legislation that will allow the government to acquire land under powers of eminent domain. This legislation paves the way for projects on roads,
ports and railways that have been major obstacles for business and economic
growth. As an archipelago with more than 17,000 islands, building an efficient
infrastructure is inherently a daunting task made much more difficult by political corruption and bureaucracy. If Indonesian development is to match its
growth potential, the obstacles to development need to be aggressively attacked by Mr. Yudhoyono during the last full year of his term. Failure to do
so jeopardizes more than economic growth, it is a recipe for political instability. Mr. Yudhoyono has only two years until the next election in 2014 that
will elect his successor as the country’s next president. Mr. Yudhoyono’s
leadership of the Democratic Party and its chances for its candidate to win
the presidency in 2014 hinge on Mr. Yudhoyono’s willingness to take a hard
line on cronyism and corruption and demonstrate aggressive pursuit of developmental reforms. Despite the acute need for action, he has failed to
demonstrate a willingness or ability to act. Democratic Party (PD). The scandal concerning former PD party treasurer, Muhammad Nazaruddin, is a case
in point. Sentenced to prison last year, Mr. Nazaruddin has made wideranging allegations against several senior members of the PD. While the
Democratic Party government led by President Yudhoyono is outwardly
stable and appears likely to hold power until the next elections scheduled in
2014, there are deep fissures in the party that voters recognize. As the economic expectations for Indonesia grow among its people, so too do the
pressures on government to end corruption in the interests of the growing
middle class. We anticipate that the ruling Democratic Party will be tested by
a rising tide of opposition politics coupled to growing Islamic sentiment in
politics. Cracks in Mr. Yudhoyono’s political armor are evident and these are
opportunities from which new leadership will emerge in 2014.
INVESTMENT STRATEGY
Indonesia’s GDP expanded by 6.3% YoY in the first quarter of 2012, 6.4%
YoY in the second quarter and by 6.2% YoY in the third. These form a pattern of strong growth amidst the financial problems in the EU, a struggling
U.S. economy, China’s slowdown and Japan’s ongoing struggle with deflation.
We expect that 2013 GDP growth will follow trend and remain above 6%.
64
The linchpin for this economy is private consumption. Indonesia’s consumer
confidence and domestic spending remained buoyant in the fourth quarter.
We note the Bank of Indonesia’s consumer confidence index rose each
month during the July through November period with a corresponding double-digit increase retail sales each month. We expect that private consumption will remain robust in 2013 outweighing a growing but smaller
contribution from exports. Indonesian consumers are shielded from external
price shocks by many government subsidies. In 2012, the Yudhoyono government backed away from reducing the fuel subsidy when civil protests
grew violent. This subsidy costs the government an estimated US$15 billion
each year that could be redirected into improving the transportation system
so less fuel was wasted by the country’s inefficient transportation systems
and used to target many other infrastructure projects needed to unlock the
country’s economic potential.
We note that Indonesia’s economy has been resilient largely because of its
dependence on domestic spending rather than external demand and export
trade for its excellent growth. While small, Indonesia’s export sector includes
forest products, minerals and energy resources in the form of coal, gas and
oil. We believe that Indonesia’s crude oil, natural gas and coal are important
energy resources to China despite the mainland’s economic slowdown. We
feel that Indonesian energy resources are an important future cornerstone
for Asia-centric energy demand especially with persistent turmoil in the Middle East. The major impediment to exploiting the country’s natural resource
base is a widespread lack of infrastructure. Without highways, railways, airports and ports, getting to these resources and bringing them to global markets is difficult. In December 2011, the government enacted law to acquire
land necessary to develop critical infrastructure under eminent domain.
However, implementation has been extremely slow. It has been estimated
indicate that Indonesian companies spend roughly one third of total production costs on the transportation of goods to domestic and foreign market
outlets. The infrastructural tasks are daunting because Indonesia is an archipelago of 17,000 islands. The need for infrastructure is enormous and we feel
that Indonesia is one of the world’s largest markets for infrastructure development. With little time left in his presidential term, Mr. Yudhoyono needs
to accelerate investment to give a PD successor a good chance to win in the
looming 2014 election.
Headline inflation has been tame giving the Bank Indonesia latitude to remain
on the sidelines. In its December policy meeting, BI held the benchmark rate
at the historic low 5.75% maintaining its policy focus on growth. BI’s rate
position has diminished speculative interest in the Rupiah but this has been
largely offset by the bank’s high relative interest rate differential to other key
global benchmark rates. In concert with ample and growing FDI flows, the
rate differential attracts carry trade money inflows. In this regard we note
that the Rupiah remained one of Asia’s worst performing currencies last year
largely because of the country’s weak current account position. The currency
depreciated against the US$ by roughly 6.5% in 2012. This helps the fledgling
export sector but increases debt service costs. We expect the Rupiah will
depreciate in 2013 which will make it difficult to limit Rupiah volatility and
maintain a stable currency regime as foreign capital inflows increase.
We note that the government of President Yudhoyono remains stable and
appears likely to survive until the next election is 2014. Government cronyism and corruption are major problems facing Mr. Yudhoyono and his Democratic Party. These limit the effectiveness of government programs to build
new infrastructure and deliver meaningful reforms to voters. Elections will be
held in 2014 and we foresee a rising tide of opposition politics that in this
Muslim nation that could acquire a risky fundamentalist foundation if Mr.
Yudhoyono does not attack fundamental problems more aggressively. For
now, President Yudhoyono’s mandate to govern remains strong and his
government is stable but the massive protests over the fuel subsidy are indicative of widespread frustration with the government that lingers just below
the surface. Cracks in the armor of the ruling Democratic Party and Mr.
Yudhoyono’s political machine are evident and these are opportunities from
which new leadership will emerge in 2014.
TIS Group January 2013 Global Markets
INDONESIA REVIEW
We believe that the momentum of Indonesia’s economic expansion will
continue this year driving GDP growth to above 6%. We believe that the
investment climate in Indonesia remains structurally favorable and the government of President Yudhoyono demonstrated that the country can deliver
solid economy performance under a stable democratic government. Indonesia’s growth potential is an opportunity but until the government takes aggressive steps to reform the economy and implement infrastructural
development this potential will not be fully realized. Indonesia is a resource
rich country with abundant timber, minerals and fossil fuels. We feel that the
lack of strong dependence on exports will help maintain the economy this
year in the face of slowing demand from China and considerable uncertainty
over the fate of EU and North American demand. We feel a slight overweight is appropriate for Indonesia.
Source:
Bloomberg LP Data
TIS Group January 2013 Global Markets
65
ISRAEL REVIEW
financial crisis, but the move will undoubtedly act to inhibit growth in
construction spending.
Tel Aviv 25 Index

It has become apparent that Barack Obama’s administration is going to
have a much different attitude toward Israel and her interests than the Bush
administration had. Israel will not wait for anyone’s permission to move
forward with direct military action against Iran, if they deem it necessary.
VALUATION
Israel’s equity market carries a low P/E of 12.11x making it among the
world’s cheapest markets.
CURRENCY
Bloomberg LP
S T O C K M A R KE T
C UR R E N T
Tel A viv 25___
1206.78
P /E Estimate___
12.11x
Dividend 12 M o Yield -Gro ss ___
3.10%
Current M arket Cap (B il/Shekel)___
42100%
2013 EP S Gro wth* ___
+22%
Data Source: Bloomberg LP; *TIS Group
OVERVIEW
The TA-25 rose 12.4% in Q3, bringing ytd 2012 performance to +9.5%. This
follows returns of +33.3%, +12.5, +31.4, -46.2%, +74.9%, +15.8%, and 18.2% in the years 2005-2011, respectively. Israel’s export-driven economy
is suffering under the strength of the Shekel, as 60% of the country’s exports
go to Europe and the U.S. As geopolitical risks in the region rise with
changing political leadership, security is becoming a larger question. On the
bright side, Israel seems to be somewhat insulated from many of the root
causes of the developed markets’ weaknesses. As a result, relative growth
rates and deficit levels are favorable. Large-scale gas production in the
Tamar field will be an added revenue generator for 2013 and going forward.
MARKET POSITIVES

Israel should begin drilling in the large Tamar gas field in H1, 2013. The
production here could add as much as 1% to GDP, if all goes well. The
revenues and profits from this project should help the economy
dramatically. (Lahav, Avital. “Interest rate cut amid slowdown fears.”
YnetNews.com 25 Dec. 2012)

Israel’s central bank is back in easing mode, joining a global group of
central banks around the globe that are generating liquidity. The BoI has
the advantage, however, of a government with much better control of
their purse strings. Deficits remain in check.

Part of the reason Israel is in such a strong economic position is the
monetary policy moves by Bank of Israel’s Stanley Fischer. Unlike the
U.S. and other developed nations, Mr. Fischer was increasing rates during
the economic rebound. In 2010-2011, he increased the country’s
benchmark rate from 0.50% to 3.25%. This discipline has paid dividends
as the global economy weakened in 2012, and allowed the BoI to
stimulate with cuts. Unlike the U.S. & Japan, which appear to be on longterm zero interest rate policies, the BoI has 175bps to play with if further
weakness ensues.
MARKET NEGATIVES

Electricity prices are expected to rise 10-15% in Q1, which will impact
consumer spending and corporate profits. (Lahav, Avital. “Interest rate cut
amid slowdown fears.” YnetNews.com 25 Dec. 2012)

At the end of 2012, the supervisor of banks limited the loan-to-value ratio
in new housing loans. The conservative nature of Israel’s mortgage
market is one of the reasons it faired so well in the 2008-2009 global
66
The BoI cut its benchmark interest rate in December to 1.75%, the first time
the rate has been below 2% since September 2010. The Shekel continued to
strengthen in Q4 after hitting 3-year lows in Q2. We would target a 3.7:1
ratio to the USD going into Q1 of 2013, with a year-end target of 3.5:1.
Inflation may begin to push higher in 2013, as global growth led by China,
pushes to the high end of the BoI’s target range.
POLITICAL
A political mess is developing in Israel over the issue of military deferments
for ultra-orthodox Jewish men. The issue is hotly contested, and is
threatening the current coalition government. The Kadima Party is
threatening to leave the Kadima-Likud government coalition over the issue,
and creating unneeded political instability at a time when larger issues are
facing the nation. (Ben-David, Calev. “Israel’s Kadima Says it may leave coaltion
over draft issue.” Bloomberg News 3 July 2012)
With the election of the Muslim Brotherhood in Egypt, relations between
the two countries will likely deteriorate. President Morsi is Egypt’s first
democratically-elected civilian president, and its first Islamist head of state.
There is still a struggle between he and the military, but the result will
undoubtedly slow trade and peace negotiations with Israel. (“Egypt’s Islamist
president to shake regional politics” Oxford Analytica 25 Jun. 2012)
INVESTMENT STRATEGY
We recommend an overweight position in Israeli equities mainly because it
provides exposure to the Shekel, which remains strong. The combination of
growth and commitment to fiscal conservatism in Israel is one of the best in
the world right now. The central bank reported 3.3% GDP growth for
2012, which is higher of most developed countries. This is down from 5% in
2010 and 4.6% in 2011, but strong in a global comparison. On the budget
side, the country has one of the best central bank governors in the world at
keeping politicians’ spending in line. Recently, he helped push through both
a value-added tax and an increased income tax to pay for deficit spending.
While we don’t normally encourage increased taxes as a path to growth, we
recognize that the effect on the Shekel will likely be significant. With every
other economy in the world ignoring deficits, these moves by Tel Aviv will
certainly stand out in the currency markets. Exporters are starting to feel
the pinch, but as investors, a strong currency at our backs is a very valuable
asset. (Odenheimer, Alisa “Israel economy expands3.3% in 2012, Missing previous
estimate.” Bloomberg News 31 Dec. 2012)
Sizeable military expenditures, overexposure to Europe, a lack of a peace
agreement, and an Obama administration which may not be as supportive as
Bush, all add to the country’s risk profile, however we would recommend an
overweight exposure to the Shekel and support industries involved in the
gas drilling operations in the Tamar field.
TIS Group January 2013 Global Markets
JAPAN REVIEW
Eco no mi c F o r ecast
GDP Economic Forecast (QoQ)
—
St o ck M ar ket
F i xed I nco me
Q 1 2 0 13
-0.45%
C ur r ent
C ur r ent
Target Rate —
0.10%
Nikkei 225
CPI Economic Forecast (YoY)
—
-0.10%
6-M o Discount Bills —
0.10%
P/E Estimat e
Current Accnt %GDP Est
—
0.70%
2-Year Bond Yield —
0.10%
Dividend 12 M o Yield - Gross
Unemployment Rat e
—
4.20%
5-Year Bond Yield —
0.20%
*2013 EPS Growt h
Central Bank Rat e (%)
—
0.10%
10-Year Bond Yield —
0.83
10-Yr Spread/US Treas —
-107.71bps
Bloomberg Cont r ibut or Composit es
OVERVIEW
The Nikkei closed at 10,395 on December 31st. The market was up
22.9% YoY. On an annualized, seasonally adjusted basis, Japan’s third
quarter GDP contracted by 3.5% QoQ. Macro factors remain negative
and government stimulus programs are the main drivers for GDP
growth emanating from domestic spending in lieu of external demand
for exports. Consumer sentiment is weak as is consumer spending.
Manufacturing is subdued and industrial production contracted moving
into the third quarter. In the fourth quarter, the large manufacturer
Tankan fell 9-points from -3 to -12. The foundations for the Japanese
economy remain in a disinflationary state reflected by negative headline
and core CPI. The newly elected LDP government led by Shinzō Abe is
set to change this plethora of bad news. Mr. Abe’s triadic framework
for what must be done immediately is s to apply pressure on the Bank
of Japan to lift its inflation target, depreciate the Yen and boost job creating growth (exports). Easier said than done, but we believe that Mr.
Abe and Japan’s people will rise to the task. The newly elected LDP
government led by Shinzō Abe promises to change the face of Japan’s
economic future. We believe that with the Mr. Abe and the LDP in
power an overweight stance in Japan is appropriate.
POLITICAL
In November 2012, Japanese Prime Minister Noda dissolved the Lower
House Parliament setting the stage for a snap election that took place on
December 16th. The election resulted in a change of leadership as voters
ousted Mr. Noda and the DPJ in favor of an LDP government headed by
Shinzō Abe. This is not a surprise. Pre-election polls and Mr. Noda himself forecast the LDP win. Mr. Abe is no stranger to the prime minister’s
job. He held the position for a year between September 2006 and September 2007 before resigning his post. Mr. Abe is a foreign policy hawk
who will oppose China and rearm Japan as well as a fiscal hawk intent on
overcoming deflation and weakening the Yen. The days of frustrating inter-party wrangling in the Diet are not over but we expect that Mr. Abe
will become a force to be reckoned with. The composition of the Diet
gives Mr. Abe’s LDP a majority in the Lower House, but he faces a DPJ
majority in the Upper House. This will have an effect on the rapidity with
Mr. Abe can enact legislation.
Nikkei
Current M arket Cap (Yen/t rlns)
_
_
_
_
_
10599.01
19.6x
1.89x
+31%
203789 t ril
Bloomber g LP; * TIS Gr oup
We believe that Mr. Abe will immediately apply pressure to the Bank of
Japan to ease more aggressively and push the bank’s inflation target to 3%.
In short order, we also expect Mr. Abe to inject more fiscal stimulus.
Dealing with Japan’s ailing economy becomes the job for Mr. Abe’s Economy Minister, Akira Amari a former Sony executive. Mr. Abe tasked Toshimitsui Motegi, his Trade Minister, with increasing Japan’s penetration
and competitiveness in external markets. Taro Aso, is Mr. Abe’s Finance
Minister. Mr. Aso’s main focus will be engineering a fiscal stimulus package. Dealing with thorny geostrategic issues is Fumio Kishida, Mr. Abe’s
Foreign Minister. Mr. Kishida faces the difficult task of confronting Chinese aggression in the South China Sea where sparing over disputed territorial claims is likely to intensify. For his Environmental Minster and State
Minister for Nuclear Power Mr. Abe chose Nobuteru Ishihara. Mr. Ishihara is a proponent of nuclear power and will work with the cabinet and
LDP controlled Lower House to rescind the Diet’s ban on nuclear power
generation. Overall, we see Mr. Abe ushering in a new era for Japan that
has favorable ramifications for the economy and Japan’s relationship with
the United States. Mr. Abe’s election aligns nicely with the Obama administration’s Asia pivot geostrategic planning which will increase U.S.
presence and influence in Asia and the South Pacific. We look for Mr.
Abe to return to LDP hawkish politics on the economy and foreign policy. Politically, Mr. Abe must work quickly to win voters over to the
LDP ahead of the July Upper House election where the DPJ still holds a
majority.
MARKET POSITIVES
 In the December snap election, voters turned to the LDP and Shinzō
Abe to lead the government. This increases pressure on the BoJ to
adopt a more dovish policy stance and a likely increase in the inflation target to 3%, some 3-fold higher than the Noda DPJ government
target. Mr. Abe will pressure the bank to print Yen to meet his inflation target.
 Japan’s Yen appreciated to US$1:JPY77 in September before depreciating throughout the fourth quarter. The Yen hit US$1:JPY86 after
Mr. Abe’s election. Mr. Abe wants the Yen weaker. We expect that
Yen will move to US$1:JPY90 or above.
 Prior to the December election defeat, the DPJ controlled lower
house approved former Prime Minister Noda’s FY12/13 budget of
some ¥90.3 trillion. We expect that the Lower House under LDP
Topix Index
Charts courtesy of Bloomberg LP
TIS Group January 2013 Global Markets
67
JAPAN REVIEW




control will revise this and drive a ¥10 trillion supplemental budget
through the Diet. The money will target public works projects.
All bets are on the new BoJ governor to quickly revise the banks polies to align with Mr. Abe’s wishes.
In May 2012 Japan shutdown the last of nuclear power stations. By
July, the government began to restart reactors to alleviate power
shortages and in October construction resumed on a new nuclear
plant in Aomori prefecture. We believe that Mr. Abe will act quickly
to restart nuclear power stations.
Consumers have been shielded from rising prices in Japan’s deflationary environment but his must change if the economy is to grow. In
the BoJ’s December meeting the policy committee adopted an interim 1% inflation target. The bank plans to “consider” carefully Mr.
Abe’s request for the bank to set a 2% CPI target.
Crude oil prices remained moderate in the fourth quarter. This is
providing relief to the Japanese petroleum energy landscape which
has assumed greater importance since the Fukushima disaster. Near
term, Japan’s energy import risk is primarily from sharp, event driven
increases that will come from rising tensions with Iran.
MARKET NEGATIVES
 In the third quarter, Japan’s seasonally adjusted real GDP contracted
sharply. Third quarter GDP contracted by an annualized 3.5% QoQ
and showed weak 0.1% YoY growth. The rapid deterioration points
to a recessionary period for this economy that will make Prime Minister Abe’s job difficult.
 In the fourth quarter, the large manufacturer Tankan fell 9-points from
-3 to -12. The Medium Business Tankan also plunged, shedding 6
points to a -12 reading and the Small Business Tankan fell 4-points to
-18. The decline in sentiment across small, medium and large manufacturers reflects pervasive pessimism as the outlook for export demand remains weak and domestic spending has been in retreat. We
expect that first quarter Tankan results may look very different as
Mr. Abe’s commitments to right the economy gain traction with
businesses.
 Evidence of the weakness in the external sector is contained in the
trade deficit numbers. The merchandise trade balance has been in
deficit since March 2011. Exports showed month-over-month declines each month in the June to November period.
 Anti-Japanese protests and boycotting of Japanese goods in mainland
China over territorial disputes is a major problem for Japan’s export
manufacturing core. This is reflected in industrial production numbers
that have been negative in the June to October period. China’s boycott could backfire because Japanese automakers and other corporations employ millions of Chinese workers in plants located in China.
Japanese corporations could retaliate by moving production to other
Asian countries with cheap labor.
 Japan’s coincident index dropped 2.3-points in September to 91.2 and
shed half a point to 90.7 in October. October data showed another
contraction when released in December compelling the Cabinet Office
to downgrade its view for a second straight month stating that the index shows deterioration an implicit recognition of recession.
 Consumer confidence showed no improvement into the fourth quarter. The confidence index levels for household and Tokyo dipped in
to the 30’s with the November confidence index at 39 and the Tokyo confidence number a tick better at 39.2. Retail spending faded
from YoY gains near 3% in the March-April period to a weak -1.2%
YoY decrease in October.
 Japan’s import trade receipts are bearing a heavy debt from energy
to replace the country’s loss of the majority of its nuclear electrical
generation capacity. This energy trade deficit is now a fixture in the
overall merchandise trade balance. If the Abe cabinet restarts the
fleet of nuclear reactors this situation will change quickly.
68
 June, Mr. Noda finally succeeded in getting the LDP opposition to
support his consumption tax increase. The 5% consumption tax level
will increase to 8% in April 2014 and to 10% from October 2015.
This ultimately cost him his position as prime minister. Despite the
Diet’s approval under Mr. Noda, Mr. Abe has hinted that he might
delay the increase until the economy improves. We believe that the
consumption tax carries significant risks for Japan’s economic recovery.
 Japan’s overall unemployment rate remained largely unchanged at
4.2% into the fourth quarter. The employment picture isn’t going to
improve quickly and consumers acclimated to deflation, weak employment, and stagnant wages will continue to express weak sentiment and limit domestic spending.
 Reconstruction and Mr. Abe’s aggressive spending plans will significantly exacerbate Japan’s public debt. If Mr. Abe gets his wishes to
sharply increase spending, public debt already headed to 250% of
GDP will go higher. This is the highest public debt level of any developed country. Japan’s citizens face high taxes in the post-recovery
period and Japan may need external assistance to service its debt in
the future if the economy does not improve.
VALUATION
Japanese stocks have an average P/E of 19.60x, the lowest level in
years. Compare that to the U.S.’s P/E of 13.14x, Singapore’s
14.49xand EPS -15%, and Hong Kong’s 11.33x and +6%.
INVESTMENT STRATEGY
The election of Shinzō Abe as Prime Minister may be the tonic needed
to set Japan’s ailing economy on a path to recovery. Mr. Abe, elected
on December 16th, wasted no time announcing the triadic framework
for what must be done; apply pressure on the Bank of Japan to lift its
inflation target, depreciate the Yen and boost job creating growth. Mr.
Abe’s task is daunting. Japan’s economy has languished for so long that
robust, sustainable growth is lost from common economic memory.
The macro environment is uniformly stacked against him.
On an annualized, seasonally adjusted basis, Japan’s real GDP contracted sharply in the third quarter, falling 3.5% QoQ. The former Noda
government injected significant fiscal stimulus to rebuild infrastructure
damaged in the 2011 earthquake-tsunami but this failed to boost
growth in the broad economy. For Mr. Abe, the reconstruction is a
foundation upon which to build.
Mr. Abe will have little control over the external environment that has
been a debilitating brake on exports. An increase in demand from EU
member states wallowing in sovereign debt problems is unlikely and the
U.S. import picture in the second half has been characterized by sub-1%
month-over-month gains. To address foreign market penetration Mr.
Abe tasked Toshimitsui Motegi, his Trade Minister, with increasing Japan’s competitiveness in external markets. We think that an immediate
focus will be Japan’s Asian trading partners. This brings China to the
fore. China’s boycott of Japanese merchandise over disputed territorial
claims in the South Chain Sea is potential damaging to Japan but China
is not immune to Japanese retaliation. Japanese corporations have manufacturing facilities in China that employ millions of Chinese workers.
We believe that Mr. Abe’s choice of foreign minister, Fumio Kishida,
and Mr. Motegi will leverage Japan’s hold on Chinese jobs to point out
that there are other low cost labor pools in Asia and other large markets in India and Indonesia that offer Japan attractive offshore opportunities. Japan’s biggest manufacturing competitor in Asian markets is
South Korea. A key aspect of Mr. Abe’s directives to depreciate the
Yen is diminished export competitiveness of South Korean goods and
services when the Yen-Won cross rate falls. Overall, we see Japan
holding far more economic power over China than China has over Japan.
TIS Group January 2013 Global Markets
JAPAN REVIEW
Adding to Japan’s export debacle is the decision made by the former
Noda government to idle Japan’s fleet of nuclear power stations. This
shifted the burden for electrical energy production to fossil fuel fired
generation stations that need to import fuel to spin the turbines. Energy imports are a growing problem for Japan’s trade deficit. Again, Mr.
Abe’s choice of Nobuteru Ishihara as his Environmental Minster will be
instrumental in addressing this matter. Mr. Ishihara is a proponent of
nuclear power and we believe that he will use his cabinet position to
rescind the former DPJ controlled Diet’s ban on nuclear power generation. This will involve a new energy policy that will exploit the existing
fleet of nuclear power stations, perhaps adding more generating capacity, and rejuvenating Japan’s renewable energy sector. This high tech
sector was once a flagship for Japanese industry that can be restarted
to create jobs. Restarting Japan’s fleet of nuclear power stations is not
without risk. The occurrence of another Fukushima-Daiichi event
would have severe consequences for Mr. Abe’s economic recovery
strategy.
The effects of a strong Yen on trade are a particular concern for Mr.
Abe. The Bank of Japan is a linchpin in Mr. Abe’s plan to increase inflation. In the BoJ’s December meeting, the policy committee adopted an
interim 1% inflation target. The bank plans to “consider” carefully Mr.
Abe’s request for the bank to set a 2% CPI target. We expect the new
governor will oversee and insure that the central bank is aligned with
Mr. Abe’s plans to increase the inflation target to 2%. We believe that
the BoJ will outpace the U.S. Federal Reserve this year in printing money. This will put the Yen on a path to depreciate to US$1:JPY90 and
eventually a target of 99.
On foreign policy, Mr. Abe is a hawk. We believe that Mr. Abe will resume what he began in his first term as prime minister in 2006. When
Mr. Abe took the reins of power as Junichiro Koizumi’s successor, Mr.
Abe set about to rearm Japan. This included a nuclear weapons capability. A pacifist nation by constitutional declaration since World War II,
Mr. Abe set his cabinet to work to determine the legality of nuclear
weapons capability. The legal test focused on Article Nine of Japan’s
constitution which lays the foundations for Japan’s pacifism. The key legal finding by the Cabinet Ministry was that Article Nine does not bar
Japan from possessing nuclear weapons that could be used defensively
in matters of national security. This opened the matter to public debate
but the first term Abe government established that a redraft of Japan’s
constitution would be necessary if Japan was to remilitarize in a manner
that accommodated enhanced military capability beyond those deemed
strictly defensive, including nuclear weapons. In so doing the stage
would was to be set for Japan to become a military power capable of
independent action. This debate was abruptly ended when Mr. Abe resign his position in September 2007, less than one year after taking office. We feel that Mr. Abe will soon resume his quest for remilitarization and do so without the timid approach that he took in his first
term. This forebodes a rewriting of Japan’s constitution and the emergence of a remilitarized Japan as a threat to Chinese aggression in the
region. Remilitarization has significant ramifications for increased defense budgets as a tool for creating jobs and as a economic growth engine.
We note that many advisors accustomed to Japan’s economic pathologies have maintained small positions in Japan equities. The newly elected LDP government led by Shinzō Abe promises to change the face of
Japan’s economic future. We believe that with the Mr. Abe and the LDP
in power an overweight stance in Japan is appropriate.
Source: Bloomberg LP Data
TIS Group January 2013 Global Markets
69
MEXICO REVIEW
Bolsa Index
Mexican Peso to US Dollar
Bloomberg LP
S T O C K M A R KE T
B o lsa___
P /E Estimate___
Dividend 12 M o Yield -Gro ss ___
2013 EP S Gro wth* ___
Current M arket Cap (P eso s $ /trlns)___
C UR R E N T
44482.44
15.90x
1.36%
+20%
4864.92
Data: Bloomberg LP; *TIS Group
OVERVIEW
The IPC Index was up 1.7% in Q3, bringing ytd 2012 performance to
+10.2%. Returns 2004-2011 have been +46.9%, +37.8%, +48.6%,
+11.7%, 24.2%, +43.5%, +20.0, and -3.8% respectively. New President
Enrique Pena Nieto appears to be working well with other political parties to enact reforms. This is a positive development, and a badly needed one as efforts to infuse the oil industry with capital, and the battle
with drug cartels will take a great deal of cooperation.
Bloomberg LP
(Arrest shows cartel influence on Mexico’s institutions.” Oxford Analytica
25 Sept. 2012).
 Oil production in Mexico is falling precipitously. A production rate of
2.55 million bbl/d was recorded in 2011, a 21-year low. Mexico contains the second-largest active oil field in the world, Cantarell, but it is
an aging field, and becoming increasingly unproductive. The giant field
accounts for half of the country’s total production, and the process of
replacing its output is going much too slowly.
CURRENCY
Through October, annual inflation stood at 4.6%. This has moved above
the top limit of the Bank of Mexico’s 2-4% target range, thus making
interest rate cuts more likely. As a result, the Peso continues to
strengthen against the Dollar. Banxico has left unchanged the benchmark overnight interest rate at 4.5% for 3 years now. We think the risk
of inflation in Mexico is low, but we also don’t see the Peso trading outMARKET POSITIVES
 The incoming President has vowed to allow international inves- side a tight trading range anytime soon. Growth prospects are hard to
find in an economy so dependent on the U.S., and with so many fiscal
tors into the country’s oil market, to increase the country’s prodifficulties ahead. On the positive side, debt-to-GDP currently sits at
duction capacity. This may be an uphill battle, as the PRI failed to only 34%, so there is some flexibility there, if needed.
gain majorities in both houses on congress. However, having this
issue at the forefront of the political scene, will give it the attenVALUATION
tion it deserves.
On a regional and global valuation basis, Mexico remains unattractive at
 PEMEX announced that it discovered a light crude deposit with 15.90x. With EPS growth around +20% the Mexican market needs
400 million barrels of reserves in the Gulf of Mexico. The find higher oil prices to attract domestic and foreign investors.
has a potential output of 10,000/bbd. (“Mexico announces discovery
amid reform deadlock.” Oxford Analytica 30 August 2012)
 There was some concern that President-elect Nieto would adopt
a low-profile stance regarding foreign affairs and international
trade that his PRI party had followed during its 70-year long rule
up to 2000, but in the days after his election, he has traveled to
Guatemala, Columbia, Brazil, Chile, Argentina, and Peru. This is
an indication that he will continue President Calderon’s efforts to
integrate Mexico into trade and security relationships with neighbors, including the U.S. (“Trade and security will drive Mexican foreign
POLITICAL
President Nieto is pushing out statistics about how poorly the previous
administration did against the drug cartels. This is a strategy to buy is
own administration time to implement a new crime-fighting campaign.
The PR may work in the short-run, but we are skeptical any efforts will
be effective against a drug infrastructure that has reached critical mass.
Enrique Pena Nieto was elected Mexico’s president at the beginning of
July, returning the PRI to power once again. The PRI will not have a
majority of seats in the 500-seat lower house, winning only 241 seats.
Nor will their alliance have enough seats in the senate, winning only 58
of the needed 65 seats to control that body. The results will force Niepolicy” Oxford Analytica 26 Sept. 2012)
to to compromise and form alliances with opposition parties and individuals. This will most certainly slowdown any reforms, and make any
MARKET NEGATIVES
slower and likely watered down. He took office on December
 We are becoming increasingly concerned about the influence of drug change
1st. (“Small and medium drug cartels multiply in Mexico.” Oxford Analytica
cartels in Mexican politics. The July elections showed widespread
19 Dec. 2012)
success for the PRI party, but the more interesting events to witness
were the violence so brazenly initiated by illegal drug gangs. Recently,
INVESTMENT STRATEGY
the Navy captured 35 policemen accused of working for the Zetas
The lack of control of any one political party was a concern for us after
cartel, indicating how deeply ingrained in the system the problem is. the election. We felt there was a strong risk of stalemate, and a logjam
that would prevent any meaningful changes in reform. To our surprise,
70
TIS Group January 2013 Global Markets
MEXICO REVIEW
however, the PRI, PAN, and PRD appear to be playing fairly nicely together. In December they came up with a major agreement they termed
the “Pact of Mexico,” which will supposedly lead to a host of legislation
on education reform, increased competition in the telecommunications
sector, increased social spending and aid to the poor, and reduced drugrelated violence.
One area the Nieto administration has particularly stressed is the need
for increased competition and the end of monopolistic industries. We
are hopeful this terminology is cover for allowing more foreign capital
into the country, but specifically in the oil industry. This move will be a
tricky sell to the public, so couching it in terms of anti-monopoly could
possibly work. Capital infusions into the oil industry is badly needed.
(“Signs of cooperation will follow Mexican inauguration.” Oxford Analytica 3
Dec. 2012)
(“Mexican government signals anti-monopoly stance.” Oxford Analytica 17
Dec. 2012)
We continue to recommend a neutral position in Mexican equities, as
structural problems continue to hamper our ability to view a clear, sustainable path forward for growth.
TIS Group January 2013 Global Markets
71
NEW ZEALAND REVIEW
440
New Zealand Exchange Limited 50 Free Float Total
Return Index
 The ANZ Roy Morgan Consumer Sentiment Index rose to 114 in
August, where it remained through December. This suggests that
consumers are not yet ready to abandon the economy and will
continue to use loose credit for purchases. However, we feel that the
trend is for greater caution in consumer spending habits and weaker
retail spending data. Stagnant sentiment and weaker domestic
spending highlight downside risks to the economy.
 New Zealand is at net importer of crude oil and refined products.
Crude oil prices moderated in 2012 mitigating the impact of energy
imports on economic growth.
 In early November 2012, ahead of the UN COP 18 Doha meeting,
the Key government announced that it was not in the country’s best
interest to retain the Kyoto treaty commitments that it original
agreed to. The policy shift benefits New Zealand’s carbon intense
industries.
MARKET NEGATIVES
Bloomberg
S T O C K M A R KE T
C UR R E N T
NZSE To p 50___
4084.84
P /E Estimate___
15.62x
Dividend 12 M o Yield -Gro ss ___
4.54%
2013 EP S Gro wth* ___
+15%
Current M arket Cap (NZ Do llar/billio ns)___
334.89
Source Data: Bloomberg; *TIS Group
OVERVIEW
New Zealand’s Exchange Limited 50 Free Float Total Return Index
closed at 4,067 on December 31st, up 24.2% YoY. New Zealand’s
seasonally adjusted third quarter GDP grew 2% YoY and a weak 0.2%
QoQ. This represents a sharp contraction following 2.5% YoY growth
in the second quarter. The local, export dependent economy will
struggle in 2013 on weak export demand and sluggish private
consumption. With inflationary pressure easing, the RBNZ held the
benchmark at 2.5% through the fourth quarter of 2012. The low rate is
supporting relative strength in the NZ$ which hurts export
competitiveness. Weak external demand is a constraint on corporate
job creation and unemployment rose to over 7% in the third quarter.
Consumers have support the economy with spending but we believe
that consumers are becoming more cautious and spending will trend
lower. Mr. Key’s National government is stable and carries a fragile
majority in parliament. In comparison to Russia and South Africa, New
Zealand carries low risk for investors that want exposure to a natural
resource based economy. We hold our neutral position in New
Zealand.
MARKET POSITIVES
 Expenditure on fixed investment will be a key growth driver in 2013.
Fiscal spending to repair earthquake damage is far from complete and
will accelerate in 2013. Spending on fixed investments is projected to
grow by 7.4% this year. The construction sector will be a main
beneficiary providing employment and bolstering domestic
consumption as industries return to full production.
 While CPI will be moderate this year, the rise in fixed asset spending
will consume much of the economy’s spare capacity generating
inflationary pressure. This will combine with a rising tide of imported
inflation and upward revisions to the local tax on tobacco excise tax.
We expect that CPI will remain within the RBNZ 1% to 3% target
band.
 With CPI moderate, the RBNZ held the benchmark rate at 2.5% in
its December 2012 policy meeting. We expect the bank to be on the
sidelines during the first half as Governor Graeme Wheeler
continues the bank’s wait and see watch on the economy.
 The New Zealand property market has been very strong with
elevated property prices and rents. The RBNZ has been unwilling to
fuel a property bubble with loose credit but the key driver,
reconstruction activity will continue to support the sector.
72
 In the third quarter, New Zealand’s seasonally adjusted GDP grew





