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SEA CHANGE: THE EBBING OF QUANTITATIVE EASING POLICY AND ITS IMPACT ON THE CAPITAL MARKETS THE GLOBAL FINANCIAL CRISIS – INITIATED BY A LIQUIDITY CRISIS Z-Score Euro Zone U.S. BFCI Source: Bloomberg. August 2013 The Bloomberg U.S. Financial Conditions Index combines yield spreads and indices from U.S. money markets, equity markets, and bond markets into a normalized index. The Bloomberg Euro-area Financial Conditions Index combines yield spreads and indices from euro-area money markets, equity markets, and bond markets into a normalized index. FINANCIAL CRISIS – THE KEY ROLE OF FINANCIAL SECTOR LEVERAGE U.S. financial sector debt as a percent of GDP Source: Federal Reserve, Epoch Investment Partners, Inc. 2013 THE SET-UP The liquidity pyramid: Global liquidity by source of claim 976% of world GDP Derivatives 145% of world GDP Securitized Debt 80% of world GDP 7% of world GDP Source: Independent Strategy, CLSA; 2009 Bank Loans Power Money 81% liquidity 12% of liquidity 6% of liquidity 1% of liquidity POLICY RESPONSE TO THE GFC ENDED THE LIQUIDITY CRISIS Z-Score U.S. BFCI Euro Zone Source: Bloomberg. August 2013 The Bloomberg U.S. Financial Conditions Index combines yield spreads and indices from U.S. money markets, equity markets, and bond markets into a normalized index. The Bloomberg Euro-area Financial Conditions Index combines yield spreads and indices from euro-area money markets, equity markets, and bond markets into a normalized index. DEBT REMAINS A GLOBAL PROBLEM – POLICY CHOICES Advanced economies’ gross general government debt to GDP Debt to GDP (%) Potential solutions to the overriding debt problem 1. Growth 4. Financial Repression (QE) 2. Austerity 5. Devaluation 3. Default 6. Hyperinflation Source: International Monetary Fund, World Economic Outlook Database, Epoch Investment Partners 2013 QUANTITATIVE EASING BECAME A GLOBAL PHENOMENON Index Central bank balance sheet expansion Source: Pavilion Global Markets; 2013 Sea Change – June 19, 2013 THE END OF EASY MONEY “We also see inflation moving back toward our two percent objective over time. If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” – Federal Reserve Chairman Ben Bernanke, June 19, 2013 BERNANKE’S TAPERING COMMENTS DRIVE YIELDS HIGHER U.S. Treasury yield curve: May 1, 2013 vs. September 6, 2013 (%) September 6, 2013 128 bps June 18, 2013 September 6, 2013 10-Year Treasury yield 2.20 2.94 Source: US Department of the Treasury, Epoch Investment Partners; September 6, 2013 May 1, 2013 30-Year Treasury yield 3.34 3.87 APPLE’S BOND OFFERING • On April 30, 2013, Apple issued a total of US$17.05 billion worth of bonds in six tranches with a weighted coupon of approximately 1.8% and a weighted duration of approximately 10 years. Coupon Current Price1 10 Year 2.40% 88.84 30 Year 3.85% 82.05 Issue 1As of September 11, 2013 THE “MOVIE RUN BACKWARDS” 10-year Treasury constant maturity rate (%) Source: Federal Reserve, Epoch Investment Partners; September 6, 2013 MATURITY AND CREDIT QUALITY SPREADS WIDENING Yield spreads US 10Y - US 3M Yield BAA - AAA Yield Source: Federal Reserve, Epoch Investment Partners. September 6, 2013. RECENT GLOBAL RETURNS DRIVEN BY MULTIPLE EXPANSION Breakdown of MSCI World Index performance Annualized Total Return: 19% Expected Earning Growth Source: Bloomberg, MSCI, Bernstein Analysis; May 2013 Fwd P/E Expansion Annualized Total Return: 33% Dividend (Inc. Reinvestment) CHINA’S SHADOW BANK LIQUIDITY SQUEEZE China interbank 7-Day repo (%) Source: Bloomberg, Epoch Investment Partners; August 2013 CHINESE MANUFACTURING ACTIVITY CONTINUES TO SLOW . . . Index China Manufacturing PMI Source: Bloomberg, Epoch Investment Partners; September 1, 2013 FLOWING THROUGH TO COMMODITY-BASED ECONOMIES Index Emerging Market Economic Surprise Index1 1. Aggregates economic data from multiple EM countries; positive numbers indicate that the data is beating expectations; negative numbers show data missing expectations Source: Citigroup Global Markets. August 15, 2013. EMERGING AND COMMODITY-BASED MARKETS HIT HARD IN 2Q World equity market returns 2Q 2013 (%) Source: MSCI, S&P, Russell; June 2013 QE – BANK OF JAPAN ACCELERATING ASSET PURCHASES . . . 