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The Committee’s view includes an assessment of global fiscal and monetary conditions,
projected economic growth and inflation, as well as the expected course of interest rates,
major currencies, corporate profits and stock prices.
From this global forecast, the RBC Investment Strategy Committee develops specific
guidelines that can be used to manage portfolios.
These include:
the recommended mix of cash, fixed income instruments, and equities
the recommended global exposure of fixed income and equity portfolios
the optimal term structure for fixed income investments
the suggested sector and geographic make-up within equity portfolios
the preferred exposure to major currencies
Results of the Committee’s deliberations are published quarterly in The Global Investment
Outlook.
an
EXECUTIVE SUMMARY 2
The Global Investment Outlook
Daniel E. Chornous, CFA – Chief Investment Officer, RBC Global Asset Management
Allan Seychuk, CFA – Economist & Institutional Portfolio Manager,
Phillips, Hager & North Investment Management Ltd.
CURRENCY MARKETS 50
Dagmara Fijalkowski, MBA, CFA – Head, Global Fixed Income and Currencies (Toronto and London),
RBC Asset Management Inc.
Canada 62
Stuart Kedwell, CFA – Senior V.P. & Senior Portfolio Manager, RBC Asset Management Inc.
Europe 64
Dominic Wallington – Chief Investment Officer, RBC Asset Management UK Limited
Asia 66
Yoji Takeda – Director & V.P., Asian Equities, RBC Investment Management (Asia) Limited
OUTLOOK HINGES ON growth. Despite this relatively recovery to growth of 1.10% next
SELF-SUSTAINING RECOVERY optimistic longer-term outlook, year. Finally, we have boosted our
we’d be the fi rst to agree that some 2009 GDP forecast for Japan to
The deepest U.S. recession since the key conditions for a self-sustaining -5.50%, increasing to +1.00% in 2010.
Great Depression came to an end recovery remain somewhat
sometime this past spring or early elusive. In particular, the U.S. job Inflation remains low and
summer. New sources of economic market remains weak and credit contained. However, there are
growth are surfacing. Home prices availability continues to be severely several signs that suggest today’s
are no longer falling, and both constrained for all but the largest benign inflation environment
buyers and builders are re-emerging. and most creditworthy borrowers. may not last beyond 2010. As last
While we are uncomfortable Additionally, there are broader year’s sharp drop in energy prices
with the sheer volume of homes concerns about the ability of falls out of the yearly inflation
moving through the foreclosure authorities to reduce their support figures, headline CPI is expected to
pipeline, the fact remains that the for the economy without tipping rebound into positive territory. In
root of the credit crisis – the bust it back into recession, and how addition, the rebound in commodity
in housing – is fi nally stabilizing. they go about timing their efforts. prices and the added impact from
Inventory re-stocking is another Finally, the ballooning debt burden a falling dollar raising the cost
potential source of growth in the casts a long, dark shadow over the of imports are both expected to
coming quarters. As companies future potential of the U.S. economy push inflation upward. We will
see the economy stabilize and and for many major industrialized be monitoring these metrics
sales pick up, they will have nations in Europe and Asia. closely for signs that the trillions
less and less motivation to pare in global monetary and fiscal
inventories. In fact, before long, stimulus are pushing expectations
inventory levels will have to be MODEST GROWTH, for future price growth higher.
rebuilt in order to meet demand. CONTAINED INFLATION
SHORT-TERM WEAKNESS,
The main economic issue is how We have raised our U.S. growth
close the U.S. is to a self-sustaining forecast to -2.60% for 2009 and BUT DOLLAR SHOULD FIND
recovery. In our view, even in the 1.80% for 2010. Our expectation SUPPORT IN MEDIUM TERM
absence of government support, for growth in Canada is lowered
the likelihood of the economy to -2.50% in 2009, while the 2010 The U.S. dollar has continued
falling back into recession is low forecast remains unchanged at to grind lower as dollar-bearish
given the building and broadening 2.00%. We expect U.K. GDP to stories dominate the media. The
momentum in the sources of decline by 4.20% in 2009, with a list of negative arguments is long
and well disseminated, with the and confidence in the recovery, key reasons. First, while earnings
market positioned for further dollar pressure will build for central banks have already rebounded sharply
weakness. While sheer momentum to send a message about vigilance on aggressive cost-cutting, they
may push the greenback lower in regarding future inflation. We look do not yet reflect the increase in
the short term, it should fi nd some for the fi rst, minor rate hikes to sales volumes that we think will
support in the medium term. Many begin in mid-2010, but the bulk of occur with the improving economy.
developed-market currencies are the move in global short rates above Second, U.S. stocks remain very
getting extremely overvalued. At the current levels remains a 2011 story. attractively valued and are close
same time, many emerging-market to their greatest discount to fair
governments continue to prevent value in a half-century. Global
their domestic currencies from EXPECT LONG-BOND equity markets appear to be
appreciating, and in the process YIELDS TO DRIFT HIGHER even more deeply undervalued.
are accumulating large foreign- Though the current economic
exchange reserves. This cannot As the threat to the fi nancial system environment is characterized
continue indefi nitely, and emerging- dissipates and economic growth by a higher-than-usual level of
market currencies will eventually is gradually restored, we expect uncertainty, we are confident
have to appreciate. In the meantime, bond yields to move higher. A rise markets will eventually value
the negative correlation between in inflation expectations and the companies based on their earnings
the dollar and the stock market in demand for “real” returns present power through the cycle instead
2009 should be put to the test once a risk to fi xed-income markets and of during an economic trough.
the Fed begins a new tightening set the stage for very limited total-
cycle. In anticipation of that change, return prospects for government
currencies will be very sensitive bonds in the quarters ahead. We INCREASE OVERWEIGHT IN
to shifting rate expectations in look for U.S. 10-year yields to reach EQUITIES, LOWER CASH
2010. Fed hikes should support 4.25%, while yields in the U.K.
the dollar in the medium term. are forecast to be 4.75%. Yields in We have increased our overweight
Canada are expected to be 4.00%, in equities by 2.5 percentage
EXPECT SHORT RATES TO and our forecast for the Eurozone points to 62.5%, sourcing the
is unchanged at 3.75%. We expect funds from cash and leaving fi xed-
REMAIN AT RECORD LOWS Japanese yields to rise to 1.75%. income exposure unchanged. This
FOR NOW reflects our view that market and
economic signals are still pointing
Given the fragility of the recovery, EQUITY VALUATIONS to greater rewards from equities,
central banks are widely expected REMAIN ATTRACTIVE given attractive valuations, relative
to hold short-term interest rates to other asset classes. We remain
at rock-bottom levels for at least Equity markets have spent the past underweight bonds versus the
the next six months in North eight months in one of the strongest benchmark, as we believe that the
America, Europe and Japan. and most impressive rallies most likely longer-term direction
Monetary authorities will want to since the 1930s. Unfortunately, for yields is higher, while near-
be confident that the recovery is many investors have stayed on term total return prospects seem
self-sustaining before beginning the sidelines, waiting for an limited. For a balanced global
the long trek back to a neutral appropriately sized correction as an investor, we recommend an asset
policy setting. In our view, they are entry point, only to watch markets mix of 62.5% equities (allowed
likely to delay as long as possible climb inexorably higher. While range 40% to 70%), 35% bonds
provided inflation expectations we don’t deny that there is a risk (allowed range 30% to 60%), with
remain stable. Eventually, with of correction, we are increasing the balance of 2.5% in cash.
the return of sustained growth our overweight in equities for two
Asset mix – the allocation within further divided into recommended specific asset classes with a goal
portfolios to stocks, bonds and cash exposures to the variety of global of tilting portfolios toward those
– should include both strategic and fi xed income and equity markets. markets that offer comparatively
tactical elements. Strategic asset mix Our recommendation is targeted attractive near-term prospects.
addresses the blend of the major at the Balanced profi le where the
benchmark setting is 55% equities, This tactical recommendation for the
asset classes offering the risk/return
40% fi xed income, 5% cash. Balanced profi le can serve as a guide
tradeoff best suited to an investor’s
for movement within the ranges
profile. It can be considered to be
A tactical range of +/- 15% around allowed for all other profi les. If, for
the benchmark investment plan that
the benchmark position allows example, the recommended current
anchors a portfolio through many
us to raise or lower exposure to Continued on next page...
business and investment cycles
independent of a near-term view
of the prospects for the economy GLOBAL ASSET MIX
and related expectations for capital BENCHMARK PAST NEW YEAR SPRING SUMMER FALL NEW YEAR
POLICY RANGE 2009 2009 2009 2009 2010
markets. Tactical asset allocation
CASH 5.0% 1.5% – 16% 7.5% 5.0% 5.0% 5.0% 2.5%
refers to fine tuning around the
strategic setting in an effort to add BONDS 40.0% 25% – 54% 32.5% 35.0% 35.0% 35.0% 35.0%
value by taking advantage of shorter STOCKS 55.0% 36% – 65% 60.0% 60.0% 60.0% 60.0% 62.5%
term fluctuations in markets.
REGIONAL ALLOCATION
Every individual has differing return CWGBI* PAST NEW YEAR SPRING SUMMER FALL NEW YEAR
GLOBAL BONDS
expectations and tolerances for NOV. 2009 RANGE 2009 2009 2009 2009 2010
volatility, so there is no “one size fits North America 25.4% 9% – 46% 18.7% 24.3% 25.4% 19.9% 22.9%
all” strategic asset mix. Based on a Europe 45.0% 40% – 90% 48.6% 42.1% 49.5% 50.6% 50.0%
35-year study of historic returns and
Asia 29.6% 0% – 29% 32.6% 33.6% 25.1% 29.6% 27.1%
the volatility of returns (the range
Note: Based on anticipated 12-month returns in $US hedged basis
around the average return within MSCI** PAST NEW YEAR SPRING SUMMER FALL NEW YEAR
GLOBAL EQUITIES
which shorter-term results tend to NOV. 2009 RANGE 2009 2009 2009 2009 2010
fall), we have developed five broad North America 52.6% 15% – 60% 55.0% 56.0% 56.0% 53.0% 53.5%
profiles and assigned a benchmark Europe 32.1% 30% – 70% 31.0% 30.0% 31.0% 33.0% 33.0%
strategic asset mix for each. These
Asia 15.4% 10% – 39% 14.0% 14.0% 13.0% 14.0% 13.5%
profiles range from income through
balanced to aggressive growth. It GLOBAL EQUITY SECTOR ALLOCATION
goes without saying that as investors MSCI** RBC ISC RBC ISC CHANGE FROM WEIGHT vs.
accept increasing levels of volatility, NOV. 2009 FALL 2009 NEW YEAR 2010 FALL 2009 BENCHMARK
and therefore greater risk that the Energy 11.38% 11.00% 13.00% 2.00 114.24%
actual experience will depart from Materials 7.15% 8.00% 8.50% 0.50 118.88%
the longer-term norm, the potential
Industrials 10.44% 10.50% 10.75% 0.25 102.97%
for returns rises. The five profiles
presented below may assist investors Utilities 4.56% 3.25% 3.00% (0.25) 65.79%
in selecting a strategic asset mix best Consumer Discretionary 9.28% 10.25% 9.50% (0.75) 102.37%
aligned to their investment goals.
Consumer Staples 10.33% 10.00% 10.25% 0.25 99.23%
Each quarter, the RBC Investment Health Care 9.88% 9.75% 8.25% (1.50) 83.50%
Strategy Committee publishes a Financials 20.95% 21.00% 20.75% (0.25) 99.05%
recommended asset mix based on
our current view of the economy and Information Technology 11.60% 13.00% 13.00% N/C 112.07%
return expectations for the major Telecom. Services 4.43% 3.25% 3.00% (0.25) 67.72%
asset classes. These weights are * Citigroup World Global Bond Index **MSCI World Index Source: RBC Investment Strategy Committee
equity exposure for the Balanced The value-added of tactical strategies returns and risk tolerances best
profile is set at 62.5% (i.e.: 7.5% above its are, of course, dependent on the degree suited to individual investors.
benchmark of 55% and part way toward to which the expected scenario unfolds.
its upper limit of 70% for equities), that Anchoring portfolios with a suitable
would imply a tactical shift of + 5.02% Regular review of portfolio weights strategic asset mix, and placing
to 25.02% for the Income profile (i.e.: is an essential part of the ultimate boundaries defining the allowed range for
success of an investment plan as it tactical positioning imposes a discipline
a proportionate adjustment above
that can limit the damage caused by
the benchmark equity setting of 20% ensures that current exposures are
swings in emotion that inevitably
within the allowed range of +/- 15%). aligned with the level of long-term
accompany both bull and bear markets.
1. Average Return: The average total return produced by the asset class over the period 1973 – 2008, based on monthly results.
2. Volatility: The standard deviation of returns. Standard deviation is a statistical measure that indicates the range around the
average return within which 2/3 of results will fall into, assuming a normal distribution around the long-term average.
