Global Insight Weekly

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1 AUGUST 9, 2013 RBC Wealth Management Global Insight Weekly Equity Scorecard August 9, 2013»» Stocks took a summer break and pulled back despite better-than-expected economic data across regions.»» North American and European equity markets have experienced meaningful increases in P/E ratios since November. Another round of significant multiple expansion seems unwarranted. (page 2)»» Global Roundup: Opportunities in Canada s preferred share market; analysis of the BoE meeting and European banking regulations; overview of Asian economic data. (pages 3-4) Global Insight Monthly Now Available The August edition discusses RBC s latest thoughts about the economy, equities, fixed income, currencies, and asset allocation. It includes these articles Looking Forward to the Second Half: Equity markets have raced higher in anticipation of better growth in the U.S. and Europe. It seems markets are about to get what they ordered. The main drags on the U.S. economy are lifting. Europe could soon move out of recession. Mr. Li s Put: For the first time, a senior Chinese official has drawn a line in the sand regarding short- to medium-term economic growth. By singling out 7% as the minimum growth rate, and at the same time beginning to introduce pro-growth policies, we now have a Greenspan-like Li Put for China. Index (local currency ) Level 1 week MTD YTD S&P 500 1, % 0.3% 18.6% S&P/TSX Comp 12, % 0.4% 0.9% FTSE All Share 3, % -0.2% 13.2% Hang Seng 21, % -0.3% -3.7% Dow (DJIA) 15, % -0.5% 17.7% NASDAQ 3, % 0.9% 21.2% Russell , % 0.3% 23.4% STOXX Europe % 2.1% 9.4% German DAX 8, % 0.8% 9.5% Nikkei , % -0.4% 31.0% Straits Times 3, % 0.2% 2.0% Shanghai Comp 2, % 2.9% -9.6% Brazil Bovespa 49, % 3.4% -18.2% Note: Equity returns do not include dividends. Author Kelly Bogdanov San Francisco, United States kelly.bogdanov@rbc.com; RBC Capital Markets, LLC Contributors Jean-François Dion & Mikhial Pasic Toronto, Canada jean-francois.dion@rbc.com & mikhial.pasic@rbc.com; RBC Dominion Securities Inc. Frédérique Carrier London, UK frederique.carrier@rbc.com; Royal Bank of Canada Investment Management (UK) Ltd. Jay Roberts Hong Kong, China jay.roberts@rbc.com; RBC Dominion Securities Inc. All values in U.S. dollars unless otherwise noted. Priced as of August 9, 2013, market close (unless otherwise stated). For Important Disclosures, see pages 5-6.

2 Markets & the Economy Market Scorecard August 9, 2013 Govt Bonds (bps chg) Yield 1 week MTD YTD US 2-Yr Tsy 0.302% US 10-Yr Tsy 2.577% Canada 2-Yr 1.138% Canada 10-Yr 2.482% UK 2-Yr 0.347% UK 10-Yr 2.460% Germany 2-Yr 0.162% Germany 10-Yr 1.680% Commodities (USD) Price 1 week MTD YTD Gold (spot $/oz) 1, % -0.8% -21.6% Silv er (spot $/oz) % 3.6% -32.2% Copper ($/ton) 7, % 4.2% -9.4% Oil (WTI spot/bbl) % 0.9% 15.4% Oil (Brent spot/bbl) % 0.5% -2.6% Natural Gas ($/mlnbtu) % -6.4% -3.8% Agriculture Index % -2.2% -18.9% Currencies Rate 1 week MTD YTD US Dollar Index % -0.4% 1.7% CAD/USD % -0.1% -3.6% USD/CAD % 0.1% 3.7% EUR/USD % 0.3% 1.1% GBP/USD % 2.0% -4.6% AUD/USD % 2.4% -11.5% USD/CHF % -0.4% 0.7% USD/JPY % -1.7% 10.9% EUR/JPY % -1.4% 12.2% EUR/GBP % -1.7% 5.9% EUR/CHF % -0.1% 1.9% USD/SGD % -1.1% 2.9% USD/CNY % -0.1% -1.7% USD/BRL % -0.3% 10.7% Source: Bloomberg. Note: Bond yields in local currencies. Copper and Agriculture Index data as of Thursday s close. Dollar Index measures USD vs. six major currencies. Currency rates reflect market convention (CAD/USD is the exception). Currency returns quoted in terms of the first currency in each pairing. Data as of 8:34 pm GMT 8/9/13. Examples of how to interpret currency data: CAD/USD 0.97 means 1 Canadian dollar will buy 0.97 U.S. dollar. CAD/USD -3.6% return means the Canadian dollar fell 3.6% vs. the U.S. dollar year to date. USD/JPY means 1 U.S. dollar will buy yen. USD/JPY 10.9% return means the U.S. dollar rose 10.9% vs. the yen year to date. Most equity markets pulled back, and bond markets were little changed during relatively quiet summer trading. Japan s TOPIX underperformed and fell 4.6% for the week as the yen rose roughly 2.7% against the dollar. Investors once again questioned