Global Insight Weekly

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1 JULY 26, 2013 RBC Wealth Management Global Insight Weekly Equity Scorecard July 26, 2013 Most equity markets consolidated recent gains. Safe-haven bond yields rose as economic data exceeded expectations, especially in Europe. In the U.S., the magnitude of earnings beats has lessened. (page 2) China set minimum GDP growth targets. But observers are still asking: can its economic data be trusted? (page 3) Global Roundup: Highlights of Canada s strong retail sales report, Europe s bank lending trends, and Japan s inflation data. (pages 3-4) Index (local currency ) Level 1 week MTD YTD S&P 500 1, % 5.3% 18.6% S&P/TSX Comp 12, % 4.3% 1.7% FTSE All Share 3, % 5.6% 12.3% Hang Seng 21, % 5.6% -3.0% Dow (DJIA) 15, % 4.4% 18.7% NASDAQ 3, % 6.2% 19.7% Russell , % 7.3% 23.4% STOXX Europe % 4.9% 6.9% German DAX 8, % 3.6% 8.3% Nikkei , % 3.3% 35.9% Straits Times 3, % 2.7% 2.2% Shanghai Comp 2, % 1.6% -11.4% Brazil Bovespa 49, % 4.1% -18.9% Note: Equity returns do not include dividends. Author Kelly Bogdanov San Francisco, United States kelly.bogdanov@rbc.com; RBC Capital Markets, LLC Contributors Lucy So & Sara D Elia Toronto, Canada lucy.so@rbc.com & sara.delia@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 July 26, 2013, market close (unless otherwise stated). For Important Disclosures, see pages 5-6.

2 Markets & the Economy Market Scorecard July 26, 2013 Govt Bonds (bps chg) Yield 1 week MTD YTD US 2-Yr Tsy 0.313% US 10-Yr Tsy 2.564% Canada 2-Yr 1.150% Canada 10-Yr 2.448% UK 2-Yr 0.295% UK 10-Yr 2.333% Germany 2-Yr 0.150% Germany 10-Yr 1.665% Commodities (USD) Price 1 week MTD YTD Gold (spot $/oz) 1, % 8.0% -20.4% Silv er (spot $/oz) % 1.9% -34.0% Copper ($/ton) 6, % 4.0% -11.5% Oil (WTI spot/bbl) % 8.4% 14.0% Oil (Brent spot/bbl) % 7.0% -3.1% Natural Gas ($/mlnbtu) % 0.6% 4.5% Agriculture Index % -3.4% -17.6% Currencies Rate 1 week MTD YTD US Dollar Index % -1.8% 2.4% CAD/USD % 2.4% -3.4% USD/CAD % -2.3% 3.5% EUR/USD % 2.0% 0.6% GBP/USD % 1.1% -5.4% AUD/USD % 1.3% -10.9% USD/CHF % -1.7% 1.5% USD/JPY % -0.9% 13.2% EUR/JPY % 1.1% 13.9% EUR/GBP % 0.9% 6.3% EUR/CHF % 0.3% 2.1% USD/SGD % -0.3% 3.5% USD/CNY % -0.1% -1.6% USD/BRL % 1.1% 10.0% 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 7/26/13. Examples of how to interpret currency data: CAD/USD 0.97 means 1 Canadian dollar will buy 0.97 U.S. dollar. CAD/USD -3.4% return means the Canadian dollar fell 3.4% vs. the U.S. dollar year to date. USD/JPY means 1 U.S. dollar will buy yen. USD/JPY 13.2% return means the U.S. dollar rose 13.2% vs. the yen year to date. As the dog days of summer came upon global financial markets, North American and European equities took a breather, consolidating recent gains amid relatively quiet trading. Asia-ex Japan markets led for the week. China s second in command and chief steward of the economy, Premier Li Keqiang, drew a line in the sand regarding economic growth. He said the acceptable lower range of the government s GDP growth target is 7.5%, and growth cannot be allowed to fall below 7% during a slowdown. Li s comments came after a string of disappointing economic releases which caused an equity selloff and led market participants to question China s near- and long-term growth potential. Hong Kong s Hang Seng Index rallied, and China s Shanghai Index attempted to stabilize as these pronouncements and Li s full speech were digested. Li s comments took the spotlight away from disappointing manufacturing data. Safe-haven government bond prices fell, and yields rose across regions mainly on improved European economic data. Preliminary July euro area purchasing managers reports even beat our economist s optimistic forecasts. Manufacturing activity rose into expansion territory for the first time in two years. Services activity rose to its highest level since early If the eurozone climbs out of recession later this year (albeit to modest growth), not only would that be positive for European nations but also for China (Europe is the largest importer of Chinese Earnings Momentum Indicator Fewer Companies Than Usual Are Beating Earnings Estimates by a Wide Margin in Q2 50% 40% 30% 20% Low 15.6% % of S&P 500 Companies that Beat EPS Estimates by More than 10% Average from 1Q98-1Q13 High 44.3% Average 24.9% 2Q %* 10% * 2Q13 data represents the 50% of S&P 500 companies that have reported results thus far; data subject to change as more companies report. Source - RBC Wealth Management, Bloomberg; data through 7/25/13 goods) and U.S.-based multinational companies, some of which normally derive more than 20% of their revenue from the region. Second-quarter earnings reports are still garnering a lot of attention. With roughly one-half of S&P 500 companies having reported so far, earnings growth is tracking at 4.1% year over year, ahead of the 2.9% estimate when the reporting season began, according to Thomson Reuters I/B/E/S. The bulk of earnings gains have come from the Financials sector. S&P 500 revenue growth is pacing at 1.6% versus the prior year. The earnings beat rate of 68% is in line with the previous four quarters and ahead of the 63% long-term average. But the magnitude of earnings beats has lessened. So far, only 20% of companies have exceeded earnings estimates by 10% or more, well below the 27% rate for the first quarter and the 25% long-term average (see chart). 2 GLOBAL INSIGHT WEEKLY JULY 26, 2013