2% YoY and a weak 0.2% QoQ. This represents a sharp contraction
following 2.5% YoY growth in the second quarter. The local, export
dependent economy will struggle in 2013 on weak export demand
and sluggish private consumption.
In his December 2012 policy statement, RBNZ Governor Graeme
Wheeler did not adjust the bank’s bias to reflect imminent easing.
We believe that the bank is reluctant to cut rates. This will support
continued strength in the local currency. We believe that the NZ$
will remain stubbornly strong near term
New Zealand business sentiment is weak. The BNZ performance
indexes for manufacturing, services and new orders all fell in the
fourth quarter. The NBNZ business confidence index shed almost
four points in December dropping from 26.4 to a 22.7 reading.
New Zealand’s trade deficit widened sharply in October. The
cumulative 12-month balance of payments deficit rose NZ$492
million to NZ$1,376 million. We expect that the deficit will persist.
Export growth will be under pressure this year as New Zealand’s
Asian markets moderate and the EU’s sovereign debt problems
continue to weigh on member states.
The New Zealand Dollar remains stubbornly strong. We believe that
the RBA is content with the inflation outlook and has held rates at
2.5% expressing concern that it does not want to inject more
stimulus into the hot property markets. We believe that the NZ$
will remain relatively strong in the first half of 2013 as the bank’s new
leader, Governor Graeme Wheeler, keeps the bank on the sidelines.
Through the end of the third quarter, unemployment remained
stubbornly high, increasing to 7.3%. We note that job creation is
weak in the manufacturing and export sector while rebuilding has
maintained construction employment. Overall, we expect that job
creation will remain weak in 2013 as will wage growth.
VALUATION
With price/earnings estimated ratios of 15.62x and EPS growth of +15%
New Zealand is comparative on a relative basis to Australia (14.46x and
+23%), Canada (13.18x and +16% and South Africa (13.69x and +3%).
POLITICAL
The incumbent conservative National Party government led by Prime
Minister John Key was reelected in the November 2011 general
election. Mr. Key’s National Party won 47% of the vote giving it 59
seats in the 121-seat parliament. To secure a majority Mr. Key’s
National coalition developed around the Maori Party, ACT and the
United Future Party. The four party coalition gives the Nationals 64seats, a three seat majority in parliament. This slim majority provides a
foundation from which the Nationals seek to advance key legislation.
There was bipartisan support the reconstruction spending but other
National programs face significant opposition. Specifically, we note that
New Zealand’s retirement age and public pension system is the subject
of intense parliamentary debate between Labor and the Nationals. Mr.
TIS Group January 2013 Global Markets
NEW ZEALAND REVIEW
Key’s Nationals are determined to hold the retirement age at 65 while
Labor wants to gradually increase the age to 67. The basis for the
debate targets the encroachment of late arrival age immigrants into the
pension system without having paid adequate taxes to cover their
pensions and finding a means to reduce the government’s
superannuation payout costs to New Zealand’s rapidly ageing
population. Adding to the pension problem is a growing loss of workeraged adults to Australia, which reduces tax revenues into the pension
system. The next scheduled election is scheduled for 2014. In power
since 2011, the popularity of Mr. Key’s Nations fell in recent polls while
support for the Nationals has gained. Never-the-less, National still hold
a strong poll lead over Labor but still lacks the popular support that
would give it confidence that it will win over the opposition LaborGreen bloc. We expect that the next election will be tighter than the
2011 election and much depends on how Mr. Keys handles the
economy and job creation. Overall, we see little change in New Zealand
politics in the near term and expect that Mr. Key’s Nationals will
continue to govern but a referendum is possible and the National
coalition could face difficulty retaining their fragile hold on power.
INVESTMENT STRATEGY
In the third quarter, New Zealand’s seasonally adjusted GDP grew 2%
YoY and a weak 0.2% QoQ. This represents a sharp contraction
following 2.5% YoY growth in the second quarter. The local, export
dependent economy will struggle in 2013 on weak export demand and
sluggish private consumption. The major downside risk to growth is
weak demand for natural resource and agricultural exports. The bright
side for the economy remains earthquake reconstruction.
Expenditure on fixed investment will be a key growth driver in 2013.
Fiscal spending to repair earthquake damage is far from complete in
many areas and reconstruction activities will accelerate in 2013.
Spending on fixed investments is projected to grow by 7.4% this year.
The construction sector will be a main beneficiary providing
employment and bolstering domestic consumption as industries return
to full production. In part because of extensive earthquake damage and
slow reconstruction, New Zealand’s property and rental markets have
been strong. Building permits trend series data show month over month
gains into the fourth quarter. While the central bank has been on the
sidelines holding the benchmark at 2.5%, New Zealanders have taken
advantage of relatively low borrowing costs for homes and household
credit spending.
Investor sentiment has historically gravitated toward maintaining a
stronger NZ$ on the basis of the country’s low risk profile which makes
the NZ$ a surrogate safe haven currency. This points to some level of
risk that the Kiwi will be subject to overvaluation, which will hurt
export competitiveness and give consumers leverage in purchasing
imported goods.
In November 2011, New Zealand held general elections that returned
the National Party government led by Prime Minister John Key. Mr. Key
quickly formed a coalition to secure a 64-seat majority in the 121-seat
parliament. The next scheduled election is scheduled for 2014. In power
since 2011, the popularity of Mr. Key’s Nations fell in recent polls while
support for the Nationals has gained. We expect that the next election
will be tighter than the 2011 election and much depends on how Mr.
Keys handles the economy and job creation. Overall, we see little
change in New Zealand politics in the near term and expect that Mr.
Key’s Nationals will continue to govern but a referendum is possible
and the National coalition could face difficulty retaining their fragile hold
on power.
We observe that growth in New Zealand’s economy is slowing. A bleak
export picture is partially offset by domestic reconstruction activity.
The RBNZ is holding the benchmark rate at 2.5% creating a significant
rate differential to the U.S., Japan and ECB. This turns investor attention
to fixed income at the expense of equities. In comparison to Russia and
South Africa, New Zealand carries low risk for investors that want
exposure to a natural resource based economy. We hold our neutral
position in New Zealand.
Source:
Bloomberg LP Data
We note that New Zealand’s balance of payments has slid into deficit
due to the effect of declining commodity prices coupled to weak
demand from Asian trading partners. We expect that weak external
demand will continue to put pressure on export growth this year
emphasizing the impact of reconstruction on the domestic
manufacturing sector. The central bank’s policy is permissive support
for the NZ$ which was strong in the second half of 2012. NZ$ strength
clearly affects export competitiveness and gives consumers leverage in
purchasing imported goods and services which imports inflation. As the
current account deficit grows, pressure will mount to depreciate the
currency but this runs counter to the policy bias of the RBNZ. We note
that in its December policy meeting, the Reserve Bank of New Zealand
held the benchmark at 2.5% citing moderate CPI and an unwillingness to
ease in an effort to contain the property market. We expect the bank
to be on the sidelines during the first half as Governor Graeme
Wheeler continues the bank’s wait and see watch on the economy.
Against weak external demand for exports, we note that New Zealand
consumer confidence has held up relatively well. The reserve Bank of
New Zealand has played an important role in supporting domestic
consumption by holding the benchmark at a relatively low 2.5%. We
expect that the central bank will remain the sidelines as Governor
Graeme Wheeler continues to advocate a wait-and-see approach to
managing monetary policy. We believe that the RBA is content with the
inflation outlook and has held rates at 2.5% expressing concern that it
does not want to inject more stimulus into the hot property markets.
Consequently, believe that the central bank’s inaction will support the
NZ$, allowing it to remain relatively strong in the first half of 2013.
TIS Group January 2013 Global Markets
73
RUSSIA REVIEW
CRTX Index
Bloomberg LP
S T O C K M A R KE T
C UR R E N T
RTX Index___
2192.15
P /E Estimate___
5.29x
Dividend 12 M o Yield -Gro ss ___
3.92%
2013 EP S Gro wth* ___
+4%
Current M arket Cap (Rubles/billio ns)___
509.21
Data Source: Bloomberg LP; *TIS Group
OVERVIEW
Russia’s RTX closed at 2,192 on December 31st up 12.5% YoY.
GDP slowed to a 2.9% YoY growth rate in the third quarter. Russia’s natural resource based economy will get a boost from rising
commodity prices in 2013. Weak external demand for manufactured
goods will continue to hurt Russia’s export manufacturing sector.
Consumer price inflation has been stubbornly above Bank Rossii’s
6% upper band and look to remain so. Bank Rossii tightened in September increasing the benchmark by 25bps to 8.25% and held this
rate in December. We note that domestic spending in the economy
is holding up well despite weak consumer sentiment. Mr. Putin is
Russia’s President again and we expect him to remain a hardline politician who resists overt economic reforms. Investors able to tolerate the risks inherent in Russia can benefit from this growing economy but we feel that risks have grown and we hold our slight
overweight position in Russia. Foreign investors seeking energy and
natural resource exposures can look to Canada and Australia which
offer less risk.
MARKET POSITIVES
 Global crude oil prices were steady in the fourth quarter with
Brent trading between US$112 and US$108 during the quarter. In
4Q12, prices for Russian Urals NWE and Siberian light crude averaged US$108.80/Bbl (+$0.06 per Bbl QoQ) and US$110.62/Bbl
(+0.54 per Bbl QoQ) respectively. We look for crude oil prices
to gain in 2013.
 Russia’s merchandise trade balance remained in surplus at
US$14.5 billion in October. After narrowing in July and August
the surplus gained in September and October on strong export
values. With roughly two-thirds of trade coming from oil and gas,
rising in energy prices will add to the surplus.
 The U.S. Federal Reserve decision to implement a third cycle of
quantitative easing is bullish for commodity prices. Adding to the
QE-3 boost is China's decision to inject stimulus amounting to
trillions of Renminbi targeting infrastructure development projects. Russia will benefit from Chinese demand and generally
higher commodity prices.
 Russia has a strong balance sheet. The budget is in surplus grew
from RUB285 billion in July to RUB 7887 billion in November.
The budget is heavily dependent on US Dollar based oil and gas
tax revenues which will appreciate along with global crude oil
prices. A down side to the energy picture is the potential for Ruble appreciation. The budget is Ruble based and a stronger Ruble
against the US$, will causes terms of trade and investments to result in lower returns when converted back to Rubles. This works
against the state budget surplus.
74
 After a sharp increase in September, Russian headline CPI fell back to a
6.5% YoY rate in October and November. The annualized core rate ran
6%. Headline inflation is still running above the Russian Central Bank upper 6% target band which makes loosening to defend growth problematic.
 In December, Bank Rossii held the benchmark at 8.25% citing inflationary
risks to the economy. However, the central bank raised the rate on
fixed-term deposit operations by 25bps to 4.5% and reduced the rate on
the Ruble leg of the Bank of Russia FX swap transactions by 25bps to
6.5%. By narrowing the interest rate corridor the bank holds a neutral
monetary policy stance but is set on reducing money market volatility
and increasing Ruble liquidity by lowering the swap rate.
 Russia’s labor market saw the November unemployment rate at 5.4%.
This is a 0.2% uptick from August and September but well below the
6.5% rate level seen from July 2011 through the end of 2011. Real
monthly wages continued to increase showing a 7.3% YoY gain in November. Following his election victory, President Putin promised to create 25 million jobs by 2020 fueled by a new round of privatization to decrease the number of inefficient state monopolies. With the economy
slowing, this promise will not be met and we expect employment to soften in 2013.
 Foreign investment is beginning to move back into Russia.
In the
third quarter foreign investment rose to US$114 billion from US$74
billion in 2Q12. Russia has unveiled a number of reforms that will aid
foreign investment. Beginning in 2013, global accounting rules, including
International Financial Reporting Standards (IFRS) and General Accepted
Accounting Principles (GAAP) will be compulsory for all listed Russian
companies. Importantly, the new accounting rules also apply to the majority of state-owned companies.
MARKET NEGATIVES
 Russia's GDP growth slowed in the third quarter to a 2.9% YoY rate.
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This is well below the 4.9% YoY rate in 1Q12 and the 4% YoY rate in
2Q12. We look for this energy and natural resource dependent economy to get a boost from the rebound in commodity prices in 2013. Deputy Economy Minister Andrei Klepach projects that growth will slow to
3% this year.
Output from Russia’s manufacturing sector slid in the fourth quarter.
After a peak increase of 3.4% YoY in July, output fell below 2% in October and November. Business confidence numbers in the manufacturing
and mining sector were negative in November. The data reflect weaker
demand from the external and domestic economies.
Russian consumer confidence remains weak falling 2-points to -6 in the
third quarter. Confidence index numbers have been negative since 3Q08.
We note that while confidence is subdued, domestic spending has held
up reasonably well showing above 4% YoY gains in October and November.
The decision by the United States Federal reserve to implement a third
cycle of quantitative easing effectively devalues the U.S. Dollar. This increases the cost of imported Dollar based commodities and triggers inflation. For Russia this is a mixed bag, as a net energy and hard commodity exporter higher US$ based commodity prices add to receipts but
rising input costs will be inflationary.
A rebound in commodity prices and energy prices this year will underpin
Ruble appreciation. Ruble appreciation works against export based manufacturing and makes imported goods less costly for Russian consumers.
Civil unrest directed at President Putin continues to shadow his 2012
election victory. Demonstrations underscore growing dissatisfaction
with political corruption and ineffective leadership that has not introduced reforms and improved social conditions. President-elect Putin
faces the threat of serious social unrest if he fails to deliver improved
economic conditions early in his term.
The ongoing sovereign debt issues in the EU remain a problem for Russia. As Russia’s main export market for energy, goods, and services, the
debt problems, which have slowed economic activity, are a major constraint on growth for Russia’s export oriented economy.
China and Japan are also major trade partners for Russia. With the natural disaster constraining Japan’s trade and China’s slowing economy the
combined impact of diminished demand from these two Asian markets
will impose limitations on Russia’s export trade this year.
TIS Group January 2013 Global Markets
RUSSIA REVIEW
POLITICAL
Without surprise and with little fanfare, Vladimir Putin was reelected to the presidency last year. Accompanying Mr. Putin was Dimitri
Medvedev who stepped aside from the presidency and became Mr.
Putin’s prime minister. Since the election popular support for the
leadership team has fallen. Despite the decline, Mr. Putin’s mandate
to govern is strong and supported by more than 50% of Russians in
recent polls. In his election campaign Mr. Putin made many economic promises that he has been unable to fulfill. Even though the economy will slow in 2013, Mr. Putin’s support base in United Russia
hold nearly all municipal and regional offices in Russia. This does not
prevent public demonstrations but it shields Mr. Putin from immediate threats to his office. Mr. Putin is a hardline politician with a
strong sense of possession when it comes to strengthening his hold
on power. Reforms sufficient to silence his critics and quell demonstrators will be slow to emerge from the Duma during his presidency. We also doubt that Mr. Putin will make significant concessions
to the West during his term. He will resume the hardline, semiparanoid foreign policies that characterized his first and second
terms as president. Relations with the U.S., Britain and NATO are in
for a bumpy ride and defense spending may be in vogue. This is especially noteworthy as U.S. President Obama enters his second term
and promises to implement an Asia-pivot as a key foreign policy objective. With U.S. policy focused on Asia, European disengagement
will give Mr. Putin new opportunities to make inroads that were
formerly absent. Following a weak soft power oriented Medvedev
government, the West must determine how it will deal with a resurgent-hard-power Putin government Mr. Putin has a six-year term
to mold Russia to his vision and a possible fourth term for six more
years in 2018.
VALUATION
The Russian equity market performed very well last year, recording
a 15.1% gain. The RTX carries a current P/E estimate of 5.29x, well
below many of its European counterparts, but has a dividend yield of
only 3.92%, which is lower than many other global equity markets.
INVESTMENT STRATEGY
Russia’s GDP growth continues to slow. GDP growth slowed in the
third quarter to a 2.9% YoY rate. This is well below the 4.9% YoY
rate in 1Q12 and the 4% YoY rate in 2Q12. We look for this energy and natural resource dependent economy to get a boost from
the rebound in commodity prices in 2013.
Deputy Economy Minister Andrei Klepach projects that growth will
slow to 3% this year. While this growth rate would make many EU
states very happy, it is going to make it very difficult for Presidentelect Putin to deliver on the many economic promises that he made
during his campaign. We also note that if growth slips below 3%,
Mr. Putin will be faced with an increasingly risky political environment in which he could be forced to acknowledge that his aggressive
economic growth campaign has failed. In this environment, it is likely that demonstrations against the Putin government would intensify.
Weak external demand lowered output from Russia’s manufacturing
sector. Output from Russia’s manufacturing sector slid in the fourth
quarter. After a peak increase of 3.4% YoY in July, output fell below
2% in October and November. Business confidence numbers in the
manufacturing and mining sector were negative in November. The
data reflect weaker demand from the external and domestic economies. While global demand for commodities will slowly improve in
2013 we do not believe that there will be a corresponding rebound
in manufacturing in the near future for Russia’s factories and businesses. China, now Russia’s main trading partner is slowing,
propped up by government stimulus and EU member state economies encumbered by sovereign debt problems remain fragile and
harbor significant risk to member state economies.
modity prices add to receipts but rising input costs will be inflationary.
After a sharp increase in September, Russian headline CPI fell back to a
6.5% YoY rate in October and November. The annualized core rate ran 6%.
Against the backdrop of a slowing economy, Russia’s headline inflation is
still running above the Russian Central Bank upper 6% target band which
makes loosening to defend growth problematic. Another downside to rising
energy prices is the end of sharp Ruble depreciation that began in the second quarter. Ruble appreciation works against export competitiveness
and gives Russian consumers to buy imported goods rather than goods
produced domestically. We note that in December, Bank Rossii held the
benchmark at 8.25% citing inflationary risks to the economy. However, the
central bank raised the rate on fixed-term deposit operations by 25bps to
4.5% and reduced the rate on the Ruble leg of the Bank of Russia FX swap
transactions by 25bps to 6.5%. By narrowing the interest rate corridor the
bank holds a neutral monetary policy stance but is set on reducing money
market volatility and increasing Ruble liquidity by lowering the swap rate.
The bank’s decision to defend against CPI rather than to accommodate
growth directly with monetary policy through a rate cut exposes the Ruble
to appreciation. We believe that a rebound in commodity prices and energy
prices this year will underpin Ruble appreciation. Ruble appreciation works
against export based manufacturing and makes imported goods less costly
for Russian consumers.
The private sector has been relatively strong despite weak consumer confidence. Russian consumer confidence fell 2-points to -6 in the third quarter
which extends the string of negative numbers that began in the third quarter of 2008.We note that while confidence is subdued, domestic spending
has held up reasonably well showing above 4% YoY gains in October and
November. In this regard we note that following his presidential election
victory, President Putin promised to create 25 million jobs by 2020 fueled
by a new round of privatization to decrease the number of inefficient state
monopolies. This rhetoric resonates with Russians but with the economy
slowing and manufacturing under pressure from weak demand, it is going to
be impossible for President Putin to deliver on many economic promises
that he made during his campaign. With the economy slowing, and manufacturing unable rebound we expect employment to soften in 2013.
In May, Vladimir Putin was installed as Russian President after his resounding March 2012 election victory. We believe that Mr. Putin remains a hardline politician with a strong sense of possession when it comes to strengthening his hold on power. Reforms sufficient to silence his critics and quell
demonstrators will be slow to emerge from his presidency. We do not
believe that Mr. Putin will make significant concessions to the West. He
will resume the hardline foreign policies that characterized his first and second terms as president. Relations with the U.S., Britain and NATO are in
for a bumpy ride and defense spending may be in vogue during Mr. Putin’s
term. This is especially noteworthy as U.S. President Obama enters his second term and promises to implement an Asia-pivot as a key foreign policy
objective. With U.S. policy focused on Asia, European disengagement will
give Mr. Putin new opportunities to make inroads that were formerly absent.
The Russian economy is still performing well relative to many EU member
states. We expect that demand for Russian energy and natural products will
begin to slowly recover in 2013. Investors able to tolerate the risks inherent in Russia can benefit from this growing economy and rising commodity
prices. However, the risks in Russia remain substantial compared to natural
resource based economies in Canada and Australia. We hold our slight
overweight position in Russia as Russian stocks are cheap.
Source: Bloomberg LP Data
We also note that the decision by the United States Federal reserve
to implement a third cycle of quantitative easing effectively devalues
the U.S. Dollar. This increases the cost of imported Dollar based
commodities and triggers inflation. For Russia this is a mixed bag, as
a net energy and hard commodity exporter higher US$ based com-
TIS Group January 2013 Global Markets
75
SCANDINAVIAN REVIEW
Eiu
DJ Nordic Index
Bloomberg LP
S T O C K M A R KE T C UR R E N T
DJ Sto xx No rdic Index___
1420.32
P /E Estimate___
13.69x
Dividend 12 M o Yield -Gro ss ___
3.33%
Current M arket Cap ___
4665.74
2013 EP S Gro wth* ___
+20%
Data Source: Bloomberg; *TIS Group
OVERVIEW
Finland’s resource based OMX Helsinki Index closed at 5,801 on December
31st up 8.3% YoY. Norway’s energy based OBX closed at 410 up 14.7%
YoY. Denmark’s defensive Copenhagen 20 Index closed at 496 up 27.2%
YoY. Sweden’s OMX Stockholm 30 Index closed at 1,105 up 11.8% YoY.
Economic growth slowed across Scandinavia. Only Norway’s energy dependent economy is showing signs of holding growth to a respectable level this
year. Finland, Denmark and Sweden contracted sharply in the second half.
Scandinavia’s major trading partners in the EU remain under the weight of
sovereign debt problems and the associated bailouts that continue to dampen
demand for Scandinavian goods and services exports. Regionally, consumer
sentiment has been weak and private consumption is not able to offset the
decline in external demand. Inflationary pressure is subdued giving the region’s central banks room to adjust policy to promote growth. Political sentiment in Scandinavia is shifting back to the conservative right as voters suffer
from the effects of weak economic growth. We hold a slight overweight
position in Norway where the energy-dependent economy will benefit from
ongoing energy demand despite weak prices. We are neutral in Denmark
were the market’s reputation as one of Europe’s most defensive equity markets and some energy support will help it weather the Eurozone turmoil.
We expect that growth in Sweden will slow and hold a slight underweight.
We also maintain an underweight position in Finland where Euro membership marks the economy for greater exposure to the ongoing EU sovereign
debt problems.
POLITICAL
Denmark: Denmark’s center-left Social Democratic government led by
Prime Minister Helle Thorning-Schmidt has been in power since September
2011. Prime Minister Thorning-Schmidt’s Social Democrats do not hold a
clear majority forcing them to govern by coalition. Support for the governing
“Red-bloc” coalition (the Social Democrats, the Social People’s Party and the
Social Liberal Party) has slid in recent polls as many swing voters have begun
to show support for the center right. The ruling Red bloc has maintained a
level of fiscal austerity, introducing caps on public spending. This along with
welfare and labor market reform are part to the coalition’s objective of fiscal
consolidation and boosting job growth in the private sector. Implementing
labor reform will be difficult. New regulations that took effect on January 1st
terminated employment benefits for many Danes that were long-term unemployed. The government estimated that 12,500 jobs were needed in an accompanying program that made acute jobs available to the long-term
unemployed. However, most jobs were taken by other than the chronic
unemployed target population suggesting that attempts to recruit prospective
workers from the ranks of the unemployed will be very difficult. Additionally,
in 2014, the center left government plans to increase the early-retirement
age gradually from 60 to 65. Ms. Thorning-Schmidt’s tax reform agenda will
subject Danes to the reality of the higher taxes needed offset the govern-
76
ment’s fiscal stimulus and the state’s existing legacy of social welfare programs. These issues represent a departure from pre-election campaign
promises. Consequently, the center-left’s “new” reform agenda has not been
well received by voters prompting swing voters to shift political alliance to
the center right. While inside the EU, Denmark is not in the Eurozone which
mitigates some aspects of the Euro centric financial crisis. This will help the
Red bloc manage the economy but we believe that the Thorning-Schmidt
Red bloc coalition government will be forced into an early election the will
shift governance to a center right stance.
Finland: Finland’s first Conservative president in 50-years, President Sauli
Niinistö, has been in office for nearly one year. Mr. Niinistö’s government
coalition consists of the National Coalition Party (KOK), the Social Democratic Party (SDP), the Left Alliance (VAS), the Green Party (VIHR), the Swedish People's Party (RKP) and the Christian Democrats (KD). This is a
diverse, complex government that spans the political gamut from right to left.
Holding the coalition together for the full four year term until 2015 will test
Mr. Niinistö’s political abilities while he tries to press forward on key legislative issues. The recent downturn in the economy paralleled a sharp drop in
consumer spending reflecting growing consumer (voter) concern about the
government’s management of the economy. The government’s agenda to
promote domestic fiscal restraint to reduce debt and add new taxes coupled
may be difficult to maintain as the economy sags. The new taxes appear to
be directed at the wealthy and large corporations and sparing of small and
medium sized businesses where confidence levels are now very weak. We
believe that the new Conservative government will struggle to keep the
coalition on course and we feel that the risk that the government will not
survive its four-year parliamentary term is significant.
Norway: Norway’s Labor Party led red-green coalition government faces
re-election in September 2013. Prime Minister Jens Stoltenberg’s Labor led
coalition government has slipped in the polls from his 2009 election rating of
47.8% approval to the current 37.9% level. The opposition is running close to
60% approval. However, the economy remains Scandinavia’s strongest due to
the booming energy sector. We look for the coalition to survive until the
2013 election but the conservative opposition has made gains that threaten
to unseat Mr. Stoltenberg in September. The Labor led Coalition’s centrist
politics remain fixated on retention of the status quo with a bent toward
providing incentives for workforce participation. We look for Norway to
aggressively move offshore oil and gas exploration and development into the
Barents Sea as production from North Sea fields decline. Energy remains the
cornerstone of the economy supporting spending on education and
healthcare, the centerpieces of Norway’s social welfare programs. Based on
current voter support levels, which are soft for Labor, we look for Mr. Stoltenberg's Labor led coalition to continue until next election in 2013 but the
risk that he will be unseated has risen.
Sweden: Sweden’s center-right Alliance led by Prime Minister Fredrik Reinfeldt's Moderates remains a stable government and should continue until the
next election in 2014. However, the four party coalition composed of Mr.
Reinfeldt’s Moderates, the People's Party Liberals, the Christian Democrats
and the Center Party does not have a parliamentary majority. This gives the
center-left bloc leverage in derailing Alliance initiatives is key policy areas.
However, the center-right coalition bloc is somewhat protected from defeat
on important issue that could precipitate dissolution of the Riksdag because
all major parties shun the far-right Sweden Democrats which limits the ability
of the opposition to form a cohesive coalition. Also, under the constitution, a
new coalition would only have until the September 2014 election before it
too faced re-election. The rapid deterioration of the economy is becoming a
major factor for the survival of Mr. Reinfeldt’s government. The Alliance is
concentrating its domestic policy focus on stimulating the economy, increasing employment through economic incentives for workers based on tax cuts
and benefit reforms. Overall, we feel that Prime Minister Reinfeldt's Alliance
should survive to the scheduled 2014 elections but the potential for reelection is in doubt and highly contingent on his management of the economy.
MARKET POSITIVES
 Denmark’s government remains focused on containing the budget deficit.
Debt is expected to be less than 30% of GDP this year and into 2013.
Stringent fiscal restraint in the face of the Eurozone’s debt crisis bolsters
Denmark safe haven status.
TIS Group January 2013 Global Markets
SCANDINAVIAN REVIEW
 Recent polls indicate that Danes are more Euro-sceptic than ever. As
of 1Q13, the government of Helle Thorning-Schmidt has not committed
to joining the forthcoming European banking union which is compulsory
for the 17 Eurozone members. The new banking union is set to commence in March 2014 to provide new oversight of the EU banking sector.
 New numbers from Statistics Denmark suggest that only one in five
domestic businesses moved jobs out of the country between 2009
and 2011. This is slightly less than during the period between 2001
and 2006.
projected to increase the budget deficit to 0.8% of GDP this year and 0.2%
in 2014.
 Through the end of November, Sweden’s trade balance and current account remained in surplus. However, we expect both to remain under
pressure in the first half of 2013 as external demand remains weak in the
Eurozone.
MARKET NEGATIVES
 Denmark’s economy contracted in the second and third quarters of 2012.
 Denmark’s rate of inflation ticked down to a 2.3% rate in October and
November. We expect upward pressure on CPI in 2013. Increasing producer prices will be passed along to consumers and food costs are expected to rise on concerns that widespread drought in 2012 will curtail
global crop yields.
 In July Denmark’s central bank cut the benchmark by 25-bps in to 0.2%
making the effective rate negative. The bank remains in full stimulus mode,
and it will keep rates low to support the economy this year.
 Finland’s national CPI rate eased in November and declining energy costs.
The headline rate ticked down to a 2.2% rate from a 2.6% rate in October.
 We note housing prices in Finland moderated in the second quarter.
While we look for prices in the housing market to generally follow the
economy lower, we believe that low lending rates and scarce property
supply will support the property sector keeping the market relatively stable.
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 The Bank of Finland is locked into following the ECB monetary policy
and matching rates. Through December, the ECB policy remained at
a loose 0.75% rate to provide stimulus. The ECB faces the prospect
that the Eurozone economy will contract more than previously expected this year and recovery will be slow. ECB rates are likely to
move lower.
 While Norway’s economic growth is slowing, the economy remains Scan-
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dinavia’s strongest. Norway’s real, seasonally adjusted GDP contracted
0.8% QoQ in the third quarter. Statistics Norway cut its 2013 growth
forecast excluding the energy sector from 3.1% to 2.9%.
Norwegian investments in oil and gas, roughly 20% of the economy, will
rise to NOK207.8 billion in 2013 from NOK180.6 billion in 2012. Energy
companies are running at near capacity to explore and develop recent offshore discoveries.
Norway is set for record investment in oil and gas this year and next. The
government projects that it will invest NOK204 billion in 2013 following
the estimated NOK185 billion that will be invested this year.
Norges bank held the 1.5% benchmark rate in December but maintained
its upward policy bias. The bank is dealing with rising inflationary pressure.
CPI accelerated from a 0.5% rate in August and September to a 1.1% YoY
rate in September and a 1.3% YoY rate in October. We expect that a tight
labor market and a hot real estate market will continue to put upward
pressure on CPI.
Norway’s labor market remains tight. The unemployment rate moved
fourth quarter to 2.3. The booming energy sector and construction activity fueled by the hot property market will keep the labor market tight.
Norway’s consumer confidence rose to a 25.4 reading in the fourth quarter. Confident consumers drove retail spending higher. We expect domestic spending to hold up well this year as employment prospects are good
and tight labor pool held wage growth.
Sweden’s CPI is declining as the domestic economy slows. The HICP
adjusted headline rate fell to a 0.8% YoY rate in November while the
HICP adjusted core rate fell to 0.5% YoY. We expect that CPI will remain
tame in 2013 giving the Riksbank room to loosen for stimulus.
Sweden’s Riksbank cut its benchmark rate by 25bps to 1% in December.
The bank will be in stimulus mode until the economy shows signs of improvement.
Sweden’s unemployment rate ticked up in November to 7.5% from 7.1%
in October. Third quarter data show that job openings fell 6.8% QoQ. fell
from June’s 8.8% rate to 7% in July. With good job prospects, consumer
sentiment is holding up well. July retail sales rose 2.4% YoY.
Sweden’s government plans to spend 0.7% of GDP on infrastructure,
research and corporate tax cuts this year to cushion the economic This is
TIS Group January 2013 Global Markets
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Real GDP fell 0.5% YoY in 3Q12 and 1% YoY in 2Q12. The impact of the
country’s housing decline and banking problems have been key factors in
the contraction. With the rest of Europe in a slump, we feel that Denmark will continue to struggle in 2013 but growth should turn positive this
year.
Consumer confidence remains weak. Although November confidence
ticked up, it was still negative. Danes worried about the economy aren’t
spending and 4Q12 retail sales numbers were down ahead of the Christmas shopping period.
Although the government is trying get unemployed Danes back to work
by curtailing unemployment benefits and social welfare, the unemployment
rate remains above 7% and chronic unemployment is a problem.
New regulations that took effect on January 1st terminated employment
benefits for many Danes that were long-term unemployed. An estimated
12,500 jobs were needed in an accompanying program that made acute
jobs available to the long-term unemployed. However, most jobs were
taken by other unemployed suggesting that attempts to recruit prospective workers from the ranks of the unemployed will be very difficult.
After Denmark’s industrial production rose in May to August period,
production slumped on falling order flow. We note producer prices rose
3.5% YoY in October and 3.4% YoY in November
External demand for Denmark’s goods and services remains weak. Seasonally adjusted exports fell 0.8% QoQ in the third quarter.
The Danish Krone is pegged to the Euro at DKR7.46:UEU1 ±2.25% which
helps with intra-EU trade. However, the Krone strengthened against the
US Dollar in the fourth quarter which will hurt export competitiveness.
Weak demand is depressing the price of crude oil. Denmark’s energy
output is projected to fall sharply. The DEA's five-year forecasts a fall in
oil production from 15.2 million cubic meters in 2009 to 10 million cubic
meters in 2014. Likewise, the volume of natural gas will fall from 7.3 billion cubic meters to 4.5 billion cubic meters. By 2018, Denmark is expected to shift from net energy exporter to a net importer.
Finland’s real, seasonally adjusted GDP contracted by 1.2% QoQ in the
third quarter. Annualized growth was negative in the second and third
quarters. The slump was broad based with weak domestic demand and a
similar decline in external demand that hit exports hard.
Although Finland’s unemployment rate fell from above 9% in 2Q12 to
under 7% in October, we expect job growth to stall as the economy contracts. Consumer sentiment is weak and will remain so taking retail spending lower as overall consumer demand falls.
Through November, Finland’s annualized industrial production has been in
decline every month except July. Weak external and internal demand will
continue to constrain the manufacturing sector. Manufacturing confidence
hit minus 14 in November, the lowest reading since November 2009.
Finland’s financial sector will be hit by a new “tax” in the form of the Eurozone bailout reserve fund levy. This is major concern because banks are
already struggling, the economy is struggling and recovery from the Eurozone debt problem is distant.
Norwegian households are among the most indebted in Europe. A debt
to income ratio of 200% underscores the problem. We note that the
property market has been very strong and that the IMF and the OECD
have warned that Norway is at risk of a housing bubble.
Norway’s energy sector is the main propellant for economic growth.
Weaker global crude oil prices and Eurozone problems will slow demand
for refined products and natural gas as well as manufactured goods and
services exports.
The Norwegian Krone remains stubbornly strong to the chagrin of exporters. The performance of Norway’s energy based economy and con-
77
SCANDINAVIAN REVIEW
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tinued investment in new discoveries in the Barents Sea will continue to
support the Krone and drive hot money inflows.
The booming oil and gas sector has attracted a large immigrant workforce.
This adds to housing demand which inflates real estate prices and plays to
the conservative, nationalist politics that were behind the Utoya Island violence in July 2011.
Sweden’s economy is slumping. In the third quarter, real, seasonally adjusted GDP rose a modest 0.7% YoY and QoQ growth slid to 0.5%. We expect that the economy will contract sharply this year with growth slowing
to less than 1% this year. The recessionary environment will take a toll on
jobs and domestic spending.
Sweden’s unemployment rate ticked up in November to 7.5% from 7.1%
in October. Third quarter data show that job openings fell 6.8% QoQ.
Near term, we don’t look for the labor market to show signs of improvement.
Swedish private debt is at a record 173% of disposable income. Much of
this debt load is being driven by an increase in property prices.
The Swedbank PMI sank to a 43.21 reading in November. The poor performance in manufacturing reflects weak order data from both domestic
and external sources.
Currency appreciation is a problem for Sweden’s export competitiveness.
In the second half of 2012, the Swedish Krona strengthened against the US
Dollar. After hitting a 12-year high of SEK8.18EUR1 against the Euro in
August the Krona weakened to near SEK8.6:EUR1 at the end of the fourth
quarter. We expect the Krona to remain strong against the Dollar but the
weaker Euro cross rate will persist in the near term aiding export competitiveness in the Eurozone.
VALUATION
Swedish stocks have an average P/E of 12.95x. Compare that to Norway’s 10.53x, Finland’s 19.33x, and Denmark’s 15.00x.
INVESTMENT STRATEGY
Economic growth in Scandinavia slowed in each of the four economies
covered in this report. Only Norway’s energy dependent economy is
weathering the Eurozone storm reasonably well. Sharp growth contractions in Denmark, Finland and Sweden are reason for concern contracted. These were subject to weak external demand from Eurozone
trading partners and weak domestic demand.
Consumer price inflation will be subdued across the region this year as
growth slows. CPI has been subject to weak commodity prices and
weak energy prices. In Sweden and Norway, strong currencies provided
a shield against CPI by lowering the cost of goods and services sourced
from external suppliers. Sweden’s Riksbank cut its benchmark rate by
25bps to 1.0% in December. We also note that Denmark’s Nationalbanken cut the benchmark by 25bps in August to 0.2% where it remained through the end of the fourth quarter. Norway’s Norges Bank
has been on the sidelines holding its benchmark at 1.5% in December
but noted that its policy bias is for tightening to combat rising inflationary pressure. Finland’s benchmark rate is tied to the ECB which stood
at 0.75% in December. Despite Norges Bank’s policy bias, Scandinavian
consumer price inflation is being held at a very low rate by Eurozone
sovereign debt problems and weak global growth.
As we note that strong domestic currency in Norway is due primarily
to the energy dependent strength of the economy acting as an attractant for investors seeking a safe-haven and for speculative money inflows.
This will serve to support a stronger Krone even with Norges bank on
the sidelines. In Sweden, the Riksbank’s rate cut will ease pressure on
the Krone which has weakened against the Euro. Finland is in the Eurozone and Denmark’s Krona is pegged to the Euro which will support a
weaker currency.
Demand for goods and services from Scandinavia’s major export markets in the EU remains very weak due to the persistence of the Eurozone’s debt problems. The potential for other member state sovereign
debt defaults looms as an ongoing concern and dissolution of the EU
remains a strategic concern. The acute phase of the crisis may be over
but the EU’s main growth drivers are in disarray and Eurozone economies are in no position to experience a turnaround recovery in short
order that boosts demand for Scandinavia’s exported goods and ser-
78
vices. We foresee little help for export demand from outside the EU.
Growth in India and China, Asia’s two main growth drivers have slowed
and the U.S. economy is not well positioned for a sharp increase in
export demand this year.
Scandinavia’s economies continue to support some of the world’s most
robust social welfare programs. Welfare programs are addictive alternatives to private sector jobs that contribute to productivity and economic growth. Across Scandinavia, governments faced with the choice of
curtailing fiscal spending to contain budget deficits are also facing the
prospect of increasing taxes to pay for the stimulus monies that have
already been doled out on public programs. As domestic economies
contract, governments have few options but to maintain stimulus. Consequently there are no easy solutions to the social welfare/future tax
problem. We note that in Denmark, unemployment benefits ended on
January 1st for the long-term unemployed. Attempts to lure these
workers into new “acute jobs” has not worked well. This underscores
the difficulties facing these benefits oriented economies. We expect
Scandinavia’s elected governments to try to choose a middle ground,
preserving the social welfare programs and avoiding tax reform while
they bide time hoping that the EU recovers enough to support economic expansion in their respective domestic economies. We do not believe that this option will exist for several years and Scandinavia’s
economies will continue to struggle under debt burdens attributable to
social welfare systems.
We note that sentiment in Scandinavia’s manufacturing sector remains
generally weak even in Norway where the energy sector is the cornerstone of the economy. Consequently, broadly based employment
growth will be nil again this year with job opportunities confined to key
industries such as Norway’s booming energy sector and construction
industry driven by a robust property market. The unemployed and
those unwilling to work will continue to seek benefits under government social benefit programs which exacerbates the welfare problem
that these governments are trying to solve. Scandinavia’s welfare programs are robust, entrenched, very costly to government budgets and
unlikely to disappear anytime soon.
Political sentiment in Scandinavia underwent a shift from support for the
conservative right in favor of centrist politics. This was mainly based on
the tragic Utoya Island shootings by a Norwegian ultra-conservative
nationalist citing resentment over a rising tide of immigrants. While the
shift away from politically conservative nationalism is still evident, deterioration in economic conditions are a hardship for many voters many
of whom are the beneficiaries of social benefit programs. This makes
anti-immigration sentiment difficult to avoid. We believe that a return
to the conservative right within the urban workforce is now underway
rebalancing political support to the conservative right. Quick economic
recoveries are out of the question this year and agonizingly slow recoveries may not become apparent until late 2013 or 2014. We believe that
economic frustration directed at immigrant workers may actually become an element of economic recovery and a strategic foundation for a
resurgence in nationalistic politics that will become evident in the September 2013 election in Norway.
Scandinavian economies will struggle this year as the Eurozone’s debt
problems weigh heavily on all member state economies. We hold a
slight overweight position in Norway where the energy-dependent
economy will benefit from ongoing energy demand despite weak prices.
We are neutral in Denmark were the market’s reputation as one of
Europe’s most defensive equity markets and some energy support will
help it weather the Eurozone turmoil. We expect that growth in Sweden will slow and hold a slight underweight. We also maintain an underweight position in Finland where Euro membership marks the
economy for greater exposure to the ongoing EU sovereign debt problems.
Source:
Bloomberg LP Data
TIS Group January 2013 Global Markets
SINGAPORE REVIEW
Strait Times Index
corporate tax rates in Singapore fell by some 3% to 17% over the
past five years.
 Singapore’s FY12/13 state budget expenditure of some S$50.28
billion, 14.2% of GDP was a 5.8% increase over FY11/12. The
looming FY13/14 budget which will be announced in February is
expected to show an increase aimed a supporting growth in the
sluggish economy.
 In September, Standard and Poor’s reiterated its triple-A long term
Bloomberg LP
S T O C K M A R KE T
C UR R E N T
Straits Times Index___
3218.26
P /E Estimate___
14.49x
Dividend 12 M o Yield -Gro ss ___
2.89%
2013 EP S Gro wth* ___
-15%
Current M arket Cap (S $ / billio ns)___
530.95
Data Source: Bloomberg LP
OVERVIEW
The Straits Times Index closed at 3,167 on December 31st, up 19.7%
YoY. Singapore’s export oriented economy slowed in 2012 and we
believe that 2013 will present a similar, sluggish external demand environment. Crude oil and pharmaceuticals supported Singapore's balance
of payments surplus through the fourth quarter. Consumer sentiment
declined in the fourth quarter. Domestic spending ex-autos showed
gains but consumers are very cautious with big-ticket items. We expect
that full year headline inflation in 2013 will be inside the MAS 4% to 5%
band. CPI drives will be the robust property market and transportation.
MAS policy continues to allow gradual appreciation in the Singapore
Dollar In politics, Singapore’s PAP led by Prime Minister Lee Hsien
Loong is in tight control of government but voter frustrations are rising
and stronger opposition politics are a threat to the PAP’s long supremacy. We look for the local market to perform respectably this year.
Singapore offers foreign investors a stable market relatively free from
political risk. However, the risk of slower growth will put pressure on
corporate earnings. We adopt a slight overweight position in Singapore.
MARKET POSITIVES
 After rising above 5% in the March to June period, the annual rate of
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consumer price inflation moderated in the second half of 2012. Headline CPI ran at a 3.6% YoY rate in November. We expect that full
year headline inflation will be inside the MAS 4% to 5% band. CPI
should be moderate in 2013 and remain inside to MAS band.
In December, Singapore and the European Union signed a bilateral
free-trade deal. he timeline for implementation of the agreement differs. For Singapore, import tariffs were lifted immediately, while the
EU has five years to restructure its tariffs.
Industrial production rose sharply in November on pharmaceutical
demand. Production rose at a 3.1% YoY rate against a three consecutive months of contraction in the August to October period. The
manufacturing PMI was still a pessimistic 48.8. Weak external demand
from the EU and Asian trading partners will remain a problem for this
export economy in 2013.
Singapore’s oil exports grew at a 9.9% YoY and 1.5% YoY rate in
October and November respectively. Moderate strengthening of
crude prices in 2013 will benefit Singapore.
Singapore-listed REITs have current yields of between 6% and 7%,
compared with a local interest rate of only 0.25% on 12-month S$
deposits. We expect that investors will remain interested in Singapore’s REITs this year. The robust property market will remain a key
factor in rising inflationary pressure this year.
 Singapore is strategically situated to become the hub for com-
modities trading in Asian markets. A key factor that favors Singapore’s ascent is the city-state’s low tax environment. Official
TIS Group January 2013 Global Markets
sovereign debt rating for Singapore. The excellent rating decreases
borrowing costs and underscores Singapore’s low-risk profile for foreign investment.
 The November 2012 reelection of U.S. President Obama to a second
term emphasizes his foreign policy rebalancing to focus on Asia and
less on Europe. Greater U.S. interest in Asia has benefits for regional
stability.
MARKET NEGATIVES
 Singapore's economy contracted sharply in the third quarter of 2012.
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Real GDP fell to a 0.3% YoY growth rate from 2.5% YoY in the second quarter. On a quarter-on-quarter basis, GDP contracted by 5.9%. The impact of weak external demand for exports will push
2012 growth to a three year low near 1.5%. Sluggish export demand
will continue to impeded growth in 2013 with full year growth showing only slight improvement.
Singapore's merchandise trade balance remains in surplus. The trade
balance has been relatively stable near S$80 billion in the second half
of 2012. Never-the-less we see persistent weakness in the non-oil
export picture this year. Domestic electronics export have contracted sharply. With China and India slowing and the EU bogged down
with debt bailout costs we expect the external demand will remain
weak. This shifts much of the economy’s growth emphasis to domestic spending which is problematic on weak consumer sentiment.
Singapore’s labor market is very tight, running at a low unemployment rate of 1.9% in the third quarter. The 14-year low in unemployment is putting inflationary, upward pressure on wages.
Consumer sentiment plunged in the second half of 2011, was weak in
the first half of 2012 and showed little improvement in the second
half. Retail spending growth fell from high of 19.9% YoY in February
2012 to a 1% YoY contraction in October. Ex-autos, retails sales rose
each month during the August to October period. We look for consumers to remain cautious about big-ticket discretionary items as the
economy slows and external demand affects job creation.
The Monetary Authority of Singapore reviews its currency stance in
October and April. In its October policy meeting the MAS unexpectedly refrained from slowing the Singapore Dollar’s appreciation despite signs of a rapid deceleration in GDP growth. Consequently we
expect that the MAS will maintain a modest and gradual appreciation
of its currency in April. Through December, the MAS held the prime
lending rate at 5.38% and has the overnight rate at 0.3% and the 3month deposit rate 0.31%.
The MAS’ inflexible rate policy isn’t providing a much needed brake
on the property market. Growth in Singapore REITs driven by asset
acquisitions and rental appreciation outpaced gains in the U.S., U.K.
and Japan. The property market remains a source of inflationary
pressure in this economy. A Stamp Tax on property sales was set at
10% which should cool off the property markets.
VALUATION
The Straits Times Index has a P/E ratio of 14.49x, a dividend yield of
2.89%, and an estimated EPS growth of -15%. These numbers compare
relatively well to its regional counterparts. P/E and dividend yield comparative figures are Hong Kong (11.33x, 3.03) and Japan (19.60x, 1.89).
POLITICAL
Prime Minister Lee Hsien Loong handily won the last general election in
May 2011 extending the PAP’s strangle hold on power. With a commanding majority of 81 of 87-seats in parliament, the PAP faces little
79
SINGAPORE REVIEW
opposition to its legislative agenda. We expect that the Lee led PAP will
retain it firm grip on power until the next parliamentary election which
is not scheduled until 2016. Despite the strength of the PAP, we note
that the opposition made gains in the May 2011. In May 2012, an opposition Worker’s Party candidate, Png Eng Huat running in a by-election
convincingly won, keeping his parliamentary seat. The by-election result
is not a direct challenge to the PAP’s power, but is a clear indication
that voters frustrated with the PAP are willing to vote for opposition
candidates. Mr. Loong has been far too slow in bringing the PAP into
the twenty first century and dealing with young Singaporean voters
which are the key to the party’s long term success. We note that the
PAP recently opened a www site seeking input from the population on
the FY13/14 budget. We feel that voter sentiment in Singapore is shifting toward more liberal politics that increase representation of opposition politics in government. Overall, we feel that demographics are
working against the staid, entrenched politics of the PAP and its future
control of political process in Singapore. The 2016 election could mark
the beginning of a period in which the political opposition forms a credible framework from which to challenge the incumbent PAP.
INVESTMENT STRATEGY
Singapore's economy contracted sharply in the third quarter of 2012.
Real GDP fell to a 0.3% YoY growth rate from 2.5% YoY in the second
quarter. On a quarter-on-quarter basis, GDP contracted by -5.9% following contractions in the first and second quarters. The impact of
weak external demand for exports will push 2012 growth to a threeyear low near 1.5%. Sluggish export demand will continue to impeded
growth in 2013 with full year growth showing only slight improvement.
With China and India slowing and the EU bogged down with debt
bailout costs we expect the external demand will remain subdued. Although Singapore's merchandise trade balance remains in surplus, holding
a relatively stable S$80 billion in the second half of 2012. Never-the-less,
we see persistent weakness in the non-oil export picture this year noting that pharmaceuticals demand has been good but the dominant electronics export sector contracted sharply in the fourth quarter. With
China and India slowing and the EU bogged down with debt bailout
costs we expect the external demand will remain weak. Against weak
performance in the manufacturing sector, Singapore’s oil exports rebounded early in the fourth quarter. Moderate strengthening of crude
prices in 2013 will benefit Singapore but energy alone cannot entirely
compensate for weak external demand for goods and services. Overall,
business sentiment is very weak and we do not feel that global conditions are favorable for a near term pick-up in external demand so the
near term trend in manufacturing will reflect continued pessimism. This
shifts much of the economy’s growth emphasis to domestic spending.
This shifts much of the economy’s growth emphasis to domestic spending which is problematic on weak consumer sentiment.
We do not believe that the economy can expect much help from domestic spending in the first half of 2013. Consumer sentiment is weak.
This is reflected in retail sales data that shows consumer purchases fell
from an annualized growth rate of 19.9% YoY in February to a to a 1%
YoY contraction in October. This is primarily due to consumer caution
in purchasing big-ticket items. Ex-autos, retails sales rose each month
during the August to October period. We look for consumers to remain cautious about big-ticket discretionary items as the economy remains sluggish this year. One bright spot for consumerism is the job
market. Singapore’s labor market is currently very tight, running at a
low unemployment rate of 1.9% in the third quarter. Demand is high for
skilled IT applicants in the financial sector where continued expansion is
draining the pool of the skilled applicants. A factor that irks Singaporeans is the large number of foreign immigrant workers in Singapore.
Estimates put the number jobs held by foreigners at roughly 30%. This
has ramifications for the political process in Singapore. In this regard we
note that the government’s FY12/13 budget targets this problem with
provisions designed to reduce in the dependence on foreign workers
and to attract and retain citizens in the workforce. Low unemployment
underpins consumerism but puts inflationary upward pressure on wages.
rency management policy. The central bank continues to use a managed
S$ as its main monetary tool, not benchmark interest rate policy. The
MAS strategy has been to allow the S$ to appreciate to fend off rising
CPI. The MAS reviews its currency stance in October and April. We
note that in its October policy meeting the MAS unexpectedly refrained
from slowing the Singapore Dollar’s appreciation despite signs of a rapid
deceleration in GDP growth. Consequently, we expect that the MAS
will maintain a modest and gradual appreciation of its currency in April
when it next meets to consider policy. Through December, the MAS
held the prime lending rate at 5.38% and has the overnight rate at 0.3%
and the 3-month deposit rate 0.31%. While the MAS is constantly on
guard for inflationary containment, the static interest rate environment
has done very little to curb activity in Singapore’s property markets.
Growth in Singapore REITs, driven by asset acquisitions and rental appreciation, outpaced gains in the regional Asian markets, the U.S., U.K.
and Japan. The property market remains a source of inflationary pressure in this economy acting to counter the MAS currency management
actions.
In politics, Singapore’s PAP led by Prime Minister Lee Hsien Loong is
entrenched and is in firm control of parliamentary process with a commanding majority holding 81 of 87 seats. However, there is an undercurrent of political discontent among younger Singaporeans that poses a
strategic problem for the PAP’s dominance of politics. The willingness
of voters to vote for the opposition was evident in the recent May byelection that saw an opposition candidate hold his parliamentary seat
despite strong campaigning by the PAP. We feel that demographics are
working against the PAP and its future control of the political process in
Singapore. This is reflected in a growing trend toward opposition politics displayed by younger, digitally enabled voters who find the opposition more to their liking. The next election scheduled for 2016 could
mark the beginning of a period in which the political opposition forms a
credible framework from to challenge the incumbent PAP.
Singapore’s export dominated economy slowed in 2012 and will struggle
with modest improvement in 2013. Singapore offers foreign investors a
stable market relatively free from political risk. The government’s strong
budget surplus prompted S&P and Moody’s to give the city state strong
credit ratings that underscore its ability to withstand global financial
shocks. We also see Singapore growing in importance as a hub for As
ian financial transactions. However, the risk of slower growth will put
pressure on corporate earnings this year. We feel that Asian’s general
slowdown and rising inflation will take a toll on Singapore’s market in
the near term. We see the economy improving slowly this year and
adopt a slight overweight position in Singapore.
Source:
Bloomberg LP Data
The Monetary Authority of Singapore must simultaneously contend with
rising CPI and slowing growth. This combination complicates its cur-
80
TIS Group January 2013 Global Markets
SOUTH AFRICA REVIEW
Johannesburg All Share Index
sure. Weakness reflects the widening current account deficit and sluggish
demand from Europe that is putting a brake on economic growth.
MARKET NEGATIVES
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Bloomberg LP
S T O C K M A R KE T
C UR R E N T
FTSE/JSE A frica To p 40 Index___
40162.56
P /E Estimate___
13.69x
Dividend 12 M o Yield -Gro ss ___
3.07%
2013 EP S Gro wth* ___
+3%
Current M arket Cap (SA Rand/blns)___
7625.27
Data Source: Bloomberg LP; *TIS Group