whether the planned sales tax hike would be implemented or scrapped. The economic center of interest shifted to China as a slew of July data were released. Four important sectors exceeded economists expectations: industrial production, electricity production, services, and trade (details on page 4). This means the Chinese economy s multi-month deceleration phase could be taking a hiatus. U.S. and European data also sent positive signals. Services activity beat analysts forecasts on both sides of the Atlantic. Germany s factory orders surged 3.8% in June versus May, and industrial production rose 2.4%. In Europe s still-fragile Southern periphery, Italy s GDP fell 2.0% in the second quarter versus the same period a year ago, slightly better than economists forecast of a 2.2% contraction. These data support our view that the European and U.S. economies should improve during the second half of this year, and China s economy could stabilize. But because financial markets tend to lead economic realities, much of this could already be priced into equities. Consider that North American and European equity markets have experienced meaningful increases in price-to-earnings (P/E) ratios since mid-november, when the current stage of the global rally began. The S&P 500 P/E ratio has risen to 16.4 from 13.5 during this brief period, based on trailing 12-month earnings. Canada s S&P/TSX P/E P/E Ratios Have Risen in North America and Europe, but Not in Asia Trailing 12-month Price-to-Earnings Ratio Before Extraordinary Earnings Items P/E Ratio at Most Recent Low in Global Equities (mid-nov 2012) P/E Ratio Current S&P 500 S&P/TSX FTSE All Share German Dax Nikkei Hang Seng Shanghai Comp Source - RBC Wealth Management, Bloomberg; Current P/E ratio is on 8/8/13 has jumped to 16.5 from 14.7, and the U.K. s FTSE All-Share P/E ratio expanded to 18.6 from 15.5 (see chart). These higher ratios are considered averageto-above average on a historical basis. P/Es rose sharply because gains in the markets prices (the P in the P/E ratio) far exceeded increases in earnings (the E ). For example, the S&P 500 s price rose 24.8% since mid-november, but trailing 12-month earnings only grew 2.8% during the same period. We anticipate earnings will grow only modestly in coming quarters for these markets, and not enough to justify further significant multiple expansion. Asian markets haven t experienced P/E multiple expansion. Even though Japan s Nikkei has surged (the P has soared), earnings growth has also been quite strong (the E has risen). For China, the story is the opposite. Its market has performed poorly and earnings growth has been hard to come by (the P and E are nearly the same since mid- November). 2 GLOBAL INSIGHT WEEKLY AUGUST 9, 2013

3 Markets & the Economy Global Roundup United States Equity traders cited thin liquidity and light flows during what is normally peak vacation time on Wall Street. Overall, buyers stood on the sidelines. The equity pullback was broad-based with only the materials sector trading higher for the week. That sector was boosted by China s improved economic data. Industries that helped fuel the market s recent run transportation, banks, biotechnology, and semiconductors underperformed. The 10-year Treasury auction attracted healthy demand and produced a higher price and lower yield than was expected (2.60% versus 2.635% forecast). In contrast, there was weak demand at the 30-year auction. RBC Capital Markets U.S. rates strategist said the market normally has trouble absorbing large 30-year auctions in August due to summer trading conditions. This auction was actually better than previous years. Overall, he was encouraged about the composition of buyers, which included a greater share of foreign central banks than normal. Market participants are still paying close attention to Federal Reserve comments about forthcoming tapering of asset purchases. Charles Evans, president of the Chicago Fed, said he wouldn t rule out a tapering announcement on September 18 at the Federal Open Market Committee meeting. This comment is notable because Evans is considered to hold dovish views, which closely align with Fed Chairman Ben Bernanke s