RBC Global Asset Management Daniel E. Chornous, CFA Chief Investment Officer RBC Global Asset Management

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1 RBC Global Asset Management Daniel E. Chornous, CFA Chief Investment Officer RBC Global Asset Management November 212

2 % Global Investment Outlook PMIs swing upward 65 Global Purchasing Manager's Indices 6 ISM Peak Jan 211: U.S. 1-Year T-Bond Yield Equilibrium Range Last Plot: 1.69% 4 JPMorgan Global Mfg. PMI 35 ISM Mfg. PMI China Mfg. PMI Euro Area Mfg. PMI Source: Haver Analytics, RBC GAM Current Range: 2.31% % (Mid: 3.22%) S&P 5 Equilibrium Normalized Earnings & Valuations Nov. '12 Range: (Mid: 163) Nov. '13 Range: (Mid: 1747) Current (23-November-12): Source: RBC GAM, RBC CM Source: RBC GAM 2

3 X YoY % Change Critical factors Housing sector begins to heal Home Prices as a Multiple of Median Household Income Existing House Price Divided by Median Income Average Ratio : 2.85 Last Plot: % Below peak housing price 3% Below peak housing price 4% Below peak housing price Source: National Association of Realtors Peak of Housing Market Median Price $23,9 22% Correction required to achieve average ratio U.S. Housing Prices Core Logic National HPI ex-distressed Properties* *Distressed Properties include short sales and real estate owned (REO) Source: Core Logic 3

4 Months Million Units YoY % Change Units Sold Critical factors Housing sector begins to heal U.S. Housing New Private Housing Units Started Total Starts Including Farm Housing Source: Census, Housing Starts United States Housing Statistics Existing Home Sales Source: National Association of Realtors 12 U.S. Housing Month's Supply of Homes on the Market Existing Single Family Homes Last Plot: Source: National Association of Realtors 4

5 QoQ % Change QoQ % Change Critical factors Credit conditions continue to ease Senior Loan Officer Survey on Bank Lending Practices Loan Officers Reporting Tightening Standards Easing 8 6 Senior Loan Officer Survey on Bank Lending Practices Banks Reporting Stronger Demand for C & I Loans Tightening Mortgage Loans to Individuals (Inverted) Commercial & Industrial Loans (Inverted) Source: Federal Reserve, Haver Analytics More Demand Large and Medium Firms Small Firms -8 Less Demand Source: Federal Reserve, Haver Analytics 5

6 QoQ % Change QoQ % Change QoQ % Change QoQ % Change Critical factors Credit conditions continue to ease ECB Euro Area Bank Lending Survey Banks Reporting Tightening Credit Standards Loans to Individuals for House Purchases (Inverted) 1 Loans to Enterprises (Inverted) Source: European Central Bank, Haver Analytics Easing Tightening ECB Euro Area Bank Lending Survey Change in Business Loan Demand Large Enterprises Small and Medium Enterprises Source: European Central Bank, Haver Analytics More Demand Less Demand 6 ECB Euro Area Bank Lending Survey Change in Demand for Consumer Credit 8 ECB Euro Area Bank Lending Survey Change in Demand for Housing Loans Source: European Central Bank, Haver Analytics Source: European Central Bank, Haver Analytics 6

7 $ Billions % Critical factors Corporate and household deleveraging largely behind U.S. Consumer Debt Outstanding (Total, SAAR) U.S. Financial Obligations Ratio Total Obligations as a % of Personal Disposable Income 16, 2 14, 19 12, 1, Peak: Q1 '8 $13.9 Tr Last Plot: Q2 '12 $12.9 Tr 18 8, 6, 4, 2, Last Plot: (Q2'12): 15.8% Average 198-Present: 17.2% Source: Federal Reserve Source: Federal Reserve 7

8 Index Level Index Level Critical factors Corporate and household deleveraging largely behind United States Consumer Confidence by Income Level Confidence: Income Over $5, Confidence: Income Under $5, Source: The Conference Board, RBC GAM Luxury Stocks S&P Global Luxury Index Relative to S&P Source: Standard & Poor's, Bloomberg, RBC GAM 8

9 Tier 1 Risk-Based Capital Ratio (%) Corporate Debt-to-Income Ratio (%) Critical factors Corporate and household deleveraging largely behind U.S. Banks Capital Ratios U.S. Corporate Leverage Note: Tier 1 risk-based capital ratio of all FDIC insured institutions. Source: FDIC, Haver Analytics, RBC GAM Source: Federal Reserve Board, Haver Analytics, RBC GAM 9