3 Markets & the Economy China s Data: Can it be Trusted? With China s Premier Li Keqiang drawing a line in the sand at 7.0% GDP growth, some observers are questioning whether such a pronouncement really matters. Regardless of whether the country officially achieves growth at 7.0% or above, or even if it s able to reach the 7.5% target, China watchers are still asking a bigger-picture question: can the economic data be trusted? The regional Federal Reserve Bank in San Francisco (SF Fed) conducted a study to find out the answer. It compared the actual, official government GDP data to two alternative measures of GDP since 2000 using statistical analysis. One alternative measure of GDP is based on data preferred by Li in 2007 when he served as vice premier. At that time, he supposedly described China s official GDP measure as man made and, therefore, unreliable. (This was revealed Chinese Growth is in the Ballpark of What Official Data Have Reported Official Versus Alternative GDP Data GDP Growth Reported (official government data) GDP Growth Based on Li Keqiang's Data GDP Growth Based on Broad Data (chosen by SF Fed) Source - Federal Reserve Bank of San Francisco, FRBSF Economic Letter: On the Reliability of Chinese Output Figures, 3/25/13 by Wikileaks disclosure of a U.S. diplomatic cable of Li s comments to the U.S. ambassador.) Apparently, Li said he preferred to gauge Chinese economic output by electricity production, railroad cargo shipments, and loan activity. The SF Fed developed an index of these alternative data to measure whether or not they corresponded to the official GDP reading over time. The other alternative measure of GDP is based on a basket of data selected by the SF Fed that include an index of consumer sentiment, construction of new floor space, an index of raw materials usage, air passenger volume, and the nominal value of new residential real estate construction. The SF Fed found, at times, China s official GDP data overstated growth compared to the alternative measures (especially from 2006 to 2007, the period when Li s comments were apparently made). But at other times, the government s official GDP data understated growth compared to the alternative measures (mid 2010 to mid 2012), as the chart illustrates. Because the alternative measures come from data gathered within China and, therefore, could theoretically be manipulated, the SF Fed also examined the relationship between official GDP data and key trading partners import and export data. And it reviewed China s industrial production data against that of peer nations and global data. It concluded the official Chinese government data are similar to external output measures. Overall, in analyzing all of the aforementioned internal and external data since 2000, the SF Fed concluded, Chinese growth has been in the ballpark of what official data have reported. While the study did not examine 2013 activity, our suspicion is that official GDP was probably somewhat overstated recently due to speculation in China s currency, which artificially inflated export data. Bottom line: From our perspective, the SF Fed study indicates investors don t need to be much more skeptical about Chinese output data than they would about data of other countries. After all, even in developed countries (including the U.S.), economic data have their flaws. Regarding our outlook for China, we believe it could end up reaching its 7.5% GDP growth target this year. Beyond 2013, we question whether it will be able to remain above the 7.0% line-in-the-sand level. We have a Neutral rating on Asia ex-japan equities (includes China). Global Roundup Canada The S&P/TSX Composite Index ended the week in negative territory as its earnings season unofficially kicked off with a flurry of reports amongst commodity producers, with mixed results. The Energy sector was particularly weak as disappointing results from Cenovus cast a shadow over the group. Meanwhile, the Materials sector outperformed due to betterthan-expected results from Teck Resources and a strong bullion price. Canadian government bond yields moved higher across the yield curve, given strongerthan-expected economic data in Canada and the United States. In Canada, Retail Sales posted the largest monthly gain in over three years, driven by auto, food, and beverage sales. The outpaced increase in sales prompted some economists to revise Q2 Gross Domestic Product (GDP) forecasts higher as this bodes 3 GLOBAL INSIGHT WEEKLY JULY 26, 2013