OVERVIEW
The Johannesburg All Share Index closed on December 31st at 34,796 up
22.2% YoY. In the third quarter, South Africa's real, seasonally adjusted
GDP fell to a 2.3% YoY growth rate and experienced a sharp decline on the
quarter to a 1.2% expansion. A major cause of the lower growth was the
impact of mining strikes on output. South Africa’s resource based economy
will continue to slow as weak global demand for exports extends into 2013.
Consumer spending has been important for economic growth but we note
that consumer sentiment is weak and a period of cautious spending looms.
Business confidence is weak and will remain so. The South African Reserve
Bank held the benchmark at 5% through the end of the fourth quarter and is
likely to hold the rate until CPI forces it to tighten. CPI has been running
near SARB’s upper band at 6% and the impact of a new gasoline and electricity weighted inflation basket could push headline CPI above this threshold. In
December, the ANC chose Mr. Zuma as its leader by a landslide vote. Mr.
Zuma will be the party’s candidate in the 2014 election. While the ANC remains by far the country’s largest and most powerful political block, frustrated voters may finally be ready to shift their allegiance to opposition. Mindful
of the increasing risks in South Africa we are underweight in this resource
based market.
MARKET POSITIVES
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In December the ANC choose Mr. Jacob Zuma to continue as its president. This positions Mr. Zuma to be re-elected to the South African presidency in the forthcoming national election to be held in 2014. His record
on reform is weak and we believe that he will emphasize government
spending and cheap money as a means of maintaining, and if possible, increasing voter support.
Headline consumer price inflation ran unchanged at 5.6% YoY pace in October and November. A seasonal increase in food costs was a key driver
for maintaining the relatively high CPI rate. This is very close to the upper
band in the central bank’s 3% to 6% target range. We expect that CPI will
be contained in the near term. As of January 2013, a new inflation basket
is now online. The new basket more heavily weights gasoline and electricity. This could push CPI to SARB’s 6% band if not above.
The Reserve Bank of South Africa held the benchmark rate at 5% in November. The bank’s Monetary Policy Committee citied Rand depreciation,
inflation and the impact of strike driven wage increases as looming threats
to inflation. Despite a bias toward inflation fighting and tightening, the
downturn in economic growth slowing will make the bank reluctant to
tighten in early 2013. We also believe that Mr. Zuma would prefer that
the bank refrain from increasing the cost of money while he seeks reelection in 2014.
South African producer inflation fell to a 5.2% YoY rate in October and
November. Overall, we expect PPI to remain below SARB’s 6% PPI target
adding to the expectation that SARB monetary policy will be to hold the
low 5% rate for stimulus as long as possible this year.
Rand bias in the first half is for volatility and continued weakness. Rand
depreciation helps export competitiveness but adds to inflationary pres-
TIS Group January 2013 Global Markets
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In the third quarter, South Africa's real, seasonally adjusted GDP fell to a
2.3% YoY growth rate and experienced a sharp decline on the quarter to
a 1.2% expansion. A major cause of the lower growth was the impact of
mining strikes on output.
Consumer confidence fell two points to a -3 reading in the fourth quarter. Weak retail sales data paralleled the decline in consumer confidence.
We expect that domestic spending will remain weak on the basis of rising
inflation, persistent high unemployment and no prospects for wage
growth.
Business sentiment in South Africa remains very weak. Last year strikes
at gold and platinum mines cut output by more than ZAR10 billion and
mining output plunged 12.7% YoY in the third quarter following a 31% increase in the previous quarter. Against the collapse of mining output,
manufacturing rose a weak 1.2% QoQ while output from the agriculture
sector rose 7.4% YoY.
South Africa’s third quarter current account gap widened slightly to
ZAR202 billion roughly 6.4% of GDP. This is the largest deficit since 2008.
With mining out paralyzed by strikes, the trade balance deficit rose to
ZAR 21.2 billion in October. South Africa’s export sector will continue to
struggle against weak external demand.
Because the EU is South Africa’s largest trading partner, absorbing roughly one third of exports, the region’s debt problems are a significant problem for exporters. We feel that the EU’s deteriorating economic outlook
will continue to impose severe constraints on South African export
growth.
Finance Minister Pravin Gordhan stated that the government budget deficit forecast for FY12/13 would be 4.5%. We have doubts that the Zuma
government has the fiscal restraint to control the deficit and bring it
down particularly in this period of slower economic growth. Through
November, the state budget widened to ZAR32.3 billion. Running high
deficits hurts the country’s credit rating and risks higher debt servicing
costs. Moody's, Standard and Poor and Fitch have all cut their credit rating for South Africa.
Unemployment remains a major economic and social problem in South
Africa. The official unemployment rate remains near 25%. The economy
needs to grow 7% YoY over the next two decades to significantly reduce
the unemployment rate. This is unrealistic if not impossible especially in
the economic downturn that is unfolding.
In December the ANC choose Mr. Jacob Zuma as its next president. This
positions Mr. Zuma to become the next leader of South Africa.
VALUATION
The JSE market may be fully valued at 10.04 forecast earnings and +3% earnings growth. However, political and structural risks bring the risk-reward
ratio a bit above other commodity-oriented markets in Canada (P/E 13.18x,
EPS +16%) Australia (14.46x, EPS +23%) and New Zealand (15.62x, +15%).
POLITICAL
At the December 2012 ANC Congress, Jacob Zuma was reelected to be the
party’s leader. This makes Mr. Zuma the ANC presidential candidate for the
2014 national election. Despite his inability to prevent labor unrest in the
mining sector that crippled the economy, widespread graft and corruption,
Mr. Zuma won by a landslide. This should clarify to doubters that the hinge
upon which the upper echelon of ANC political leadership pivots is selfenriching cronyism. Along with its selection of Mr. Zuma, the ANC delegates chose anti-apartheid hero and millionaire businessman Cyril Ramaphosa to be the ANC Deputy President. The ANC’s former Deputy
President, Kgalema Motlanthe, who mounted a vigorous campaign against
Mr. Zuma, was crushed at the December party meeting. He will struggle to
mount any sort of effective campaign against Mr. Zuma ahead of the 2014
election. To another outspoken critic, ANC Youth League leader Julius
Malema, who was ousted from the ANC in early 2012, Mr. Zuma offer only
open criticism to Mr. Malema for his failure to support the ANC and Mr.
Zuma’s leadership. Mr. Zuma made clear that he will deal harshly with future
attempts to disrupt the ANC asserting that there must be consequences for
this behavior. The ANC victory for Mr. Zuma indicates that he still holds the
reigns of power for the powerful tripartite alliances formed between the
ANC, the Congress of South African Trade Unions (COSATU) and the
81
SOUTH AFRICA REVIEW
South African Communist Party (SACP). While it is clear where intra-party
allegiances and power lie, we question if voter support for the party runs as
high. The ANC and as its leader, Mr. Zuma, remain by far the country’s
largest and most powerful political block. The next two years until the 2014
election will test if credible opposition candidates can be found and if voters
are finally be ready to shift their allegiance to opposition candidates as the
economy slows and their quality of life remains unchanged after decades of
unfulfilled ANC promises.
INVESTMENT STRATEGY
In the third quarter, South Africa's real, seasonally adjusted GDP fell from a
3.1% YoY rate to a 2.3% YoY growth rate and underwent a sharp decline on
the quarter to a modest 1.2% expansion from 3.4% in 2Q12. A major cause
of the lower growth was the impact of mining strikes on mine output. The
mine strikes that crippled the economy added to the economy’s struggle
against weak external demand for goods and services.
Business sentiment in South Africa is very weak. Last year strikes at gold
and platinum mines cut mining by more than ZAR10 billion. Mining output
plunged 12.7% YoY in the third quarter following a 31% increase in the previous quarter. Against the collapse of mining output, manufacturing rose a
weak 1.2% QoQ while output from the agriculture sector, a comparative
bright spot, rose 7.4% YoY. Labor problems in the mining sector drive the
trade balance deficit higher, to ZAR21.2 billion in October. The mining labor
problems were compounded by weak global demand for commodities
stemming from slowdowns in China and India and the Eurozone’s sovereign
debt problems. The current account was not sparred. South Africa’s third
quarter current account gap widened slightly to ZAR202 billion roughly 6.4%
of GDP. This is the largest deficit since 2008. Near term, we see little reason to expect improvement in the external environment. We expect that
South Africa’s export sector will continue to struggle against weak external
demand.
During the second half of 2012 the Rand depreciated giving export competitiveness a boost. We believe that Rand bias in the first half will be for volatility and continued weakness. Weakness reflects the widening current
account deficit and sluggish demand from external trade partners that is putting a brake on economic growth. Investor sentiment concerning the labor
unrest in 2012 was also an important factor in Rand depreciation. The mining sector was the epicenter for these strikes but we believe that there is
still the potential that labor unrest could spread other sectors of the economy. We believe that Rand depreciation will help the beleaguered export
sector but for investors looking for natural resource exposure, the violent
labor unrest last year is a strong incentive to look for resource exposure in
less risky markets such as Australia, Canada or New Zealand.
pect that CPI will be contained in the near term. However, as of January
2013, a new inflation basket is in place which more heavily weights gasoline
and electricity. This could push headline CPI to SARB’s 6% band if not above.
High unemployment is deeply entrenched in South Africa. The employment
problem has defied monetary policy, economic expansions and the promises
of politicians to solve the issue. While we note that the official unemployment rate has been steady near 25%, unofficial joblessness is higher, perhaps
above 40%. Unemployment is predominately associated with the country’s
black population which forms the support base for the ANC. The ANC has
not significantly increased black participation in the economy since coming to
power in post-apartheid South Africa twenty years ago. This keeps black
empowerment on the ANC’s campaign agenda but implementation is unlikely as the country prepares its candidate list for an election in 2014. For the
ANC, this will be Mr. Zuma.
At the December 2012 ANC Congress, Jacob Zuma was reelected to be the
party’s leader. This makes Mr. Zuma the ANC presidential candidate for the
2014 national election. Despite his inability to prevent labor unrest in the
mining sector that crippled the economy, widespread graft and corruption,
Mr. Zuma won by a landslide. The ANC and as its returning leader, Mr. Zuma, remain by far the country’s largest and most powerful political block.
The next two years until the 2014 election will test if credible opposition
candidates can be found and if voters are finally be ready to shift their allegiance to opposition candidates as the economy slows and their quality of
life remains unchanged after decades of unfulfilled ANC promises.
We believe that the South African economy will continue to slow. Exports
will remain under pressure and we feel that consumer sentiment is eroding.
The violent labor unrest seen in the mining sector last year was a turning
point for investor sentiment that will take considerable time to overcome.
For natural resource biased investors, there is less risk in the resource markets in Australia, Canada or New Zealand. Mindful of the increasing risks,
we feel an underweight is appropriate for South Africa.
Source: Bloomberg LP
The other pillar for the South African economy, consumer spending is also
under pressure. We note that consumer confidence fell two full points to a 3 reading in the fourth quarter. The decline in sentiment was paralleled by
weak retail sales data. Consumer face a difficult set of issues going forward.
With the economy slowing there will be no substantive increase in job creation and hopes for wage growth outside of the strike driven mining sector
are bleak. This raises the specter that strike driven mining wage gains could
provide a template for additional strikes in the transportation and agriculture sectors. These would have a severe impact on growth this year. Overall, we expect that domestic spending will remain weak on the basis of rising
inflation, persistent high unemployment and no prospects for wage growth.
The South African Reserve Bank held the benchmark at 5.5% through the
end of 2012. The bank’s Monetary Policy Committee citied Rand depreciation, inflation and the impact of strike driven wage increases as looming
threats to its inflation outlook. Despite a bias toward inflation fighting and
tightening, we believe that the downturn in economic growth slowing will
make the bank reluctant to tighten in early 2013. We also believe that Mr.
Zuma would prefer that the bank refrain from increasing the cost of money
while he seeks reelection in 2014. South African headline consumer price
inflation ran unchanged at 5.6% YoY pace in October and November. While
this is very close to the upper band in SARB’s 3% to 6% target range, we ex-
82
TIS Group January 2013 Global Markets
SWITZERLAND REVIEW
Eco no mi c F o r ecast
St o ck M ar ket
F i xed I nco me
C ur r ent
GDP Economic Forecast
—
Q 1 2 0 13
0.75%
CPI Economic Forecast
—
-0.05%
2-Year Bond Yield —
-0.21%
P/E Estimat e —
13.3x
Unemployment Rat e
—
3.00%
5-Year Bond Yield —
0.10%
Dividend 12 M o Yield - Gross —
316.0%
Central Bank Rat e Lombard (%)
—
6.60%
Swiss Franc USD/CHF Forecast
—
0.9
Cental Bank Rate —
C ur r ent
0.00%
SM I —
10-Year Bond Yield —
0.56%
*2013 EPS Growt h —
10-Yr Spread/US Treas —
-134.81bps
Current M arket Cap (SwF/ blns) —
Bloomberg Cont r ibut or Composit es
7049.30
+56%
891.19
Bloomber g LP; * TIS Gr oup
Swiss Market Index
 The Swiss seasonally adjusted unemployment rate held at a low 3%
rate through November. The rate has weathered the Euro-zone crisis with minimal change and we expect that job creation will be on
hold until the EU sovereign debt crisis abates.
 Consumer sentiment showed no significant improvement in the
fourth quarter. Never-the-less, retail sales showed gains each month
in 2012 through October when sales rose 2.8% YoY.
 The value of Swiss exports rose CHF2 billion to CHF18.6 billion
in October overcoming a modest CHF1 billion gain in imports.
This kept the trade balance in surplus. Much of the gain came
from luxury items while demand for machinery and electronics remained sluggish.
 Switzerland is a net energy importer. The decrease in global
crude oil prices benefits the economy.
Bloomberg LP
OVERVIEW
The SMI closed at 6,822 on December 31st, up 14.9% YoY. The Swiss
economy continues to show weak growth which will persist in 2012.
The KOF is slowly rising but other macro indicators do not overwhelmingly support sustainable economic recovery. We expect that full year
growth will exceed 1% in 2013. The SNB’s decision cap the Franc has
held it steady against the Euro at CHF1.2:€1 to support export competitiveness and limit consumer leverage for import purchases. Swiss government began to reform the retirement pension system by increasing
the retirement age of women to that of men and we note an ongoing
policy trend to limit the influence of immigrants in the country. Investors should note that Switzerland is not in the Euro-zone and it is a
defensive market which will offset some of the disadvantages of other
EU markets. However, the Swiss market is still exposed to macro factors that are influencing the EU. We hold a neutral position in Switzerland.
MARKET POSITIVES
 In the third quarter, the Swiss economy rebounded from its se-
cond quarter contraction. Third quarter real, seasonally-adjusted
growth rose to 1.3% YoY and 0.6% QoQ. Growth was underpinned by the SNB’s Franc cap and export gains. The KOF Economic Institute forecasts 1.2% growth in 2013.
 In the fourth quarter, the KOF economic barometer remained
positive. The October reading of 1.60 slid slightly to 1.5 in November.
 The November Swiss SVME PPI which measures he average change
over time in the selling prices received by domestic producers for
their output increased to a 1.2 reading from the previous month 0.4
reading. The SVME PMI rose 2.4 points to 48.5 level nearing the optimistic 50-threshold.
 Through December, the Swiss National Bank held its three-
month LIBOR target rate at 0%. We don’t expect the bank to
move off this loose, stimulus oriented policy stance this year.
 We also note that the SNB continues its commitment to cap
Franc appreciation against the Euro at €1:CHF1.2. With the Eurozone struggling as its sovereign debt problems continue and bailout
costs mounting, we don’t see the Franc losing its safe haven status
anytime soon. We expect the SNB to continue its commitment to
enforcing the Franc’s minimum exchange rate.
TIS Group January 2013 Global Markets
MARKET NEGATIVES
 After hitting -19 in January, the SECO Swiss consumer confidence
indicator rose to -17 in July where it remained October. The stagnant measure of confidence indicates that consumer demand is not
yet on a sustainable path to support economic recovery with domestic spending.
 Switzerland’s headline and core inflationary rates were negative in
November. Headline CPI ran at a -0.4% YoY, -0.3% MoM rate
and the corresponding core rate ran at a -0.6% YoY, -0.1% MoM
rate. We look for the SNB's exchange-rate ceiling and Franc liquidity
creation to prevent a persistent deflationary spiral. CPI is expected
to average 0.5% in 2013.
 Swiss manufacturing continues to suffer from weak external demand.
In neighboring Germany a major export market, import demand has
been volatile and weak. The German PMI has been below 50 since
March with the December reading at 46.3.
 Swiss insurance and reinsurance firms are exposed to large property
damage claims attributable global weather anomalies which have become more frequent and more severe.
VALUATION
Investors have not yet turned to the Swiss market in recent months, as
a safe-haven against rising tensions in Iraq and the Middle East. With a
P/E estimate of 13.32x, the Swiss market remains more expensive than
Germany at 11.30x and France at 10.89x and other European defensive
markets like the UK (11.19x) and the Netherlands (10.92x).
POLITICAL
The five party coalition formed from the 2011 election appears stable
and able to fulfill its mandate until the fall 2015 election. Each of the five
hold a seat in the seven seat governing Federal Council with the centrist
Social Democrats and left Radical Democratic Party Liberals each holding two seats. In late November, the Federal Council announced its
reform of the retirement pension insurance system. The headline issue
was an increase in the retirement age for women from age 64 to age 65.
This makes the women’s retirement age equal to that of men. The
change was made in the interests of increasing the solvency of the retirement system which was threatened by demographic trends that
reflected longer lives for women and a wage gap where women earned
on average 10% less than their male counterparts. We also note that in
early December the Lower House upheld the “Lex Koller” legislation
that restricts acquisition of property by foreigners. The about face by
the Lower House reflects growing concern about the large influx of
83
SWITZERLAND REVIEW
immigrants seen as necessary to moderate demand. A related proposal
that, the Zweitwohnungsinitiative, restricts the purchase of secondary
homes by foreigners was approved by popular vote in March 2012 and
comes into force in the first quarter of 2103.
INVESTMENT STRATEGY
In the third quarter, the Swiss economy rebounded from its second
quarter contraction. Third quarter real, seasonally adjusted growth rose
to 1.3% YoY and 0.6% QoQ. Growth was under-pinned by the SNB’s
Franc cap and export gains. The fourth quarter KOF economic barometer remained in positive territory with a reading of 1.5 in November.
Since March when the indicator first turned positive, the KOF has been
pointing to a slow increase in business sentiment. While the KOF has
been increasing, there is little reason for immediate optimism that the
economy is about to turn the corner and resume pre-debt crisis
growth. Switzerland’s key export market in Germany has yet to show
significant improvement in demand. The German PMI has been below
50 since March.
claim risks attributable to global weather anomalies. Investors should
note that Switzerland is not in the Euro-zone and it is a defensive market, which will offset some of the disadvantages of other EU markets. It
is however, still affected by macro risk factors that are influencing the
EU. Overall, we believe that a neutral position in Switzerland is appropriate.
Source: Bloomberg LP Data
Swiss National Bank cap on the Franc has proved to be instrumental in
supporting growth by curbing imports, aiding exports and diminishing
speculative interest in the Franc as a safe haven currency. The SNB has
been obliging advocates of a weaker Franc by using foreign currency
reserves to defend the Franc. This activity is beneficial for exports but
it cannot completely overcome the demand deficit in EU member states
that continues to constrain external demand. We expect that demand
from Germany and other key Euro denominated economies will remain
weak as the continuing saga of the sovereign debt crisis and bailout
package evolves among the 27-member states. This will continue to sap
vitality from these economies resulting in weak export demand for
Swiss goods and services.
We note that inflationary pressure is virtually absent in Switzerland.
Inflation has been negative and the immediate risk is deflationary. This
translates into loss of pricing power for corporations. An uptick in inflation is likely to come from energy and food. Food prices are subject to
increase due to drought conditions in many producing regions. Global
crude oil prices have been stable in upper US$80 per barrel range but
geostrategic tensions are not absent from the market. We note the
December election of Shinzo Abe as Japan’s prime minister. Mr. Abe is a
hawk who promises to advocate standing up to China’s expansionary
plans to acquire valuable energy resource in the South China Sea. The
Swiss government’s looming phase out of nuclear energy will only serve
to increase Swiss exposure to external energy suppliers.
With export demand weakening, we do not expect the economy to get
help from domestic consumption. While seasonally adjusted unemployment remains near a relatively low 3%, we believe that the economy is
not poised for a sharp increase in job creation. We expect that as the
economy slowly improves, corporations that can spend on capex items
will shift to protecting margins with measures to create production
efficiencies, not more jobs. We also note that consumer sentiment is
sentiment showed no significant improvement in the fourth quarter.
Although retail sales showed modest gains each month in 2012 through
October, the impact of such gains cannot bring domestic spending to a
level that will completely offset external demand.
In the October 2011 elections, Swiss voters moved political power
away from the right to more moderate, centrist politics. Importantly,
Switzerland’s most powerful party, the right-wing Swiss People's Party
(SVP) lost votes in comparison to its 2007 showing but remains the
most powerful political bloc in government. We believe that the move
to the center will slow legislative progress on key issues that are inherently contentious. We expect that Swiss politics will be relatively quiescent in the near term. The next election is scheduled for late 2015 and
we do not see significant perturbations to the current coalition of the
five major parties in the near future.
We note that the Swiss economy has improved but indicators remain
weak in support of sustainable recovery. The domestic Swiss Franc
denominated capital markets will continue to offer investors a defensive,
safe haven from global turbulence characterized by ongoing problems in
the Middle East, North Africa and the South China Sea. The Swiss equity
market is top heavy with financials that are generally exposed to the EU
debt problems, lingering global financial problems and looming insurance
84
TIS Group January 2013 Global Markets
UNITED KINGDOM REVIEW
Economic Forecast
Stock Market
Fixed Income
Q1 2013
Current
Current
GDP Economic Fore Annual
—
0.20%
Base Rate —
0.50%
FTSE 100 —
CPI Economic Fore (YoY)
—
2.70%
2-Year Bond Yield —
0.44%
P/E Estimate —
11.2x
Current Accnt % GDP Est
—
-3.70%
5-Year Bond Yield —
1.04%
Dividend 12 Mo Yield - Gross —
3.84%
Unemployment Rate
—
8.00%
10-Year Bond Yield —
2.09%
*2013 EPS Growth —
+37%
British Pound GBP/USD Forecast
—
1.60
10-Yr Spread/US Treas —
18.59%
Current Market Cap(GBP/ trlns) —
1697.69
Bloomberg Contributor Composites
6064.58
Bloomberg LP; * TIS Group
an effective monetary tool. Therefore, all that is left are less effective
open market operations.
FTSE 100 Index
 The LIBOR scandal is the biggest news coming out of the UK in Q2.
Bloomberg LP; *TIS Group
OVERVIEW
Increased costs for the banks in this sector will increase due to fines,
legal fees, and in the long-run increased regulation will also hurt. The
banking system in the UK will likely not resemble a capitalist, freemarket for some time. London’s reputation as a financial center of
the world is being tarnished. The calculation of LIBOR will be taken
out of the hands of the British Bankers Association, and as the investigation continues, further controls and limitations are likely to be enacted on the industry. The litigation and penalties will cause many of
the banks involved to begin deleveraging. They will need to set aside
loss provisions, and will therefore start unwinding positions they have
levered up 30x around the globe. This will add to the balance sheet
risk of investing in UK banks, as the holdings they liquidate will likely
be the highest quality holdings they own. (“UK scandal will speed shift
in bank regulatory regime.” Oxford Analytica 6 July 2012)
The FTSE was up 3.1% in Q3, bringing ytd 2012 performance to +3.0%.
This follows returns of +7.5%, +16.7%, +10.7%, +3.8%, -31.3%, +22.1%,
+9.0%, and -5.6% in 2004-2011, respectively. A weak economy has force
the new Conservative-led coalition government to abandon its 5-year
 Unlike the conservative party in the U.S., the David Cameron-led
fiscal austerity plan. The result should put pressure on the currency,
Conservatives are pushing for tax increases in order to balance the
and potentially threaten the country’s AAA credit status. While the Tobudget. While we admire his sincerity and commitment to his austerries have simply moved their debt-to-GDP targets out three more years,
ity measures, one cannot deny that raising taxes during a period of
their austerity credibility is severely damaged. Hopes are resting on a
economic weakness is a risky move for the economy.
new BoE governor, and his ability to have similar success to what he  The BoE’s effectiveness has been all but nullified as commercial and
presided over in Canada. (Bloomberg Data)
retail banks have refused to increase lending and to pass along rate
cuts to clients. Instead, banks have used increased liquidity to boost
MARKET POSITIVES
their own balance sheets.
 The BoE announced it would begin a new 50 billion Pound QE pro-  The UK’s fiscal deficit is the largest in the G20. We like the efforts
gram to stimulate economic growth. (“Euro-area, UK monetary easing
Mr. Cameron is putting in place to attack this issue, we are less sure
does not ensure growth.” Oxford Analytica 5 July 2012)
of the average British citizen’s willingness to accept the pain necessary
to implement these programs.
 UK stocks are not expensive at 11x earnings and a 4% dividend yield.
 The new budget takes a good, hard look at the welfare system in the
U.K., with a focus on getting middle-class free riders off the dole. It
will also encourage people to get back to work. If structured anything
like the Clinton reforms of welfare in the U.S. in the late 1990’s,
which were extremely successful and praised by liberals and conservatives alike, a good deal of savings could be wrung out of the system.
MONETARY AND FISCAL POLICY
The replacement for BoE Governor Mervyn King has been found, and
they went with the ultimate outsider. In July, Bank of Canada Governor
Mark Carney will succeed King, and will attempt to bring the success he
had in Canada to the UK. He will have his work cut out for him, as the
BoE is in a bad state of affairs after the LIBOR scandal. The central bank
MARKET NEGATIVES
is also wielding new, untested powers of banking supervision, stability of
 The Scottish National Party (SNP), which leads Scotland's government the overall financial system, along with monetary policy.
plans to hold a referendum on independence from the United King- Between October of 2008 and March of 2009, the BOE slashed its
dom in 2014. The SNP maintains that an independent Scotland would benchmark interest rate from 5.00% to 0.5%, the lowest level in the hisremain in the EU and would continue using Sterling as its currency. tory of the bank. Since that time, rates have remained at 0.5%, indicating
However, the EU requires new member states to promise to intro- that rate cuts are ineffective in spurring spending further. Like the cenduce the euro "eventually". A smaller and weaker UK would only fur- tral banks in the U.S. and Japan, the BoE has exhausted rate cuts as an
ther diminish its global influence. (“Scotland independence would test effective monetary tool. Therefore, all that’s left is open market operaUK-EU relations.” Oxford Analytica 11 Dec. 2012)
tions. British citizens elected a fiscally conservative government to re The BoE’s benchmark rate has been stuck at 0.5% since March 2009, verse decades of spending which created the debt problem in the first
the lowest level in the history of the bank. This seems to indicate place. Unfortunately, Conservatives have given up on their promise to
that rate cuts are ineffective in spurring spending further. Like the balance the budget, and have put the country’s AAA rating at risk of a
central banks in the U.S. and Japan, the BoE has exhausted rate cuts as downgrade. (“Carney’s success at BoE will depend on Osbourne.” Oxford
Analytica 3 Dec. 2012)
TIS Group January 2013 Global Markets
85
UNITED KINGDOM REVIEW
VALUATION
The FTSE 100’s 11.19x P/E ratio compares well with continental Europe.
Germany’s Dax Index has a 11.30x multiple, France’s CAC-40 Index has
a 10.89x ratio, and Italy’s S&P/MIB sits at 10.70x. However, with the
S&P 500 at 13.14x, British stocks are a bargain compared to U.S. companies.
POLITICS
The UK benefits greatly from its perception as a safe haven, for investments as well as Pound Sterling. This is why we are growing increasingly
concerned about Scotland’s independence movement. A smaller and
weaker UK simply cannot back the same amount of trade. The Scottish
National Party (SNP), which leads Scotland's government plans to hold a
referendum on independence from the United Kingdom in 2014. The
SNP maintains that an independent Scotland would remain in the EU and
would continue using Sterling as its currency. However, the EU requires
new member states to promise to introduce the euro "eventually". A
smaller and weaker UK would only further diminish its global influence.
(“Scotland independence would test UK-EU relations.” Oxford Analytica 11
Dec. 2012)
INVESTMENT STRATEGY
Fourth quarter numbers for the services sector, which makes up 75% of
the UK economy, are coming in and the numbers are poor. The services PMI fell below 50 (indicating contraction) to 48.9 in December, followed by a drop in the construction PMI to 48.7. Weak numbers like
this lead us to believe a third recession may be at risk for the UK. As
we feared, the weakness is causing lack of resolve in the political goals
set forth by the ruling coalition.
The Conservatives have abandoned their promise to balance the budget
within 5 years of taking power. Through Chancellor of the Exchequer
George Osbourne, the party said the goal was now to complete the task
by 2018, three years later than planned. While not surprising, it will certainly have an effect on the country’s credit status, and likely threaten
the Pound. The one thing in the country’s favor is that it is outside the
EU and has some distance from the issues in the PIIGS. (“Services slump
threatens UK ‘triple dip’.” Oxford Analytica 4 Jan. 2013)
The key to the Conservative’s five-year plan was its short duration. We
all understood that UK citizens’ tolerance for austerity was limited. The
new coalition had a very short window to accomplish their goals, at the
end of which their honeymoon period would end. Most thought 5-years
was even too long. With their edit to an 8-year plan, a period beyond
the next election, they are admitting defeat. We, therefore, must lower
our outlook on Sterling, and UK investments, in general. We recommend an underweight position in UK equities.
86
TIS Group January 2013 Global Markets
U.S. REVIEW
Economic Forecast
Fixed Income
Q1 2013
—
1.60%
Fed Funds Target Rate —
0.25%
S&P 500 Index —
1458.78
CPI Econ Forecast (YoY)
US Core PCE Forecast
1.70%
1.6%
Current Accnt % GDP Est
—
—
—
-2.90%
Prime Rate —
3-Month Gov Yield —
10-Year T-Notes —
3.25%
0.06%
-0.65%
P/E Estimate —
Dividend 12 Mo Yield - Gross —
*2013 EPS Growth —
13.1x
2.2x
+11%
Unemployment Rate
—
7.80%
Fed Res Primary Disct Rate —
0.75%
Current Market Cap (trillions) —
13533.81
US Budget Balance Fore (%)
—
-7.20%
Bloomberg LP; * TIS Group
S&P 500 Index
Courtesy of Bloomberg