10 Critical factors but threats remain Fiscal cliff is nearing FISCAL CLIFF Bush Tax Cuts Payroll Tax Cut Budget Control Act UI Extension Other If nothing is done, expiring fiscal policy chops a huge 3% off 213 GDP growth. Politicians will hopefully soften the blow. or a 213 recession could loom Source: RBC GAM, CBO 1

11 Change in Budget Balance as a % of GDP Critical factors but threats remain Fiscal cliff is nearing U.S. Fiscal Drag Mounts Fiscal boost RBC GAM base case scenario "Thelma & Louise" scenario Fiscal drag Note: A negative number indicates smaller deficit / bigger surplus versus prior year. Source: International Monetary Fund, Haver Analytics, RBC GAM 11

12 Basis Points Critical factors but threats remain European debt crisis chronic, but not terminal European Banks Ireland, Spain & Portugal CDS 5-Year Spreads Santander Banco Espirito Santo Allied Irish Société Générale BBVA Banco Comercial Portugues Bank of Ireland Source: Bloomberg 12

13 Level YoY % Change Critical factors but threats remain China growth nearing a bottom? China Purchasing Managers Index and GDP Real GDP (RHS) Purchasing Manager's Index (LHS) Source: China National Bureau of Statistics, Markit Overall CPI China Consumer Price Index -4 CPI Excluding Food Source: China National Bureau of Statistics 13

14 % % Basis Points % Stress Indicators -2 U.S. Yield Curve vs. VIX Volatility 7 High Yield Bond Spread Credit Suisse HY Index Spread-to-Worst Last Plot: 63 (LHS) 25. VIX Nov. 23: Spread-to-Worst Threshold HY Default Loss Rate (7 Months Later) Last Plot:.98% (RHS) Recession Periods U.S. 1yr-2yr Spread (LHS, Inv, Adv 3 Months) VIX (RHS) Source: RBC GAM Source: Credit Suisse, RBC GAM 588 bps 588 bps 14

15 YoY % Change % YoY % Change Index Level YoY % Change Employment A critical concern, though signs of healing are beginning to show United States Non-Farm Employment and the Fed Funds Rate Fed Funds Rate (Inverted, Adv 18 Mos, LHS) Non-Farm Employment (RHS) Source: ISI Portfolio Strategy United States ISM Manufacturing Index and Non-Farm Employment ISM Manufacturing Index (Adv. 12 Months, LHS) Non-Farm Employment (RHS) Source: Institute for Supply Management, BLS United States Real Consumer Spending and Non-Farm Employment Non-Farm Employment Real Personal Consumption Source: Bureau of Labor Statistics, Bureau of Economic Analysis, Citigroup 15

16 Index Level % of Reports Economic indicators Move past a period of negative surprise 3 Chicago Fed National Activity Index Three Month Moving Average 8 Westpac United States Data Surprise Index Positive Surprise Risk of Inflation Risk of Recession Source: Federal Reserve Bank of Chicago, RBC GAM Source: Westpac Strategy Group 16

17 Economic indicators PMIs turn higher Global Leading Indicators JP Morgan Global Purchasing Managers Index Global Purchasing Managers Indices Manufacturing - as of October 212 Current Recent Trough Cycle Peak Canada (Jul-11) 73.2 (Mar-11) Russia (Jul-11) 55.6 (Mar-11) India (Sep-11) 59. (May-1) United States (Aug-12) 59.9 (Jan-11) Brazil (Sep-11) 57.8 (Jan-1) China (Aug-12) 57.4 (Jan-1) United Kingdom (Jul-12) 59.5 (Nov-1) Japan (Apr-11) 54.7 (May-1) Germany (Jul-12) 62.7 (Feb-11) Italy (Oct-11) 59. (Feb-11) France (Sep-12) 57.9 (Nov-1) Source: Markit, Haver Analytics Source : Haver Analytics 17

18 % % Above/Below Equilibrium Fixed Income Short rates near crisis levels as central banks continue to ease U.S. Fed Funds Equilibrium Range Last Plot:.16% 2 Current Range:.3% % (Mid: 1.43%) Source: Federal Reserve, RBC GAM Global (ex-japan) Short-Term Interest Rate Composite Short-Term Interest Rates Relative to Equilibrium Source: RBC GAM Last Plot: -71.% 18

19 % Fixed Income Long term bond yields held down by risk aversion and unorthodox policy % month Centred CPI Inflation Actual Monthly CPI Inflation United States CPI Inflation Source: RBC GAM, RBC CM 36-month Centred CPI Last Plot : 2.3% 12-month Forecast: 1.8% % U.S. 1-Year T-Bond Yield Equilibrium Range +1 SD -1 SD Real T-Bond Yield United States Real 1 Year T-Bond Yield Real 1-Year Time Weighted Yield Source: RBC GAM, RBC CM Average: 2.5% 12-month Forecast: 1.14% Last Plot: -.6% 1 8 Last Plot: 1.69% Current Range: 2.31% % (Mid: 3.22%) Source: RBC GAM, RBC CM 19

