Market Insights

A difficult year ad in 20 ahe 12

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12/2011
This material is for reference only.

Andreas Utermann, Global Chief Investment Officer at Allianz Global
Investors











As we head into 2012, I will focus on the themes likely to shape the direction of capital markets and
provide a brief outlook for each major asset class. In doing so, I shall highlight our predictions from last
year and consider in the light of how actual events played out.

Economic outlook

Our predictions for 2011: Trend economic growth will remain lower than before the crisis; however,
given the low level of central bank rates, high cash positions of the corporate sector and solid demand
from emerging markets, economic growth should be reasonable.

While 2011 growth was indeed solid, we are clearly facing a significant slowdown in economic
activity in 2012. The rise in the oil price in the first of half of 2011, tighter monetary policy in emerging
markets, and, of course, fiscal tightening in the US and in Europe, is all taking its toll on growth. Since
the summer, tensions in the financial markets have added further pressure: with financing conditions
for banks becoming more difficult, we expect this to have a negative impact on credit growth going
forward. Already, lending surveys are pointing to a headwind for the credit cycle.

Still, we dont expect most developed economies to fall into recession as real interest rates remain
ultra-low and also because the private sector is in a position to spend out of cash-flow. We are also
expecting emerging market growth to remain solid supported by increasing domestic demand.

However, growth risks are clearly increasing. This is particularly true for Europe, where fiscal
tightening is most pronounced. This could be exacerbated if the stressed financial system, notably the
banks, continues to see balance sheet contraction in response to the crisis, which would further
reduce credit availability to the private sector at a time when it is needed most. A recession is
becoming increasingly likely.

Our medium term outlook remains unchanged: in times of high public sector debts, and private and
public sector deleveraging, trend growth will be lower than before the burst of the bubble. This period
is likely to last for several years.

Market Insights : A difficult year ahead in 2012
Budget deficits

Our prediction for 2011: While major sovereign defaults have been averted, the spectre of debt
restructuring or even default for some of the Euro-zones peripheral countries will continue to haunt the
markets.

While our expectations for on-going debt problems in the Eurozone have turned out to be correct, we
did not and could not have anticipated the kind of escalation of the debt crisis which we have
witnessed since the summer.

Given the complexity of the problems, a quick fix is unlikely. Political actions which can realistically be
implemented - i.e. fiscal tightening, tighter harmonization of economic and fiscal policy in Europe -
take a long time to be implemented and even longer to be effective; in our view most likely too long
for financial markets. The longer the debt crisis looms, the bigger the political risk. As the recent
developments in Greece show, there is a real threat of a break-up of the Eurozone, if political
processes get out of control.

While debt monetization is already on the agenda in the US and UK, this process is not yet on the
agenda in EMU, even though the ECB has become more Fedlike recently. Medium-term, though,
we think that a more active and aggressive role for the ECB is a likely outcome. This necessitates
decisions by policy makers to build a much more fiscally and politically integrated Eurozone including
sanctions for countries with unsound fiscal policies.

Inflation

Our prediction for 2011: We will see diverging inflation trends, with continued moderate inflation within
the Central banks comfort zone in the more highly indebted countries, and higher inflation in the
countries with trend or above trend growth.

Indeed, inflation has risen in emerging markets, in some cases to double digit rates. Central banks
have reacted accordingly and embarked on a tightening cycle. In the second half of 2011 rates peaked
but even now remain at comparatively high levels. In the developed world, inflation rates are clearly
below the levels witnessed in emerging markets. However, they have also risen to new cyclical highs
and are now above the levels which central banks are aiming for in the medium term.

The rise in the oil price at the beginning of the year is not the only explanation for a pick-up in
commodity prices. Core inflation has started to increase as well in developed markets; in emerging
markets, wage pressure has added to price increases.

We think that the cyclical moderation will trigger a moderation in inflation rates again. Given the low
level of real interest rates, on-going central bank balance sheet expansion, and our expectations of
continued solid growth in Asia, we dont expect a return of deflationary fears, despite weakening
growth. On the other hand, with demand for money being strong in the current period of
deleveraging, nor is inflation likely to be a threat in the foreseeable future.


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Market Insights : A difficult year ahead in 2012
Interest Rates and Bonds

Our predictions for 2011: We anticipate little movement in short rates for the major OECD economies but
gradual tightening in the emerging markets. We would be very cautious towards medium to long term
maturities across the world, which we feel are significantly overvalued owing to quantitative easing (QE)
activity and undue risk aversion.

The ECB hiked interest rates twice in 2011 but have now started to back-pedal and cut rates again. US
and UK interest rates have remained extremely low, whilst in emerging markets, the on-going cycle of
rate hikes has come to an end and in fact several emerging economies have recently started to cut
rates.