MARKET POSITIVES
 U.S. companies are cash heavy with corporate cash as a percentage of






Current
GDP Econ Forecast (QoQ)
Bloomberg Contributor Composites

Stock Market
Current
current assets at 30%, a twelve-year high. By some measures, large
cap U.S. companies are in the best balance sheet condition of the past
thirty years. Meanwhile, the earnings yield is 8% while 10-year Treasuries yield only 1.9%, a huge gap. I am really starting to wonder when
the M&A business is going to take-off in America, because the alternative of holding cash bears little return. On the demand side, consumers are cashed up, with household debt service at 30+ year lows. And
consumer wealth is back- Americans’ balance sheet wealth is up $13
trillion since 2009, to $78 trillion.
We think all the reflation stops are being pulled out by the Fed and
government in order to make sure economic growth continues in
2012 and a double dip recession does not occur.
The stock yield : bond yield ratio is near historic highs in favor of
stocks. While bonds provide security, their yield is not sufficient to
support the income needs of the soon-to-be-retired baby boomers.
Retirees are being forced to take on more risk to find income. However, the risk is that they may move assets overseas to find yield.
Interest rates and Fed policy are still supportive of stocks. Stocks are
not expensive at about 13x earnings.
A new breed of fiscal conservatives in Congress is pushing for substantive cuts in entitlement programs. This is long-term positive for
the U.S. Dollar.
The U.S. is benefitting as the world flocks to the Dollar as a safe haven.
The heavily oil-dependent U.S. economy benefits from cheaper oil
prices. Natural gas prices are very low.
QE3 was launched with the aim of lowering mortgage rates and raising
home prices/stocks.