20 % % % % Fixed Income Ultra-low yields not just a domestic issue Canada 1-Year Bond Yield Equilibrium Range Eurozone 1-Year Bond Yield Equilibrium Range Last Plot: 1.79% Current Range: 2.5% % (Mid: 3.34%) Last Plot: 2.58% Current Range: 3.2% % (Mid: 3.8%) Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM Japan 1-Year Bond Yield Equilibrium Range United Kingdom 1-Year Gilt Equilibrium Range Last Plot:.74% Current Range: 1.22% - 2.7% (Mid: 1.65%) Last Plot: 1.84% Current Range: 2.33% % (Mid: 3.37%) Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM 2

21 % Above/Below Equilibrium Fixed Income Long term bond yields held down by risk aversion and unorthodox policy 6 Global Bond Market Composite 1-Year Government Bond Yields Relative to Equilibrium 4 2 Last Plot: -41.5% Source: RBC GAM 21

22 YoY % Change % Bullish Fixed Income Technical indicators suggest elevated risk in fixed income markets 8 U.S. 1-Year T-bond Yields Rate of Change 1 U.S 1-Year T-Bond Bullish Consensus Too Many Bulls Last Plot: -18.3% Oversold Last Plot: 74% Bulls -2 Current Yield: 1.69% -4 Sell bonds as yield moves above 1.65% -6 Overbought Source: RBC GAM Source: Market Vane, RBC GAM Too Many Bears US TSY 1YR BOND YLD Long-term Price Momentum 1 MONTHS AUG4-23NOV12 HI-JUN6 HI/LO DIFF TREND: TURN (TU-CL)%: SMO TPL: U1Y.ZZ.U % CLOSE LO-JUL Source: RBC CM 22

23 Equity Markets Global markets far below fair value S&P 5 Equilibrium Normalized Earnings & Valuations Nov. '12 Range: (Mid: 163) Nov. '13 Range: (Mid: 1747) Current (23-November-12): Source: RBC GAM Eurozone Datastream Index Normalized Earnings & Valuations Nov. '12 Range: (Mid: 1752) Nov. '13 Range: (Mid: 224) Current (23-November-12): Source: Datastream, Consensus Economics, RBC Emerging Market Datastream Index Normalized Earnings & Valuations Nov. '12 Range: (Mid: 29) Nov. '13 Range: (Mid: 314) Current (23-November-12): Source: Datastream, RBC GAM 23

24 % Above/Below Fair Value Equity Markets Global markets far below fair value 1 Global Stock Market Composite Equity Market Indexes Relative to Equilibrium Last Plot: -15.7% Source: RBC GAM 24

25 Above Consensus Reports Consensus Earnings Estimates ($US) Earnings Sluggish economy/rising expectations are a growing challenge 15 S&P 5 Composite Index Consensus Earnings Estimates % 9% 8% 7% 6% 5% 4% 3% 2% 1% Companies Reporting Results Above Consensus Forecasts % Greater Than Expectations Long-Term Average: 62% Source: ThomsonReuters % Source: ThomsonReuters Last Plot: 64% 97% Companies Reporting $11 $15 $1 $95 $9 U.S. Analyst Overoptimism in S&P 5 EPS Estimates (Monthly Pattern, Averages for ) Average Forecast Error Rebased to Feb. 212 Forecast 212 Mean Earnings Estimate Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Chopra, ThomsonReuters, RBC GAM 25

26 X Equity Markets Valuations still depressed 35 3 S&P 5 Index Normalized (Equilibrium) Price/Earnings Ratio Nov. '12 Range: 1 Std. Dev.: 12.9x - 2.9x (Mid: 16.9x) Nov. '12 Range: 2 Std. Dev.: 8.9x x (Mid: 16.9x) Current: 14.4x P/E on Trailing 12 Months Earnings +/- 1 Standard Deviation from Equilibrium P/E +/- 2 Standard Deviations from Equilibrium P/E Source: RBC GAM 26

27 Equity Markets Valuations still depressed Earnings Estimates & Alternative Scenarios for Valuation and Outcomes for the S&P 5 Consensus 212 Top Down 212 Bottom Up Trailing 12 Months Recessionary* P/E $11.4 $12.6 $97.8 $73.4 Equilibrium Standard Deviation Standard Deviation Consensus 213 Top Down 213 Bottom Up P/E $16.3 $113.7 Equilibrium Standard Deviation Standard Deviation *Trailing 12-Month Earnings to November 212 less 25% Source: Bloomberg, Thomson Reuters, RBC GAM 27