4 Global Roundup well for overall economic growth. In the U.S., New Home Sales spiked to a five-year high, Durable Goods Orders exceeded expectations, and despite lower-than-anticipated Existing Home Sales, the internals of that report were positive (higher prices, less distressed sales, and fewer days on the market). Since the beginning of May, Canadian and U.S. government bond yields have moved higher on expectations the Federal Reserve may taper asset purchases prior to initial market expectations. As a result of the Fed s efforts to draw the distinction between the tapering of asset purchases and moving the Federal Funds rate higher, investors are acutely aware the decision to withdraw stimulative measures is data dependent. With that said, recent U.S. economic data is pointing toward a stable recovery, which could provide the Fed with the fuel needed to taper asset purchases earlier than anticipated. Coming up: GDP (July 31). Europe U.K. and European equity markets were largely unchanged during the week. The earnings reporting season has been generally positive so far with financials and media reporting good results and industrials benefitting from exposure to the U.S. recovery. Company outlooks suggest a European picture less negative than expected, corroborated by recent eurozone macroeconomic data. The eurozone Flash Composite Purchasing Managers Index headline climbed back above 50 for the first time since January Solid improvements in Germany s and France s latest readings have helped. The European Central Bank s (ECB) latest quarterly Bank Lending Survey suggested a moderately improved picture relative to The Latest Euro Area PMI Readings Signal GDP Improvement GDP Based on PMI Data vs. Actual GDP PMI-based GDP Indicator Euro Area GDP Growth, % q/q -3.0 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 Source - RBC Capital Markets, Haver Analytics, Markit Q3: 0.0% q/q Q2: -0.3% q/q the first quarter. Though credit supply and demand conditions remain fractured, the survey suggests continuing improvement in banks funding conditions. This has fed through to a net easing in credit standards for consumer loans. By contrast, lending conditions to businesses remain little changed from the start of the year, and small and medium enterprises in particular continue to struggle. In the U.K., second-quarter Gross Domestic Product (GDP) increased by 0.6% q/q, in line with expectations. All sectors (agriculture, production, construction, and services) are growing. From a policy perspective, this is unlikely to change the Monetary Policy Committee s view, which seems firmly set on a path that involves forward guidance and credit easing measures, with no further balance sheet expansion. Coming up: Spain Q2 GDP (July 30); Euro Area Inflation (July 31); ECB and Bank of England decisions (Aug 1). Asia Pacific Japanese consumer prices excluding fresh food rose by 0.4% year over year in June, the biggest increase since 2008 and slightly ahead of forecasts. However, the comparable June 2012 data had been weak. Also, excluding energy, prices fell by 0.2%, continuing the deflationary trend. The significant depreciation of the Japanese yen over the past year, down by 20% against the U.S. dollar, has caused energy import prices to rise significantly. Even so, inflation expectations among Japanese consumers are rising. A report by the Bank of Japan indicated 80% expect prices to rise, the most in five years. But wage inflation, vital if Japan is to rid itself of deflation, has failed to appear thus far. As discussed on previous pages, Chinese Premier Li Keqiang set out minimum acceptable growth levels for the Chinese economy. This is an important development. The government also introduced a number of growth measures including tax exemptions for small businesses. Finally, the government has begun to tackle industrial overcapacity, ordering more than 1,400 companies in 19 industries to idle excess production capacity by September and get rid of it altogether by the end of Minimum lending rates for Chinese banks were scrapped. In the short term, the impact is minimal. Credit conditions are tight in China, so banks mostly do not need to offer discounted lending rates to attract borrowers. However, this is an important step in the development of China s financial markets. The Reserve Bank of New Zealand kept its benchmark rate at 2.5%, as expected. There was a mild tightening bias in the statement. The Bank will be watching to see if momentum in housing and construction spills over into inflation, but still expects to keep the rate unchanged for the rest of The New Zealand dollar rallied. 4 GLOBAL INSIGHT WEEKLY JULY 26, 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. Sara D Elia, Lucy So, & 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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