MARKET NEGATIVES
 What is missing is clarity on taxes, (tax reform or no tax reform) and
a resolution on how the country will pay for entitles as currently constructed. Or will the country have to re-jigger how pays for health
care, social security and other programs. I urge everyone to read
TIS Group January 2013 Global Markets

Stephen Moore’s column in Mondays WSJ (U.S. version) in which he
describes Speaker Boehner’s interactions with Democrats over the
fiscal cliff issue. At one point, the President told Boehner, we don’t
have a spending problem. The President correctly sees a spending
problem in America’s health care system, but seems oblivious to
spending issues anywhere else- except perhaps defense. After reading
the full text of the column, I had to wonder how long it will take before Boehner understands the viewpoint of the President. No amount
of spending on social programs, no amount of tax hikes will be too
much for them. There is no spending problem in their view- which is
what I argued in December was the case. Now we have it in print,
courtesy of the WSJ. (Moore, Stephen. “The Education of John Boehner”
WSJ 7 January 2013)
Regulations are not necessarily a bad thing. Some are helpful, businesses run better when they know what the rules are. But the sheer
number and rate of growth in regulations in America, must be at or
near the point of restraining the economy. What struck me was these
numbers were tabulated before a wide range of new regs are launched
in 2013. From Dodd-Frank to fracking, another round of regulation is
coming, which does divert resources and restrain growth. I look at
this and I wonder, how does the Fed factor this into their thinking
that the economy will grow at 2.3% this year?
Creating inflation, which on the surface seems to be the Fed's intent,
we hope is secondary or perhaps even the by-product of an effort to
devalue the Dollar. If the Fed is actually trying to create inflation,
heaven help us, unless you have gold. If the Fed is going to devalue
the Dollar, which is the policy outcome we have argued would be the
answer to the debt mountain which exists in America, why would gold
not go higher?
During the post War era, the U.S. economy has been joined at the hip
to the housing market. With the exception of the introduction of the
Great Society (LBJ's experiment in economic policy of running the Vietnam War while simultaneously ramping up social spending, particularly Medicare and Medicaid) and all that meant for fiscal policy, which
blew out and inflation which followed, lower home sales have translated into a weaker economy. 15-year mortgages are now trading at
around 3%, the lowest level in years. That helps and it is going to
have a positive effect on the economy.
Calls for worldwide bank regulation, special bank levies, limits on executive compensation, punitive taxes on bonuses and a proposal in
America to resurrect the ghost of Glass-Steagall have bankers from
New York to Timbuktu in an uproar. Passing America’s Fin Reg Bill
brought clarity, but also additional costs and regulations which are still
not clear.
How is America going to fund another $1 trillion plus deficit this year
and in years ahead? The conclusion we have come to is a combination
of efforts may be employed including a potential wealth tax, a VAT,
and/or mandating 401Ks and corporate pension plans to buy Treasuries, plus raising taxes.
One of the major issues for the U.S. economy and bonds is whether
or not Japan, SE Asia, and China will continue to fund the U.S. econo-
87
U.S. REVIEW
my by purchasing U.S. debt in the amounts they have in the past. In
the short term, keeping the U.S. economy from collapsing via low U.S.
interest rates is in their interest, particularly the Chinese. But the exporters of capital to the U.S. also have a major self-interest in keeping
the Dollar stable, so as not to lose on the value of their underlying
holdings – i.e. in Treasuries and GSE paper. In the long run, it is likely
in the interest of the Chinese and others to diversify away from the
Dollar and now from the Euro.
CURRENCY OUTLOOK
We have a date certain, January 1, 2013 when we know the Fiscal Cliff
hits. I have written before that I think no deal will be done until next
year. This is hugely deflationary for the U.S. economy, China is on the
brink of a recession, and Southern Europe has entered a depression.
The scope for not only the Fed, but the ECB and PBOC to print additional fiat money, is massive. I think that is what is about to happen.
Risk assets such as silver, gold, stocks, and commodity currencies should
tell me if this is right. The Fed is going lean into the Fiscal Cliff and make
sure there is no 3%-4% fall in the U.S. economy and that asset markets
rise. I was ruminating recently on how the investing public, which is redeeming their equity funds will respond to this. Not only American investors, but also European and Chinese investors are voting with their
feet, buying bonds and holding cash and I think they are doing this at the
wrong time. Currencies are being debased everywhere. The global currency war is in full swing. While the hard asset trade has been in play for
a while, this is the recipe for take-off. I was asked today how high gold
can trade? It seems to me $2,030-$2,160 is the next level. And if silver
trades at 5% of gold’s price that would target silver at $100. You can
buy all you want today at $35. If the wheels come off and fiat money is
no longer believed, then gold could trade much higher, if it is allowed to
trade at all in the West.
POLITICS
After thinking about the quote from the January 7th WSJ column “The
Education of John Boehner” by Stephen Moore about the fiscal cliff negotiations, I had one further thought. When the President says to the
Speaker of the House, we don’t have a spending problem, he does not
think spending is an issue. There is no problem in his view. May I suggest he may have gained support for that view, from the Treasury - for
that would be the only convincing place from where it could have emanated. If the incoming Treasury Secretary has a similar view, then what
we have is one side (the Republicans in the House), who see a problem,
which the President does not even think exists. How do you get a deal
done when one side thinks there is no problem and the other side may
have their political future tied up in addressing the problem which observers from Wall Street to the former Comptroller of the Currency,
think does exist?
What I think is going to happen in the near term, is the House is going
to return to its proper function and start passing legislation, including a
budget. For our foreign readers, appropriations bills, the budget, by law
are to start in the House. Then the Senate will receive the budget bill
rom the House and it is the Senate which has failed to pass a budget for
four years. This was intentional, as it kept spending responsibility off the
Senate and the White House. By passing a budget bill, in good order,
the ball will be in the Senate’s court. That is where I think the House
will leave it as that is the proper legislative procedure. Then watch the
screaming start for negotiations, how the House budget is a non-starter,
dead on arrival, don’t even send it over here- that will be the Senate
leaders approach, as it has been in the past. That approach buys time
88
and increases the possibility of backing the Republicans into a corner, as
they were in December. If late February/early March is roughly the ending date when the Treasury runs out of options, that is the “date certain,” I would look for in terms of markets to move into the next phase
and price the next big thing.
That brings me to the last point, the U.S. and how the Fed will proceed
in 2013. As incredible as this may sound, I do not think the round of tax
hikes which were agreed to on December 31, are the end of it. I
watched a number of Republican Congressmen in the media recently,
saying we just raised taxes, that’s done. Then Democrat Congressmen
would come on screen and without a lot of probing, they were clearly
talking about more revenue increases to be discussed in February at the
time of the debt ceiling negotiations. It’s not over, the Administration
wants more revenue. The U.S. economy just took a hit due to multiple
Obamacare taxes and the negotiated hike on high earners to 39.6%. If
another hike is added in on top of these new taxes in sixty days, the U.S.
will be headed for recession this year and the Fed will respond, perhaps
aggressively. It is interesting that according to the CBO, the fiscal cliff
deal adds $3.9 trillion the long-term deficit. There was no deficit reduction, taxes alone are not able to do that. The Administration, as I said
last month, has little interest in meaningfully reducing spending. So the
issue in February will be this. Will the Republicans be willing to stand up
and say no debt ceiling increase unless meaningful spending cuts are
adopted - perhaps something along the lines of $4 in cuts for every $1 in
revenue. The fiscal cliff deal was upside down in this regard with $1 in
cuts for every $10 in revenue according to the CBO. Are the House
Republicans brave enough to say to the Democrats, show up with spending cuts or we will not vote for a debt ceiling increase - and we know a
recession will occur as a result, but we are willing to live with that. We
are willing to take a recession to stop additional tax hikes. Can they sell
that to themselves and to the country?
Sources: Bloomberg Data; Bloomberg News
INVESTMENT STRATEGY
The early January indicator for U.S. stocks has flashed ‘green’ as the S&P
500 rose 2.2% during the first five days of the month. The probabilities
now favor market gains for the full year. Since 1950, when the S&P
posted a gain over the first five trading days, the full year finished with an
average gain of 14% and gains occurred 85% of the time. This is a good
start. The full month of January trading higher would be a better indicator, as positive performance in January raises the probability of full year
gains. Positive January performances have been followed by full year
gains, 90% of the time since 1950.
Protection is cheap at these and the VIX has nearly disappeared, so it
may pay to find a VIX instrument, which works though I am at a loss to
know what instrument that is. How the timing of the correction interacts with the January indicator will be crucial. It could be a rotational
correction in which case healthcare should perform, at least for a while.
What would trigger a non-rotational decline would be a rise in Treasury
yields. The 10-year Treasury yield bears the symptoms of a chart, which
wants to go higher, but with the debt ceiling right in front of us, my
thinking has been that T-bonds rally first, then sell-off on resolution of
the debt cliff. But if they look through the debt cliff and see more spending, more issuance and no buyers other than the Fed and the possibly the
BOJ, T-bonds may scoot up to 2.4%-2.5% before pension funds and insurance companies start buying.
Sources:
Bloomberg Data; Bloomberg News
TIS Group January 2013 Global Markets
MARKET THEMES—EMERGING
MARKETS
MSCI Emerging Markets Index ETF (EEM) Dec. Performance: +6.18%
Y-T-D Performance: +16.93%
Y-T-D S&P 500 Performance: +16.00%
Emerging Markets
Investing 5% to 10% of your portfolio in emerging markets may provide the best of all worlds—little increase in risk with significant additions to returns. Lately, the number of believers in this nostrum has increased considerably. However, wars, coups, bad weather, assassinations, etc., all have been known to shave 10% to 20% off any number of emerging markets in a matter of days. Not enough risk for you?
How about the basic problem of how to invest? The costs are high, the stocks often illiquid, and if you do find a company you think attractive, confirming the numbers can be difficult because in real emerging markets there is little research. While Wall Street hasn't figured out
a way to stop minor inconveniences, like typhoons or the occasional military overthrow, it has supplied a way to participate via open and
closed-end mutual funds, including ETFs. Below is a list of available emerging market closed-end funds and ETFs, trading in U.S. Dollars on
U.S. exchanges. Many often sell at discounts to net asset value, providing a bit of downside protection. All are volatile.
Emerging Markets Theme—U.S. Traded Funds
Asia/SE Asia
Morgan Stanley China A Share (CAF)
Singapore Fund (SGF)
SPDR China (GXC)
Thai Fund (TTF)
China Fund (CHN)
Thai Capital Fund (TF)
Greater China Fund (GCH)
Powershares Golden Dragon (PGJ)
SE Asia Regional
Templeton Dragon (TDF)
WisdomTree Pacific HY (DNH)
iShares FTSE/Xinhua China (FXI)
WisdomTree Pacific Div. (DND)
iShares Hong Kong (EWH)
SPDR Asia Pacific (GMF)
Morgan Stanley India Fund (IIF)
iPath MSCI India (INP)
PShrs RAFI Asia Pac. ex Jap (PAF)
India Fund (IFN)
Powershares Asia Pacific (PUA)
Korea Fund (KF)
iShares MSCI Pacific ex Jap. (EPP)
iShares South Korea (EWY)
iShares Asia Property (IFAS)
Korea Equity Fund (KEF)
First Trust Chindia Fund (FNI)
iShares Malaysia (EWM)
BLDRS Asia 50 ADR (ADRA)
Malaysia Fund (MAY)
Morgan Stanley Asia Pacific (APF)
Taiwan Fund (TWN)
iShares S&P Asia 50 (AIA)
Taiwan Greater China (TFC)
Asia Tigers Fund (GRR)
iShares Taiwan (EWT)
Asia Pacific Fund (APB)
iShares Singapore (EWS)
JF China Region Fund (JFC)
January Comment
China’s inflation is hitting 7-month highs as that country’s
weather is having some devastating effects on crops. The coldest winter in 28 years is pushing the prices of vegetables off the
charts. Vegetable prices rose nearly 15% from a year ago, and
contributed to over half the monthly increase in December’s
CPI number.
Latin America
Latin American Fund (LAF)
iShares Mexico (EWW)
Mexico Equity & Income (MXE)
Mexico Fund (MXF)
iShares Brazil (EWZ)
Chile Fund (CH)
iShares Chile (ECH)
iShares Latin America 40 (ILF)
SPDR Latin America (GML)
Eastern Europe
Morgan Stanley East Europe (RNE)
Templeton Russia & East Eur. (TRF)
Market Vectors Russia (RSX)
SPDR Emerging Europe (GUR)
Africa/Middle East
Turkish Investment Fund (TKF)
iShares South Africa (EZA)
SPDR Middle East (GAF)
WisdomTree Mid. East Div. (GULF)
PowerShrs MENA Frontier (PMNA)
General Emerging Mkts
Claymore/BNY BRIC (EEB)
iShares BRIC (BKF)
iShares Emerging Markets (EEM)
Powershares Emer. Mkts. (PIE)
PShrs RAFI Emer. Mkts. (PXH)
SPDR BRIC 40 (BIK)
SPDR Emerging Markets (GMM)
Vanguard Emer. Mkts. (VWO)
WisdomTree EM Small (DGS)
WisdomTree EM HY (DEM)
Short Emerging Markets
Short MSCI Emer. Mkts. (EUM)
UltraShort MSCI Emerging (EEV)
China’s CPI (5 years)
Well In Control
The rise in the inflation rate means that further stimulus by the
PBOC will likely be on hold for the near-term. This sent Chinese shares down sharply, after being on a hot streak for much
of the past few months.
As we’ve stated before, we think central planners in China are
much more concerned about keeping growth steady and people
employed, than they are about inflation rates. So, we suspect
that while inflation is certainly on their radar screens, growth
targets are the key moving forward.
Courtesy of Bloomberg
Source: Xin, Zhou. “China’s inflation accelerates as chill boosts food prices (3).”
Bloomberg News 11 Jan. 2013.
TIS Group January 2013 Global Markets
89
MARKET THEMES—EURO DEBT-FREE
Euro Debt-Free Stock Index©
MSCI Euro Index (orange) vs.
Euro Debt-Free Theme (black)
Courtesy Bloomberg LP
Index Members
REL_LN, SGSN_VX, ADM_LN, SKAB_SS, SOON_VX, GETIB_SS, BOKA_NA,
LOGN_VX, HOME_LN, AMEC_LN, GEN_DC, DYK_GR, ARM_LN WWG_GR,
PSG_SM, HAKN_SS, ICON_ID, IGG_LN, ASHM_LN, BKG_LN, SECOB_SS,
PLTR_LX, BAIN_FP, HL/_LN, TAA_NO, DAL_GR, DGO_LN
IG Group Holdings, Plc. (IGG_LN)
Background
Since the end of July 2007, when two Bear Stearns hedge funds went
broke, increasingly tight credit has roiled global financial markets. The
efforts by government central-planners around the world to shore up
confidence in lending may have slowed the trend, but they have not
been able to reverse its course. The U.K.’s purchase of Northern
Rock didn’t do it, the lowering of interest rates in China don’t appear
to be having a major effect, and the multitude of stimuli and nationalizations the U.S. Treasury and Federal Reserve have enacted do not appear to be flooding the market with new credit. The $700 billion
TARP passed by U.S. Congress appears to not be having a significant
effect, thus far. So, do we think the freewheeling days of no-doc and
low-doc loans will return to us anytime soon? No.
So, as far as the eye can see, a new market environment lies ahead of
us. This market will likely be one in which credit standards fall somewhere between tight and vice grip. Who succeeds in this environment? Our simple speculation is that companies that do not currently
need funding from the credit market will have a competitive advantage.
Using this hypothesis, we screened the European equity markets for
companies with less than 1% total debt-to-total equity ratios and a
market cap over $1 billion. Our screen produced 34 names, which we
used to create an equally-weighted index we have titled the “Euro
Debt-Free Theme.”
To the left we show the Euro Debt-Free Theme charted against the
MSCI Euro Index going back to July 2007, the beginning of the credit
crisis. Since July 2007 to date (through Dec. 7, 2012), the
Debt-Free group has outperformed the index of European
stocks by 61%. In 2009, the Debt-Free group outpaced the
index by 2768 bps. (+50.18% vs. +22.50%). In 2010, it beat it
by 2368 bps. (+21.43% vs. -2.25%). In 2011, it has outperformed by 9.3%. In 2012, the index is ahead by 1004 bps. We
will continue to follow the group, as the theory appears to be working.
The theory continues to hold up well in the U.S., too.
Courtesy of Bloomberg LP
Positioning our portfolios with companies whose business models do
not rely on infusions of capital from the debt market would seem to be
a winning strategy going forward. Companies that are, in essence, selffunding should benefit in the current environment on many levels.
Their lack of leverage will mitigate damage to the financial statements
as the economy slows. Their solid balance sheet will also be given priority from increasingly stingy banks if and when funding does become
necessary for expansion. When the global recession ends, it is likely
the economies of emerging markets around the world will turn up before that of the U.S. Therefore, those companies that can increase
capital to ramp up export production heading into the recovery phase
will gain market share. Finally, as inflation creeps back into the system,
and interest rates begin to rise back to historically normal levels, the
interest-expense portion of the income statement will begin to further
hurt leveraged companies.
January Comment
New bank liquidity rules put in place by Basel III are causing some interesting
quirks in the European banking system. For example, Dutch mortgage-backed
securities, which have a very high 95% loan-to-value ratio, cannot be listed as
liquid assets. Even though they have default rates close to zero, Basel rules will
only allow a ratio less than 80% to qualify as liquid assets.
This err-on-the-side-of-safety is an inevitable effect of an attempt to apply global
standards to banks. The result will certainly be tighter credit standards for many
countries, and this should make those companies who rely on debt for financing
pay more for their issuances.
Source: Duarte, Esteban. “Basel III punishing Dutch debt over a risk that isn’t: mortgages.”
Bloomberg News 11 Jan. 2013.
90
TIS Group January 2013 Global Markets
MARKET THEMES—GLOBAL ENERGY
Mr. Abe’s Economic Fix Needs Nuclear Power
Impact of sustained loss of nuclear power on GDP
Impact on Real GDP %
0.0 %
-0.02 %
-0.04 %
-0.1 %
-0.2 %
-0.09 %
-0.11 %
-0.25 %
-0.3 %
-0.28 %
-0.4 %
Simulation A: Nuclear Power Cut / No Fossil Fuel Substitution
-0.5 %
Simulation B: Nuclear Power Cut / Fossil Fuel Substituition
-0.6 %
-0.7 %
-0.74 %
-0.8 %
-0.86 %
-0.9 %
-1.0 %
5%
10%
15%
20%
Cut in Nuclear Power Generation
(% of total nuclear power)
Source Data: Itakura (6)
Disposition of 134Cs and 137Cs Radionuclides
Released from Fukushima-Daiichi
Contamination from long half-life isotopes underscores
risks of nuclear restart
Source Data Yoshida, N and J. Kanda (7) and TIS Group
Japanese Nuclear Power Sector
Restart of idle plants benefits owners
Japanese Fleet of Nuclear Reactors
(does not include six reactors damaged at Fukushima-I power station)
Bloomberg
Ticker
Equity Name
Number
Total Generating
of Rectors Capacity (mWe)
US$ Adjusted
Market Cap
(Millions)
9502 JP Equity
Chubu Electric Power Co Inc
3
3528
9504 JP Equity
Chugoku Electric Power Co Inc/The
2
1228
$10,000
$5,759
9509 Equity
Hokkaido Electric Power Co Inc
3
2012
$2,583
9505 JP Equity
Hokuriku Electric Power Co
2
1863
$2,466
private
Japan Atomic Power Company / JAPC
3
2512
—
9503 JP Equity
Kansai Electric Power Co Inc/The
11
9284
$9,767
9508 JP Equity
Kyushu Electric Power Co Inc
6
5004
$5,347
9507 JP Equity
Shikoku Electric Power Co Inc
3
2222
$3,519
9501 JP Equity
Tokyo Electric Power Co Inc
11
12233
$3,798
9506 JP Equity
Tohoku Electric Power Co Inc
4
3159
$4,632
Source Data: Bloomberg, LP
TIS Group January 2013 Global Markets
January Comment
When the Fukushima-Daiichi nuclear power station was catastrophically damaged
by the combined effects of earthquake and tsunami in March 2011, events were
set in motion that ultimately led to the cold shutdown of Japan’s entire fleet of
nuclear power reactors. For Japan the loss of all nuclear power generating capacity had very serious economic ramifications. Japan was not alone in abandoning nuclear energy. Japan’s nuclear power sector consisted of 54 nuclear reactors distributed across 17 power plants and ten operating companies. The 54 reactors
had a base load generating capacity of representing roughly 29% of Japan’s gross
generating capacity in 2009. Soon after Japan’s nuclear debacle, Germany decided
that it would eliminate all nuclear power by 2022. This decision will ultimately remove all 17 operational reactors from the grid and eliminate roughly 27% of the
country’s total electrical generating capacity (2). Neighboring Switzerland also determined that nuclear power was not to be part of its energy future. Nuclear energy accounts for roughly 40% of electrical power generation in Switzerland
where the government plan will shutdown each nuclear reactor as it reaches its
expected operating lifespan of 50-years (3). The first nuclear plant will come off
line in 2019 and the last plant will come off line in 2034. With Japan’s economy ailing for more than a decade and the full consequences of Europe’s sovereign debt
debacle still unknown, can these countries afford to abandon nuclear energy? For
Japan, the country subjected to greatest harm from nuclear energy, the answer is
likely going to be “No”. On December 16th, 2012, Shinzō Abe was elected to the
office of prime minister by a landslide vote. Mr. Abe is a fiscal hawk that has a single mission in mind. Fix the economy. To do so we believe that he will task his
Environmental Minster and State Minister for Nuclear Power, Nobuteru Ishihara,
with the job of putting nuclear energy back on the grid. Mr. Ishihara is a proponent of nuclear power and will work with the cabinet and LDP controlled Lower
House to rescind the Diet’s ban on nuclear power generation. Resumption of nuclear power generation is not without risk. Japan’s recorded seismic history points
to at least 18 seismic events that produced tsunami wave-fronts equal or greater
than 10-meters during the last millennia (4). We also note that a related search of
the NOAA geophysical earthquake data returned 180 significant earthquake
events with magnitude of 7.0 or greater that occurred in Japan between 684 and
2011. During the twentieth century, Japan experienced 74 earthquakes of magnitude 7 or greater occurred and since 2000, 18 have been recorded. This is of
concern because while the March 11, 2011 Tohoku event registered Richter magnitude 9.0 at the epicenter, the quake was estimated at Magnitude 7.5 to 7.9 at
the Daiichi nuclear power station. Our interpretation of the current status of the
Daiichi station is that it remains structurally vulnerable to seismic activity and associated tsunami events. An earthquake/tsunami event similar to the March 2011
event could subject the Fukushima-Daiichi station and other at-risk stations to
further seismic and tsunami damage that could potentiate another nuclear disaster. Just as restarting nuclear reactors is not without risk so too are premature
shutdowns. Nations that elect to eliminate nuclear power may actually exacerbate
the risk of nuclear accident because of a lack of expedient means to decommission all plants and to safely and permanently disposing of the entire compliment of
nuclear fuel. In the aftermath of the Fukushima – Daiichi plant failure, the global
fleet of nuclear reactors was evaluated for risk of seismic and tsunami event based
on the geographic location of the reactor (5). Among Japan nuclear reactor fleet,
thirteen reactors other than the six stricken reactors at the Fukushima-Daiichi
station were assigned the highest level of risk. These reactors were the Hamaoka3, 4 and 5 reactors operated by Chu-bu Electric (9502 JP Equity); the Mihama-1, 2
and 3 reactors and the Ohi-1 and 2, reactors operated by Kansai Electric (9503 JP
Equity); the Onagawa-1, 2 and 3 reactors operated by To-huku Electric (9508 JP
Equity); and the Tsuruga-1 and 2 reactors operated by privately held Japan Atomic
Power Company. We feel that while the restart of Japan’s reactor fleet while not
without physical risk, the risk to the economy of not doing so is larger (6). We
expect that it will take several years for Japan’s nuclear power stations to fully resume electrical generation at pre-Fukushima levels and for Mr. Abe to create the
industrial capacity to absorb it.
Sources:
1. TIS Group. “Evaluation of the Fukushima Daiichi Nuclear Power Station: Current Status Reveals Instability. The Institutional Strategist –
Global Edition. June 2012.
2. Government of Germany. “The way toward the energy of the future.” Press release. May 30, 2011. <http://www.bundeskanzlerin.
de/Content/EN/Artikel/_2011/05/2011-05-30-energiewende-energiekonzept_en.html;jsessionid=FA8B11D50774835B967B7D0EF31B5
D59.s3t1?nn=77364>
3. Government of Switzerland, Federal Department of the Environment, Transport, Energy and Communications. “Federal Council decides
to gradually phase out nuclear energy as part of its new energy strategy.” Press release. May 5, 2011. <http://www.uvek.admin.ch/dokumen
tation/00474/00492/index.html?lang=en&msg-id=39337>
4. NOAA National Geophysical Data Center <http://www.ngdc.noaa.gov/nndc/struts/form?t=101650&s=7&d=7>
5. Tamman, M., B. Casselman and P. Mozur. “Scores of Reactors in Quake Zones.” Wall Street Journal: Environment and Science. Online
content. March 19, 2011. <http://online.wsj.com/article/SB10001424052748703512404576208872161503008.html?mod=googlenews
_wsj>
6. Itakura, K. The Economic Consequences of Shifting Away from Nuclear Energy. Economic Research Institute for ASEAN and East Asia.
ERIA Policy Brief, No. 2011-04, December 2011 < http://www.eria.org/ERIA-PB-2011-04.pdf>
7. Yoshida, N and J. Kanda. "Tracking the Fukushima Radionuclides." Science 336:1115-1116. June 1, 2012.
91
MARKET THEMES—MALTHUS REVISITED
Dec. Performance:
Y-T-D Performance:
Y-T-D S&P 500 Performance:
Background
TIS Malthus Revisited Index©
8500
8000
7500
7000
6500
6000
MALTHUS INDEX
5500
Index Members
+3.09%
+23.92%
+16.00%
Data Source: Bloomberg LP
Deere & Co. (DE), CHN Global N.V. (CNH), Kubota Corp. (6326_JP), AGCO Corp.
(AGCO), First Tractor Co. (38_HK), Exel Industries (EXE_FP), Kverneland (KVE_NO),
Iseki & Co. (6310_JP), CB Industrial Product (CBP_MK), Alamo Group (ALG), Buhler Inds.
(BUI_CN), Archer-Daniels-Midland (ADM), Bunge Ltd. (BG), Tejon Ranch (TRC), Saskatchewan Wheat Pool (VT_CN), China Agri-Industries (606_HK), Vilmorin & Cie
(RIN_FP), KWS Saat AG (KWS_GR), China Green Holdings (904_HK), Andersons
(ANDE), Genus Plc. (GNS_LN), Graincorp Ltd. (GNC_AU), Australian Agricultural Co.
(AAC_AU), Sakata Seed Corp. (1377_JP), Sipef NV (SIP_BB), United Int’l Enterprises
(UIE_DC), Hokuto Corp. (1379_JP), Monsanto Co. (MON), Potash (POT), Mosaic (MOS),
Syngenta (SYNN_VX), Yara Int’l (YARIY), Agrium (AGU), CF Industries (CF), Sinofert
Holdings (297_HK), Taiwan Fertilizer (1722_TT), Terra Nitrogen (TNH), HQ Sustainable
Maritime (HQS), Tractor Supply Company (TSCO), Yongye Int’l (YONG), Art’s Way
Manufacturing Co. (ARTW), China Green Agriculture (CGA), Corn Products Int’l (CPO),
Cosan Ltd. (CZZ), Gulf Resources (GFRE), Haikou Agriculture & Industry & Trade
(000735_CH), MGP Ingredients (MGPI).
China Green Agriculture (CGA)
Thomas Robert Malthus (1766-1834), the
English economist famous for his theory that
the world’s population growth often precedes and then overwhelms its capacity to
produce enough food, predicted that demographic trends resulting from the Industrial
Revolution could spark this phenomenon,
thus leading to mass starvation, epidemics,
and resource wars. His ideas have been very
influential on many aspects of society and philosophy; however, in
economic history, due to his incorrect assumption of a constant
labor demand, his predictions are generally considered failures.
But, perhaps it is time to reconsider Malthus. As portfolio managers, we can sympathize with him, as we often like to say, “We’re
not wrong, we’re just early.”
In the past century, due to cheap fuel, cheap land, technological
advances, easy access to clean water, and improved techniques,
farming capacity expanded much faster than many had predicted.
However, some of these input costs are not as cheap as they once
were. Furthermore, on the demand side of the equation, not only
are the 3 billion people in the BRIC countries requiring more meat
in their diet, they are also increasingly making fuel with their crops.
This potential supply/demand imbalance can lead to higher agricultural prices. Long-term, inflation-adjusted charts show that prices
can rise a long way before coming anywhere near new highs. Who
will benefit from this pricing power? We attempt to identify those
players in this theme.
Source: Wikipedia.com: Thomas Malthus bio
January Comment
The coldest winter in 28 years is pushing the prices of vegetables
off the charts. Vegetable prices rose nearly 15% from a year ago,
and contributed to over half the monthly increase in December’s
CPI number. Cabbage is a staple in China, and its price alone
jumped 9.3% in the last week of the year.
Snow and cold is having a harsh effect on cattle and livestock, too.
Nearly 200,000 livestock were found dead in northern China
around the beginning of the year as icy weather in normally subtropical climates are playing havoc with both animal and plant populations.
McDonald’s announced on January 7th that it is raising their prices
in China as input costs increase. Further, the weeklong Chinese
Lunar New Year is coming up, and the huge demand for food during this holiday will add to the increased supply/demand gap and
push prices even higher.
Courtesy of Bloomberg L.P.
Source: Xin, Zhou. “China’s inflation accelerates as chill boosts food prices (3).”
Bloomberg News 11 Jan. 2013.
92
TIS Group January 2013 Global Markets
MARKET THEMES—MATERIALS EXTRACTION EQUIP.
Dec. Performance:
Y-T-D Performance:
Y-T-D S&P 500 Performance:
Materials Extraction Equipment Stock Index©
+15.65%
-13.19%
+16.00%
Background
With the skyrocketing prices of raw materials, many “offline”
mines, oil wells, timber forests, quarries, farmlands, and gas
fields are becoming economically viable again. These caches
have been shelved in various stages of exploration, development, and even acquisition until their supply/demand fundamentals change back into their favor. In most instances, the equipment and supplies necessary to do this work was shifted to
other active projects, however, some of it may have been sitting idle, maybe for years. This equipment is now old, out of
date, and needs replacement.
40100
35100
30100
25100
20100
15100
10100
Materials Extraction
5100
Source Data: Bloomberg LP
Index Members
Joy Global, Inc. (JOY US), Caterpillar, Inc. (CAT), Titan Int’l (TWI), Komatsu, Ltd.
(6301_JP or KMTUY), Atlas Copco AB (ATCOA_SS), Argent Industrial Ltd. (ART_SJ),
Terex Corp. (TEX), Astec Industries, Inc. (ASTE), Hitachi Construction Machinery
Co., Ltd. (6305_JP), Modec, Inc. (6269_JP), United Tractors Tbk (UNTR_IJ), Manitou
BF (MTU_FP), Palfinger AG (PAL_AV), Danieli & Co SpA (DAN_IM), Duro Felguera
SA (MDF_SM), Sandvik AB (SAND_SS), Oshkosh Truck Corp. (OSK), Deere & Co.
(DE), CNH Global N.V. (CNH), AGCO Corp. (AGCO), Lindsay Corp. (LNN), Alamo
Group, Inc. (ALG), ERA Mining Machinery Ltd. (8043_HK)
Atlas Copco (ATCOA_SS)
The mining and drilling companies themselves are one way to
play the high commodity price trend, but we’ve found most of
them to be extremely pricey, and overly volatile. We think the
suppliers to those companies are a surer bet. Pouring through
the earnings announcements of these companies, one common
theme emerges – their fast-growing mining, construction, and
energy segments. Yes, the companies’ housing construction
units are losing strength, but the effects of this news on the
stocks’ prices should be used as buying opportunities. The
companies to focus on are those that have large and growing
international business units. The winners in this theme will be
those that successfully brand their products, and gain market
share in the emerging and developing markets. Billions of people growing up watching Hollywood movies now have the desire and opportunity for a more Western lifestyle.
January Comment
One of the most positive stories we can see regarding heavy
equipment is the news coming out of India that they are going
to ease up on development restrictions.
India has one of the strictest set of laws regarding land development. It has heavily favored farm land for decades, and made
it almost impossible for industrial or mining projects. As a result, despite a country rich in both land and natural resources,
India has had to import much of its raw materials and endproducts that could have been produced internally for much,
much cheaper.
Courtesy of Bloomberg LP
While we don’t expect this to change overnight, we do expect
the easing momentum to continue. We expect this for no
other reason than absolute necessity. The government is desperate to increase tax revenues, and has had to explore other
areas of revenue generation. Its current account has grown to
a dangerous level, and the country simply must start producing
more products its middle class is demanding.
Source: Chowdhury, Roy. “India steps up policy overhaul with land law
approval” Bloomberg News 14 Dec. 2012.
TIS Group January 2013 Global Markets
93
MARKET THEMES—OIL TRANSPORTATION/SHIPBUILDING
Dec. Performance:
Y-T-D Performance:
Y-T-D S&P 500 Performance:
TIS Oil Transportation/Shipbuilding Index©
700
Thousands
600
Background
A number of events are occurring simultaneously in the oil
shipping market which is resulting in steady growth in shipping
rates.
On December 6, 2002, European governments agreed to bar
single-hulled tankers from transporting heavy grades of oil to
and from European ports. The agreement was made quickly, in
reaction to the gigantic oil spill which occurred off the NW
coast of Spain. The ban took effect on October 21, 2003 and
no single-hull tankers with a cargo capacity of 5,000 tons or
more will be allowed to transport heavy grades of crude, fuel
oil bitumen, and tar to and from member states' ports or offshore oil installations.
500
400
300
200
Oil Transportation
100
Index Members
+13.07%
-0.38%
+16.00%
Data Source: Bloomberg LP
Hyundai Heavy Industries Co., Ltd. (009540_KS), Samsung Heavy Industries Co., Ltd.
(010140_KS), Daewoo Shipbuilding & Marine Engineering Co., Ltd. (042660_KS), Mitsui
Engineer & Shipbuilding Co., Ltd. (7003_JP), Hitachi Zosen Corp. (7004_JP), Hanjin Heavy
Industries Co., Ltd. (003480_KS), Teekay Shipping Corp. (TK), Overseas Shipholding
Group, Inc. (OSG), General Maritime Corp. (GMR), Knightbridge Tankers, Ltd. (VLCCF),
Tsakos Energy Navigation, Ltd. (TNP), B&H Ocean Carriers, Ltd. (BHO), Frontline, Ltd.
(FRO), China Shipping Development Co. (1138_HK), Mitsui O.S.K. Lines, Ltd. (9104_JP),
A/S Dampskib. Torm (TRMD), Shipping Corp of India (SCI_IN), Cosco Corp. Singapore
Ltd. (COS SP), Vietnam Petroleum Transport Joint-Stock (VIP_VN)
Teekay Shipping (TK)
The EU isn’t the only group jumping on the bandwagon. The
UN shipping agency, the International Marine Organization,
agreed to accelerate their ban on single-hulled oil carriers to
April 2005. It is estimated that one-half of all tankers will be
eliminated by 2010 by this measure, five years earlier than previous agreements.
With this theme, we attempt to help our readers keep track of
the latest developments in this area. This artificial, government-created supply shortage is generating a great catalyst of
which we, as investors, can take advantage. We will point out
the winners/losers and trends. Our index attempts to capture
a sample of companies which will benefit from the current environment. It includes shippers with much of their business in
Europe, and with a good deal of their fleet double-hulled. Also,
shipbuilders will benefit as the industry attempts to double the
number of double-hull tankers in less than ten years.
January Comment
Saudi oil output has been reduced to its lowest level in 19 months.
This is the result of booming output in the U.S. from oil sands
production in North Dakota and recovering production in Iraq.
Courtesy of Bloomberg LP
This is by far the biggest story in the oil shipping industry in the last
year, and will likely continue to be going forward into the foreseeable future. The U.S. had been the biggest demander of overseas
oil, and to reduce this demand is a huge hit. We think at some
point in the future, China and India’s demand will take the place of,
then surpass that of the U.S., but that time is still a few years away
from now.
Saudi production fell 4.9% in December to 9.025 million barrels
per day. The 465,000 barrel drop from November is the biggest
monthly drop since November 2008, a drop caused by the beginning of the global financial crisis.
Sources:
Bloomberg Data
Mahdi, Wael. “Saudi Arabia said to cut December oil output to 19-month low.”
Bloomberg News 10 Jan. 2013.
94
TIS Group January 2013 Global Markets
MARKET THEMES—WATER
Dec. Performance:
Y-T-D Performance:
Y-T-D S&P 500 Performance:
Background
TIS Water Index©
50000
45000
40000
35000
Water Index
30000
Index Members
+8.37%
+18.11%
+16.00%
Courtesy Bloomberg LP
Agilent Tech. (A), ITT Corp. (ITT), Pentair, Inc. (PNR), Veolia Environment (VE), Danaher Corp. (DHR), Valmont Industries (VMI), Pall Corp. (PLL), Aecom Tech (ACM),
National Oilwell Varco Inc (NOV), Tetra Tech (TTEK), URS Corp. (URS), Nalco Holding (NLC), Itron, Inc. (ITRI), Lindsay Corp. (LNN), Watts Water Tech (WTS), Calgon
Carbon (CCC), IDEX Corp. (IEX), Badger Meter (BMI), Layne Christensen (LAYN),
Gorman-Rupp (GRC), SJW Corp. (SJW), Aqua America (WTR), Cia de Saneamento
Basico do Estado de Sao Paulo (SBS), California Water Service Group (CWT), Consolidated Water (CWCO), American States Water (AWR), Hyflux Ltd. (HYF_SP), Kurita
Water (6370_JP), Woongjin Coway (021240_KS), Tianjin Capital Environmental
(1065_HK), Fluidra SA (FDR_SM), BWT AG (BWT_AV), Energy Recovery (ERII),
Sound Global (SGL SP), Puncak Niaga (PNH_MK), Christ Water Tech (CWT_AV), Pan
Asia Enviro (556_HK), Tyco International (TYC), Pennichuck Corp. (PNNW), Thai Tap
Water Supply (TTW_TB), Ion Exchange (India), Ltd. (ION_IN), Tri-Tech Holding
(TRIT), Duoyuan Global Water (DGW), A.O. Smith (AOS), FlowServe (FLS), Northwest Pipe (NWPX), United Utilities (UU/ LN), Severn Trent (SVT_LN), American Water Works (AWK), Chongqing Water (601158_CH)
Corn Price (1 year)
Courtesy of Bloomberg LP
Water, that essential source of life that is seemingly limitless and
ever-flowing. But, is it? The cost of water is not even a consideration for most people in the world. It is an afterthought, and its
bounty is taken for granted. However, what we are observing is
that similar to the peak oil phenomenon with crude oil, water is
beginning to see some supply/demand constraints. For oil, the
“light sweet” grade of crude is the low-hanging fruit. It is often the
easiest to get to; it needs the least refining, and is therefore a cheap
source of energy. The world is by no means running out of oil.
The tar sands in Canada are estimated to have more oil in them
than all of the Middle East. The problem is that the oil is extremely
expensive, difficult, and time-consuming to extract. With water,
the fresh reservoirs from rivers, lakes, and streams, are the lowhanging fruit. However, as these sources dry up, become more
polluted, and get diverted to agriculture, it is becoming more and
more expensive to extract.
Water is plentiful. We are surrounded by oceans of it, but an increasing number of people, demanding a better quality of life, are
buying an increasing amount of industrial products. They need an
increasing amount of fresh water to be produced. Desalination and
filtration, currently, are expensive and time-consuming processes.
Technologies will emerge to improve efficiency and cost in these
areas, but the developments here are not keeping up with demand.
In the interim, prices for current water technologies will rise. The
price of services offered by companies providing treatment, monitoring, and delivery will also rise. Through this theme, we will attempt to identify the companies that have exposure to this pricing
power, and will benefit from it.
January Comment
The water level in the Mississippi continues to be a main story in
agriculture in the U.S. this month. The worst drought in the U.S. in
50 years is having a severe effect on the water level, and therefore
the transportation viability of our nation’s rivers. The Mississippi
River alone is responsible for handling around $7 billion in cargo
every year, so a reduction or stoppage of barge traffic could have
severe effects on grain prices and truck and railway transportation
costs.
With nearly 60% of the U.S. experiencing drought conditions, levels
of the Mississippi are well below normal. This is having an effect on
the more than 100 million tons of products shipped in barges on
the river.
Around half of that bulk is soybeans and corn, so congressmen
from Iowa and Illinois are lobbying the Obama administration to
step up funds for dredging. Through the Army Corps of Engineers,
the federal government has already increased efforts to remove
rock formations and shoals which could impede barge traffic, but
this is not enough, says Iowa’s Tom Harkin and Illinois’ Dick Durbin.
They would also like the Corps to open dams in the Missouri River
to raise the water level in the Mississippi. The Army Corps of Engineers is pushing back on this suggestion, citing a lack of authority
and a concern for the effects on the Missouri River valley itself.
Sources:
Abbott, Charles. “UPDATE 2-Mississippi water low, but enough for river barges."
Reuters.com 7 Dec. 2012.
Wilson, Jeff. “Tightest corn crop since ’74 as Goldman sees rally: commodities.”
Bloomberg News 11 Dec. 2012.
TIS Group January 2013 Global Markets
95
CANADIAN DOLLAR/CURRENCY
Canadian Dollar Spot (MACD)
RS Momentum and Ratio Comparatives**(see description below)
103.0
RS Momentum
102.5
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
AUD
SGD
GBP
CHF
99.5
Courtesy of Bloomberg LP
RUB
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
101
102
103
104
105
CAD/USD IS IN MAJOR BULL TREND
THE NEXT MAJOR MOVE DEPENDS ON COMMODITIES, ESPECIALLY GOLD
Australia
Switzerland
Japan
Canada
U.S.
Euro
UK
Real Short
Rates
(Using 3- mo
rates
less CPI)
1.23%
0.41%
0.30%
0.12%
- 1.74%
- 2.18%
- 2.28%
Real Long
Rates
(Using 10- Yr
Govt Bonds
less CPI)
1.43%
0.97%
1.03%
1.14%
0.10%
- 0.69%
- 0.62%
3 mo & 10 yr rat es on 1/ 7/ 13; Lat est CPI as available 1/ 7/ 13
Dat a Source: Bloomberg LP
REAL INTEREST RATE DIFFERENTIALS
 Real short rates are -0.25%. In the U.S., real
short rates are -2.11%. Nominal short rates
in Canada are 0.95% vs. 0.09% in the U.S.
 Canadian real long rates are slightly higher
than real U.S. long rates. More important,
the C-Dollar has a high correlation to
gold. If gold trades above $2,000 and
stays there, the C-Dollar will move higher.
INFLATION DIFFERENTIALS
 On a year-over-year basis, current CPI is
1.2%. Official U.S. inflation is 1.8%.
GDP DIFFERENTIALS
 Year-over-year GDP growth is about
1.1%. Almost three-fourths of Canada’s
exports go to America, so if the U.S.
economy accelerates, so should Canada’s
economy, though Asia is becoming an increasingly important trading partner. If
the U.S. goes into recession early in 2013,
Canada will need a lower CAD. The Bank
of Canada is aware of the problem and
should intervene if the cross rate trades
too high. Home prices in Canada are being viewed as too expensive now. This development plus the CMHC reduction in
mortgage purchases may usher in a decline
in the real estate market. Toronto area
real estate is expensive. Existing Vancouver property as well as future projects are
96
being snapped up by Chinese buyers, putting upside pressure on prices.
 Canada's economy is highly correlated to
gold, oil and other commodity prices the
U.S. and Chinese economies, which are in
long-term bull markets.
Many ag
commodities are very cheap relative to
their inflation-adjusted highs, which also
argue in Canada’s favor over the long run.
Demand for real assets will underpin the
C-Dollar/U.S. Dollar in the intermediate
term.
 The macroeconomic picture for Canada is
in a generally strong position. Canada ran
huge surpluses for years until 2008 and
could do so again in a couple years, so the
C-Dollar should continue to strengthen
over the long term. At 0.93-0.95 to the
USD, we think the BoC will intervene and
attempt to slow down C-Dollar
appreciation. At 1.05-1.06, the CAD/USD
may be too weak and will begin to
strengthen naturally.
Canada’s strong
fiscal position gives the government
flexibility to reflate the economy.
Canada’s recent budget deficits reverse
years of budget surpluses, but Canada can
afford it, and unlike many other countries,
Canada’s credit rating should not be
appreciably damaged by recent deficit
spending.
 Canada has some of the best economic
fundamentals in the G-8. However, if the
base metals mining boom has ended; or if
China’s economy fails to pick up, Canada’s
growth rate will slow.
BUDGET, DEBT AND TRADE FACTORS
 The OECD predicts Canada's debt burden
will soon be the lowest among G-8 nations.
 The Conservatives have announced a plan
to eliminate Canada’s Federal debt in 15
years. If they are careful, it may not take
that long to pay off the debt.
 Canada’s debt to GDP ratio is about 41%.
It is from the 40% Debt:GDP level which
the U.S. launched its economic revival in
the 1980s. Canada's debt-to-gross domestic product ratio is expected to drop to
25% within 10 years (compared to Japan at
about 200%) while the U.S. Debt:GDP ratio is close to 100%. Canada has plenty of
room to reflate its economy, and re-arm
its military, which it is beginning to do.
 Budget deficits/surpluses and whether or
not a currency is perceived as “hard” are
clearly factors being watched by the currency markets. A quick review of fiscal
policies and currency performance shows
that countries with positive fiscal balances
generally have strengthening currencies, in
the long run. The CAD is a hard currency
thanks to its resource base and fiscal policies.
MONETARY FACTORS
 Canada’s money supply is growing at
5.71% on a y-o-y basis, a bit high in
nominal terms, but relative to some other
countries, it is low.
 As international interest rate differentials
remain relatively narrow, the currency
markets are weighing factors beyond yield
differentials. Creditor vs. debtor countries, commodity markets exposure, fiscal
management, and asset diversification
seem to be additional determining factors.
These may be the next themes along with
the soundness of the banking system and
reflation, releveraging and eventually control of budget deficits. Canada shines on
most counts.
 Significant appreciation of the Canadian
currency against the U.S. Dollar over the
past several years has been a problem for
Canada’s exporters. Canada is exporting
commodities, but what else in size? And,
to whom in the world will they export if
the global economy, and particularly the
U.S. economy, falls back into recession?
TIS Group January 2013 Global Markets
CANADIAN DOLLAR/CURRENCY
The BoC also cannot forget Canada’s
domestic manufacturing base, especially
Ontario’s auto industry, which should be
doing better now that the U.S.
automakers are recovering. The halcyon
days may be over for southern Ontario
manufacturing, but a C-Dollar which is
too strong, may not be what the BoC has
in mind.
 The Bank of Canada probably has the best
fiscal backdrop against which to design
monetary policy in the G-8.
POLITICS
Following the May 2011 election that gave
Mr. Harper the long sought majority of 166
seats in parliament, the Conservative government continues to enjoy a firm mandate
to govern. We look for the Conservatives to
serve the full five year term. With its Parliamentary majority the Conservatives focused on their list of reforms in 2012 passing
corporate tax cuts, a law ending the monopoly on control of wheat exports by the Canadian Wheat Board, several bills that together toughened Canada’s crime laws, abolish the long-gun registry unpopular with
right-to-bear-arms voters and passed provisions that lighten the regulatory burden on
large energy projects. With the economy
limping along Mr. Harper will focus additional
energies on fiscal spending to boost the
economy. Early indications are that the Conservatives are planning a new round of infrastructure spending to begin in 2014 when the
current “Building Canada” program ends this
year. The new stimulus cycle could earmark
roughly C$5 billion each year a year over a
10-year to 15-year period. The source of the
funds would in part come from proceeds
from an excise tax the Canadian government
already collects on gasoline. The benefits to
construction sector beginning in 2014 would
be significant. It is clear that the Conservatives want to redirect spending to stimulate
economic growth in the private sector
where jobs need to be created. We note
that The Liberal opposition has been reasonably quite in Mr. Harpers first year with a
sound parliamentary majority. We look for
the Liberals to regroup but be unable to
mount significant opposition to the Conservatives this year. We look for the Harper
government to be stable and stand a good
chance to complete their full five year term
to the next general election.
kick into high gear, which is possible given
low global inventories, drought conditions in
the U.S., growing condition in South America
which are deteriorating and financialization of
the ag markets, the C-Dollar could enter another period of strength. Gold and the CDollar are highly correlated. Gold looks
higher in H1, 2013; the C-Dollar should
trade up as well. Buy the C-Dollar on any
dips.
**Bloomberg Relative Rotation Graphs (BLP
command <RRG>) plot relative strength along
the horizontal axis and relative strength momentum along the vertical axis. When these
two data sets are plotted over time, the result
is an apparent rotation about a fixed point (the
plot origin) defined by the base variable. In the
case of the currency RRG, the U.S. Dollar is the
basis for cross rate comparisons. The mutually
perpendicular vertical and horizontal axes form
a four quadrant interpretive framework that
points to relative weakening or strengthening
against the currency base.
Sources:
Bank of Canada.
Bloomberg.
TARGETS
I think the BoC will be sensitive to keeping
the CAD from strengthening too much verses the USD. Over the long term, the CAD
should rise along with commodity prices,
reaching its peak at the conclusion of a longterm commodity cycle, which could be as
late as 2017-2018. I believe the world is
about two-thirds of the way through this bull
market commodity cycle with agriculture
taking the lead over the next 4-5 years.
When the bull phase in commodities ends,
the bull market in the C-Dollar will probably
end as well. Our near-term CAD/USD target is 0.95-0.96. If the agricultural markets
TIS Group January 2013 Global Markets
97
EURO/CURRENCY
Euro:Dollar (MACD)
RS Momentum and Ratio Comparatives**(see description below)
103.0
RS Momentum
102.5
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
AUD
SGD
GBP
CHF
99.5
RUB
Courtesy of Bloomberg LP
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
101
102
103
104
105
Euro/Dollar—In A Trading Range Between 1.27-1.31
A u s t ra lia
S w itz e rla n d
Ja p a n
Can ada
U .S .
Eu ro
UK
R e a l S h o rt
R a te s
(U s in g 3 - m o
ra te s
le s s C P I)
1.2 3 %
0 .4 1%
0 .3 0 %
0 .12 %
- 1.7 4 %
- 2 . 18 %
- 2 .2 8 %
Real Lo ng
R a te s
(U s in g 10 - Y r
G o vt B o n d s
le s s C P I)
1.4 3 %
0 .9 7 %
1.0 3 %
1. 14 %
0 .10 %
- 0 .6 9 %
- 0 .6 2 %
3 mo & 10 y r r at es o n 1/ 7/ 13 ; Lat es t C P I as av ailab le 1/ 7/ 13
D at a S o ur c e: B lo o mb er g LP
Courtesy of Paul Nesbitt, 618034 Ltd
EURO: DOLLAR—IN TRADING RANGE (1.27-1.32)
REAL INTEREST RATE DIFFERENTIALS
 Euro short rates will become less competitive against many other developed country
currencies as the ECB is forced to adjust to
deteriorating economic conditions.
INFLATION DIFFERENTIALS
 Fighting inflation, the ECB’s mandate, is not
going to be the main issue for monetary policy over the next year. Fighting recession,
deflation, credit downgrades, and a
bank/sovereign debt-funding crisis are Europe’s main problems. Tighter fiscal policies
and high levels of unemployment should
keep inflation in check. Deflation is Europe’s
risk.
GDP DIFFERENTIALS
 We think Europe is well behind the U.S. in
the economic cycle and in recapitalizing the
banking system. That suggests a weak Euro
is needed as an offset to a weak and uncompetitive (in the south) European economy.
Either southern European countries must
lower costs by 20%-30%, or the Euro must
fall by 20%-30%. Parts of Europe, such as
Spain, Youth unemployment in Spain is at
98
55%. Italy and Greece are in near depressions. Wages have fallen by 25% in Greece,
improving competitiveness. This type of adjustment must occur across southern Europe.
MONETARY FACTORS
 Narrow money supply growth is (+6.5%
Y-o-Y). Broad money growth is (+3.8% Y-oY). In some European countries, housing
bubbles have popped and banking sectors
have imploded, i.e. in Spain, Iceland, Greece,
and Ireland. Europe had housing bubbles in
Spain, Portugal, Ireland, England, and Scandinavia, and the popping of their housing
bubbles may have top-ticked inflation in Europe. Deleveraging will be an ongoing
problem as some EU banks have bigger balance sheets than the GDP of the country
they reside in. Portuguese, Greek, French,
and Spanish banks are particularly vulnerable to further weakness in their economies.
ECONOMICS/POLITICAL
A huge shift in power has taken place in
Europe away from elected officials, and toward the ECB. This occurred when Mario
Draghi stood up and promised the world
that he would back Spain’s debt. He didn’t
have the legal authority to do so, but the
markets like it, and as a result, the EU is
working on giving him his legal authority
retroactively. The election of Francois
Hollande in France is a sign that austerity in
Europe is a long way off, but his losses in
the recent by-elections give us some hope.
Germany and the EU will continue to give
good lip service to austerity, but sentiment
is clearly moving the other way across the
Eurozone. With Spain and Italy talking austerity, yields on their government debt
have come off their highs. This is providing
somewhat of a respite to the markets, and
allowing the fear trade to come off. The
snap election called in Italy, however, is going to bring their recently-ignored fiscal situation to the fore. This will likely begin to
lift rates again, and put pressure back on
the enormous debt service levels. This is
where we begin to get skeptical. Growth is
the only hope for Europe, but prospects
are grim. We are also skeptical of the longterm commitment of the PIGS to their new
“austere” pledges, as set forth in what is
TIS Group January 2013 Global Markets
EURO/CURRENCY
now known as the “fiscal compact.” (“Spain
rescue could determine market view of Italy.” Oxford Analytica 18 Dec. 2012)
TARGETS
Euro/Dollar is in a trading range for now between 1.27-1.32. The ECB continues to push
Spain, Greece, and Portugal toward bailouts.
The numbers still do not add up in Greece,
but Greece will be saved; Portugal is moving
voluntarily toward a fiscal restructuring, while
Spain is slowly being forced to the bailout table, in fact, Spain’s recent request for funds to
help its banks should accelerate the process.
A majority of the ECB’s governing board, favors another interest rate cut. If done in conjunction with further monetary tightening.
The Euro could go much lower.
Spain 10-yr CDS Prices—CDS Prices in Retreat
French 10-yr CDS Prices—CDS Prices in Retreat
German 10-yr CDS Prices—CDS Prices in Retreat
**Bloomberg Relative Rotation Graphs (BLP
command <RRG>) plot relative strength along the
horizontal axis and relative strength momentum
along the vertical axis. When these two data sets
are plotted over time, the result is an apparent
rotation about a fixed point (the plot origin) defined by the base variable. In the case of the currency RRG, the U.S. Dollar is the basis for cross
rate comparisons. The mutually perpendicular
vertical and horizontal axes form a four quadrant
interpretive framework that points to relative
weakening or strengthening against the currency
base.
Charts courtesy of Bloomberg
Sources:
Bloomberg.
EUROPEAN UNION: “Euro-area Bailouts May Threaten
Democratic Legitimacy.” Oxford Analytica 11 Apr.
2011.
TIS Group January 2013 Global Markets
99
JAPAN YEN/CURRENCY
Japanese Yen to U.S. Dollar (MACD)
RS Momentum and Ratio Comparatives**(see description below)
103.0
RS Momentum
102.5
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
GBP
CHF
99.5
RUB
Courtesy of Bloomberg LP
AUD
SGD
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
101
102
103
104
105
JAPAN NEEDS A LOWER YEN—AN INFLECTION POINT HAS BEEN REACHED
tion of retirees demand, i.e. health care, may
SUMMARY
begin to see price increases.
 We think Japan has an interest in weakening