100 Million Yen Bank of Japan: Total assets Source: Bank of Japan; July 2013 . . . DRIVING YEN LOWER AND SPURRING GROWTH Japanese Manufacturing PMI Yen/dollar exchange rate ¥/$ Source: Federal Reserve; Bloomberg; Epoch Investment Partners; September 2013 Index STRUCTURAL REFORMS REQUIRED FOR ABE-NOMICS TO WORK • Labour market reforms • Introduction of favourable corporate tax structure • Reduce trade barriers and encourage foreign direct investment • Reform agricultural policy, in particular the supply management policy U.S. EMPLOYMENT: A SLOW BUT STEADY RECOVERY Change in total U.S. non-farm employment Thousands of Persons 3/2010 through 7/2013: 6.7 million jobs gained 2/2008 through 2/2010 8.8 million jobs lost Source: Federal Reserve Economic Data; July 2013 INFLATION IS STILL NOT A FACTOR Year-Over-Year % Change Personal Consumption Expenditures Price Index Source: Federal Reserve Economic Data; June 2013 U.S. RETURNS ALSO DRIVEN BY MULTIPLE EXPANSION S&P 500 and forward earnings multiples 15x Index 14x 13x S&P 500 Source: Standard & Poors, Yardini Research, Epoch Investment Partners; August 16, 2013 LOOKING BEYOND QE IN THE U.S. • Stocks are attractive in the long term, especially relative to bonds, providing the world grows. • Extreme valuation disparities present an investment opportunity. • As interest rates rise and other macro factors wane, equity returns will be more dependent on company fundamentals. • Companies with growing free cash flow and effective capital allocation policies should outperform. BEGINNING OF THE “GREAT ROTATION” $ Billions Net flows into mutual funds Source: Strategas; August 2013 A “RISK AVERSION RALLY” Discount/premium 1-year forward P/E to 15-year avg. P/E Discount/premium 1-year forward P/E to S&P 500 Telecommunication Services Utilities Telecommunication Services Utilities Materials Health Care Industrials Industrials S&P 500 Materials Health Care -45% Source: Strategas; June 2013 Information Technology Information Technology DEFENSIVE SECTORS ARE EXPENSIVE RELATIVE TO CYCLICAL SECTORS Ratio S&P 500 Defensive Sectors* NTM P/E to S&P 500 Cyclical Sectors# NTM P/E Defensive sectors expensive Parity Defensive sectors relatively cheap * Defensive: Health Care, Staples, Utilities, Telecom; # Cyclical: Industrials, Discretionary, Energy, Tech, Materials Source: Strategas; June 2013 INVESTORS BECOMING MORE DISCRIMINATING ABOUT YIELD High payout ratio less of a dominant factor 108 106 104 102 100 98 96 94 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Dividend Payout Ratio High to Low Performance Source: Cornerstone Macro; May 2013 Jun-13 OPPORTUNITIES AFTER THE END OF ZIRP Most crowded factors Percentile of crowding vs. 10-Year history* *U.S. Large Caps, 100% = Most Crowded **U.S. Large Caps, 0% = Least Crowded Source: FactSet, Thomson Reuters and Bernstein Analysis; May 2013 Least crowded factors Percentile of crowding vs. 10-Year history** SUMMARY • • • A sea change underway – the end of ZIRP in the U.S. – Discount rate for financial assets will rise – Bonds most adversely affected – Equities to experience P/E headwinds Global themes – Best positioned geography: U.S. – Worst positioned geography: Emerging markets – Wait and see: Japan – Valuation beginning to be attractive in Europe As macro factors wane, equity returns will be more dependent on company fundamentals – Slow economic growth will limit revenue and earnings growth – Shareholder yield will continue to play a dominant role in total return strategies – Companies with growing free cash flow and effective capital allocation policies should outperform – P/E upward move at an end Thank you All charts and illustrations in this guide are for illustrative purposes only. They are not intended to predict or project investment results. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. ®CI Investments and the CI Investments design are registered trademarks of CI Investments Inc.