philosophy. While the 10-year Treasury yield drifted a bit higher on the news, it settled back below 2.60% late in the week. Coming up: Retail Sales (Aug 13); Consumer Price Index (Aug 15). Canada Second-quarter earnings were the focus in Canada. BCE and Telus reported solid results generally in line with expectations. Telus management indicated it remains committed to its 10% annual dividend growth policy and annual $500 million buyback through 2016 despite the threat of new competition from Verizon. Tim Hortons reported tepid samestore-sales growth but announced a $900 million share buyback above and beyond the company s existing $250 million buyback program. Manulife reported results slightly below consensus, but most of the items that drove the weakness are not expected to recur. Government of Canada bond yields were fairly stable during the week, with yields on short and intermediate maturities moving lower at the end of the week as disappointing Canadian employment data muted investor expectations on the timing of a potential rate hike by the Bank of Canada. The July employment report showed the Canadian economy lost 39.4K jobs during the month. After subtracting the net job losses in July from the annual tally, the Canadian economy has only added 42K jobs in 2013 (see chart). The preferred share market lost 1.5% during the week as investors have recently soured on the asset class. It has lost 6% since March 28. We do not think it is a coincidence March 28 marks a high water mark for the asset class as that was the date the first rate reset issue was extended beyond its first reset date. The decline has been led by rate reset preferred shares with low reset spreads that are at risk of extension and perpetual preferred shares with low dividends that were most exposed to losses due to the move higher in interest rates. Following the preferred share selloff, we believe opportunities have emerged in the market: Rate reset preferred shares that carry large reset spreads and come due in one year that offer comparable yields to 5-year bonds from the same issuer. We think there is a high likelihood these issues will be redeemed in a year due to the large reset spreads. Rate reset preferred shares from investment-grade issuers with reset spreads above 250 basis points that have traded into the low 20s; and Perpetual preferred shares that trade in the low 20s that carry cash yields in the 5.50% or higher area. Coming up: Existing Home Sales (Aug 15), International Securities Transactions (Aug 16). Net Change in Monthly Jobs for Canada and U.S. (in thousands) The relative underperformance of Canada is one factor that has fed into the poor performance of the Canadian equity market and decline in the loonie. Canada United States Year-to-Date Totals U.S.: +1,314,000 Jobs Canada: +42,000 Jobs January February March April May June July Source - RBC Dominion Securities, Bloomberg 3 GLOBAL INSIGHT WEEKLY AUGUST 9, 2013

4 Global Roundup Europe New Bank of England (BoE) Governor Mark Carney announced a Fed-style forward guidance policy, linking interest rate rises to a targeted unemployment rate of 7%. He also introduced three knockouts (conditions), although he stated, there is therefore no presumption that breaching any of these knockouts would lead to an immediate increase in Bank Rate or sale of assets. The three knockouts are: if, in the Monetary Policy Committee s (MPC) view, the consumer price index (CPI) inflation in months time is expected to move above 2.5%; if mediumterm inflation expectations cease to be well anchored; or if the Financial Policy Committee judges the monetary policy poses risks to financial stability. Those expecting firm guidance by the BoE were disappointed. The guidance remains very loose, and the BoE gives itself remarkable leeway. Any outcome seems possible. Based on their assessment of the U.K. economy, however, RBC Capital Markets economists do not believe the knockouts are likely to provide binding constraints over the next 12 months. They pushed back their expectations of the first rate hike to Q In the eurozone, the European Banking Authority (EBA) suggested it is looking to adopt the U.K. s tougher bank capital