The
BOJ recently set a target for inflation of
the Yen. The BOJ eased monetary policy by
1%. The LDP wants a 2%-3% target.
intervening in the FX market in recent
months, so far with success. A new govern-  We think the new government will push the
BOJ to create at least 2% inflation.
ment led by the LDP is to develop policies
GDP DIFFERENTIALS
which weaken the Yen further.
REAL INTEREST RATE DIFFERENTIALS  Without a change in its immigration policy,
Japan’s demographics will prove to be a ma Japan’s deflation disappears and then rejor challenge for the economy in the long
appears, depending on the latest CPI numrun.
ber. With inflation at -0.2%, Japan’s CPI is

Among the G-7 nations, Japan’s economy
the lowest among the major markets and
has the best potential to surprise on the uplikely will remain that way.
side due to fiscal/monetary policy changes.
 Real long rates are positive at 1.03%, depending on where you think CPI actually is ECONOMICS
(currently -0.2% on a year-over-year basis).  Exports are down -4.1% on a Y-o-Y basis.
Tankan Survey Business Conditions
But if the BOJ is successful in creating 1% inLarge Enterprises Mfg
flation, the real yield will become zero – that
should lead to a sell-off in JGBs and in the
Yen.
A u s tra lia
S w itz e rla n d
Ja p a n
Canada
U .S .
Eu ro
UK
R e a l S h o rt
R a te s
(U s in g 3 - m o
ra te s
le s s C P I)
1.2 3 %
0 .4 1%
0 .3 0 %
0 .12 %
- 1.7 4 %
- 2 .18 %
- 2 .2 8 %
Real Long
R a te s
(U s in g 10 - Y r
G o vt B o n d s
le s s C P I)
1.4 3 %
0 .9 7 %
1.0 3 %
1. 14 %
0 .10 %
- 0 .6 9 %
- 0 .6 2 %
3 mo & 10 y r r at es o n 1/ 7/ 13 ; Lat es t C P I as av ailab le 1/ 7/ 13
D at a S o ur c e: B lo o m b er g LP