VERY CONSERVATIVE
ASSET CLASS
BENCH-
RANGE
LAST CURRENT Very Conservative investors will seek income with
MARK QUARTER RECOMMENDATION
CASH & CASH EQUIVALENTS 5% 0-15% 5.4%
maximum capital preservation and the potential for
2.8%
modest capital growth, and be comfortable with small
FIXED INCOME 75% 55-95% 71.0% 72.2%
fluctuations in the value of their investments. This
TOTAL CASH & FIXED INCOME 80% 65-95% 76.4% 75.0%
portfolio will invest primarily in fixed-income securities
CANADIAN EQUITIES 10% 5-20% 11.8% 12.6%
and a small amount of equities to generate income while
U.S. EQUITIES 5% 0-10% 5.9% 6.3%
providing some protection against inflation. Investors
INTERNATIONAL EQUITIES 5% 0-10% 5.9% 6.1%
who fit this profile generally plan to hold their investment
TOTAL EQUITIES 20% 5-35% 23.6% 25.0%
for the short to medium term (minimum one to five years).
RETURN VOLATILITY
CONSERVATIVE
ASSET CLASS
BENCH-
RANGE
LAST CURRENT Conservative investors will pursue modest income
MARK QUARTER RECOMMENDATION
and modest capital growth with reasonable capital
CASH & CASH EQUIVALENTS 5% 0-15% 5.2% 2.6%
preservation, and be comfortable with moderate
FIXED INCOME 60% 40-80% 54.9% 55.4%
fluctuations in the value of their investments. The
TOTAL CASH & FIXED INCOME 65% 50-80% 60.1% 58.0%
portfolio will invest primarily in fixed-income
CANADIAN EQUITIES 15% 5-25% 17.1% 18.2%
securities with some equities to achieve more
U.S. EQUITIES 10% 0-15% 11.4% 12.1%
consistent performance and provide a reasonable
INTERNATIONAL EQUITIES 10% 0-15% 11.4% 11.7% amount of safety. The profile is suitable for investors
TOTAL EQUITIES 35% 20-50% 39.9% 42.0% who plan to hold their investment over the medium
RETURN VOLATILITY to long term (minimum five to seven years).
35-YEAR AVERAGE 10.2% 7.8%
BALANCED
ASSET CLASS
BENCH-
RANGE
LAST CURRENT The Balanced portfolio is appropriate for investors
MARK QUARTER RECOMMENDATION
5.0%
seeking balance between long-term capital growth
CASH & CASH EQUIVALENTS 5% 0-15% 2.5%
and capital preservation, with a secondary focus on
FIXED INCOME 40% 20-60% 35.0% 35.0%
modest income, and who are comfortable with moderate
TOTAL CASH & FIXED INCOME 45% 30-60% 40.0% 37.5%
fluctuations in the value of their investments. More than
CANADIAN EQUITIES 20% 10-30% 21.8% 23.0%
half the portfolio will usually be invested in a diversified
U.S. EQUITIES 20% 10-30% 21.8% 23.0%
mix of Canadian, U.S. and global equities. This profile is
INTERNATIONAL EQUITIES 15% 5-25% 16.4% 16.5%
suitable for investors who plan to hold their investment
TOTAL EQUITIES 55% 40-70% 60.0% 62.5%
for a medium to long-term (minimum five to seven years).
RETURN VOLATILITY
GROWTH
ASSET CLASS
BENCH-
RANGE
LAST CURRENT Investors who fit the Growth portfolio profile will
MARK QUARTER RECOMMENDATION
3.0%
seek long-term growth over capital preservation
CASH & CASH EQUIVALENTS 5% 0-15% 2.3%
and regular income, and be comfortable with
FIXED INCOME 25% 5-40% 21.2% 21.1%
considerable fluctuations in the value of their
TOTAL CASH & FIXED INCOME 30% 15-45% 24.2% 23.4%
investments. This portfolio primarily holds a
CANADIAN EQUITIES 25% 15-35% 27.1% 27.7%
diversified mix of Canadian, U.S. and global equities
U.S. EQUITIES 25% 15-35% 27.0% 27.7%
and is suitable for investors who plan to invest for
INTERNATIONAL EQUITIES 20% 10-30% 21.7% 21.3%
the long term (minimum seven to ten years).
TOTAL EQUITIES 70% 55-85% 75.8% 76.7%
RETURN VOLATILITY
AGGRESSIVE GROWTH
ASSET CLASS
BENCH-
RANGE
LAST CURRENT A ggressive Growth investors seek maximum long-term
MARK QUARTER RECOMMENDATION
growth over capital preservation and regular income,
CASH & CASH EQUIVALENTS 5% 0-15% 3.0% 2.0%
and are comfortable with significant fluctuations
FIXED INCOME 0% 0-10% 0.0% 0.0%
in the value of their investments. The portfolio is
TOTAL CASH & FIXED INCOME 5% 0-20% 3.0% 2.0%
almost entirely invested in stocks and emphasizes
CANADIAN EQUITIES 35% 20-50% 35.7% 36.5%
exposure to international equities. This investment
U.S. EQUITIES 30% 15-45% 30.7% 31.3%
profile is suitable only for investors with a high risk
INTERNATIONAL EQUITIES 30% 15-45% 30.6% 30.2%
tolerance and who plan to hold their investments
TOTAL EQUITIES 95% 80-100% 97.0% 98.0%
for the long term (minimum seven to ten years).
RETURN VOLATILITY
September 1, 2009, and November Current 3 months YTD 1 year 3 years 5 years
USD (%) (%) (%) (%) (%)
30, 2009. The greenback dropped
USD–CAD 1.0556 -3.55 -13.21 -14.77 -2.57 -2.31
most against the yen, depreciating
7.1%, while posting declines USD–EUR 0.6663 -4.53 -6.98 -15.42 -4.10 -2.41
of 4.5% against the euro, 3.6% USD–GBP 0.6079 -1.06 -11.31 -6.35 6.11 3.04
versus the Canadian dollar and USD–JPY 86.4496 -7.11 -4.73 -9.54 -9.27 -3.43
1.1% against the British pound. Note: all changes above are expressed in US dollar terms
versus the euro, 14.8% versus the 3 months YTD 1 year 3 years 5 years
Fixed Income Markets: Total Return (%) (%) (%) (%) (%)
Canadian dollar, 9.5% versus the
DEX Universe Bond Index 2.19 6.93 10.01 5.40 5.75
yen and 6.4% against the pound.
U.S. (USD $ BASIS)
PERIODS ENDING NOVEMBER 30, 2009
Global equity markets turned in
3 months YTD 1 year 3 years 5 years
another decent three months in Fixed Income Markets: Total Return (%) (%) (%) (%) (%)
the period ended November 30,
Citigroup US 2.08 -1.15 2.23 6.77 5.61
2009, adding to the year’s already
Barclays Capital Agg. Bond Index TR 2.86 7.61 11.63 6.40 5.49
significant gains. Most global fi xed-
income markets also performed GLOBAL (USD $ BASIS)
well, with the continued decline PERIODS ENDING NOVEMBER 30, 2009
in the U.S. dollar helping to fuel 3 months YTD 1 year 3 years 5 years
Fixed Income Markets: Total Return (%) (%) (%) (%) (%)
the gains. The DEX Universe
Citigroup WGBI 5.02 10.07 17.04 8.47 5.99
Bond Index, a measure of the
performance of the broad Canadian Citigroup Europe 5.68 14.11 24.54 8.14 6.36
bond market, returned 2.2% the Citigroup Japan 8.40 5.79 13.43 12.88 5.28
Note: all rates of return presented for periods longer than 1 year are annualized
past three months, measured in Source: Bloomberg/MSCI
which returned 10.3% and 9.4%, MSCI Emerging Markets* 13.90 71.72 85.12 5.29 15.70
* Net of Taxes
respectively. The laggards were the
Financials sector, which gained less GLOBAL EQUITY SECTORS (USD $ BASIS)
PERIODS ENDING NOVEMBER 30, 2009
than 1% after two strong quarters, 3 months YTD 1 year 3 years 5 years
and Utilities, which returned 2.1%. Sector: Total Return (%) (%) (%) (%) (%)
Since December 1, 2008, the Utilities Energy 10.28 24.72 20.46 -0.50 8.46
sector performed worst, with a gain Materials 13.67 57.22 66.04 2.49 10.30
of 7.9%. The Telecommunication Industrials 6.89 24.39 30.67 -5.73 2.24
Services sector was next, with a
Utilities 2.14 3.31 7.94 -3.09 7.34
gain of 18.7%. The best performing
Consumer Discretionary 5.71 34.36 42.32 -7.87 -0.42
sectors for the 12-month period
Consumer Staples 9.37 20.49 23.12 3.91 7.66
were Materials and Information
Technology, which returned Health Care 7.72 16.47 25.07 -1.46 3.84
66.0% and 48.4%, respectively. Financials 0.63 32.53 34.89 -16.76 -4.15
Information Technology 6.41 44.21 48.41 -2.35 1.90
Telecommunication Services 7.31 12.54 18.73 -1.61 2.44
Note: all rates of return presented for periods longer than 1 year are annualized Source: Bloomberg/MSCI
GLOBAL RECOVERY EXHIBIT 1. OECD Leading Economic Indicator and Industrial Production
EXPANDING – KEY ISSUE IS
SUSTAINABILITY 10.0 6.0
4.0
5.0
The world economic recovery 2.0
Annual % Change
Annual % Change
continues to unfold, supported 0.0 0.0
by a powerful inventory cycle and -2.0
-5.0
epic policy responses enacted by -4.0
governments and central banks -10.0 -6.0
in the wake of the financial crisis. -8.0
-15.0
Led by China, most developed and -10.0
Source: Organization for Economic Cooperation & Development
developing economies returned -20.0 -12.0
to growth in the third quarter. The 1998 2000 2002 2004 2006 2008 2010 2012
list included much of Continental Industrial production (LHS) Leading economic indicator (RHS)
Europe, Japan, Brazil, Russia,
Canada and the U.S., although the
U.K. was the notable exception to EXHIBIT 2. Asia
Industrial Production
this trend as real GDP fell again.
Financial conditions continue to 30.0
improve as evidenced by the strong 20.0
global equity rally, which has been
10.0
Annual % Change
Bust 2. Stagnation
ODDS OF A
DOUBLE DIP QUITE LOW “Green Shoots ” 1. Double-Dip
Recession
initial claims for unemployment EXHIBIT 6. Fed Hikes and the U.S. Unemployment Rate
insurance peaked in the spring
and are trending lower while
monthly job losses are subsiding. 20
The drop in payroll employment 18 Unemployment
Unemployment
peaks Dec '82,
averaged 104,000 per month in 16 Unemployment peaks in May '75, Fed starts hiking by Unemployment
Unemployment
Fed starts hiking peaks Jun '03,
14 peaks in Dec '70 and Mar '84 peaks
the four months ended November, by May '76 Jun '92, Fed starts Fed starts hiking by
12 again in Aug '71, Fed
hiking by Mar '94 Jul '04
compared to losses averaging starts hiking by
10
%
August '71
560,000 per month in the fi rst half 8
of the year. However, absorbing 6
new entrants into the workforce 4
requires an estimated 100,000 2
Source: Federal Reserve, BLS, PH&N
job gains per month, suggesting 0
the unemployment rate will rise 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
further. Indeed, claims have yet Fed Funds Rate Unemployment Rate
to fall into the range consistent
with gains in employment. The
soft labour market remains a England, along with the Bank of critical to monitor 2-year Treasury
major impediment to growth. Japan and the European Central yields as a harbinger of Fed rate
Bank, will undertake a timely hikes. Two-year yields have traded
The silver lining in the weak reduction in the elevated levels of in a narrow range of 70 to 90 basis
labour market is the remarkably assets currently on their balance points since the start of the year,
strong productivity performance. sheets. To date, central bankers in tune with the Federal Reserve’s
This cycle was unprecedented have been extremely transparent stated intention to keep interest
– a deep recession with a large in communicating their intentions rates low for a prolonged period.
drop in employment and hours in this regard. The critical issue for
worked resulted in a sharp gain the economy and capital markets To date, inflation expectations
in productivity. This came at the is the timing of interest rate hikes, remain fairly well anchored,
expense of labour income, however, particularly for the Federal Reserve. although the spread between
as hourly compensation (which The Reserve Bank of Australia has nominal and real yields on 5-year
includes wages and benefits) fell already increased overnight rates Treasury bonds has begun to rise.
to 0.5% year on year in the third three times as the economy is Gold prices have soared to record
quarter, a record low. Strong growing strongly and inflation has highs and are elevated not only in
productivity growth is a significant become a greater concern. Norway U.S. dollars but also when priced
benefit to corporate profit margins and Israel have followed suit. in other major currencies. This is
and earnings, but this will wane as Markets are currently pricing in one an indication that the rise in gold
companies begin to add to payrolls. Fed rate hike in the fi rst half of next is not related solely to concerns
year, but we feel this is premature. of a weaker U.S. dollar, but also
MARKETS AHEAD OF Core inflation in the U.S. stood to a desire for diversification
at 1.7% as of October and is set to into hard assets by investors and
THEMSELVES IN PRICING IN move lower owing to considerable central banks. It may also be an
SPRING FED TIGHTENING excess capacity and a yawning indication of longer-term inflation
output gap. As well, historically the concerns. Real interest rates are
Central bank exit strategies are Fed does not raise interest rates deep in negative territory in every
contingent in large part on the until roughly a year after the peak G-7 country except Japan (exhibits
outlook for inflation and inflation in the unemployment rate (Exhibit 7 – 8). Historically, there is a strong
expectations. We feel confident the 6). This would place the timing of a correlation between gold prices
Federal Reserve and the Bank of rate increase in late 2010. It will be and negative real interest rates.