Looking ahead we expect rates to start to come down further in the Eurozone whilst emerging
markets are likely to continue to reduce rates. In the US and UK, as well as in Japan, we expect the
policy of extremely low interest rates to continue into the foreseeable future.

While our expectations for the short end of the yield curve turned out to be reasonably correct, the
long end of the yield curve has behaved differently. In the US and UK, on-going Sovereign bond
purchases by the central banks in addition to weaker economic data since the spring have brought
bond yields down. As we dont anticipate a major reversal in the economic newsflow, and as the Fed
and the BoE may continue to buy bonds again on a large scale, the downside to bond prices in both
markets is clearly limited. Bond returns in both markets are likely to be at around the current
redemption yield.

In Europe, bond markets are very much driven by political developments. Admittedly, bonds in the
EMU periphery very much discount potential losses. However, as long as the political uncertainty
persists and economic data remains weak, we expect risk aversion to prevail. Bunds are likely to
remain safe haven assets for the time being.

A risk-on trade within the European bond markets is only likely to start once economic data starts to
improve or the ECB takes a more active role in solving the debt crisis.

Longer-term, we remain cautious on sovereign bonds at current yields. Even if nominal returns may
turn out to be positive, we expect real returns - i.e. inflation adjusted - to be disappointing.

Equities

Our predictions for 2011: Political tensions or sovereign debt fears would be another buying opportunity
for those who want to establish longer term positions. Note that these preferences could reverse following
a bout of risk aversion, during which emerging market equities would probably underperform.

After a strong performance in the first half of 2011 equity prices have fallen significantly from their
calendar-year highs and are now slightly below the levels seen at the beginning of the year in the US;
are down around 20% in Europe; and 17% in Japan. Emerging markets, too, have fallen in absolute
terms. Some of the headwinds which explain the reversal in stock prices in the course of 2011 are
likely to stay with us in the coming months and could continue to weigh on equities next year. In
particular, the EMU debt crisis remains unsolved, even though the most recent decisions are a step in
the right direction. Still, markets are likely to continue to price-in the continuation of the debt crisis for

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Market Insights : A difficult year ahead in 2012

longer. This, per se, also increases the risk of policy failures or electorates may start to question the
concept of a European currency union altogether. The most recent developments in Greece and Italy
show that this risk is not abstract but very real.

Against this backdrop, and with economic activity slowing down globally and moderate equity returns,
we prefer stocks with relatively high dividends and pay-out ratios. Dividend payments should offer
investors some protection in the current environment.

A lasting rebound in equity markets is expected to take place only if markets can start to price in a
credible solution to the EMU debt crisis and/or when economic data are pointing towards a
stabilisation in economy activity.

Currencies

Our prediction for 2011: The US Dollar currently could rally somewhat against the Euro. Longer term, we
continue to expect emerging market currencies to appreciate against the US dollar and somewhat less
against the Euro.

The US Dollar has range-traded against the Euro this year. Going forward, we expect some
appreciation of the US Dollar because of the still-unsolved Eurozone debt crisis. In addition, the US
Dollar looks somewhat undervalued relative to the Euro.

Emerging markets turned out to be weaker this year than we originally expected. With the exception
of the Chinese Renminbi, which has continued to show solid and steady appreciation against
developed market currencies, the picture for other emerging markets is rather mixed. The Real and
the Rupee in particular depreciated against the US Dollar, explained by both risk aversion and
relatively high valuations.

Strategically, we hold on to our expectation of appreciating emerging market currencies due to
superior growth (and productivity gains). We are waiting for an attractive entry point to re-enter this
trade.

Emerging Markets

Our prediction for 2011: the strategic importance of Emerging Markets has been confirmed and 2011
will see a continuation of this theme. Good bye G7 and hello G20.

Emerging markets remain strategically important and the slowdown in economic activity will end, in
our opinion, in a soft rather than a hard landing. The reasons for our relative optimism are the
negative real interest rates, the rather low level of total indebtedness, as well as strong underlying
demand. Our positive view on emerging markets leads us to a strategically positive view on emerging
markets assets, be they equities, bonds, or currencies, valuations notwithstanding.



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Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to
revise any information herein at any time without notice.
No offer or solicitation to buy or sell securities, nor investment advice or recommendation is made herein. In making investment
decisions, investors should not rely solely on this material but should seek independent professional advice.
Investment involves risks, in particular, risks associated with investment in emerging and less developed markets. Past performance
is not indicative of future performance. Investors should read the fund prospectus for further details, including the risk factors, before
investing.
This material has not been reviewed by the SFC in Hong Kong and the Monetary Authority of Singapore, and is published for
information only, and where used in mainland China, only as supporting materials to the offshore investment products offered by
commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.
Issued by Allianz Global Investors Hong Kong Limited (Singapore office: Allianz Global Investors Singapore Limited (Co. Reg. No.
199907169Z)).