Courtesy of Bloomberg LP
 Will the Japanese government have to repat-
INFLATION DIFFERENTIALS
riate capital, i.e. sell U.S. Treasury bonds or
 Japan’s inflation rate calculation was recently
even Japanese government bonds, in order
restated by the Bank of Japan. Every 5 years,
to fund Japan’s next stimulus plan or to
the BOJ overhauls the inflation measure.
simply make pension payments? InterestingThe upshot is that the assessment that Japan
ly, Japanese pension funds are now contemescaped deflation last year was premature.
plating investing in emerging markets.
The long-term battle against deflation is not  Japan’s government debt-to-GDP ratio is
over, but until the 2011 earthquake, very
around 200%, the highest among the develmild inflation was emerging. There appears
oped nations. That ratio may go still higher.
to have been sufficient disruption to the
Is another credit downgrade coming? What
economy that inflation will not be a problem
happens if interest rates begin to rise on Japfor some time.
anese debt? For Japanese banks, margins
 Demographics (baby bust, lower consumer
would expand. The cost of servicing Japan’s
demand) will help keep inflation in check
debt, pensions, and health care system
generally, though the items which a generawould also rise and could be the trigger to
100


repatriate assets and plunge Japan into a fiscal crisis. It would also cause the Yen to
strengthen, something corporate Japan
would not benefit from.
Japan's unemployment rate is 4.1% compared to the Eurozone's 11.7% and the U.S.
at 7.8%.
Japan has tried to diversify its oil sources
away from the Middle East. Their relative
lack of success shows how hard it is to replace oil in general and Middle Eastern oil in
particular. Post-earthquake, Japan has become a major importer of LNG and coal. In
a change of policy, Japan may have to renew
its nuclear power programs.
In 2005, the Japanese population declined for
the first time in decades, with deaths exceeding births. This trend will continue unless immigration reform takes place, which
we do not think will happen. Japan is the
first major economy to go off a demographic
cliff. How Japan handles this issue will have a
profound long-term effect on the economy,
financial markets, and the currency.
We expect Japan’s baby bust to decrease
consumption patterns in specific parts of the
economy. With immigration so low, Japan
faces a bleak long-term demographic future.
The “baby bust” in Japan, while it has significant long-term consequences, may be overshadowed in the short run by an enormous
intergenerational wealth transfer and the
high earnings/high consumption environment
generated by the “baby boomlet” entering
their peak earning years.
Japan’s economy is a warrant on global
growth. If other global central banks accelerate easing policies, along with the BOJ, Japan will be a prime beneficiary.
POLITICS
 In November 2012, Japanese Prime Minister
Noda dissolved the Lower House Parliament
setting the stage for a snap election that
took place on December 16th. The election
resulted in a change of leadership as voters
ousted Mr. Noda and the DPJ in favor of an
LDP government headed by Shinzō Abe.
TIS Group January 2013 Global Markets
JAPAN YEN/CURRENCY
This is not a surprise. Pre-election polls and
in terms of the fiscal stimulus they can proscribed by Abe as the “control tower” for
Mr. Noda himself forecast the LDP win. Mr.
vide their economies, so their central banks
developing growth strategies for the econAbe is no stranger to the prime minister’s
will likely provide additional monetary easomy and specific industries. He is known as
job. He held the position for a year between
ing? The ECB is getting involved on the buy
a proponent of nuclear power, defending the
September 2006 and September 2007 before
side of the European government bond marnuclear industry even after the March 2011
resigning his post. Mr. Abe is a foreign policy
ket, in part because European politicians
nuclear crisis. He worked at Sony before
hawk who will oppose China and rearm Jahave experienced policy failures and in the
entering politics. Toshimitsui Motegi, Trade
pan as well as a fiscal hawk intent on overcase of Japan, the BOJ is in the same posiMinister, is Tokyo University/Harvard and
coming deflation and weakening the Yen.
tion. The LDP is forcing a change in policy?
ex-McKinsey. He will develop new offshore
The days of frustrating inter-party wrangling  The BOJ took steps to bolster the markets
markets for Japanese goods and design a
in the Diet are not over but we expect that
new energy strategy. Kyodo News is alin early 2011 by purchasing equity ETFs and
Mr. Abe will become a force to be reckoned
ready reporting that Japan is set to resume
REITs. It worked, until the earthquake hit.
with. The composition of the Diet give Mr.
using nuclear reactors deemed safe by the
In 2012, REITs were the stock market’s best
Abe’s LDP a majority in the Lower House,
regulator. Fumio Kishida, the foreign Minisperforming sector last year, up about 30%.
but he faces a DPJ majority in the Upper  The rate of growth in the broad money
ter dealt with issues on Okinawa during the
House. This will have an effect on the rapidifirst Abe administration. This has been a
supply is 1.9% on a Y-o-Y basis. Narrow
ty with Mr. Abe can enact legislation.
sticking point in U.S.-Japanese relations for
money supply is down 3.2% Y-o-Y. For the
years. Resolution might unlock U.S. help in
past few years, Japan's monetary policy has
 We believe that Mr. Abe will immediately
moving the Yen lower, especially against the
been too tight. This policy will be loosened,
apply pressure to the Bank of Japan to
Korean Won. Taro Aso, the Finance Minisand that shift probably occurred due to the
ease more aggressively and push the
ter, is 72-years old, a former Prime Minister
recent election. Even after the earthquake
bank’s inflation target to 3%. In short orand has experience in Cabinet positions.
created so much economic damage, the BOJ
der, we also expect Mr. Abe to inject
The fiscal stimulus package will be his primarefused to ease monetary policy. A major
more fiscal stimulus. Dealing with Japan’s
ry responsibility. The next step, in terms of
shift in Japan’s power structure is needed to
ailing economy becomes the job for Mr.
“people positioning,” will be the appointshift
monetary
policy.
Abe’s Economy Minister, Akira Amari a
ment of new Deputies at the BOJ as well as
 Has the BOJ kept the Yen strong in order to
former Sony executive. Mr. Abe tasked
the Governor. If Ito or Iwata are appointed
fund Japan’s burgeoning LNG/crude oil bill?
Toshimitsui Motegi, his Trade Minister,
to replace Shirakawa, I would expect
If yes, then re-starting the nuclear program
with increasing Japan’s penetration and
Yen/Dollar to move toward 90, stocks to
should remove the need for a high Yen.
competitiveness in external markets. Taro  Policy Changes Unfolding—On defense
move 20%-30% higher and the BOJ will be
Aso, is Mr. Abe’s Finance Minister. Mr.
back in the game as a major central bank
policy, I believe Abe would like to re-write
Aso’s main focus will be engineering a fisplayer. By the numbers, Japanese stocks are
the Constitution allowing the country to build
cal stimulus package. Dealing with thorny
cheap.
a standing army. This is not possible in the
geostrategic issues is Fumio Kishida, Mr.
near term as the LDP controls 61% of the  While economic considerations are crucial,
Abe’s Foreign Minister. Mr. Kishida faces
politics intersects much of Japan’s trade patLower House seats and a 2/3 majority is
terns. For example, it appears that the Chithe difficult task of confronting Chinese
needed. The LDP’s partners, new Komeito
nese government has given tacit approval of
party, are financed by a Buddhist foundation,
aggression in the South China Sea where
a boycott by Chinese consumers of Japanese
so funding for a military build-up seems unsparing over disputed territorial claims is
cars and other Japanese goods. This will not
likely to be achievable for now. Still, I think
likely to intensify. For his Environmental
go on much longer as I expect to see Japan
Japan’s re-armament will quietly begin as an
Minster and State Minister for Nuclear
start moving production and FDI to Burma,
offset
to
China’s
growing
military
power.
Power Mr. Abe chose Nobuteru Ishihara.
Vietnam, India and Indonesia. About 10 milAbe spoke on the matter the other day, “For
Mr. Ishihara is a proponent of nuclear
lion Chinese are employed by Japanese
the
last
ten
years,
Japan
has
reduced
defense
power and will work with the cabinet and
companies operating in China, while Chinese
spending by 1% per year, including during my
LDP controlled Lower House to rescind
employment of Japanese workers in Japan, is
ad-ministration, 2006-2007. Meanwhile, Chithe Diet’s ban on nuclear power generaminimal. Japan will start locating FDI in new
na has been increasing its military spending by
tion.
markets, big markets such as India and Indomore than 10% annually for two decades.
 Overall, we see Mr. Abe ushering in a
nesia. Export markets such as these, while
This has created an imbalance in the area of
new era for Japan that has favorable ramialways important, will become a focus of
defense. The U.S. also plans to make deep
fications for the economy and Japan’s relapolicy attention. When the Yen/Won drops
cuts to its defense budget in the coming years,
tionship with the United States.
Mr.
as it has, pressure on Korean car companies
which could reduce its presence in the Pacific.
Abe’s election aligns nicely with the
which sell into China, becomes pronounced.
I believe this has led to the aggressive actions
Obama administration’s Asia pivot geoBut if the Chinese are not buying Japanese
of China in the East China Sea and in the
cars despite the price drop, new markets
strategic planning which will increase U.S.
South China Sea.” (1)
have to be opened up. This is Motegi’s job.
presence and influence in Asia and the  This statement should be read as a clear
signal that Japan is moving closer to the U.S.  Finally, it is becoming clear the BOJ is being
South Pacific. We look for Mr. Abe to repushed to cooperate with the government.
again in terms of foreign policy, defense politurn to LDP hawkish politics on the econThe days of complete BOJ independence are
cy and quite possibly, economic policy. It
omy and foreign policy. Politically, Mr.
coming to an end. Amari said on Wednesmay be that economic considerations are
Abe must work quickly to win voters
day that he would consider attending BOJ
the
principal
factors
which
drive
many
of
over to the LDP ahead of the July Upper
meetings if needed. This was taboo for
Abe’s policies. Beating deflation and the
House election where the DPJ still holds a
years, but now the gloves seem to be off.
strong Yen are Abe’s top priorities. On Demajority.
Abe calls this his “Crisis Beating Cabinet.”
cember 27, Japan’s Finance Minister Taro
TECHNICAL INDICATORS
(2) So far, he has the markets going his way.
Aso said he won’t necessarily stick to a 44
 The question is will the BOJ print enough
Where it will really get interesting is when
trillion Yen cap on new bond sales to pay for
Yen in order to achieve a 2%-3% inflation
the BOJ Governor and Deputies are named.
an extra budget. Aso also stated that PM
rate or will election of the LDP drive the inFor the first time in ages, Japan is moving. I
Abe asked for comprehensive steps to counflation target even higher/Yen lower?
have said this to some of you over the years,
ter the strong Yen.
but now it is time to put it in print. It takes
 The new Cabinet, named hours after Abe’s
MONETARY FACTORS
years, even decades for Japan to decide on a
swearing in, is very telling in terms of poli It has become increasingly clear that govstrategy. Their development of the auto incies which are coming. Akira Amari, Econernments from the UK, to the U.S., Europe
dustry, which was done over decades and
omy Minister, Akira Amari, has a role deand Japan will be constrained going forward
TIS Group January 2013 Global Markets
101
JAPAN YEN/CURRENCY
took market share from America’s Big 3, is
an example.
TARGETS
When the Japanese move, look out. Our Yen
Dollar target is moved from 90 to 99.
Sources:
(1) “Land of the Rising Sun (and Falling Yen)” Halkin
Services Limited 20 December 2012.
(2) Nakamoto, Michiyo. “Abe reveals ‘Crisis Beating’
Japan Cabinet” FT 26 December 2012.
Bloomberg Data.
Bloomberg News.
McPherson, Steven. “Japan to Resume Reactors Deemed
Safe by Regulator, Kyodo Says” BN 27 December 2012.
**Bloomberg Relative Rotation Graphs (BLP command <RRG>) plot relative strength along the horizontal
axis and relative strength momentum along the vertical
axis. When these two data sets are plotted over time,
the result is an apparent rotation about a fixed point (the
plot origin) defined by the base variable. In the case of
the currency RRG, the U.S. Dollar is the basis for cross
rate comparisons. The mutually perpendicular vertical
and horizontal axes form a four quadrant interpretive
framework that points to relative weakening or strengthening against the currency base.
Sources:
Bank of Japan. (http://www.boj.or.jp/en/)
Bloomberg Data
Department of the Treasury/Federal Reserve Board
HSNW Homeland Security Newswire. 1 Sept 2011,
http://www.homelandsecuritynewswire.com/tokyo-toldprepare-massive-earthquake.
102
TIS Group January 2013 Global Markets
SWITZERLAND FRANC/CURRENCY
Swiss Franc (MACD)
RS Momentum and Ratio Comparatives**(see description below)
103.0
RS Momentum
102.5
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
GBP
CHF
99.5
RUB
SF/Aussie Dollar
AUD
SGD
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
A u s t ra lia
S w it z e rla n d
Ja p a n
Canada
U .S .
E u ro
UK
Courtesy of Bloomberg
101
102
R e a l S h o rt
R a te s
(U s in g 3 - m o
ra t e s
le s s C P I)
1. 2 3 %
0 . 4 1%
0 .3 0 %
0 . 12 %
- 1. 7 4 %
- 2 . 18 %
- 2 .2 8 %
103
104
105
Real Long
R a te s
(U s in g 10 - Y r
G o vt B o n d s
le s s C P I)
1. 4 3 %
0 .9 7 %
1. 0 3 %
1. 14 %
0 . 10 %
- 0 .6 9 %
- 0 .6 2 %
3 m o & 10 y r r a t e s o n 1/ 7 / 13 ; L a t e s t C P I a s a v a i l a b l e 1/ 7 / 13
D at a S o ur c e: B lo o m b er g LP
SWISS FRANC—EURO/SWISS FRANC IS PEGGED TO THE EURO AT AN ARTIFICIAL
PRICE - FOR HOW LONG? SNB RESERVES ARE MASSIVE NOW
REAL INTEREST RATE DIFFERENTIALS
 Switzerland’s real short rates are no longer
the lowest in the developed world, in fact,
they are one of the highest. But nominal SF
rates do not have much room to decline
further, on either the short or long end of
the yield curve. Pushing interest rates up
may strengthen the SF – which is not what
the SNB wants.
INFLATION DIFFERENTIALS
 CPI on a year-over-year basis is -0.4% thru
November. PPI is at 1.54% on a Y-o-Y basis thru November.
 GDP was 1.3% Y-o-Y in Q3.
POLITICAL FACTORS
The five party coalition formed from the
2011 election appears stable and able to fulfill its mandate until the fall 2015 election.
Each of the five hold a seat in the seven seat
governing Federal Council with the centrist
Social Democrats and left Radical Democratic Party Liberals each holding two seats.
In late November, the Federal Council announced its reform of the retirement pension insurance system. The headline issue
was an increase in the retirement age for
women from age 64 to age 65. This makes
the women’s retirement age equal to that of
men. The change was made in the interests
of increasing the solvency of the retirement
system which was threatened by demo-
TIS Group January 2013 Global Markets
graphic trends that reflected longer lives for
women and a wage gap where women
earned on average 10% less than their male
counterparts. We also note that in early
December the Lower House upheld the
“Lex Koller” legislation that restricts acquisition of property by foreigners. The about
face by the Lower House reflects growing
concern about the large influx of immigrants
seen as necessary to moderate demand. A
related proposal that, the Zweitwohnungsinitiative, restricts the purchase of secondary homes by foreigners was approved by
popular vote in March 2013 and comes into
force in the first quarter of 2103.
MONETARY FACTORS
 With M1 up 11.12% YoY, and broad money up 9.33% YoY, the SNB's goal of managing the currency against the Euro to assist
the country’s export oriented firms, is being expressed by aggressive growth in
money supply. The decision to put a peg
on the SF/Euro at 1.20 is a major shift in
policy. What did the Swiss authorities see
coming, that made them fear further SF appreciation? I believe they correctly forecast
capital flight from other European countries to Switzerland and even now, after
the ECB removed tail risk from the Euro,
the SF is still pushing higher.
 The SNB's policy of maintaining SF weak-
ness against the Euro was intended to keep
Swiss exports flowing across the border into major trading partner Germany.
Greece and Portugal’s fiscal blowout along
with new strains in Spain and Italy, and a
rapid spread of sovereign debt issues has
complicated life for the SNB, as it
strengthened the SF too much, too fast.
 Very low interest rates may be contributing to too much strength in the real estate market via cheap mortgages. Shortterm mortgages are around 1%. Is there a
real estate bubble? Some Swiss banks must
think so as they are beginning to turn down
home mortgage applications.
 The SNB now holds the fifth largest reserve position in the world. With negative
interest rates being set by the Swiss banks,
some of the upside pressure on the SF
should abate.
ECONOMY
 The unemployment rate is only 3%
(November). This remains one of the lowest unemployment levels in core Europe.
Germany, its northern neighbor, has unemployment of 6.9%. France, the western
neighbor, has 9.9%, and Italy, the southern
neighbor, has 10.61% unemployment. Interestingly, German and Swiss unemployment rates are lower than America’s.
103
SWITZERLAND FRANC/CURRENCY
 Business conditions in Switzerland are
pretty good, though the financial sector will
be hard hit by tax agreements with the UK,
France, and Germany and normalization
with the EU directives on alternatives/fund
management. GDP growth should be in
the 2% plus area this year. The banking
sector, along with the rest of the European
banks, may have to raise more capital in
order to maintain their ability to compete
globally, but banks have returned to profitability now and the capital markets are
open, so capital raisings should not be too
onerous. Swiss banks, along with tourism
remain the linchpins of the economy. Still,
the banking sector is under intense pressure to reform and cut costs. UBS has
started the restructuring bandwagon by firing thousands of employees.
 The balance sheets of Swiss banks are 4x
the multiple of the Swiss economy. Big
banks remain a major risk for many European countries, and Switzerland’s economy
remains highly sensitive to the fortunes of
its large banks, especially CS and UBS.
 Consumer spending will become an increasingly important factor in Swiss economic growth over the long run as a
potential means of compensating for sluggish export demand. Will the Swiss consumer pick up the slack? In the short run,
we are doubtful. Switzerland needs immigrant/capital inflows, but the cost of living
in Switzerland is quite high. People from
higher tax countries, countries with growing economic/political instability and people
with wealth (i.e. UK hedge fund managers)
are relocating to Switzerland, though hedge
fund migration seems to have moderated a
bit.
**Bloomberg Relative Rotation Graphs (BLP
command <RRG>) plot relative strength along the
horizontal axis and relative strength momentum
along the vertical axis. When these two data sets
are plotted over time, the result is an apparent
rotation about a fixed point (the plot origin) defined by the base variable. In the case of the
currency RRG, the U.S. Dollar is the basis for
cross rate comparisons. The mutually perpendicular vertical and horizontal axes form a four quadrant interpretive framework that points to
relative weakening or strengthening against the
currency base.
Sources:
Bloomberg.
Swiss National Bank http://www.snb.ch/e/search/index.html.
TARGETS
The SF is still too strong against the Euro and
Dollar. This experiment being undertaken by
the SNB to peg the Swiss Franc/Euro and limit
the Swissie’s appreciation, may determine the
economy’s fate. How long can the SNB continue on its current policy path? Currency
pegs such as this one tend to be temporary,
but this policy effort has lasted for over one
year. Will the market eventually target the
SF/Euro peg and attempt to break it? I think
Mr. Market will do just that. Does the SNB
have the staying power to see this through?
The SNB says it does, but it was political pressure, which ended former SNB leader Hillenbrand’s career. Will political pressure force
President Jordan to end the peg? Or will the
SNB be forced by Mr. Market to end this innovation in SNB currency policy? For now, buy
Swiss Franc on every dip against the USD and
the Euro. Over the intermediate term, the
Swiss Franc should continue to rise.
104
TIS Group January 2013 Global Markets
UNITED KINGDOM POUND
```
British Pound to U.S. Dollar (MACD)
RS Momentum and Ratio Comparatives**(see description below)
103.0
RS Momentum
102.5
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
GBP
CHF
99.5
RUB
Courtesy of Bloomberg LP
AUD
SGD
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
101
102
103
104
105
U.K. POUND/U.S. DOLLAR–STERLING’S OUTLOOK IS IMPROVING
INTEREST RATE DIFFERENTIALS
Real short rates are -2.28% and nominal rates
have fallen to multi-century lows.
INFLATION DIFFERENTIALS
Official CPI is 2.7%. PPI is at 3%. A build-up
inflation has pretty much been ignored by the
BoE. There is a credible fiscal plan to address
the budget deficit, so the funding outlook could
improve. But, will Europe’s recession, and the
knock-on effect of deleveraging of UK banks
eventually sink the UK into deflation? For how
long will the BoE keep short-term interest
rates negative?
Austra lia
Switze rland
Japa n
Can ada
U.S.
Eu ro
UK
Re al Sh ort
Rates
(Using 3- mo
ra te s
le ss CPI)
1.23 %
0.41%
0 .30%
0.12 %
- 1.74%
- 2.18%
- 2 .2 8%
Re al L on g
Rate s
(Usin g 10 - Yr
Govt Bond s
less CPI)
1.43%
0.97 %
1.03%
1.14 %
0.10%
- 0.69 %
- 0.62 %
3 mo & 10 yr rat es o n 1/ 7/ 13 ; Lat est CPI as availab le 1/ 7/ 13
Dat a So urce: B lo o mb erg LP
GDP DIFFERENTIALS
 Changes in EU regulations may restrain
London’s role as a world financial center
and change how banks operate. Ring fencing the banks retail operations from investment banking is one example. This
could significantly alter London’s long-term
banking and economic outlook, as would
the threat of moving Europe’s financial
center away from London. Continental
European GDP is in recession, which will
pressure the UK economy this year.
 The UK unemployment rate is at 7.8%
(November). This is lower than the rest of
the Eurozone, where some western banking
countries still have unemployment figures in
the high single digits and are moving toward
double digits, while Eastern Europe is already well into double digits. But with the
economy still under so much stress, the
UK’s unemployment rate may go on rising
for a while. The UK government has limited
TIS Group January 2013 Global Markets
room to reflate fiscal policy, while monetary
policy is running out of bullets. The BOE’s
asset purchase program just added another
GBP 50 billion to the system.
ECONOMY
 The Libor scandal, which cost Barclays $435 million and wiped out top management has spread
to other banks. This may be the beginning of a
series of bank related investigations involving energy trading, Libor and insider activity.
 Derivatives markets, which at some point may
become a problem, are an area where some UK
banks, are heavily exposed. Leveraged assets at
just a few UK banks, exceed the UK’s GDP.
 We see the UK economy as potentially very
bumpy in 2012 and 2013. GDP could swing between -1 % and 1.0% growth. A triple dip recession is possible.We think the right economic policies are generally in place, but the government’s
renewed focus on banker pay will not help regenerate economic growth. Politically, it may be
popular, but as a policy tool, misses the mark.
POLITICAL
The UK benefits greatly from its perception as a
safe haven, for investments as well as Pound Sterling. This is why we are growing increasingly concerned about Scotland’s independence movement.
A smaller and weaker UK simply cannot back the
same amount of trade. The Scottish National Party
(SNP), which leads Scotland's government plans to
hold a referendum on independence from the
United Kingdom in 2014. The SNP maintains that
an independent Scotland would remain in the EU
and would continue using Sterling as its currency.
However, the EU requires new member states to
promise to introduce the euro "eventually". A
smaller and weaker UK would only further diminish
its global influence. (“Scotland independence would
test UK-EU relations.” Oxford Analytica 11 Dec.
2012)
MONETARY FACTORS
 Broad money supply growth (M4) was -2.8% YO-Y.
 The UK is a much more service-oriented econ-
omy than it is export-driven. Higher Sterling,
which attracts capital, may be of greater benefit
to the general economy than devalued Sterling,
which aids a smallish export sector. If the Euro
looks ready to weaken, Sterling could become a
safe haven currency. Foreign capital is pouring into the London real estate market.
 The BOE is including asset prices in their policy
making mix. This is a good thing which we believe other central banks should also do. The
BOE’s relationship with the government has become easier in recent months as the new government’s fiscal plans are agreeable to the BOE.
The tug of policy war between fiscal and monetary policy is over.
 The BOE’s new governor, Mark Carney, ran the
Bank of Canada quite effectively. He will bring
credibility to the bank. Will he change BOE policy to target nominal GDP?
TARGETS
Against the Euro, Sterling should strengthen
over the intermediate term and in the longrun, which does not help the economy. The
UK has already set out its fiscal policy shingle,
austerity, long before Greece and the rest of
Europe did. Thus, the possibility of rate hikes,
which would continue to push GBP/USD higher is dim. However, the ECB may be catching
up to the BOE on the QE front. Euro:Sterling
could well sell-off when the ECB starts to expand its balance sheet, unless the BOE responds with a new QE. Sterling/Dollar should
trade higher on any pullback – to 1.58-1.59.
Sterling and Euro/Dollar are being pushed
higher by a weakening Yen.
**Bloomberg Relative Rotation Graphs (BLP
command <RRG>) plot relative strength along the
horizontal axis and relative strength momentum
along the vertical axis. When these two data sets
are plotted over time, the result is an apparent
rotation about a fixed point (the plot origin) defined by the base variable. In the case of the currency RRG, the U.S. Dollar is the basis for cross
rate comparisons. The mutually perpendicular
vertical and horizontal axes form a four quadrant
interpretive framework that points to relative
weakening or strengthening against the currency
base.
Sources: Bank of England.
.co.uk/) and Bloomberg
(http://www.bankofengland
105
UNITED STATES DOLLAR
DXY–Is The USD Ripe For A Major Downturn?
DXY U.S. Dollar Trade-Weighted Index
Coppock Monthly Data-1988 – Present
1750
DXY US DOLLAR TRADE WEIGHTED INDEX
Coppock Monthly Data - 1988 to Present
1500
Coppock
1250
150
140
DXY
1000
130
750
COPPOCK
250
110
0
-250
DXY Index
120
500
100
-500
90
-750
Courtesy of Bloomberg LP
RS Momentum and Ratio Comparatives**(see description below)
103.0
-1000
80
-1250
-1500
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
RS Momentum
70
Data Courtesy of Bloomberg LP
102.5
10-Year Gov't Yields
Are Generational Yield Lows In Place?
Leading
Strengthening
102.0
101.5
JPY
101.0
MXN
100.5
CAD
100.0
EUR
NOK
AUD
SGD
GBP
CHF
99.5
RUB
ZAR
Lagging
Weakening
RS Ratio
99.0
98
99
100
101
102
103
104
105
Courtesy of Bloomberg LP
GOING OFF THE DEBT CLIFF COULD TEMPORARILY STRENGTHEN THE USD
A u stra lia
S witze rla n d
Ja p a n
Ca n a d a
U.S .
Eu ro
UK
Re a l S h o rt
Ra te s
(Usin g 3 - mo
ra te s
le ss CP I)
1.2 3 %
0 .4 1%
0 .3 0 %
0 .12 %
- 1.7 4 %
- 2 .18 %
- 2 .2 8 %
Re a l L o n g
Ra te s
(Usin g 10 - Y r
G o vt B o n d s
le ss CP I)
1.4 3 %
0 .9 7 %
1.0 3 %
1.14 %
0 .10 %
- 0 .6 9 %
- 0 .6 2 %
3 mo & 10 yr rat es o n 1/ 7/ 13 ; Lat est C PI as availab le 1/ 7/ 13
D at a So urce: B lo o mb erg LP
QUICK SUMMARY
Long-term fundamental trends continue to
be bearish for the Dollar. Last year, deterioration in the U.S. government’s balance sheet
and QE2 helped move the Dollar lower.
Over the long run, the simple economic
need for a lower currency, and a policy
which inflates away the debt may be the deciding factor favoring further monetary ease
and a lower Dollar. Official replacement of
the Dollar as the global reserve currency is
unfolding as Russia, China and Iran accept
other currencies for energy and buyers such
as China wish to pay for oil imports in other
forms than USD. A more likely scenario than
full Dollar replacement is that competitors
to the Dollar will emerge, i.e. The Yuan-Yen,
106
stocks, & real estate appears to be coming to
a close, unless another financial/economic
crisis unfolds in the U.S. or in Europe. Are
government bond yields and aggregate U.S.
credit, the bubbles of the past decade? If
they are bubbles and the bubbles pop, where
TECHNICAL ANALYSIS
will 30-year yields and the Dollar eventually
 On the charts, we remain long-term Dollar
trade? Can the Fed control the long end of
bears.
the yield curve? In the long run, we do not
MONETARY FACTORS
think so.
 The Fed is in a policy box. If the Dollar  The Fed extended its ZIRP to the end of
weakens too much, too quickly, it may ignite
2014. Will ZIRP end with Bernanke’s deparinflation, but inflation is what the Bernanke
ture or 6.5% unemployment in 2014? I
wants. However, inflation should push indoubt it, as I expect Vice-Chair Janice Yellen
terest rates up, which the Fed does not
would succeed Bernanke and she is a dove
want. Rapidly rising interest rates designed
on monetary policy.
to defend the Dollar, is in no one’s interest. INFLATION DIFFERENTIALS
For how long will the Fed keep monetary
policy easy? We think the Fed will err on  "Official" CPI in the U.S. is at 1.8%. We believe
CPI is underreported and may be well above
the side of accepting inflation and in favor of
1.8%.
restarting growth, rather than risking further
deflation. All the policy stops were pulled GDP DIFFERENTIALS
out to reflate the economy in 2008-2009-  Problems in the housing market are easing in
2010 and the QE process, which was a key
some areas (lower-end housing and apartpolicy, will continue despite growing internal
ments). House builders’ traffic is rising and
opposition at the Fed.
housing affordability is at a multi-decade high.
 Is the major trend for long-term interest
Household formation is still rising and new
rates about to reverse to the upside? The
building is not keeping up. Housing could be
60-year downtrend in rates, which has been
the surprise part of the economy this year,
behind much of the bull market in bonds,
and a more multi-polar currency will evolve.
On a long-term Coppock curve, the Dollar is
a sale. But if the Fed indicates QE will slow
or be withdrawn, the Dollar will rally sharply.
TIS Group January 2013 Global Markets
UNITED STATES DOLLAR
especially if mortgage rates continue to decline and mortgage availability improves.
 The Fed is fighting the credit crisis/economic
contraction hard, so the really steep fall in the
economy could come later, perhaps even in
2014. The next financial/credit crisis is more
likely to be debt/currency/derivative/CDS centered and may not come until 2014.
 The Labor Department’s unemployment figures have improved recently, falling to 7.8%.
The U6 number remains well in double-digits
at 14.4%.
Major Foreign Holders of
Treasury Securities
How Long Will Foreigners Continue Buying?
(in billions $)
Nov
Nov
%
2012
2011
Change
75.5
59.2
24.7
13.1
58.9
93.3
65.3
75
194.4
29.3
94.3
51.6
27.3
30.6
258.5
137.2
201.6
58.2
22.2
27.5
36.7
1134.7
165.4
255.2
139.4
19.5
117.3
12.5
266.2
14.5
25.9
30
133.3
37
31
14.1
8.6
40.1
66.2
46.4
53.7
143.9
21.8
70.7
40.5
21.5
24.7
212.1
113.3
167.4
49.9
19.3
24
32.2
1006.1
147.5
229.4
126.5
17.7
106.5
11.5
248.4
13.6
24.6
28.6
132.4
104%
91%
75%
52%
47%
41%
41%
40%
35%
34%
33%
27%
27%
24%
22%
21%
20%
17%