4.0 6.0
Investors should bear in mind that
5.0
at some point, the Federal Reserve 3.0
4.0
will begin to raise interest rates and 2.0 3.0
bond yields will move higher. A recent 1.0 2.0
%
%
0.0
Indeed, a critical factor that may 1.0
restrain growth in many developed Source: Datastream Source: Datastream
-0.5 0.0
economies over the near term is
2000 2002 2004 2006 2008 2010 2012 2000 2002 2004 2006 2008 2010 2012
the substantial increase in federal
government indebtedness in the
aftermath of the recession and global EXHIBIT 9. U.S. 10-Year Treasury Bond Yield
credit crisis. According to the IMF,
gross debt-to-GDP ratios are set to
rise dramatically in countries such 16.0
Double Dip
as the U.S., U.K. and Japan, whereas 14.0
the increase in Canada and China Mid-Cycle
12.0 S&L Crisis Slowdown/
is expected to be much less severe. Mexican Peso
Indeed, while the credit crisis is now 10.0 crisis Tech Bubble
Burst
%
The issue could otherwise continue EXHIBIT 10. Fiscal Balances and General Government Debt
to play out in currency markets, (as a share of GDP)
with investors pushing down the
FISCAL BALANCE GROSS GOVERNMENT DEBT
pound and U.S. dollar even more.
COUNTRY 2007 2009 2010 2014 2007 2009 2010 2014
In summary, economic recovery is CANADA 1.6 -4.9 -4.1 0.0 64.2 78.2 79.3 68.9
underway and despite considerable
headwinds, the odds of a double dip CHINA 0.9 -3.9 -3.9 -0.8 20.2 20.2 22.2 20.0
remain quite low. Financial conditions GERMANY -0.5 -4.2 -4.6 0.0 63.4 78.7 84.5 89.3
have improved markedly, setting the
INDIA -4.4 -10.4 -10.0 -5.7 80.5 84.7 85.9 78.6
stage for positive feedback loops. In
the near term, inflation is a non-issue, JAPAN -2.5 -10.5 -10.2 -8.0 187.7 218.6 227.0 245.6
and central bankers in North America U.K. -2.6 -11.6 -13.2 -6.8 44.1 68.7 81.7 98.3
have clearly stated their intention
to keep short-term interest rates at U.S. -2.8 -12.5 -10.0 -6.7 61.9 84.8 93.6 108.2
low levels for an extended period. Source: IMF World Economic Outlook, October 2009 Update
These factors provide fundamental
support for global equity markets.
Bond yields are ultimately headed
higher, but not until the Federal
Reserve signals an interest rate hike
is at hand. Monitoring the labour
market and 2-year Treasury yields
will be critical in this regard.
We have increased our overweight experience, faith in capital markets the subsequent 24 months would
in equities by 2.5 percentage has been shaken, the outlook is be 5.5% (as compared to doing
points to 62.5% (allowed range: murky and investors continue to nothing with the portfolio’s asset
40%-70%), sourcing the funds from de-risk their portfolios. History mix). Such a decision ensures that
cash and leaving fi xed-income suggests this is the wrong move. the recovery of losses will take
exposure unchanged at 35%. The longer. While simply leaving the
necessary preconditions for a EXCESSIVE CAUTION AFTER portfolio’s asset mix alone would
sustained recovery continue to be a better choice, increasing the
fall into position. The epic dose THE DROP MEANS THAT allocation to equities at the trough
of monetary and fiscal stimulus RESULTS WILL LAG IN THE would be better still. Increasing the
has yet to have its full impact and RECOVERY equity allocation by 20 percentage
will remain in place, supporting points at the trough would result
markets, for several more quarters. Each market cycle presents unique in a 6.7% outperformance of the
Meanwhile, equity-market challenges and this one is no “no-rebalance” option and a 13.2%
valuations remain unusually exception. A common element of outperformance of the de-risked,
attractive despite the huge recovery each cycle, however, is that recovery bond-heavy option. Of course,
in prices since March. The window eventually comes, seemingly active management throughout
of opportunity remains open, as against all odds. Exhibit 1 shows the cycle would be best, but this
the global economy remains on the effects of a decision to de-risk is very difficult for professional
the path to normalcy, and we have a balanced portfolio following a and individual investors alike,
boosted our exposure to stocks to significant sell-off. If an investor as market peaks and troughs
take even greater advantage of it. succumbed to fear after each are only obvious in hindsight,
sell-off in the postwar era and especially when the catalysts for
THE OUTLOOK, NOT RECENT shifted an additional 20 percentage change are highly improbable
points of the portfolio from stocks “tail risk” events. However, we
EVENTS, SHOULD BE OUR to bonds after the trough, the can all recognize when we’ve
GUIDE median underperformance over experienced a sharp decline. It is
risks remain high in this recovery. 120 50% Equity, 45% Bonds,
5% Cash, letting Asset Add 20% Allocation to Equities
Date of Prior Market Peak
at these times that we need to have EXHIBIT 2. Bear Markets and Recoveries
faith that markets will eventually Average Duration and Returns
recover, and take on more risk.
100 9 Month
28.7% Return from Low
THE REBOUND HAS BEEN 90
in a wide range of areas. Oftentimes EXHIBIT 4. Bull Markets: Valuations vs. 1st Year Recovery
investors get caught up in the First Year Returns as a Function of Valuations at Onset
nuances of the economic data, but at
this point in the cycle pretty much 70%
that the root of the credit crisis – the EXHIBIT 6. U.S. Housing – Month's Supply of Homes on the Market
bust in housing – is finally stabilizing. Existing Single Family Homes
The recovery will be sluggish and
rocky, and price growth will be 12.0
dampened by bank-sponsored real
estate fire sales for many quarters, 10.0
but at least the direction is right.
Months 8.0
RELATIVE TO SALES
4.0
Another source of growth in the Source: National Association Of Realtors
coming quarters is expected to come 2.0
from inventory re-stocking. A notable 1990 1995 2000 2005 2010 2015
feature of this recession was the
speed with which inventories shot up
and then collapsed in relation to sales EXHIBIT 7. U.S. Inventories/Sales Ratio
Total Business
(Exhibit 7). A reduction in inventories
subtracts from GDP, but a smaller 1.6
reduction in inventories from one
quarter to the next actually adds to
GDP. As companies see the economy 1.5
stabilize and sales pick up, they will
have less and less motivation to pare 1.4
inventories. In fact, before long, just
to meet demand, inventory levels
will have to be rebuilt (Exhibit 8). 1.3
This has already started to bolster
Source: U.S. Census Bureau
growth and will be increasingly 1.2
additive in the quarters ahead. 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
spending some replacement EXHIBIT 9. U.S. ISM Manufacturing Index and the Fed Funds Rate
demand is to be expected. Fed Funds Inverted and Advanced Six Months
%
the surplus of available workers
create compelling reasons to bring 45 5
some types of production back 40 6
onshore. Meanwhile, somewhat 35 7
Source: Institute for Supply Management
lower consumer spending growth 30 8
in the years ahead suggest import 1998 2000 2002 2004 2006 2008 2010 2012
growth could run below growth in ISM Diffusion Index (LHS) Fed Funds Rate (Inverted, Adv 6 Months) (RHS)
exports, making net trade another
potential source of growth.
EXHIBIT 10. U.S. Net Worth
Finally, as credit markets recover we Median Net Worth by Percentile
can expect rock-bottom borrowing
costs to begin to have their typically
900
powerful stimulative effect on the
800 Source: Federal Reserve Board Survey of Consumer Finances (2007) 738
economy. Although the lift from new
700
borrowing will be muted this cycle
600
$US Thousands
the bottom 80% and over 80 times EXHIBIT 11. U.S. Consumption Growth Betas
the bottom quintile’s (Exhibit 10). Sensitivity to Total Consumer Spending Growth
3.0
HIGHER-INCOME Source: Parker, J.A. and Annette Vissing-Jorgenson, 2009. "Who Bears Aggregate 2.5
HOUSEHOLDS DRIVE OVERALL 2.5 Fluctuations and How?" NBER Working Paper 14665.
2.0
SPENDING 2.0 1.7
1.5
This concept becomes especially 1.0
interesting when applied to 1.0
0.6
behaviour. It makes intuitive sense 0.5
that households that earn more,
spend more. These households are 0.0
also better able to carry debt if they All Households Bottom 80% Top 20% Top 10% Top 5 %
desire. Finally, asset-rich households Percentile of Income
are not necessarily required to save
a portion of their paychecks in the
way that an average worker might. EXHIBIT 12. Debt Ratios by Income Level
And because the amounts saved
and spent by the richest Americans Debt to Net Worth Debt to Assets
are so large in aggregate, they 1.2
overwhelm the amounts saved and 99% Source: Federal Reserve Survey of Consumer Finances, 2007
1
spent by the rest of the population.
0.8
66%
These intuitive predictions are
brought to life by data from the 0.6 50%
39%
annual Consumer Expenditure 0.4 28%
Survey (CES), which is conducted 22%
by the Bureau of Labor Statistics. 0.2
According to the most recent survey 0
using 2007 data, the top 20% of Lowest 20% of Earners Bottom 80% of Earners Top 20% of Earners
earners account for 39% of total
consumer spending and 43% of
discretionary spending. So more compensation for high-income WIDE DISPERSION IN
than $4 of every $10 in “shopping” earners, and these payments can HOUSEHOLD BALANCE-SHEET
comes from the wallets of this small be especially volatile. In contrast,
HEALTH
group, while the remaining 80% of the bottom three quintiles
households contribute less than $6. generally have a pretty good idea Our contribution to this line of
of their annual income well in thinking this quarter has to do with
Even more striking, the change in advance, commit that income to the state of household balance
consumption by the highest-income certain steady expenditures such sheets on the eve of the crisis and
quintile was five times as large as mortgage payments and the what has likely happened since. By
as the change in consumption of like, and have little flexibility. decomposing and analyzing the
the remaining 80% of consumers data, we know that towards the end
(Exhibit 11). This makes sense – of 2007 (the “eve” of the recession)
bonuses, dividends and other balance sheets within the uppermost
forms of variable compensation quintile of U.S. earners were in
make up a large share of total excellent shape (Exhibit 12).
We then used the Federal Reserve’s EXHIBIT 13. Composition of Balance Sheet Assets
Survey of Consumer Finances Average Holdings, by Major Type of Asset
to construct an estimate of
the composition of assets by 60%
Source: Federal Reserve Survey of Consumer Finances, 2007
income quintile. As expected, 50%
the principal residence makes up
40%
the largest chunk of total assets
for all households. However, the 30%
uppermost income quintile holds 20%
a higher percentage of total assets
in fi nancial assets than does the 10%
remaining population. Exhibit 0%
13 depicts the estimated average Real Estate Stocks Bonds Cash Pooled Inv + Business All Else
holdings by major type of asset. Ret Accounts Equity
A clear pattern emerges from the Bottom 80% Top 20% Top 10%
data. The share of wealth held
in real estate declines as income portfolios of America’s wealthiest ARE THE OBSTACLES
rises. The average share of stocks, households, this snapback makes
bonds and holdings of pooled TO FULL RECOVERY
sense. The disparity with the
investment and retirement accounts average household will persist until INSURMOUNTABLE?
rises with income. Finally, average residential real estate prices stage a
ownership of business equity more meaningful increase, which Despite this relatively optimistic
also rises sharply with income. is not likely to occur for some time. longer-term outlook, we’d be the first
to agree that some key conditions
FINANCIAL MARKET The implications of stratifying for a self-sustaining recovery remain
U.S. households are clear. Higher- somewhat elusive. In particular,
RECOVERY HELPS WEALTHY income households spend more. the U.S. job market remains weak
HOUSEHOLDS THE MOST Due to their fi nancial heft, and credit availability continues to
they drive the behaviour of the be severely constrained for all but
Given our estimates of the relative
broader U.S. spending and saving the largest and most creditworthy
importance of each asset class
aggregates. During the downturn, borrowers. Additionally, there are
to the various income quintiles,
their assets took a significant hit broader concerns about the ability
we can derive an estimate of how
and their sources of income and of authorities to reduce their support
each income quintile has been
wealth were thrown into question. for the economy without tipping
affected by the fi nancial crisis
With their income more volatile it back into recession, and how
and the subsequent recovery. By
than the average, their spending they go about timing their efforts.
plugging in the performance of
is similarly more volatile. The Finally, the ballooning debt burden
each asset class from the survey
wealthy cut spending dramatically casts a long dark shadow over the
period in 2007 through the market
during the credit crisis but now future potential of the U.S. economy,
and economic trough in early 2009
have the ability to resume spending and for many major industrialized
and ending with the recovery to
at a more normal level given the nations in Europe and Asia.
date, we fi nd that the dollar value
recovery that is underway. Although
of this recovery has been sizeable
relatively small in numbers, the Of these challenges, the labour
and dramatic at the upper end of
spending and saving patterns of market may be the most crucial,
the income distribution. Given the
this portion of the population will at least in the near term. The
overrepresentation of fi nancial
determine the scale and durability economy as measured by GDP
and business interests in the
of the economic cycle ahead. may already be recovering, but
the economy as measured by job EXHIBIT 14. U.S. Initial Unemployment Claims Filed
creation is not. Ultimately, creating Four-Week Moving Average
new jobs is the key to creating a
durable recovery, not to mention 700
a lasting rebound in profits. 650
600
Last Plot: 497 Peak:
THE U.S. JOB MARKET IS STILL 550
March 27,
500
WEAK… 2009
450
November’s payroll survey unveiled 400 Median: 355
some very good news as only 11,000 350
jobs were lost, a figure too small in
300
the context of the U.S. labour force to Source: BLS, Haver Analytics
250
be considered statistically different
1990 1995 2000 2005 2010 2015
from zero. Average monthly job
losses over the past three months
sit just under 90,000, significant
EXHIBIT 15. United States
progress from the peak rate of over Non-Farm Employment and the Fed Funds Rate
700,000 lost jobs per month last
winter. However, the total number 0.0 6.0
of jobs lost this recession continues 2.0
4.0
to mount and has reached 7.2 4.0
million, or 5.2% of pre-recession 2.0
YoY % Change
6.0
levels, the most severe labour
8.0 0.0
%
farm employment. That relationship EXHIBIT 16. U.S. ISM Employment Indices
has been missing in action as the Manufacturing and Non-Manufacturing Employment Sub-Indices
normal transmission mechanism
between official borrowing costs 70
and economic activity were
broken by the credit crisis. This 60
correlation appears poised to
50
re-assert itself in the months ahead.