28 Styles What s working 2.% U.S. Factor Returns Relative to the S&P 15 Cumulative Returns to Small Cap 1.% U.S. Factor Returns Relative to the S&P 15 Cumulative Returns to Value 15.% 1.% 7.5% 5.% 5.%.% -5.% 2.5% -1.% Source: RBC GAM *Returns to small cap vs. S&P 15 starting 3/29.% Source: RBC GAM *Returns to value vs. S&P 15 starting 3/29 28

29 Styles What s not working 2.5% U.S. Factor Returns Relative to the S&P 15 Cumulative Returns to Momentum (Technical) 5.% U.S. Factor Returns Relative to the S&P 15 Cumulative Returns to Growth.% 2.5% -2.5%.% -5.% -7.5% -2.5% -1.% Source: RBC GAM *Returns to momentum vs. S&P 15 starting 3/29 *Returns to growth vs. S&P 15 starting 3/29-5.% Source: RBC GAM 29

30 Quarterly Returns Styles Macro/beta trade continues to dominate Long-term Average: Source: Ned Davis Research S&P 5 Stock Correlations Median Correlations of S&P 5 Stocks to the S&P 5 Index Last Plot:.57 9% 8% 7% 6% 5% 4% 3% S&P 5 - Returns to Perfect Foresight Difference Between Median Performance of Top and Bottom Deciles Average: 47.8% Foresight = 1 quarter in advance High Spreads Low Spreads 2% Source: Bank of America Merrill Lynch 3

31 % % Equity Markets Technical indicators AAII Sentiment Survey Percent Bearish AAII Sentiment Survey Percent Bullish 8 7 Too Many Bears 8 7 Too Many Bulls Not Enough Bears Source: American Association of Individual Investors (AAII) Last Plot: Source: American Association of Individual Investors (AAII) Not Enough Bulls Last Plot:

32 Equity Markets Technical indicators 75% S&P 5 & Strategists' Recommended Allocation for Stocks S&P 5 & Equity Mutual Fund Flows 35 7% 65% 6% 55% 5% 45% Allocation to Equities (LHS) S&P 5 (RHS) 4% Source: Bloomberg, RBC GAM, Bank of America Merrill Lynch ? Domestic Equity Flows (13-Week Moving Average, RHS) S&P 5 (LHS) Source: ICI, Ned Davis Research, RBC GAM 32

33 Equity Markets Technical indicators Emerging markets turn a corner Absolute Price with Price Momentum MSCI EMERGING MARKET GLOBAL 1 MONTHS AUG4-23NOV12 HI-OCT7 LO/HI DIFF TREND: TURN (TU-CL)%: SMO TPL: 12 Relative Price with Price Momentum EMGL.ZZ.I MSCI EMERGING MARKET GLOBAL Rel. S&P MONTHS AUG4-23NOV % HI-SEP1 LO/HI DIFF TREND: TURN (TU-CL)%: SMO TPL: EMGL.ZZ.I % CLOSE CLOSE LO-AUG LO-AUG Source: RBC CM Source: RBC CM 33

34 Stock Market Outperformance % Asset Mix Trailing 1-year Stock vs. Bond Market Performance Year U.S. Stock and Bond Performance Stock Market 1-Year Total Return minus Long Bond Total Return S&P 5 1-Year Total Return minus Barclays Capital Long-Term T-Bond 1-Year Total Return -2-2 Std Dev Source: Ned Davis Research +2 Std Dev +1 Std Dev Mean: 12.5% -1 Std Dev 34

35 This report has been provided by RBC Global Asset Management Inc. (RBC GAM) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC GAM. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. Due to the possibility of human and mechanical error as well as other factors, including but not limited to technical or other inaccuracies or typographical errors or omissions, RBC GAM is not responsible for any errors or omissions contained herein. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information. Any investment and economic outlook information contained in this report has been compiled by RBC GAM 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 GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any errors or omissions. All opinions and estimates contained in this report constitute our judgment as of the indicated date of the information, are subject to change without notice and are provided in good faith but without legal responsibility. To the full extent permitted by law, neither RBC GAM nor any of its affiliates nor any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of the outlook information contained herein. Interest rates and market conditions are subject to change. A Note on Forward-looking Statements This report may contain forward-looking statements about future performance, strategies or prospects, and possible future action. The words may, could, should, would, suspect, outlook, believe, plan, anticipate, estimate, expect, intend, forecast, objective and similar expressions are intended to identify forwardlooking statements. Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties about 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. 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. Registered trademark of Royal Bank of Canada. RBC Global Asset Management is a registered trademark of Royal Bank of Canada. Used under license. RBC Global Asset Management Inc