rules and to impose a leverage ratio cap. In the U.K., this new leverage cap ratio, set at 3%, has led some banks to raise capital or cut lending. The BoE, which recently took charge of financials services industry regulation, insists this cap is needed to keep the banking system stable and enable it to borrow and lend more cheaply in the future. The EBA is looking at this measure for similar reasons. A well-funded and functioning The Bank of England Raised its GDP Forecasts Meaningfully % 1.9% banking system is key to a sustainable eurozone recovery. Bank lending in the eurozone remains subdued. According to recent European Central Bank monetary data, the annual growth rate of loans to the private sector originated by banks fell to -1.0% in June from -0.7% in May, a new record low. The annual growth rate in lending to households rose 0.3%, while annual growth in loans to nonfinancial businesses slipped 2.3% in the period. Coming up: U.K. CPI/Retail Price Index (Aug 13); U.K. MPC Minutes, U.K. Labour Market Report, Euro Area Q2 GDP (Aug 14). Asia Pacific Annual GDP Growth (% year over year) 1.5% 2.7% 1.4% 2.3% BoE Forecast in May BoE Forecast Current RBC Forecast Current Source - RBC Capital Markets, Bank of England Mr. Raghuram Rajan, a finance professor at a leading U.S. university, was named governor of the Reserve Bank of India. He has also been serving as chief economic advisor to the Indian government since mid The Indian economy faces a number of challenges including slowing growth, consistently high inflation, a fiscal debt of approximately 10% of GDP, a sharply wider current account deficit, and the rupee close to a record low against the dollar. There were a number of central bank decisions during the week. The Reserve Bank of Australia cut its benchmark lending rate to a recordlow 2.5%, as forecast. South Korea kept its benchmark rate at 2.5%, and its second-quarter growth was the highest in two years. The Bank of Japan kept policy unchanged and repeated there was a moderate recovery in the economy and an increase in inflation expectations. The yen strengthened through the week, and equities were volatile. The TOPIX declined 4.6%. China s key economic data for July was generally better than expected. Notably, the Services Purchasing Managers Index, a leading economic indicator, rose to 54.1 from 53.9, the first increase since March. Industrial production rose 9.7% (forecast: 8.9%), and trade data improved, with exports gaining 5.1% (forecast: 2%) and imports gaining 10.9% (forecast: 1%). Improved export demand was led by G3 countries (U.S., E.U., and Japan). Chinese inflation data remains benign. Consumer prices rose 2.7% y/y in July (forecast: 2.8%). The Chinese renminbi rose to a new high of USD/CNY The currency has been consistently strong in Singapore s economy grew 2% in the first half of 2013, up from weak 1.3% growth in Prime Minister Lee Hsien Loong raised his growth forecast for 2013 to 2.5%-3.5%. The lower range of the forecast was a considerable increase, as the previous range was 1%-3%. Indonesia s economy grew 5.8% in the second quarter, slightly below forecasts and the 6% first-quarter rate. However, inflation remains high, and the rupiah is near its weakest level since GLOBAL INSIGHT WEEKLY AUGUST 9, 2013

5 Important Disclosures Analyst Certification All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report. Important Disclosures RBC Wealth Management is a division of RBC Capital Markets, LLC, which is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Jean-Francois Dion, Mikhial Pasic, & Jay Roberts, employees of RBC Wealth Management USA s foreign affiliate RBC Dominion Securities Inc.; and Frédérique Carrier, an employee of RBC Wealth Management USA s foreign affiliate Royal Bank of Canada Investment Management (UK) Limited; contributed to the preparation of this publication. 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Copyright RBC Capital Markets, LLC Member NYSE/ FINRA/SIPC Copyright RBC Dominion Securities Inc Member - Canadian Investor Protection Fund Copyright RBC Europe Limited 2013 Copyright Royal Bank of Canada 2013 All rights reserved 6 GLOBAL INSIGHT WEEKLY AUGUST 9, 2013