40
Unfortunately, the employment
component of the non- 30
manufacturing ISM continues to Source: Institute for Supply Management
languish below 50, suggesting that 20
the far larger, non-export-related 1998 2000 2002 2004 2006 2008 2010 2012
sectors of the U.S. economy have ISM Manufacturing Employment Sub-Index ISM Non-Manufacturing Employment Sub-Index
yet to move into hiring mode
(Exhibit 16). We suspect the scar
tissue from the crisis is tilting EXHIBIT 17. United States
Real Consumer Spending and Non-Farm Employment
hiring managers toward pessimism
when they should be anticipating
8.0
an eventual recovery (though it’s
understandable that smaller fi rms 6.0
will avoid hiring until new work 4.0
YoY % Change
800
The second major obstacle to
recovery is the still-fragile state of 600
lending. In an economy built on $US Billions
credit, lending channels are still 400
not functioning normally. The
200
latest Fed survey of senior loan
officer revealed that banks are, on 0
balance, still tightening lending Source: Federal Reserve
standards on all major types of -200
loans to businesses and households, 1990 1995 2000 2005 2010 2015
the ninth consecutive quarter that
standards have been raised (Exhibit
18). Though we are encouraged EXHIBIT 20. U.S. Bank Failures
Total Assets of Failed/Assisted Institutions
that fewer and fewer banks are
tightening standards, we need to 400
see greater credit availability in Source: FDIC, Haver Analytics
350
order for consumers and small
businesses to become major players 300
in the recovery. We are not yet at 250
$US Billions
bonds, and pocketing the spread. EXHIBIT 21. Senior Loan Officer Survey on Bank Lending Practices
This serves two crucial purposes: Loan Officers Reporting Stronger Demand for Loans
it upgrades the quality of bank
balance sheets and restores bank 80
Source: Federal Reserve, Haver Analytics
fi nances. Without this balance-sheet 60
repair, the U.S. fi nancial system 40
QoQ % Change
would remain shaky. In time, the 20
economic recovery will flatten the
0
yield curve and this risk-free trade
-20
will disappear, with the result that
banks will return to their usual -40
role as credit intermediaries. -60
-80
1990 1995 2000 2005 2010 2015
… AND A LOT IS AT STAKE IN Commercial & Industrial Loans Mortgage Loans to Individuals Consumer Loans
The peak in impaired loans always EXHIBIT 22. U.S. Corporate Balance Sheets
comes after stock-market bottoms,
as businesses and households that 100 14.0
have grimly held on through the
12.0
downturn fi nally throw in the towel. 80
40 6.0
stop rising and reverse. If this
doesn’t happen soon – and spur an 4.0
uptick in credit availability, lending 20
2.0
activity and, ultimately, hiring – we Source: U.S. Federal Reserve / Royal Bank of Canada
0 0.0
will be forced to re-evaluate our
1990 1995 2000 2005 2010 2015
assumptions for this recovery. Debt-Equity (LHS) Interest Coverage (RHS)
bond issuance, including a revival EXHIBIT 23. United States Corporate Funding Gap
in the IPO market. Exhibit 25 shows Corporate Expenditures Less Internally Generated Funds
that creditworthy corporations
have had little trouble tapping 400
markets for new funding. In fact,
300
corporate bond issuance has set a
new record high in 2009. Finally, 200
100
$US Billions
U.S. productivity growth is surging,
driving profitability higher, a 0
theme we will return to shortly. -100
-200
2010 WILL SEE THE -300
Source: Federal Reserve
BEGINNING OF THE END OF -400
HISTORIC STIMULUS 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
%
Many investors are seeking greater
clarity on these issues before 1.0
3.0
fully committing to the recovery.
2.0 2.0
Unfortunately, they may not get it.
3.0 1.0
NAVIGATING EXIT STRATEGIES 1990 1995 2000 2005 2010 2015
U.S. 10-2 Spread (Lt, Inv, Adv 30 Months) Moody's Baa-10 year T-bond Spread (Rt)
IS WHERE WE FLY ON A WING
AND A PRAYER
EXHIBIT 25. United States Corporate Debt Issuance
Timing the removal of the massive New Debt Security Issues, Non-Financials
policy easing to minimize the risk
of inflation without pushing the 300
6-Month Cumulative Sum ($US Billions)
350
Total Size of Fiscal Stimulus Package: $787 Billion
Our perspective on the fiscal issue 300 Funds Available to Date: $ 297.1 Billion (37.8% of Total)
Funds Paid Out to Date: $ 136.3 Billion (17.3% of Total)
lies more in its direct impacts on 250
the economy and capital markets. 200
While fears of higher taxes later
150
might lead to reduced spending
down the road, spreading money 100
on the ground today will produce 50
Source: Federal Recovery Accountability & Transparency Board
economic activity right now. So far, 0
less than one-fi fth of the $787 billion May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09
stimulus package has been paid Funds Available Funds Paid Out
out, according to U.S. government
figures (Exhibit 27). That leaves over
$600 billion still to hit the streets MONETARY POLICY EXIT system that were so prevalent
and fi nd its way into household STRATEGIES SHOULD BE last year have largely dissipated,
wallets. Of the total $1.9 trillion we see little systemic risk from
made available since 2008 through
OF GREATER CONCERN FOR the end of direct Fed support for
various programs (including the MARKETS sections of the credit market.
stimulus package, TARP and others),
less than 40% has actually left The Fed’s monetary policy exit We have more concern about
government hands, leaving over $1 strategy is of more immediate the timing of the fi rst Fed rate
trillion in stimulus already approved concern to capital markets. The hike. In addition to marking the
and on its way to Main Street USA. Fed has already closed a variety beginning of the end of risk-free
That will buy a lot of shovels. of programs designed to unclog bank profits, a rising fed funds
credit markets and plans to end its rate hits the burgeoning U.S.
purchases of Treasury and Agency dollar carry trade and signals the
debt early in 2010. Given that the imminent end of this period of
immediate threats to the fi nancial epic monetary easing. A change in
-4.0
LOW CORE INFLATION MEANS 2000 2002 2004 2006 2008 2010 2012
A LOW FED FUNDS RATE Core (Ex-Food & Energy) Headline
page 13). The second is that the EXHIBIT 30. S&P 500 and the Fed Funds Rate Hike
manufacturing ISM index must Implications for Current Cycle, Following First Rate Hike
remain above 50 for one full year.
130
months prior to the fi rst hike, and EXHIBIT 32. Global (ex-Japan) Short-Term Interest Rate Composite
in most cases continue to climb Short-Term Interest Rates Relative to Equilibrium
thereafter. This tells us two things.
One, even though we don’t know 100
the timing of the fi rst hike, we 80
60
% Above/Below Equilibrium
know where to look for signals and
it’s in yields, not stocks. Two, if 40
history is any guide we will have 20
a short window following the fi rst 0
hike to assess the landscape. If -20
it turns out the Fed has moved -40
prematurely and the economy -60
cannot withstand higher rates, -80 Source: RBC AM Last Plot: -62.1%
we can make a decision to reduce -100
our allocation to equities. We do 1980 1984 1988 1992 1996 2000 2004 2008 2012
not have to make that decision
in advance of the Fed’s move.
EXHIBIT 33. U.S. Fed Funds
Equilibrium Range
GLOBAL SHORT RATES
24
REMAIN HIGHLY STIMULATIVE
20
Our composite global short-term 16
interest rate showing global rates 12
relative to equilibrium (Exhibit 32)
%
8
indicates just how stimulative the
current monetary policy setting is, 4
while our valuation models (exhibits 0
33-37) indicate that policy rates lie Source: Federal Reserve, RBC AM
-4
well below equilibrium in every
1980 1984 1988 1992 1996 2000 2004 2008 2012
major economic region except Japan.
Last Plot: 0.25% Current Range: 0.12% - 2.32% (Mid: 1.22%)
Given the fragility of the recovery,
central banks are widely expected
to hold short-term interest rates at EXHIBIT 34. Canada Overnight Rate
rock-bottom levels for at least the Equilibrium Range
next six months in North America,
25
Europe and Japan. The Bank of
Canada reiterated its intention to 20
refrain from adjusting the overnight
rate higher until after June 2010, 15
and recent Fed announcements
%
8
HIGHER
4
In contrast to short-term yields Source: Bloomberg, Consensus Economics, RBC AM
that stand well below their 0
equilibrium setting, global 10-year 1980 1984 1988 1992 1996 2000 2004 2008 2012
government bond yields have Last Plot: 0.47% Current Range: 0.82% - 2.50% (Mid: 1.66%)
recently moved near or above
their equilibrium levels (exhibits
38-42). In more “normal” times EXHIBIT 36. Japan Overnight Call Rate
Equilibrium Range
that might be a signal that bonds
will appreciate in the quarters 14
ahead. Our outlook, however, is
12
significantly more cautious.
10
8
Exhibit 43 shows our global 10-year
6
%
8
the band that has been moving.
6
4
This situation will reverse in the
2
months ahead. Even if 10-year Source: RBC AM
0
yields remain static, they will
1980 1984 1988 1992 1996 2000 2004 2008 2012
move back away from the top
Last Plot: 0.50% Current Range: 1.92% - 3.66% (Mid: 2.79%)
of their equilibrium bands. The
recovery has pushed real interest EXHIBIT 38. U.S. 10-Year T-Bond Yield
rates up from recent historic lows. Equilibrium Range
Moreover, as last year’s sharp
drop in energy prices falls out of 16
the yearly inflation figures and 14
headline CPI rebounds into positive 12
territory, the equilibrium bands are 10
expected to move sharply higher.
8
%
6
TREASURY YIELDS REMAIN 4
REMARKABLY LOW GIVEN 2
Source: Bloomberg, Bureau of Labour Statistics, RBC AM
DEFICIT PROJECTIONS 0
1980 1984 1988 1992 1996 2000 2004 2008 2012
This normalization in inflation and Last Plot: 3.20% Current Range: 1.74% - 3.56% (Mid: 2.65%)
demands for “real” returns present
a risk to fi xed-income markets and
set the stage for very limited total- EXHIBIT 39. Canada 10-Year Bond Yield
Equilibrium Range
return prospects for government
bonds in the quarters ahead. There 18
are a variety of scenarios that, if they 16
occur, will put upward pressure on
14
yields. The rebound in commodity
12
prices alone is expected to push
10
%
expect U.S. 10-year Treasuries to Last Plot: 3.48% Current Range: 2.53% - 3.77% (Mid: 3.15%)
yield 4.25% in a year’s time, about EXHIBIT 41. Japan 10-Year Bond Yield
100 basis points more than today. Equilibrium Range
We expect a slightly larger move in
the U.K., but in Canada we expect 14
a smaller 75-basis-point increase, Source: Bloomberg, Consensus Economics, RBC AM
12
to 4.00%. Japanese 10-year yields
are expected to climb by about 50 10
basis points to 1.75%, and we expect 8
%
to see a 25-basis-point increase in 6
Eurozone 10-year yields to 3.75%.