15%
15%
14%
13%
12%
11%
10%
10%
10%
9%
7%
7%
5%
5%
1%
Korea, Sout
41.6
42.7
-3%
Germany
64.1
68
-6%
28.5
1161.5
30.8
1256
-7%
-8%
238.3
189.6
26%
5482.2
4918.3
11%
COUNTRY
Norw ay
Mexico
Spain
Peru
India
Ireland
Canada
France
Sw itzerland
Colombia
Singapore
Turkey
Italy
Chile
Carib Bnkng
Hong Kong
Taiw an
Thailand
Israel
Netherlands
Philippines
Japan
Russia
Brazil
Luxembourg
Malaysia
UK
South Africa
Oil Exporters
Denmark
Australia
Poland
Belgium
Sw eden
China, Main
All Other
Grand Total
1. Est imated foreign holdings of U.S. Treasury marketable and nonmarket able bills, bonds, and notes report ed under t he Treasury
Int ernat ional Capit al (TIC) reporting syst em are based on annual
2. Unit ed Kingdom includes Channel Islands and Isle of M an.
3. Oil exporters include Ecuador, Venezuela, Indonesia, B ahrain, Iran,
Iraq, Kuwait , Oman, Qatar, Saudi Arabia, t he United Arab Emirat es,
Algeria, Gabon, Libya, and Nigeria.
4. Caribbean Banking Centers include B ahamas, B ermuda, Cayman
Islands, Net herlands A ntilles and Panama. B eginning with new series
for June 2006, also includes Brit ish Virgin Islands.
Department of t he Treasury/Federal Reserve Board
17-Dec-12
POLITICAL FACTORS
 After thinking about the quote from the Jan-
uary 7th WSJ column “The Education of John
Boehner” by Stephen Moore about the fiscal
cliff negotiations, I had one further thought.
I had one further thought. When the President says to the Speaker of the House, we
TIS Group January 2013 Global Markets
don’t have a spending problem, he does not
think spending is an issue. There is no problem in his view. May I suggest he may have
gained support for that view, from the
Treasury - for that would be the only convincing place from where it could have emanated. If the incoming Treasury Secretary
has a similar view, then what we have is one
side (the Republicans in the House), who see
a problem, which the President does not
even think exists. How do you get a deal
done when one side thinks there is no problem and the other side may have their political future tied up in addressing the problem
which observers from Wall Street to the
former Comptroller of the Currency, think
does exist?
 What I think is going to happen in the near
term, is the House is going to return to its
proper function and start passing legislation,
including a budget. For our foreign readers,
appropriations bills, the budget, by law are to
start in the House. Then the Senate will receive the budget bill rom the House and it is
the Senate which has failed to pass a budget
for four years. This was intentional, as it
kept spending responsibility off the Senate
and the White House. By passing a budget
bill, in good order, the ball will be in the
Senate’s court. That is where I think the
House will leave it as that is the proper legislative procedure. Then watch the screaming
start for negotiations, how the House budget
is a non-starter, dead on arrival, don’t even
send it over here- that will be the Senate
leaders approach, as it has been in the past.
That approach buys time and increases the
possibility of backing the Republicans into a
corner, as they were in December. If late
February/early March is roughly the ending
date when the Treasury runs out of options,
that is the “date certain,” I would look for in
terms of markets to move into the next
phase and price the next big thing.
That brings me to the last point, the U.S. and
how the Fed will proceed in 2013. As incredible as this may sound, I do not think the
round of tax hikes which were agreed to on
December 31, are the end of it. I watched a
number of Republican Congressmen in the
media recently, saying we just raised taxes,
that’s done. Then Democrat Congressmen
would come on screen and without a lot of
probing, they were clearly talking about
more revenue increases to be discussed in
February at the time of the debt ceiling negotiations. It’s not over, the Administration
wants more revenue. The U.S. economy just
took a hit due to multiple Obamacare taxes
and the negotiated hike on high earners to
39.6%. If another hike is added in on top of
these new taxes in sixty days, the U.S. will be
headed for recession this year and the Fed
will respond, perhaps aggressively. It is interesting that according to the CBO, the fiscal cliff deal adds $3.9 trillion the long-term
deficit. There was no deficit reduction, taxes
alone are not able to do that. The Administration, as I said last month, has little interest in meaningfully reducing spending. So the
issue in February will be this. Will the Re-
publicans be willing to stand up and say no
debt ceiling increase unless meaningful
spending cuts are adopted - perhaps something along the lines of $4 in cuts for every
$1 in revenue. The fiscal cliff deal was upside down in this regard with $1 in cuts for
every $10 in revenue according to the CBO.
Are the House Republicans brave enough to
say to the Democrats, show up with spending cuts or we will not vote for a debt ceiling
increase - and we know a recession will occur as a result, but we are willing to live with
that. We are willing to take a recession to
stop additional tax hikes. Can they sell that
to themselves and to the country?
TARGETS
Financial repression is in full swing in America
and that means years of money printing and
Dollar debasement lie ahead, unless the Feds
change their policy and/or the U.S. government
radically reduces its borrowing requirement.
Sell Dollars on strength.
**Bloomberg Relative Rotation Graphs (BLP
command <RRG>) plot relative strength along the
horizontal axis and relative strength momentum
along the vertical axis. When these two data sets
are plotted over time, the result is an apparent
rotation about a fixed point (the plot origin) defined by the base variable. In the case of the currency RRG, the U.S. Dollar is the basis for cross
rate comparisons. The mutually perpendicular
vertical and horizontal axes form a four quadrant
interpretive framework that points to relative
weakening or strengthening against the currency
base.
Sources:
Bloomberg Data; Bloomberg News.
Major Foreign Holders of Treasury Securities.” Department of the Treasury/Federal Reserve Board
(http://www.ustreas.gov/tic/mfh.txt)
107
NEWS AND NOTES
`
LLAARRRRYY''SS TTRRAAVVEELL//SSPPEEAAKKIINNGG SSCCHHEEDDUULLEE
Jan. 25 ________________________________________________ NY
Jan. 28-Feb 15 _______________________________________ Europe
Embarrassing Job Training For All
After setting off the alarms at airport security, I was escorted behind a curtain. As two
female officials "wanded" me, the senior officer gave instructions to the trainee on
proper technique: first down the front of my
body, then up the back of me, and much to
my embarrassment up between my legs.
After she was done, her boss congratulated
her.
"Great
job," she
said.
"Now
do it
again,
but this
time, try
turning
on the
wand."
Price Wins
We were eating at one of the trendier restaurants in town when my friend pointed to the
menu and told the waitress, "I'll have the 24."
"Uh, Jim," I whispered, "that's the price, not
the meal number."
"Oh," he said. "In that case give me the 12."
lars from the food money, pressed it into the
repairman's hand, then gently closed the
door and returned to the table.
"Somebody collecting," she explained, pouring the coffee.
New Insulation?
While attending an open house, my wife was
taken with the home's modern features, especially the central vacuum system installed
within the walls. But she had a practical
question: "What do you do when all the
walls fill up?"
The Truth Revealed
I wondered if I could get my husband to address Christmas cards, as I had so much to
do. I arranged everything we needed, then
pulled up a chair and said, "Come on, Dear,
let's get these out of the way."
He glanced at the array on the table, turned
away and went into the den, only to return
moments later with a high stack of cards,
stamped, sealed, and addressed.
"They're last year's," he said. "I forgot to mail
them. Now let's go out to dinner and relax."
Disbelief
When my daughter was about 9-years-old I
became pregnant again. Of course, she
wanted to know how it happened, so I gave
what I considered an appropriate explanation
Strange Guest
of the process.
The New Year's Eve party had turned into a
She asked, "Did you do that to get me?"
marathon with numerous guests coming and
going. At one point, a man knocked on the
I said "yes," and she responded, "And you did
door, was greeted heartily though no one knew it again?"
who he was, and was led to the bar in the
basement. He sat there happily for about an
hour before a strange light dawned on his face.
"You know," he confided to his host, "I
wasn't even invited to this party. I just
came over to tell you that some of your
guests' cars are blocking my driveway. My
wife's been sitting out in the car waiting for
me to get them moved."
Wrong Collection
My friend called a Venetian-blind repairman
to come pick up a faulty blind. The next
morning, while the family was at breakfast,
the doorbell rang. My friend's wife went to
the door, and the man outside said, "I'm here
for the Venetian blind."
Excusing herself in a preoccupied way, the
wife went to the kitchen, fished a couple dol-
108
WEEKDAY NAMES
Because of the reaction people
have when they wake up and realize it's a workday again and the
weekend is over, the first day of
the week is called Moanday.
Many people too busy to cook on
the second day of the week just
open a can of beans. Hence the day
is known as Tootsday.
By the third day of the week, people are wondering when they can
ever find the time to get everything
done this week that they need to,
hence the day is known as
Whensday.
Too bleary to even count properly,
people think it's only Day Three of
the week on the next day, therefore it's erroneously called
Thirdsday.
On the last day of the workweek,
people often go out "for a few" after work. By the time they get
home, they're too tired to cook
anything elaborate, so they just
throw a piece of meat, chicken, or
fish in the skillet. That's why the
day is known as Fryday.
Saturday night all the singles let
loose. There's a lot of sexual hijinks. It's pretty obvious why the
day is called Satyrday.
And on the last day of the week-and the weekend--people look at all
the items on their to-do lists that
didn't get crossed off, groan aloud,
and make themselves promises
Marriage In Jepordy
Duck decoys, fishing rods, boots -- outdoor
gear of all kinds was piled high in the garage.
One day I found my wife staring at the mess.
"I hope I die first, so I don't have to get rid of
all this," she sighed.
"Look on the bright side," I suggested. "If I go
first, you can put an ad in the paper. When all
TIS Group January 2013 Global Markets
NEWS AND NOTES
the men come by to check out the stuff, you
can pick out a replacement for me."
Still staring at the pile, she said, "Nah. Whoever would want all this stuff wouldn't be my
type."
GIFT-WRAPPING
TIPS FOR MEN
* Whenever possible, buy gifts that
are already wrapped. If, when the
recipient opens the gift, neither one
of you recognizes it, you can claim
that it's myrrh.
* The editors of Woman's Day
magazine recently ran an item on
how to make your own wrapping
paper by printing a design on it
with an apple sliced in half horizontally and dipped in a mixture of
food coloring and liquid starch.
They must be smoking crack.
* If you're giving a hard-to-wrap
gift, skip the wrapping paper! Just
put it inside a bag and stick one of
those little adhesive bows on it.
This creates a festive visual effect
that is sure to delight the lucky recipient on Christmas morning
Your wife: Why is there a Hefty
trash bag under the tree?
You: It's a gift! See? It has a bow!
Your wife: (peering into the trash
bag) It's a leaf blower.
You: Gas-powered! Five horsepower!
Your wife: I want a divorce.
You: I also got you some myrrh.
In conclusion, remember that the
important thing is not what you
give, or how you wrap it. The imhi d i
hi
on time so I ran into the house to get my
The Perfect Tree
wife to give me a hand to start the car. I
Every December it was the same excruciating
tradition. Our family would get up at the crack told her to get into our second car, a prehistoric oversized gas guzzler, and use it to
of dawn, go to a Christmas tree farm and
push my car fast enough to start it. I pointed
tromp across acres of snow in search of the
out to her that because the VW had an auperfect tree. Hours later our feet would be
tomatic transmission, it needed to be pushed
freezing, but Mom would press on, convinced
at least 20mph for it to start.
the tree of her dreams was "just up ahead."
She said fine, hopped into her car and drove off.
One year I snapped. "Mom, face it. The perfect tree doesn't exist. It's like looking for a I sat there fuming wondering what she could
man. Just be satisfied if you can find one that be doing.
isn't dead, doesn't have too many bald spots
A minute passed by and when I saw her in
and is straight."
the rear-view mirror coming at me at about
30 mph, I realized that I should have been a
bit clearer with my directions...
Gutter Living
"Do you remember first meeting your wife?"
"Sure, I found Jill lying face down in the gutter.
I lifted her to her feet and promised her that if
she agreed to marry me, she would begin a
new life and I'd never allow her near the gutter
again."
"Wow, what an incredible story! I hope she
appreciates what you did for her."
"Not really. Even though she stunk at it, Jill
hated to give up bowling."
Good Comeback
Question Reveals Intent
Jill was discussing the various aspects and
possible outcome of the Insurance policy
with the man at the Insurance Agency.
During the discussion, she asked, "Suppose I
take the life insurance for my husband today
and tomorrow he dies? What will I get?"
The agent eyed her suspiciously and replied,
"Probably 20 to life."
Mispronunciation Leads To Misunderstanding
A man goes into a restaurant, sits down at a
table and an attractive young waitress comes
for his order. He gives her a smile and says,
"I want a quickie."
She turns red in the face and ahems, "Sir, I
don't know what kind of restaurant you're
used to eating in, but I can assure you you're
The Blame Game
not going to get a quickie here!"
Once upon a time, there were four people;
"How disappointing," the man replied.
Their names were Everybody, Somebody,
"Could you ask the chef to make an excepNobody and Anybody.
tion?"
Whenever there was an important job to be "He doesn't have anything to do with it!"
done, Everybody was sure that Somebody
says the waitress indignantly.
would do it. Anybody could have done it, but
"Hmmm," do you know anywhere around
Nobody did it.
here where I could get a quickie?"
When Nobody did it, Everybody got angry
"I'm SURE I don't know," answers the waitbecause it was Everybody's job.
ress loudly.
Everybody thought that Somebody would do
A patron from the next table leans over and
it, but Nobody realized that Nobody would
taps the man on the shoulder, "I think it's
do it.
pronounced QUICHE."
So consequently Everybody blamed Somebody when Nobody did what Anybody could More Directions Needed
A few years ago the battery in my beat-up
have done in the first place.
VW Beetle had died because I left the lights
on overnight. I was in a hurry to get to work
TIS Group January 2013 Global Markets
Last year I entered the
New York City Marathon. The race started and immediately I
was the last of the
runners. It was embarrassing.
The guy who was in
front of me, second to
last, was making fun of
me. He said, "Hey
buddy, how does it
feel to be last?"
I replied: "You really
want to know?"
Then I dropped out of
the race.
Brainless
As a jet was flying over Arizona on a clear day,
the copilot was providing his passengers with a
running commentary about landmarks over the
PA system.
"Coming up on the right, you can see the Meteor Crater, which is a major tourist attraction
in northern Arizona. It was formed when a
lump of nickel and iron, roughly 150 feet in diameter and weighing 300,000 tons, struck the
earth 50,000 years ago at about 40,000 miles an
hour, scattering white-hot debris for miles in
every direction. The hole measures nearly a
mile across and is 570 feet deep."
The lady sitting next to me exclaimed:
"Wow, look! It just missed the highway!"
109
NEWS AND NOTES
Q. What equipment will I need to go
camping?
A. You need a tent. Tent sizes are
measured in units of men, as in "a threeman tent"; this tells you how many men
are required to erect the tent if they are
all professional tent engineers. Even
then, the tent will collapse under unusual weather conditions, such as nightfall.
You will also need a hatchet, for the spiders, and a credit card, for the motel.
Q. Where should I go camping?
A. The United States has a spectacular national park system with millions of unspoiled acres where wildlife is protected by
federal laws. Avoid these places. You want
a commercial facility with a name like "The
Stop 'n' Squat Kountry Kamp-ground,"
where large animals cannot fit through the
6-inch gaps between the Winnebagos.Q.
How much food should I take?
A. A lot. You'll be providing food not only
for your family, but also for the entire raccoon community. When I was a boy in rural Armonk, our garbage cans were regular
terrorized by a gang of brilliant criminal
raccoons. I recall being awakened at 3
a.m. by loud noises and looking out the
window to see, by moonlight, my father, a peace-loving Presbyterian minister, charging around in the bushes,
wildly swinging a baseball bat and saying
non-Presbyterian words.
Of course, he did not get the raccoons;
you NEVER get the raccoons.
Q. What if I get lost?
A. If you don't have a compass, stand
very still and listen very carefully, until
you hear this sound: "eh-eh-eh." That
is Canada. Whatever you do, don't go
that way.
Source:
110
www.CleanLaffs.com
TIS Group January 2013 Global Markets
BIBLIOGRAPHY
Table of Contents
Barron’s, 1/7/2013.
Bloomberg Data LP.
Investors Business Daily, 1/4/2013.
The Economist, 1/5/2013.
Executive Summary
Abbott, Charles. “UPDATE 2-Mississippi water low, but enough for river
barges." Reuters.com 7 Dec. 2012.
Barron’s, 1/7/2013.
Bit, Kelly. “Morgan Stanley Said to Suggest Paulson Redemptions to
Clients” BN 19 December 2012.
Bloomberg Data.
Bloomberg News.
Chazan, Guy and Blas, Javier. “Saudis Cut Oil Output to Lowest in a Year”
FT 12 December 2012.
Dabbour, Haitham. “Brotherhood Would Cancel Camp David Agreement
Says Hezbollah Official” egyptindependent.com 30 Jan 2012.
Donahue, Patrick. “Merkel Election Year Starts With Warning on Growth:
Euro Credit” BN 2 January 2013.
“Forex Flash: Majority of ECB Board Favoured December Rate Cut—BBH”
FXstreet.com 2 January 2013.
Fujioka, Toru. “Abe Shift on BOJ Signals Japan May Be Approaching
Volcker Moment” Bloomberg News, 18 December 2012.
“Hedgeworld: Morgan Stanley Urges Redemptions From Paulson Funds”
Reuters Hedgeworld/BN 19 December 2012.
Heintz, Jim and Hinnant, Lori. “Depardieu, In Tax Fight, Gets Russian
Citizenship” AP 3 January 2013.
IHS Jane’s Defence Weekly, April, 2011.
“Indian land bill faces hurdles despite Cabinet nod.” Oxford Analytica 14
Dec. 2012.
Investors Business Daily, 1/4/2013.
“Land of the Rising Sun (and Falling Yen)” Halkin Services Limited 20
December 2012.
Major Foreign Holders of Treasury Securities.” Department of the Treasury/Federal Reserve Board (http://www.ustreas.gov/tic/mfh.txt)
McPherson, Steven. “Japan to Resume Reactors Deemed Safe by
Regulator, Kyodo Says” BN 27 December 2012.
Nakamoto, Michiyo. “Abe reveals ‘Crisis Beating’ Japan Cabinet” FT 26
December 2012.
Paul Nesbitt, 618034 Ltd
Pew Research Center. “Millennials: A Portrait of Generation Next –
Confident. Connected. Open to Change.” Reported edited by P. Taylor
and S. Keeter. February 2010. http://www.pewresearch.org/millennials
“Scotland independence would test UK-EU relations.” Oxford Analytica
11 Dec. 2012.
Shadowstats.com.
South China Morning Post 12-13 December 2102
“Spain rescue could determine market view of Italy.” Oxford Analytica 18
Dec. 2012.
The Economist (1/5/2013).
United States Census Bureau. International Data Base (IDB)
.<http://www.census.gov/population/international/data/idb/
informationGateway.php>
Universal Economics. 24 December 2012.
Wilson, Jeff. “Tightest corn crop since ’74 as Goldman sees rally:
commodities.” Bloomberg News 11 Dec. 2012.
America’s Equity Strategy—Equity Outlook for 2013
Barron’s 1/7/2013.
Bloomberg Data
Bloomberg News
Federal Reserve Data
Investor’s Business Daily 1/4/2013
Moore, Stephen. “The Education of John Boehner” WSJ 7 January 2013.
Paul Nesbitt, 618034 Ltd.
European Equity Strategy—Time To Take Some Money Off The
Table
Bloomberg Data
Bloomberg News
Paul Nesbitt, 618034 Ltd.
TIS Group January 2013 Global Markets
Asian Equity Strategy—Thailand Economy Well Positioned To
Benefit From Rising Consumerism And Regional Trade
Abuza, Z. “The Ongoing Insurgency in Southern Thailand: Trends in Violence,
Counterinsurgency Operations, and the Impact of National Politics.” National
Defense University, Institute for National Strategic Studies, Washington, D.C.
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Bank of Thailand. Effective Exchange Rate – Nominal Effective Exchange Rate
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Clinton. H. “America’s Pacific Century.” Foreign Policy. November 2011.
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Human Rights Watch. “Thailand: From the Tiger to the Crocodile – Abuse of
Migrant Workers in Thailand.” Publication 1-156432-602-0. February 2010.
<http://www.hrw.org/sites/default/files/reports/thailand0210webwcover_0.pdf>
International Monetary Fund. “Thailand - 2012 Article IV Consultation.” IMF
Country Report Number 12/124. June 2012. <http://www.imf.org/external/
pubs/ft/scr/2012/cr12124.pdf>
McCargo, D. “Toxic Thaksin.” Foreign Affairs. September 27, 2006
Sasiwimon, W. “The Role of the Informal Sector in Thailand.” 2011 International
Conference on Economics and Finance Research. IPEDR 4, Page 450.
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investment>
TIS Group. “The Obama Second Term and European Disengagement.” The
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World Bank. “Thailand Economic Monitor.” Publication #74575. December
2012. <http://www-wds.worldbank.org/external/default/WDSContentServer/
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iFileName0.pdf>
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Market Themes
Emerging Markets
Bloomberg Data.
NOAA, National Weather Service, Climate Prediction Center. Long Lead
Seasonal Outlook. December 20, 2012. <http://www.cpc.ncep.noaa.gov/
products/predictions/long_range/fxus05.html>
United Sates Environmental Protection Agency, Office of Research and
Development. “Study of the Potential Impacts of Hydraulic Fracturing on
Drinking Water Resources: Progress Report.” EPA/601/R-12/011.
December 2012. <http://www.epa.gov/hfstudy/pdfs/hf-report2012
1214.pdf>
United States Energy Information Agency. “Weekly Natural Gas Storage
Report.” January 4, 2013. <http://www.eia.gov/naturalgas/>
Euro Debt-Free
Bloomberg Data.
Duarte, Esteban. “Basel III punishing Dutch debt over a risk that isn’t:
mortgages.” Bloomberg News 11 Jan. 2013.
Global Energy
Bloomberg Data.
Government of Germany. "The way toward the energy of the future." Press
release. May 30, 2011. <http://www.bundeskanzlerin.de/Content/EN/
Artikel/_2011/05/2011-05-30-energiewendeenergiekonzept_en.html;jsessionid=FA8B
11D50774835B967B7D0EF31B5 D59.s3t1?nn=77364>
Government of Switzerland, Federal Department of the Environment,
Transport, Energy and Communications. "Federal Council decides to
gradually phase out nuclear energy as part of its new energy strategy."
Press release. May 5, 2011. <http://www.uvek.admin.ch/dokumentation/
00474/00492/index.html?lang=en& msg-id=39337>
Itakura, K. The Economic Consequences of Shifting Away from Nuclear
Energy. Economic Research Institute for ASEAN and East Asia. ERIA
111
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NOAA National Geophysical Data Center <http://www.ngdc.noaa.gov/nndc/
struts/form?t=101650&s=7&d=7>
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TIS Group. "Evaluation of the Fukushima Daiichi Nuclear Power Station:
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Edition. June 2012.
Yoshida, N and J. Kanda. "Tracking the Fukushima Radionuclides." Science
336:1115-1116. June 1, 2012.
Malthus Revisited
Bloomberg Data.
Wikipedia.com: Thomas Malthus bio.
Xin, Zhou. “China’s inflation accelerates as chill boosts food prices (3).”
Bloomberg News 11 Jan. 2013.
Materials Extraction
Bloomberg Data.
Chowdhury, Roy. “India steps up policy overhaul with land law approval”
Bloomberg News 14 Dec. 2012.
Oil Transportation/Shipbuilding
Bloomberg Data.
Mahdi, Wael. “Saudi Arabia said to cut December oil output to 19-month
low.” Bloomberg News 10 Jan. 2013.
Water
Abbott, Charles. “UPDATE 2-Mississippi water low, but enough for river
barges." Reuters.com 7 Dec. 2012.
Bloomberg L.P.
Wilson, Jeff. “Tightest corn crop since ’74 as Goldman sees rally:
commodities.” Bloomberg News 11 Dec. 2012.




 “INDIA: Education provision hampers manufacturing.” Oxford Analytica
2 January 2009.
 “INDIA: Maoists present risks, despite lower fatalities.” Oxford Analytica
3 January 2013
 “INDIA: Study point to risks to public health, tourists.” Oxford Analytica
7 April 2011.
 “Indian land bill faces hurdles despite Cabinet nod.” Oxford Analytica 14
Dec. 2012.
 “Parliamentary constraints blunt India’s reform drive” Oxford Analytica 5
Oct. 2012.
 “RBI resists Delhi’s line on policy, despite slowdown.” Oxford Analytica
10 Dec. 2012.
Indonesia
 Bloomberg LP Data.
Israel
 Ben-David, Calev. “Israel’s Kadima Says it may leave coalition over draft
issue.” Bloomberg News 3 July 2012.
 Bloomberg LP Data.
 “Egypt’s Islamist president to shake regional politics” Oxford Analytica 25
Jun. 2012.
 Lahav, Avital. “Interest rate cut amid slowdown fears.” YnetNews.com
25 Dec. 2012.
 Odenheimer, Alisa “Israel economy expands 3.3% in 2012, Missing
previous estimate.” Bloomberg News 31 Dec. 2012.
Japan
 Bloomberg LP Data.
Mexico
 “Arrest shows cartel influence on Mexico’s institutions.” Oxford Analytica
25 Sept. 2012.
 Bloomberg LP Data.
 “Mexican government signals anti-monopoly stance.” Oxford Analytica
17 Dec. 2012.
 “Mexico announces discovery amid reform deadlock.” Oxford Analytica
30 August 2012.
 “Signs of cooperation will follow Mexican inauguration.” Oxford
Analytica 3 Dec. 2012.
 “Small and medium drug cartels multiply in Mexico.” Oxford Analytica 19
Dec. 2012.
 “Trade and security will drive Mexican foreign policy” Oxford
Analytica 26 Sept. 2012.
New Zealand
 Bloomberg LP Data
Russia
 Bloomberg LP Data
Scandinavia
 Bloomberg LP Data
Singapore
 Bloomberg LP Data
South Africa
 Bloomberg LP Data
Switzerland
 Bloomberg LP Data
U. K.
 Bloomberg LP Data.
 “Carney’s success at BoE will depend on Osbourne.” Oxford Analytica 3
Dec. 2012.
 Euro-area, UK monetary easing does not ensure growth.” Oxford
Analytica 5 July 2012.
 “Scotland independence would test UK-EU relations.” Oxford Analytica
11 Dec. 2012.
 “Services slump threatens UK ‘triple dip’.” Oxford Analytica 4 Jan. 2013.
 “UK scandal will speed shift in bank regulatory regime.” Oxford Analytica
6 July 2012.
U.S.
 Bloomberg Data.
 Bloomberg News.
 Moore, Stephen. “The Education of John Boehner” WSJ 7 January 2013.
Country Summaries
 Australia
 Bloomberg LP Data.
 Brazil
 Bloomberg LP Data.
 “Brazil Central Bank custs growth forecast, again.” Oxford Analytica 28
Sept. 2012.
 “Brazil’s demographic dividend set to be short-lived.” Oxford Analytica 23

May 2011.
 “Brazil’s Rousseff rides high despite economy, Lula.” Oxford Analytica 17

Dec. 2012.
 “FDI focus shifts to service sectors in Brazil.” Oxford Analytica 2 Jan. 2013.

 “Growing indebtedness could undermine Brazilian Growth.” Oxford
Analytica 17 June 2011.

 “New oil auctions in Brazil may not include pre-salt.” Oxford Analytica
20 Sept. 2012.

 “Reserve requirements cut to boost lending in Brazil.” Oxford Analytica
28 Dec. 2012.

 Canada
 Bloomberg LP Data.

 China
 Bloomberg LP Data.
 Eurozone
 Bloomberg LP Data.
 Bloomberg News.
 “EU summit fails to push political union as solution.” Oxford Analytica 17
Dec. 2012.
 “Euro-area, UK monetary easing does not ensure growth.'” Oxford
Analytica 5 July 2012.
 “French Socialists lose by-election despite UMP feud.” Oxford Analytica
17 Dec. 2012.

 “Greek banks sell back most of their GGB holdings.” Oxford Analytica 12
Dec. 2012.
 “Spain rescue could determine market view of Italy.” Oxford Analytica 18
Dec. 2012.
 Sparks, Ian. “More than 400 1 million Euro homes put on the market in
Currency Reviews
Paris since socialist Francois Hollande elected to power.” DailyMail.co.uk
Canada
8 Oct. 2012.
 Bank of Canada.
 Hong Kong
 Bloomberg Data LP.
 Bloomberg LP Data
Euro
 India
 Bloomberg.
 Bloomberg LP Data.
112
TIS Group January 2013 Global Markets
BIBLIOGRAPHY
 EUROPEAN UNION: “Euro-area Bailouts May Threaten
Democratic Legitimacy.” Oxford Analytica 11 Apr. 2011.
 Paul Nesbitt, 618034 Ltd
 “Spain rescue could determine market view of Italy.” Oxford
Analytica 18 Dec. 2012
Japan
 Bank of Japan. (http://www.boj.or.jp/en/)
 Bloomberg Data LP.
 Bloomberg News.
 Department of the Treasury/Federal Reserve Board.
 HSNW Homeland Security Newswire. 1 Sept 2011, http://www.homeland
securitynewswire.com/tokyo-told-prepare-massive-earthquake.
 “Land of the Rising Sun (and Falling Yen)” Halkin Services Limited 20
December 2012.
 McPherson, Steven. “Japan to Resume Reactors Deemed Safe by
Regulator, Kyodo Says” BN 27 December 2012.
 Nakamoto, Michiyo. “Abe reveals ‘Crisis Beating’ Japan Cabinet” FT 26
December 2012.
Switzerland
 Bloomberg Data LP.
 Swiss National Bank http://www.snb.ch/e/search/index.html.
U. K.
 Bank of England. (http://www.bankofengland.co.uk/)
 Bloomberg Data LP
 “Scotland independence would test UK-EU relations.” Oxford Analytica
11 Dec. 2012
U. S.
 Bloomberg Data.
 Bloomberg News.
 Major Foreign Holders of Treasury Securities." Department of the
Treasury/Federal Reserve Board (http://www.ustreas.gov/tic/mfh.txt)
News and Notes
 www.CleanLaffs.com
TIS Group January 2013 Global Markets
113
THE INSTITUTIONAL STRATEGIST
ABOUT THE EDITOR-IN CHIEF, LARRY JEDDELOH
EDITOR-IN-CHIEF:
...................................... LARRY E. JEDDELOH
RESEARCH/PORTFOLIO MANAGEMENT:
......................................................... Larry Jeddeloh
................................................... Dr. Robert Lepley
.................................................... Andrew Roalstad
AIDES-DE-CAMP:
...................................................... Patricia Bocken
................................................... Dorothy Fleming
................................................ Randa Helmberger
..................................... Ann Hokenson-Jeddeloh
.......................................................... Sara Jeddeloh
....................................................... Russell Tschida
Larry is the Editor of The Institutional Strategist; Managing Director and Chief Investment
Officer of TIS Group in Minneapolis. He is an experienced investment management
professional with over 31 years in the business. He is also a strategic advisor to a major
Canadian mutual fund group and is on the advisory board of a European fund to funds.
Most recently Larry held the position of Chief Investment Officer of Resource Capital
Advisers, with responsibilities for $1 billion in assets. Prior to joining Resource, he
spent two years in Switzerland with the Union Bank of Switzerland in Zürich, where he
was a Vice Director and the Chief Investment Strategist in the Institutional Global Asset
Management Group. In the 1980s, he was Director of Equity Research at the Leuthold
Group, a well-known institutional research firm in Minneapolis, Minnesota, for seven
years. He was also a partner of Leuthold and Anderson Investment Management
Counseling and Weeden & Company, an institutional brokerage firm. Larry earned his
Bachelor of Science in Finance and a Masters of Business Administration degree from
University of St. Thomas, St. Paul, Minnesota. He has taught courses in investments and
corporate finance at the University of Minnesota and at Augsburg and Northwestern
Colleges. His work has been noted and used in various publications such as The Wall
Street Journal, Newsweek, Money Magazine, Your Money, U.S. News & World Report, Barron’s,
and Global Finance.
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