4
2
EQUITY MARKETS HAVE
REBOUNDED FROM CRISIS 0
1980 1984 1988 1992 1996 2000 2004 2008 2012
LOWS Last Plot: 1.27% Current Range: 0.73% - 1.60% (Mid: 1.16%)
8
Almost by definition, stock markets
6
cannot remain this far above their
4
moving averages without entering
2
exponential territory. This means Source: RBC AM
0
something has to give – either the
1980 1984 1988 1992 1996 2000 2004 2008 2012
pace of increase slows and the
Last Plot: 3.52% Current Range: 2.22% - 4.31% (Mid: 3.26%)
200-day average catches up, or a
correction pulls the index level back
down to its average. We don’t deny EXHIBIT 43. Global Bond Market Composite
that there is a risk of a correction, 10-Year Government Bond Yields Relative to Equilibrium
but our work shows that trying to
tactically shift in and out of a market 60
Last Plot: 12.8%
in the early stages of a recovery is
% Above/Below Equilibrium
falling steadily throughout 2009 EXHIBIT 50. S&P500 Forward P/E Ratio
(Exhibit 49). Viewed more broadly,
economywide productivity growth
shot up sharply in the third quarter. 25
Firms have already slashed payrolls 23
and other operating expenses to 21
the bone, and have, therefore, 19
P/E Ratio 17
created an environment in which
15
profits can grow strongly as top-
13
line revenue growth returns. We
11
can afford to be patient here. 9
7
This looming profit upturn would Source: ThomsonReuters
5
be less compelling if investors 1988 1992 1996 2000 2004 2008 2012
had already incorporated it into 12-Month Forward P/E 5-year average
expectations and had pushed
market valuations up sharply in
anticipation. But, they haven’t, EXHIBIT 51. S&P 500 Index
Normalized (Equilibrium) Price/Earnings Ratio
and this is another reason to be
overweight equities. The S&P 500
35
trailing P/E ratio has indeed moved Nov '09 Range: 1 Std. Dev.: 15.3x - 24.7x (Mid: 20.0x)
30 Nov '09 Range: 2 Std. Dev.: 10.6x - 29.4x (Mid: 20.0x)
up as prices have climbed faster
25 Current: 28.1x
than earnings. However, trailing
earnings reflect an economy in 20
X
deviation above and below our EXHIBIT 53. Global Stock Market Composite
estimate of normalized P/E – that Equity Market Indices Relative to Equilibrium
is, what investors would pay in a
vacuum given the current interest 100
rate and inflation backdrop. From 80
lasted about four months, but this EXHIBIT 59. S&P 500 Returns by Credit Rating
time given the depth of the sell-
off, the rebound has been longer SEP. 1 – NOV. 30 JUN. 1 – AUG. 31 MAR. 1 – MAY. 31 #
and more dramatic. Eventually,
AAA+ TO AAA- 11.3% 6.7% 13.3% 4
stocks with the “DNA” of successful
AA+ TO AA- 7.5% 4.4% 26.2% 23
investments move to the fore.
A+ TO A- 6.0% 1.2% 35.5% 128
These stocks may lag in the initial
BBB+ TO BBB- 7.0% 0.1% 36.8% 193
stages of the recovery but tend to
BB+ TO BB- 3.7% 1.8% 52.7% 64
have the staying power to provide
gains throughout a bull cycle. B+ TO B- 6.5% 1.6% 102.4% 13
CCC+ TO C- -6.8% -1.8% 80.0% 1
Our proprietary 3D stock-rating NOT RATED (ALL) 6.0% 6.1% 37.7% 74
system has a 25-year track record NOT RATED (TECH) 7.2% 3.4% 39.9% 38
of highlighting stocks with NOT RATED (OTHER-EX TECH) 4.9% 8.5% 35.7% 36
superior long-term prospects. In a *Using current credit rating 500
maturing bull market, we expect Source: RBC AM
to see a rotation into stocks that
will most likely lead the market EXHIBIT 60. 3D Score Monthly Performance – U.S.
Top 80 Minus Bottom 20
through the remainder of the cycle.
This rotation now appears to be 10%
taking place. Exhibit 60 shows
that stocks with the highest 3D 5% 3.39%
scores (those that screen highest
0%
across fundamental, technical and
quantitative parameters) are once -5%
again beginning to lead in the U.S.
Consistent with this turn of events, -10%
a Bank of America/Merrill Lynch
-15%
analysis of the Russell 2000 shows
Source: RBC AM
that large-cap stocks outperformed -20%
small-cap stocks for the second Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
month in a row in November
and for three of the past four
months. According to this analysis, bond markets in isolation, given remains an unattractive option
S&P high-quality companies the macro environment and from a return standpoint. Treasury
outperformed low-quality outlook. But as we know, the bonds have the advantage of a bit
companies for the second month. attractiveness of stocks depends higher yields than cash along with
Finally, the anticipated preference partially on their expected offering safety of principal if held
for high-quality stocks has yet to absolute returns and partially on to maturity, and therefore have
show up in the Canadian market, their expected relative returns a place in a balanced portfolio.
but the trend continues to improve. versus other investment options However, holding government bonds
such as cash and fi xed income. still exposes investors to the risk
of capital loss if bond prices fail to
ASSET MIX STILL With short-term interest rates reflect an increasingly inflationary
FAVOURS EQUITIES holding at their effective lower environment, or if higher yields
bound until well into next year, are required to entice buyers for
The discussion above highlights our equities clearly offer superior bonds of developed countries
views on equity and government upside potential and holding cash with swelling fiscal debt levels.
700
the full market cycle. Two severe
600 Source: Ned Davis Research
bear markets in the past 10 years
500
forced trailing 10-year returns for
400
equities to their lowest level relative +1 Std Dev
300
to bonds since the Great Depression.
200 Mean: 125.6%
In the past, movement to an
100
extreme has always been followed -1 Std Dev
0
by a sustained drift in the opposite -2 Std Dev
-100
direction. But we’re not counting -200
on mean reversion just because 1935 1945 1955 1965 1975 1985 1995 2005 2015
it has always happened. Properly S&P 500 10-Year Total Return minus Barclays Capital Long Term T-Bond 10-Year Total Return
functioning capital markets require
that extra risk be rewarded with
extra return. Finally, bonds have bonds, as they have done over higher, and hence remain relatively
benefited tremendously from nearly most periods of history. light, nimble and selective in
three decades of steadily declining our fi xed-income exposures.
interest rates, which produced a As such, shifts in asset mix with
capital gain to accompany income, respect to fi xed income should be In conclusion, market and
or yield. Now that rates are at or especially price-sensitive. This economic signals are still pointing
near historic lows, the generation means that we will be opportunistic to greater rewards from equities
of further capital gains is much if yields appear poised to fall. For over the coming quarters than
less likely. If stocks produce the example, if markets come to expect from other asset classes. The
long-term normalized earnings a setback in the economic recovery current investing environment
growth rates we expect, alongside or if equities become overvalued is more challenging than usual,
regular dividend payments and relative to earnings potential. and several threats – surging
a normalization in valuations, All the while, we will continue to fiscal deficits, extreme levels of
stocks will once again outperform acknowledge that the most likely government debt, global imbalances
longer-term direction for yields is in savings and borrowing, and
aging populations – will require Most importantly, we have yet to than today, as the memory of the
Herculean efforts to resolve. These see a systemic threat to fi nancial sharpest market decline since the
efforts will certainly have an impact markets that the Fed has not been Great Depression remains fresh
on capital markets and we will, able to address and, at least partly, in our minds. History, at least as
therefore, monitor them closely. defuse (albeit at a potentially it has played out so far, suggests
great cost to future taxpayers). investment opportunities like this
That said, investors, officials do not come around very often.
and markets alike have become Given this complicated backdrop,
familiar with these problems and we try to keep in mind an old Given this backdrop, we boosted
policymakers have been working investing chestnut: there are really our target equity weighting from
overtime to devise ways to lessen very few times when all market 60.0% to 62.5%, toward the upper
their impact. Provided the recovery signals appear to be flashing end of our allowable 40%-70% range,
is still underway, there is no reason green, and these tend to come to sourcing the funds from cash and
for markets to expect another be known as market peaks. Until reducing the cash allocation from
near-term recession due to any then, there will always be potential 5.0% to 2.5%. We left the fixed-income
of these longer-term challenges. obstacles, perhaps never more so allocation unchanged at 35.0%.
forecast (exhibits 2 and 3). While (the headline reading is likely to rise central banks have kept policy on
the Fed will be on the lookout for due to the extremely low oil price of hold and the ECB is no different, with
any troublesome rise in inflation early 2009) or any renewed demand a 1.00% repo rate prevailing. Though
(and inflation expectations) and the for risk-free assets could pin down the ECB rate is substantially higher
emergence of new asset bubbles, longer-term yields at the bottom than many other central banks, it
early indications are that short-term end of their range. While upside appears the current setting will be
rates will rise at a moderate pace. risks are unlikely in our forecast the low for the cycle, barring another
period due to high unemployment, crisis. We see a modest hiking
Further out the curve, we see a anemic wage growth and soft campaign getting underway towards
continuation of the range-bound capacity utilization, any indication end of our forecast period, taking
trading that has dominated the that core inflation is on the rise the repo rate to 1.25%, up 25 basis
past six months. Longer-term would likely push yields higher. points from last quarter’s forecast.
bond yields have lingered near The slower pace of hikes in the
the bottom of the range due to EUROZONE Eurozone reflects both the relatively
benign inflation and uncertainty higher current level of rates and the
over the strength of the economic The European economy has begun to weakest outlook for real growth in
recovery. This has been bolstered crawl out of its deepest recession in our forecast universe, combined with
by continued strong fund flows into modern times, with 1.5% annualized inflation that will be weaker than in
bond mutual funds and purchases growth in the third quarter. The all regions except Japan in 2010. Our
by commercial banks, which invest broader Eurozone has lagged its two 10-year bond forecast is unchanged
in government debt as an almost largest economies, Germany and at 3.75%, and continues to be 50
risk-free alternative to lending. France, which also posted growth in basis points lower than the U.S.
These two trends bear watching, the second quarter. While a return to (exhibits 4 and 5). The expectation
however. Any reversal could break growth is good news and sentiment of European outperformance can be
the current equilibrium in the market surveys continue to improve, the explained by inflation differentials
as supply continues unabated and Eurozone economy still faces and slower growth. Less fiscal
the Treasury plans to extend the pressure from a soaring euro and stimulus will lead to a lower level of
average maturity of its debt. This lighter fiscal stimulus than in the U.S. Eurozone growth and bond supply.
will lead to less issuance of short-
term bonds, which typically meet Though there have been a few The risk to our base-rate forecast
with heavy demand from foreign notable exceptions, the world’s major is to the upside as the inflation-
central banks, and more 10-year
and 30-year issues, which are more
likely to be taken up by domestic EXHIBIT 4. Europe
buyers. Our target for 10-year bond 12-Month Yield Forecasts
yields is unchanged at 4.25%, which
30-NOV-09 BASE WORST BEST
is the upper boundary of the level
of interest rates that we think the
3mo 0.39% 1.25% 2.00% 0.50%
U.S. economy is able to withstand
given the amount of debt still carried
by businesses and consumers. 2yr 1.26% 2.25% 3.00% 1.00%
Risks to our yield forecasts reside 5yr 2.24% 3.25% 3.75% 2.00%
primarily to the downside, with
the idea of the Fed staying on hold 10yr 3.16% 3.75% 4.25% 2.50%
beyond our forecast horizon not
outside the realm of possibility. 30yr 3.89% 4.25% 4.50% 3.25%
Benign readings on core inflation
Source: RBC AM
44 THE GLOBAL INVESTMENT OUTLOOK RBC INVESTMENT STRATEGY COMMITTEE
GLOBAL FIXED INCOME MARKETS • ROBIN GULLASON, CFA
CANADA 4.0%
change brings the differential from EXHIBIT 10. Foreign Exchange Rates
U.S. Treasuries down to 25 basis GBP/EUR
points from 50 points previously,
but is still indicative of Canadian 1.8
outperformance as yields drift 1.7
higher. Though the Canadian
1.6
economy has stronger growth
potential than the U.S., at least for GBP/EUR 1.5
Our U.K. base rate forecast has risen prevails. Administered rates could EXHIBIT 13. Expected Return
25 basis points to 1.25% despite the stay low if growth and inflation are 12 Months
economy’s poor prospects (exhibits subdued, but we can also envision LOCAL U.S.
11 and 12). The U.K. still has the a more aggressive Bank of England CURRENCY HEDGED
highest inflation forecast of the should inflation accelerate past U.S.
regions we cover, and the Bank of target. The risk to our gilt yield 3MO 0.4% 0.4%
England will be keen to keep prices forecast is to the downside given 2YR 0.0% 0.0%
in check given its strict inflation that recent ranges are well below 5YR -0.9% -0.9%
mandate. The Bank may end up our target. A longer-than-expected 10YR -2.3% -2.3%
hiking more than it would like if commitment to quantitative easing 30YR -5.8% -5.8%
inflation pressures persist. Due or a prolonged recession could both ALL -1.5% -1.5%
to the Bank of England’s massive result in rates below our forecast. EUROPE
quantitative easing program, 3MO 0.8% 0.6%
rate hikes are only part of the 2YR 0.9% 0.7%
equation and Governor King has RETURNS AND 5YR 0.0% -0.2%
10YR 0.1% -0.1%
made it clear that any sustained RECOMMENDATIONS
30YR -0.2% -0.4%
hike in short-term rates will be a
ALL 0.2% 0.0%
slow process as bond purchases Our expected country returns are
JAPAN
continue. The most recent vote on listed in Exhibit 13. We maintain our
3MO 0.2% 0.5%
the size of the quantitative easing neutral duration call this quarter,
2YR 0.2% 0.5%
program resulted in a £25 billion as uninspiring total returns are
5YR -0.4% -0.1%
increase in a bid to further support balanced with fair valuations.
10YR -1.2% -0.9%
the economy, but this process will With risks generally running both
30YR -4.7% -4.4%
end at some point to the detriment ways in bond markets, we don’t
ALL -1.3% -1.0%
of the gilt market. The eventual see sufficient reward in making an
CANADA
completion of the government’s outright duration call. Our forecasts
3MO 0.6% 0.3%
bond purchases, heavy supply and indicate that the Eurozone will
2YR 0.7% 0.3%
higher inflation pressures will lead outperform. We recommend an
5YR 0.1% -0.3%
gilts to underperform, and we have Eurozone overweight and equal 10YR -1.0% -1.3%
boosted our forecast by 50 basis underweights in the U.S. and 30YR -4.7% -5.1%
points to 4.75% to reflect this. Japan. A summary of our analysis ALL -1.0% -1.3%
is presented in Exhibit 14. U.K.
Risks to our base rate run both 3MO 0.8% 0.7%
ways given the uncertainty that 2YR 0.7% 0.5%
5YR -0.1% -0.2%
10YR -3.2% -3.3%
30YR -0.7% -0.8%
ALL -0.5% -0.6%
Source: RBC AM
important example), the bulk of EXHIBIT 4. Gold Strength Not Limited to USD
global imbalances stems from trade Normalized Scale, June 2007 = 100
with these partners. One could
argue that as long as foreign-reserve 220
growth continues in export-oriented 200
emerging markets, there will be
180
more pressure on the dollar. Recent
estimates put global reserves at 160
US$7.4 trillion, of which only about 140
US$4 trillion is reported to the IMF 120
(China is one of those non-reporting
100
countries). It is mostly the growth Source: Bloomberg
in reserves that is responsible for 80
the pressure on the dollar. While Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09
the share of the dollar in IMF- USD EUR GBP CAD AUD
reported foreign-exchange reserves
fell to 63% from 72% between
2001 and 2008, undermining the EXHIBIT 5. PPP Valuation
October 2009
dollar is not in the best interest of
reserve managers since they remain 40
such large dollar holders. In fact, 27.8
30 26.5
Barclays estimates that the real 22.9 20.7 (% Over/Undervalued)
19.7
(adjusted for valuation) decline 20 16.4
of U.S. dollar holdings in foreign 7.8
10 6.0
reserves during that time was only
2.5%. The question is: how long 0
will developed countries tolerate -10 -2.7
their currencies absorbing the lion’s
share of the “adjustment” burden? -20 -16.1
Source: Deutsche Bank
-30
As an aside, the price of gold is NZD AUD EUR CHF NOK CAD GBP JPY SEK USD
not necessarily the unequivocal
signal of lack of faith in the dollar.
Looking at the change in the gold The extent to which major currencies strength, the upside potential for
price since the beginning of the absorbed the adjustment of the Australian dollar, the euro, and
credit crisis in June 2007 (Exhibit imbalances is reflected in their the Swiss franc is limited. The U.S.
4), we observe that gold appreciated valuations against purchasing dollar on the other hand, is 16.1%
in most currencies, not just in power parity (PPP). For several undervalued on a trade-weighted
U.S. dollar terms. Gold’s meteoric currencies, the PPP elastic bands basis, which is butting up against
rise appears to reflect a global have now stretched to, or beyond, its “line in the sand.” Historically,
desire to diversify away from fiat the “lines in the sand,”2 as these 90% of observations lie within 17%
money, as well as to hedge against currencies are more than 20% of the dollar's PPP valuation, which
the unexpected. In a world of low overvalued relative to the U.S. dollar means that sustainable downside
interest rates, even central banks (Exhibit 5). That means that despite should be limited for the dollar
are pursuing gold acquisitions to very convincing reasons for their (Exhibit 6). While we don’t know
diversify their foreign reserves.
2 Reference to extreme PPP under/overvaluation - from DB research publication “Fair Value Lines in the Sand”,
March 2006. We discussed it in detail in the Fall 2007 issue of the Global Investment Outlook .
what exactly will trigger a reversal EXHIBIT 6. USD vs. Purchasing Power Parity
in the euro or Australian dollar, DXY Index
we can expect with reasonable
certainty that one will occur. 160
150
In the past year, equities have been 140
driving currency markets. The 130
correlation between movements in 120
the dollar relative to the S&P 500 110
remains the most negative in the 100
past 10 years. However, as Exhibit 90
7 illustrates, the correlation has 80 Source: Deutsche Bank, Bloomberg
70
been far from stable and we monitor
73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
this relationship for signs that it
is coming to an end. Interest rates PPP Average DXY 20% bands
would be the most natural trigger
for the equity/dollar relationship to
change course. But at the moment, EXHIBIT 7. DXY Beta to S&P 500
50-Day Rolling Beta
monetary policy as represented
by the level of 2-year yields, is just 3.0
starting to matter (Exhibit 8). We 2.5
believe that interest rates will not 2.0
be a main driver of currencies 1.5
until a change in monetary policy 1.0
is imminent, which is likely no 0.5
sooner than the second half of 0.0
2010. Once it happens, however, the -0.5
change in monetary policy should -1.0
support the dollar. Looking at the -1.5
relationship between the fed funds Source: RBC AM, Bloomberg
-2.0
target rate, 2-year yields and the 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
spread between 2-year and 10-year
bond yields (Exhibit 9), we see
that there are usually a few false EXHIBIT 8. USD Correlation With Equities and Short-Term Interest Rates
dawns before real policy change 25-Period Correlation of Daily Changes
occurs. However, the change, when
100%
confi rmed, triggers a massive
80%
flattening in the 2-10 yield curve,
60%
and this is historically a very bullish 40%
dollar scenario (Exhibit 10). Only 20%
when the Fed starts hiking rates will 0%
the major obstacle to the dollar’s -20%
rise be removed. Until then, the U.S. -40%
dollar remains a funding currency -60%
– fuel for the carry trade. With this -80% Source: RBC AM, Bloomberg
setup, we expect that currencies -100%
will be very sensitive to shifting Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09
One of the most frequent arguments EXHIBIT 9. U.S. Fed Funds Rate, 2-Year Yield and Yield Curve
against a recovery in the U.S. dollar
is the size of the country’s budget
deficit and the expectation of much 6.0 2.75%
higher debt levels down the road. 5.0 2.25%
According to JPMorgan,3 each 10%
1.75%
rise in the debt-to-GDP ratio of 4.0
a G-10 country equates to a 2.5% 1.25%
3.0
decline in the real exchange rate 0.75%
for that country. Taking the IMF 2.0
0.25%
forecasts for debt-to-GDP through
1.0 -0.25%
2014 4 (markets are forward-looking)
Source: Bloomberg, RBC AM
and comparing them to the level 0.0 -0.75%
of debt in 2008 for each country Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
relative to the debt of the U.S., one Fed Target Rate (lhs) Generic US 2-Yr Yield (lhs) US 2s-10s Spread (rhs)
can come up with expected changes
in the exchange rate (making the
assumption that spot changes EXHIBIT 10. Dollar Returns in Different Curve Scenarios
Average Returns for Trade-Weighted Dollar, 1995-2009
reflect real exchange rate changes).
The expected changes versus the 15%
actual changes (current spot versus
10%
Annualized weekly returns
EURO 10%
Spot adjustment
5%
The euro, as the alternative reserve
currency to the dollar, benefits 0%
-10%
3John Normand, J.P. Morgan, “Position For Cyclical Source: IMF, RBC AM
Strength and Structural Weakness”, October 2009 -15%
4IMF World Economic Outlook, October 2009 Euro area Japan UK Canada
IMF Global Financial Stability Report, October 2009 Expected Actual
This will continue as long as the EXHIBIT 12. Long-Term Relationship Between Euro and Interest Rates
dollar and S&P 500 are negatively DB Model Suggests Euro Should Be Trading at 1.21
correlated. However, as we showed
earlier, one thing that we can be sure 1.2
1.2
Ln USDDEM = 0.496 + 0.0945*(US-German) 10yr interest
of with regards to that correlation
Sample Period: Jan. 1978 - Nov. 2009 1.0
is that it’s not stable. Certainly, one 1.0
would be less likely to accumulate Adjusted R-Squared: 53%
0.8 0.8
the euro if one considered only
the economic fundamentals of the 0.6
0.6
Eurozone. Whether we use PPP as a
yardstick, or the euro’s relationship 0.4 0.4
with interest rates (Exhibit 12), the Source: Deutsche Bank
euro should be trading much lower. 0.2 0.2
There is also the issue of Europe’s Jan-77 Jan-81 Jan-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09
banking system, where, according ln USD/DEM Fitted ln USD/DEM
to the IMF,5 expected additional
losses exceed those realized so far.
While trend-following investors may EXHIBIT 13. Comparison of Trade Partners for Canada and Australia
push the euro beyond US$1.50 in
the short term, we would expect an August 2009 Canadian Exports, % share August 2009 Australian Exports, % share
aggressive reflationary action from
Europe once it happens and the
Other 14% Other 55%
rubber band-like behaviour versus
Mexico 1% Japan 21%
PPP to pull the euro back down.
Japan 2% Hong Kong 1%
UK 3% China 23%
CANADIAN DOLLAR China 3%
U.S. 77%
October was a volatile month for
the Canadian dollar. The currency
strengthened 6% in the fi rst half
of the month, only to weaken and
Source: Scotia Capital Economics, Industry Canada, Australian Bureau of Statistics
close slightly weaker for the month.
It appears that there is a clear
divide between how foreigners and to China, while Canadian GDP driving the Canadian dollar, we
the Bank of Canada perceive the relies heavily on U.S. demand. The would not be buying the loonie
currency. Foreigners focus on “the Bank of Canada is keenly aware below parity for the longer term.
loonie” being a highly leveraged play of the strains that an overvalued In our view, a perfect recovery has
on global growth and commodity currency puts on the economy and already been priced in (Exhibit 14).
consumption, and their minds downplays scenarios that could
often link the Australian and propel the currency even higher. JAPANESE YEN
Canadian dollars. Looking at the Interestingly, the Bank of Canada,
composition of the trade flows in which hasn’t intervened in currency While it is difficult to predict
both countries, it’s rather obvious markets, had more success arresting whether the Fed or the ECB would
why they shouldn’t (Exhibit 13), as its currency appreciation than the be the fi rst to raise rates, it’s easy to
Australian trade is closely linked Swiss National Bank, which has foresee that the Bank of Japan will
sold billions of francs against the be last among the three. On the day
5 IMF Global Financial Stability Report, U.S dollar and euro in the past year. that a move to wind down credit-
October 2009 While fully acknowledging trends easing programs was announced,
Governor Shirakawa cautioned that EXHIBIT 14. Global Business Surveys vs. USD/CAD
this move should not be construed
as an indication that the BOJ plans to
alter its near-zero policy rate anytime 30% -3.0
soon. Deflationary CPI readings 25% Source: ISM, IFO Institute, Bloomberg -2.5
Standardized
(a 2.4% year-over-year decline in 20% -2.0
inverted
15% -1.5
August) give the BOJ sufficient reason
10%
to delay hikes. Without interest -1.0
5%
rate support, the yen, as a counter- -0.5
0%
cyclical currency, should weaken -5% 0.0
as the global economy improves -10% 0.5
(Exhibit 15 illustrates the relationship -15% 1.0
with LEI). As for PPP, estimates are -20% 1.5
all over the map and therefore this Jun-93 Feb-95 Oct-96 Jun-98 Feb-00 Oct-01 Jun-03 Feb-05 Oct-06 Jun-08 Feb-10
valuation indicator is not as useful as USD/CAD (lhs, YoY) ISM & IFO (rhs)
it is for other currencies. According
to Deutsche Bank, the yen is 6%
overvalued based on CPI, and has lots EXHIBIT 15. USD/JPY vs. U.S Leading Indicators
of room to appreciate. Yet the OECD
calculates that the Japanese currency 145 125
is 23% overvalued based on a 140 120
customized basket of products. In the
135 115
shorter term, the yen may strengthen
130 110
due to temporary flare-ups in risk
125 105
aversion or foreign covering of
short positions in Nikkei equities. 120 100
115 95
110 90
BRITISH POUND Source: ECRI, Bloomberg
105 85
Sterling has been little changed in Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09
the past three months. The Bank of ECRI Weekly Leading Indicator (lhs) USD/JPY (rhs)
England continues to be the most
aggressively accommodative central
bank, expanding its quantitative companies have announced or to keep declining. While sterling can
easing program as recently as completed U.K. company takeovers continue to appreciate against the
November 5. These measures, that, so far in 2009, have brought a dollar in the short term, we expect it
combined with the weak currency, net US$4.1 billion into the country. to weaken again once the Fed starts
are starting to spur the economy. There are still many negatives fueling tightening monetary policy in the
House prices and retail sales have skepticism, primary among them second half of 2010, assuming that
improved, and manufacturing and being projections that the increase the BOE keeps its monetary policy
services indices are both signalling in U.K. public debt over the next five unchanged until at least 2011.
strength. Sterling is extremely cheap years will be larger than in any other
on a PPP basis against the euro, developed country on a debt-to-GDP POSITIONING
although it’s nowhere near such basis. These negatives help keep
extremes against the U.S. dollar. IMM6 positions short – indicating With the dollar now a funding
Cheap pound-denominated assets that speculators expect the pound currency of choice along with
are attracting foreign interest and,
6 International Money Market, a division of the Chicago Mercantile Exchange (CME)
according to Bloomberg, overseas
the yen and Swiss franc, negative EXHIBIT 16. U.S. Trade-Weighted Dollar vs. Market Positioning
sentiment toward the greenback Net Non-Commercial Futures Positions, November 20, 2009
is overwhelming. The fact that the
dollar must go down is broadly 20 95
accepted and rarely disputed. 10 Long Dollars 90
Positioning and sentiment
indicators that we follow confi rm - 85
this consensus (Exhibit 16). A (10) 80
stronger-than-expected economic
recovery, earlier-than-expected (20) 75
tightening by the Fed, or steps to (30) 70
control fiscal largesse, could force Source: CFTC, Bloomberg Short Dollars
unwinding of dollar short positions (40) 65
and contribute to a change in the Oct-05 Jun-06 Feb-07 Oct-07 Jun-08 Feb-09 Oct-09
relationship between stocks and USD IMM Positions vs all currencies (lhs, Billions) USTW$ (rhs)
the dollar’s trade-weighted value.
To summarize: • Reserve growth will slow once • A Fed hike will confi rm
emerging-market currencies yield-curve flattening and
• Dollar weakness may continue are allowed to appreciate, both will support the dollar
in the short term; dollar bears in the medium term,
are still in control and the • The longer emerging-market
bulls will have to be patient, currencies are sheltered, the • Positioning is still dollar-negative
bigger the adjustment will be, and at risk of unwind.
• Many developed-market
currencies are getting extremely • Currencies will be sensitive to Our 12-month forecasts are: euro
overvalued versus the greenback shifting rate expectations in 2010, to 1.35, sterling to 1.58, yen to 105
– the rubber band is stretched, and less so to equity movements, and Canadian dollar to 1.12.
EURO
SUPPORTIVE
>> NEGATIVE
• The only alternative to the dollar as a reserve currency • Significantly overvalued based on purchasing power
at a time when the market believes that the U.S. parity.
government is trying to drive the dollar lower. • Verbal intervention intensifies as export-driven growth
• Strong momentum/trend. in emerging markets hurts European competitiveness.
• Positive correlation with equity rally/risk appetite. • Market expectations of Fed hikes and withdrawal of
• Higher commodity prices add to diversification demand monetary accommodation before any tightening by the
for euro from reserve managers. ECB.
• Additional regulation and taxes in the U.S. may shift • Curve-flattening is historically dollar-positive.
some new foreign direct investment to Europe. • Renewed worries about fiscal situation of Greece, Italy
• Flows into equities have heavily favoured Europe over and other peripheral European economies.
U.S. and Japan. • Positioning and sentiment are overly long the euro.
• Weak dollar is prompting favourable adjustment in U.S.
current-account balance.
12-MONTH FORECAST: short term strength beyond 1.50 not expected to last, lower over our forecast horizon to 1.35.
YEN
SUPPORTIVE
>> NEGATIVE
• The yen benefits during flare-ups of risk aversion. • Worst gross public debt/GDP of any major economy
• Tax breaks for Japanese corporations to repatriate (218% estimate from the IMF for 2009).
overseas retained earnings. • Threat of intervention if yen strengthens below 85 per
• Interest rate disadvantage versus other major US$1.
currencies now at historic low. • Positioning is long the JPY.
• Recent economic statistics exceeding low • Aging population leads to fewer profitable business
expectations. opportunities in domestic marketplace – Japanese
• Stronger growth in China and other emerging markets corporations forced to invest abroad.
likely to buoy Japanese exports. • Labour market still in doldrums and winter bonuses
expected to decline causing households to cut
spending.
• Corporate sector weakness weighing on rebound in
business fixed investment.
• Expectations of negative carry as Bank of Japan will
be left behind once the global rate tightening cycle
begins.
12-MONTH FORECAST: short term strength below 85 not expected to last, over our forecast horizon yen expected to weaken to 105.
CANADIAN DOLLAR
SUPPORTIVE
>> NEGATIVE
• Sensitive to global recovery, LEI improvement. • Priced for perfection - vulnerable to renewed
• Oil rebounded to 2009 highs, other commodities weakness in energy prices and weaker recovery
trading even better. scenario.
• Healthy fiscal situation. • Oil price closer to “fair value” according to OPEC
and break-even on oil-sands projects may bring out
• Commitment to keeping rates low should help hedging of future sales ($75-$85), removing a major
promote growth and prevent deflation. support for CAD.
• Housing market and financial sector are in better • BoC firmly on hold, seeing strong currency “more
shape than their U.S. counterparts. than offsetting” economic improvement since July.
• Businesses are optimistic about future sales. • Risk of U.S. trade protectionism in 2009 and “clean
• Aggressive foreign demand for Canadian assets. energy” initiatives targeting oil sands.
• Medium-term bullish trend still intact. • Sentiment and positioning positive and extended
• Bank lending stronger than in U.S. and overseas already.
markets. • Trade is in deficit and at weakest since at least 1971.
• 16.4% overvaluation on PPP basis means limited
sustainable upside from current levels.
12-MONTH FORECAST: short term strength below parity not expected to last, our 12-month forecast is 1.12.
POUND STERLING
SUPPORTIVE
>> NEGATIVE
• Increased competitiveness of exports to Europe and • BOE expected to revise growth forecast lower,
revenues from tourism. leave rates lower for longer and possibly increase
• Gross debt/GDP at 52% is lower than EU or Japan. quantitative easing.
12-MONTH FORECAST: short term strength to 1.70 will be difficult to sustain, expected to weaken over 12 months to 1.58.
ECONOMIC BACKDROP
UNITED STATES RECOMMENDED SECTOR WEIGHTS
The worst recession in the postwar RBC INVESTMENT BENCHMARK
era appears to be ending, as the STRATEGY COMMITTEE S&P 500
NOV. 2009 NOV. 2009
U.S. economy returned to growth in
the third quarter for the fi rst time ENERGY 13.3% 12.3%
in a year. The late spring trough in MATERIALS 4.0% 3.6%
economic activity has given way to INDUSTRIALS 10.8% 10.5%
rising vehicle and steel production, UTILITIES 2.8% 3.6%
oil and gas drilling, railcar loadings, CONSUMER DISCRETIONARY 9.4% 9.4%
home-appliance shipments and
CONSUMER STAPLES 11.6% 11.6%
exports. In response to improving
economic prospects and historically HEALTH CARE 11.8% 12.7%
low valuations, the stock market FINANCIALS 14.3% 14.4%
has rallied over 60% from the low. INFORMATION TECHNOLOGY 20.0% 19.0%
TELECOMMUNICATION SERVICES 2.3% 3.0%
Although the economic Source: RBC AM
environment has brightened, several
powerful forces are acting to mute S&P 500 EQUILIBRIUM
the strength of the recovery. In Normalized Earnings & Valuations
the household sector, consumer
spending has stopped falling, but a 3311
rising unemployment rate, too much 2026 Nov '09 Range: 1054 - 1724 (Mid: 1389)
debt and reduced availability of 1240 Nov '10 Range: 1328 - 2172 (Mid: 1750)
Current (30-Nov-09): 1096
credit are preventing spending from 759
increasing. In the corporate sector, 464
management teams are focused 284
on hoarding cash and cutting
174
costs. While these actions have
106
boosted profitability, manufacturing
65
inventories and capital investments Source: Bloomberg, RBC AM
have posted record declines and 40
are a drag on the recovery. 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
The link between the corporate growth, a decline in initial will likely still move higher but
and household sectors, and the unemployment claims, and the be driven more by company- and
key to a sustainable recovery, is PMI employment survey all industry-specific factors. We expect
job creation. Once companies see point to improvement in the job the economic recovery to be uneven
improvement in fi nal demand, more market sometime in early 2010. as central banks around the world
jobs will be created and consumer seek to boost benchmark interest
spending will turn up, resulting Meanwhile, the equity market is rates, and investors should expect
in additional jobs and further transitioning to a more challenging more modest returns and a likely
spending. While recent employment phase. In the fi rst phase, dating increase in market volatility.
data is sending mixed messages, from the March low, the market
forward-looking indicators of moved dramatically higher as SECTOR ANALYSIS
employment are showing signs of investor fears of a depression ceded
promise. For example, a positive to relief that this would not be the The ENERGY sector underperformed
turn in temporary employment outcome. In this next phase, stocks the broader market for most of this
year, but since early September that consumer spending remains stocks have languished. However,
has started to show some much subdued over the intermediate term, provisions for loan losses should
anticipated leadership. Energy we are downgrading our position peak sometime in the next few
stocks typically outperform as an to market weight from overweight. months and this typically has led
economic recovery takes shape. The to better relative performance. As
strength of the economic rebound The performance of the HEALTH such, we upgrade our position
in emerging economies, combined CARE sector has been hampered by to neutral from underweight.
with a favourable outlook for a uncertainty regarding health-care
moderate recovery in developing reform as investors consider which The MATERIALS sector has
economies in 2010, has boosted areas of the group will be hurt most outperformed so far this year as
investor sentiment toward the once a fi nal bill is passed. In our the global economic recovery
group. Within the sector, our opinion, given the political process, gathers pace. Demand for raw
preference is for oil producers, oil it is likely that the fi nal bill will do materials in China and other
service and drilling companies less damage to the profitability of emerging markets continues to be
and selective international the sector than is currently priced robust, and the destocking process
integrated oil companies. We into the stocks. Still, although the that characterized much of the
maintain our overweight position. sector is attractive, we expect the past year in the developing world
reform process to drag on well into appears to be giving way to small
The CONSUMER STAPLES sector the fi rst quarter of 2010 and so we production increases and inventory
lagged the broader market rally maintain our underweight position. accumulation. Shares of mining
during its initial stages, but recently and chemicals companies, as well
began outperforming despite Over the past three months, as producers of industrial gases,
a relative lack of leverage to an the INDUSTRIALS sector has have done well, while steel and
economic recovery. We continue outperformed the market as agriculture-related names have
to focus on food retailers, which confidence in the recovery has faired poorly. We expect demand for
should benefit from an end to grown. The group’s profitability commodities to remain solid while
price deflation in the coming has shown amazing resilience supply struggles to keep up and a
months, and selective household as management teams cut costs weak U.S. dollar to be supportive.
and personal product companies rapidly to better match supply We remain overweight the sector.
with global businesses. Given our with demand. The sector stands
outlook for an uneven recovery, to benefit disproportionately The INFORMATION TECHNOLOGY
it seems prudent to maintain as spending on infrastructure, sector has outperformed since
our market-weight position. machines and equipment recovers late November 2008. However,
from an unsustainably low base. As during recent months, relative
The CONSUMER DISCRETIONARY a result, we are moving to a slight performance appears to be slowing
sector continues to be one of the overweight stance on the sector. as investors become concerned
leaders in the market as investors the stocks may reflect near-peak
become more comfortable with The FINANCIALS sector has been earnings. It seems far too early in
prospects for sustainable economic the worst performing over the past the recovery to believe the sector
growth in 2010. Both specialty three months. Uncertainty around has reached this level when the
retailers and department stores potential regulatory changes, global economy has just barely
have performed well as strict mixed data from the housing climbed out of the worst recession
inventory management enabled market and rising unemployment in decades. We believe higher
them to generate more sales at full have combined to pressure the earnings lie ahead for the group
price even though traffic remains stocks. In addition, with valuations and that stock prices will follow. We
anemic. However, given the more in line with the economic maintain our overweight position.
significant outperformance of the backdrop that is widely expected to
group this year and the likelihood unfold in the coming quarters, the
ECONOMIC BACKDROP
CANADA RECOMMENDED SECTOR WEIGHTS
The S&P/TSX Composite continued RBC INVESTMENT BENCHMARK
to progress during the fall quarter STRATEGY COMMITTEE S&P/TSX COMPOSITE
with most other global equity NOV. 2009 NOV. 2009
enter this period well capitalized While weakness in the U.S. dollar growth and increased competition,
on traditional measures, but risk has accelerated gains for oil, futures on the one hand, while still
weightings are likely to rise and contracts indicate optimism that considering the reasonable
the quality of capital is likely to be a global economic recovery will valuations and high levels of
in focus. While investors have so tighten the supply-demand picture free cash flow, on the other.
far been focused on normalized for ENERGY through next year. Stocks
earnings for the 2011 to 2012 in the sector are currently fairly INFORMATION TECHNOLOGY remains
time frame, the regulatory issues valued given the environment and overweight. This sector provides
may cause investors to question offer attractively priced options investors with reasonable valuations,
whether the environment for which on higher prices. Natural gas cyclical recovery benefits and
they have modeled earnings is offers the potential for recovery some powerful secular forces,
appropriate. Insurers face similar, from current prices, which have which benefit sector heavyweight
if not heightened, risks on these been depressed by a slow start to Research In Motion, in particular.
fronts. Given the underperformance winter and an increased supply
of insurers’ shares, these risks backlog from newly drilled wells The CONSUMER STAPLES and
already appear reflected more not yet connected to pipeline CONSUMER DISCRETIONARY sectors
than elsewhere in the sector. systems. We remain overweight. stay near market weight. Well run
businesses at reasonable valuations
We are recommending an The INDUSTRIALS sector remains characterize these sectors. Tim
overweight in MATERIALS and, overweight. With economic Hortons’ valuation looks attractive,
within the sector, a slight emphasis activity picking up, a number and particularly so if one considers
on basic metals and chemicals at the of well managed Canadian that the company’s U.S. business
expense of gold. Continued concern bellwethers are well positioned is approaching profitability. We
over the U.S. dollar, coupled with for improved earnings. Further, are also focused on a potential
Barrick Gold’s decision to remove its as government stimulus triggers recovery in profit margins at Loblaw,
hedges and India’s large purchase infrastructure spending, there which could provide shareholders
of gold, contributed to a breakout in are a number of companies in with above-average returns over
the Gold sub-sector. Copper led the this sector that stand to benefit. the coming years. In addition, the
commodity surge. Many Materials controlling Loblaw stake held
companies can expect significant We remain underweight in by George Weston provides an
improvements in free cash flow on TELECOMMUNICATION SERVICES, attractive discount to net asset
the back of higher commodity prices. reflecting the sector’s slowing value for the parent company.
ECONOMIC BACKDROP
EUROPE RECOMMENDED SECTOR WEIGHTS
We remain positive on prospects RBC INVESTMENT BENCHMARK
for European equity markets. While STRATEGY COMMITTEE MSCI EUROPE
NOV. 2009 NOV. 2009
it appears that economies in the
region are either bottoming or ENERGY 12.8% 11.5%
improving, we believe the eight- MATERIALS 10.5% 8.8%
month rally from the lows in March INDUSTRIALS 9.7% 9.4%
has been driven more by the receding UTILITIES 4.9% 6.3%
financial crisis than by any great CONSUMER DISCRETIONARY 7.5% 7.4%
hope for an uptick in European GDP.
CONSUMER STAPLES 11.9% 12.0%
Equities valuations remain well
below long-term averages and look HEALTH CARE 8.2% 9.9%
cheap in comparison to other asset FINANCIALS 24.5% 24.8%
classes such as cash and bonds. INFORMATION TECHNOLOGY 3.7% 2.8%
TELECOMMUNICATION SERVICES 6.4% 7.2%
We believe that stock markets could Source: RBC AM
be driven higher by sustained levels of
profitability, and third-quarter results EUROZONE DATASTREAM INDEX EQUILIBRIUM
are again demonstrating that. Despite Normalized Earnings & Valuations
the scale and nature of the economic
downturn, profitability remains 4467
stable. There is skepticism in many 2899 Nov '09 Range: 1523 - 2546 (Mid: 2034)
quarters that this can continue in 1881 Nov '10 Range: 1744 - 2914 (Mid: 2329)
Current (30-Nov-09): 1064
Continental Europe given the region’s 1221
less flexible, laissez-faire-resistant 792
political structure. This view is based 514
more on opinion than evidence and
334
we believe that equity markets will
217
begin to price in higher levels of
141
profitability in the coming quarters. Source: Datastream, Consensus Economics, RBC AM
The U.K. is still in the grip of the worst 1980 1985 1990 1995 2000 2005 2010 2015
recession since the Second World War,
and output could fall by 6% over the may act as a drag on recovery. We consumption, and this created an
course of the downturn. However, believe that management teams early and extreme reaction. We
several things suggest that the worst have tackled problems associated expect growth in the second half
is over. Low interest rates, continued with the downturn well. of 2009 due to Germany’s rapid
quantitative easing, a weaker rebound as it rides the global
exchange rate and a recovering Continental Europe entered a manufacturing cycle. The strength
global economy will all help. Sterling severe recession in 2008 as a rapid of the euro will be a headwind,
has fallen approximately 20% since contraction in the export- and but we believe that Germany and
mid-2007, a plus for exporters. investment-oriented economies France, with their lack of consumer
The largest part of the economy, of Central Europe led to a record debt and renewed competitiveness,
consumer spending, may take some contraction in GDP in early 2009. will lead growth in the region.
time to recover and the relatively high
burden of household debt, while not Business investment and trade We have found trend P/E – the
as severe a problem as some suggest, balances are more volatile than aggregate price of the stock market
divided by its long-term level of that mining companies are now They are the continued recipients
earnings – to be a good indicator fairly valued. Steel producers remain of free reserves from Central
of valuations, and, on this basis, a relatively inexpensive part of Banks and, as access to wholesale
stocks look inexpensive. At the point the sector, but their outlook is still funding is restricted, they are able
in the cycle where the economy is somewhat unclear. Construction to charge their customers more.
perceived to have started improving stocks have also performed well
or stopped worsening, share prices and while we expect infrastructure Reductions in European interest
rise more quickly than profits spending to provide some revenue rates have set the stage for a
because investors look through the growth, valuations are quite full in recovery in household spending, as
low point in earnings to levels more the sector. However, our positive consumers feel more encouraged
in line with long-term performance. view on the economy as a whole by the economic backdrop and
For this reason, forward-looking P/ keeps the rating at overweight. more secure in their jobs. Share
Es are less of a guide to the direction performance has been robust in
of the stock market than trend P/Es, The UTILITIES sector remains the CONSUMER DISCRETIONARY
and we believe this has led to undue one of the less attractive areas sector and valuations have begun
pessimism among some investors. of the market from a dividend- to catch up with the improving
yield perspective and we remain macroeconomic outlook, but
In summary, we believe we concerned that power prices in we remain convinced that
are still in the early stages of a Europe – a key determinant of further progress is possible. Our
cyclical recovery. Investors tend the profitability of much of the exposure is now predominantly
to focus on the cyclical areas of sector – will be forced lower. auto- and media-related.
the stock market at such times, These companies may have We remain overweight.
but the performance of these moved too aggressively to cut debt
economically sensitive sectors following the fi nancial crisis. The Much of the INDUSTRIALS sector
has been so robust that, while we rating stays at underweight. has performed extremely well,
want to retain a cyclical bias in our and it now looks fully valued. Our
portfolios, we expect a degree of HEALTH CARE has been a laggard this exposure is focused on business
catch-up from other areas of the year, as investors shifted investments services and capital-goods
market that have been left behind to more cyclical sectors. We believe companies that garner substantial
from a valuation perspective. Our the sector offers the potential revenues from selling services.
strategy is, therefore, stock-specific for big relative gains, but such a The continued recovery in global
without large sector variances. scenario is difficult to forecast. growth remains a backdrop for
Within the sector, we have switched continued high profitability in
SECTOR ANALYSIS our exposure somewhat to medical these areas and we remain largely
technology companies, which offer neutral on the overall sector.
Europe’s INFORMATION TECHNOLOGY greater visibility relative to makers
sector has exhibited much greater of pharmaceuticals. We remain We believe the ENERGY sector
levels of capital discipline in the underweight the sector overall. will gain as valuations catch up
decade since the bursting of the to the overall market. Investors
Tech Bubble, and we expect that We remain neutral on the FINANCIALS have been concerned about the
this will enable companies to sector as valuations remain sustainability of dividends, but
perform better than expected. reasonable even after a strong recent results point to robust cash
Valuations remain attractive in the rally. Longer term, we can see a flows that can be directed to debt
sector and balance sheets are also much more stringent regulatory reduction after dividends are paid.
robust. We remain overweight. environment developing and we We have raised our rating on the
expect Bank sector leverage to fall. sector to overweight from neutral.
The MATERIALS sector has performed In the short term, however the
strongly this year, and we believe banks have several advantages.
ECONOMIC BACKDROP
ASIA RECOMMENDED SECTOR WEIGHTS
Our view remains somewhat RBC INVESTMENT BENCHMARK
positive on equities in Asia, where STRATEGY COMMITTEE MSCI PACIFIC
markets are benefiting from an NOV. 2009 NOV. 2009
attractive combination of excess ENERGY 3.6% 2.6%
liquidity, still-low inflation and MATERIALS 13.4% 11.6%
strong demand from China, which INDUSTRIALS 15.0% 14.7%
continues to vacuum up imports UTILITIES 3.0% 4.9%
from neighbouring countries. This
CONSUMER DISCRETIONARY 15.0% 14.4%
helps export industries around the
CONSUMER STAPLES 6.3% 6.2%
region, and makers of information
technology, consumer electronics HEALTH CARE 3.0% 4.6%
and automotive products, in FINANCIALS 28.8% 28.7%
particular. Japan’s economy is the INFORMATION TECHNOLOGY 10.4% 8.8%
exception and will require a catalyst TELECOMMUNICATION SERVICES 1.5% 3.5%
to catch up with other Asian markets.
Source: RBC AM
The pace of economic recovery in of Asia’s export-led recovery. In the enacted some mild tightening
Asia may be moderating after a sharp meantime, China will likely maintain measures, while Australia’s central
rebound from the early-2009 low. a high level of domestic demand bank has hiked short-term interest
This is evident in the 2.4% increase in through massive government fiscal rates twice since September, and
China’s third-quarter GDP versus the stimulus. The Shanghai World the Bank of Korea also hinted that
2008 period, down from 4.0% in the Expo, which begins in May 2010, monetary tightening is on the way.
previous quarter, while Japan’s GDP will provide an additional push to
rose just 1.3% in the third quarter. the expansion. Another factor in While Japanese industrial production
Growth in Japan has been driven by China’s growth is excess liquidity. is recovering in a V-shaped fashion,
strong Chinese demand and renewed Bank lending grew 34% in the nine production levels are still 20% below
factory production after cutbacks months ended September 30, 2009, their 2008 peak and there remains
following the financial crisis. We raising expectations of a gradual plenty of slack in the economy.
expect rising U.S. and European tightening in monetary policy. This scenario is deflationary, and
demand to generate the second leg China’s government has already the Bank of Japan recently forecast
that consumer prices will decline are improving, thanks to strong Taiwanese and Korean manufacturers
until 2011. In addition, a new left- money growth. One concern is are the major beneficiaries. Chinese
leaning government has shifted Japan, where financial companies consumer demand for flat-panel
the country’s budget priorities need to keep raising equity in order TVs has absorbed the excess
resulting in temporary halts to many to beef up their capital ratios. inventory that existed in early 2009.
infrastructure projects. The yen’s
persistent strength is burdening We are more positive on the Prospects for the ENERGY sector
exporters and economic growth may INDUSTRIALS sector and are, therefore, have improved as global growth
well stagnate in coming quarters. moving to a slight overweight from has recovered, and our rating
neutral. Transportation company remains overweight. Chinese oil
Exporters in Taiwan and South shipment volumes are rising and and coal companies are reporting
Korea are benefiting more than capital investment in utility and strong domestic demand, and
most from strong Chinese demand. infrastructure-related areas is prospects for Australian oil and
Electronics factories are operating strong. Construction is robust gas producers remain healthy.
near capacity for products such in real estate and infrastructure,
as TV liquid crystal displays, PCs, thanks to fiscal stimulus. Our Our rating for CONSUMER STAPLES
smart phones and memory chips. enthusiasm for the sector is tempered rises to neutral from underweight.
For these products, OECD demand by manufacturers’ reluctance to Japanese food and beverage
seems to be recovering more than invest in plant and equipment. companies are recovering with the
expected as the Christmas season help of restructurings and, in some
approaches, and inventories are Our rating on the CONSUMER cases, mergers. Lower crop costs
not excessive. Hong Kong assets are DISCRETIONARY sector remains are also a positive. The trend is less
benefiting from liquidity due to the overweight. Automobile sales are promising for convenience stores,
currency’s peg to the U.S. dollar, gradually recovering in OECD which are reporting weak sales.
which is pushing up real estate and markets as consumer confidence
stock prices. Taiwan continues to improves. Chinese auto sales remain We remain underweight the HEALTH
reap dividends from its improving extremely strong and the country is CARE sector, as many Japanese
relationship with mainland now the world’s largest car market. pharmaceutical companies face
China. Down south, Australia’s Some specialty-retail businesses patent expiries on major drugs
domestic economy is showing a in Japan are showing steady and insufficient pipelines to
solid recovery. The country was the growth because of new products, pick up the slack. Companies
fi rst to start raising interest rates although conventional retailers that sell medical equipment and
toward more normal levels and are having a more difficult time. services offer better prospects.
continues to benefit from strong
demand from China for its iron The MATERIALS sector is buoyant We remain underweight both
ore and other natural resources. and we remain overweight. Strong UTILITIES and TELECOMMUNICATION
Chinese demand and a global SERVICES. Neither sector offers
SECTOR ANALYSIS economic recovery are raising much growth. Even in China,
prices for metals and minerals, the telecom business appears
We remain neutral on the FINANCIALS as well as for steel and chemicals. to be maturing and utilities are
sector. Investor confidence has Demand for materials used in hampered by tight rate controls.
returned to the global financial electronics is also improving.
system, backed by a recovery in
economic activity. Asian financial The INFORMATION TECHNOLOGY sector
companies, particularly outside remains overweight. Demand for PCs
Japan, have forecast better asset and mobile phones has been stronger
quality and lower loan-loss than expected, and semiconductor
provisions and real estate markets production is operating near capacity.
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other inaccuracies or typographical errors or omissions, RBC Asset Management is not responsible for any errors or
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or cease publication of the information.
Any investment and economic outlook information contained in this report has been compiled by RBC Asset Management
Inc. from various sources. Information obtained from third parties is believed to be reliable, but no representation or
warranty, express or implied, is made by RBC Asset Management Inc., its affiliates or any other person as to its accuracy,
completeness or correctness. RBC Asset Management Inc and its affiliates assume no responsibility for any errors or
omissions.
©Copyright 2009. This report may not be reproduced, distributed or published without the written consent of RBC Asset
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trademark of Royal Bank of Canada. Used under license.
Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent
risks and uncertainties, both about the Fund and general economic factors, so it is possible that predictions, forecasts,
projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on
these statements as a number of important factors could cause actual events or results to differ materially from those
expressed or implied in any forward-looking statement made in relation to the Fund. These factors include, but are not
limited to, general economic, political and market factors in Canada, the United States and internationally, interest and
foreign exchange rates, global equity and capital markets, business competition, technological changes, changes in laws
and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events.
The above list of important factors that may affect future results is not exhaustive. Before making any investment
decisions, we encourage you to consider these and other factors carefully. All opinions contained in forward-looking
statements are subject to change without notice and are provided in good faith but without legal responsibility.