Investment Views GENERAL COMMENT EQUITIES. November The broad-based rally looks susceptible to profit-taking

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1 Butterfield Asset Management Investment Views November 2013 Equities Currencies Bonds The broad-based rally looks susceptible to profit-taking US shutdown, UK strength, Eurozone deflation A new Fed Chair but more of the same Commodities A positive price trend from gold? GENERAL COMMENT Rational Expectations vs. Irrational Performance-chasing Markets performed well in October, with the MSCI World rising almost 4%. Some of the major indices have gained 20% or more this year but it is important to note that this has largely been due to multiple expansion rather than earnings growth. The economic picture continues to show marginal improvement. However, this is somewhat at odds with the US decision to delay tapering, a rate cut in the ECB and continued volatility in Emerging Markets. In truth, we still await evidence that growth has taken hold. Until then, expanding valuation multiples lead to good portfolio performances but at the expense of a diminishing risk/reward trade-off. Two areas are currently hot topics of debate. The first is the validity of one of the market s long-term market measures, the Shiller PE ratio. The second is the belief that profit margins may have reached a permanently high plateau. We retain a traditional view on both, namely that the Cyclically Adjusted PE ratio ( CAPE ) works fine just as it is and that profit margins are more likely to trend towards mean-reversion than not. What both those statements mean is that we should be cautious about the latest leg-up in markets. At the end of October the CAPE reached 24x compared with a long-term average of 18x and a year-end 2012 measure under 22x. When we moved to an Overweight equities stance in January it was partly predicated on earnings growth reducing this ratio to perhaps 20x or less rather than seeing it expand by a similar amount. Similarly, the most reliable measure of margins - return on sales - stands at 8.5%, significantly ahead of its long-term average of 6%. The consequence of this is that the S&P 500 is enjoying its best year since 1997 whilst the NASDAQ is approaching 4,000, a level not seen since the dotcom bust. We remain modestly overweight stocks because the equity risk premium is positive and the forward PE is around fair value, but next year s E is dependent on earnings growth. If the rate of growth accelerates as expected during 2014 then perhaps there is no bubble, but a lacklustre labour market, political discord and the prospect of tapering all provide the potential for disruption. EQUITIES October was a strong month for equities, particularly in Developed Markets which saw the FTSE 100, S&P 500, Eurostoxx 50 and MSCI World all return 4% or more. It is testament to the strength of 2013 that October is only the third best monthly performance. A number of factors drove strong returns during the month. In the US the government shutdown led to a THE Error! BAHAMAS Unknown document BERMUDA property name. CAYMAN ISLANDS GUERNSEY SWITZERLAND UNITED KINGDOM

2 delay in tapering, while the UK saw a spate of positive economic data leading to hopes that its nascent recovery is both broadly based and sustainable. Looking east, October wasn t so good. Japan s Topix was flat as investors await the outcome of Abe s third arrow of reform, including the hike in the country s sales tax. However, this did little to dent the cumulative net inflow of $106 billion to equity funds so far this year, a primary driver of Japan s 41% YTD return. At a sector level there were positive returns across the board, led by telecommunications with a return of almost 7%. Materials lagged once again, although it s 2.4% rise put it in positive territory for the year-to-date for the first time. This year, Consumer Discretionary is up 34%, Healthcare 31% and Telecommunication Services 29%. If anything, this highlights the broad-based nature of the rally, with both cyclical and defensive sectors beating the overall market. Valuations have risen steadily over the year and the MSCI World index now trades on 14x forward earnings, marginally short of the 5-year peak of 15x in As the year comes to a close we may get more clarity on the impact of the US shutdown and the timing of the upcoming tapering. Both may lead to volatility and profittaking, although this should be constrained by a steadily improving global economy. Overall, we retain our cautiously optimistic long term view on equities. CURRENCIES The US dollar depreciated against the pound over the month on fears of lower domestic growth following the Congressional dispute and resulting government shutdown. Standard and Poor estimate that this will detract 0.6% from US GDP in Q4, an unwanted and unneeded headwind. The Yen traded around the 98 /$ level, strengthening at the beginning of the month on the back of US political uproar despite Abenomics flooding the Japanese market with excess liquidity. It subsequently returned to parity once the US politicians decided to compromise. The Euro climbed to a two year high against the dollar to touch 1.38 during October, a 3.5% rise since the start of the year. This rise has two drivers: money printing in the US and low levels of inflation in the Eurozone. The Euro s strength has been compounded by European financial institutions repatriating foreign assets to shore up their balance sheets further, given the ECB s upcoming audit. Sterling fell to below 1.17 but forecasts have risen more than any other currency as a sustained recovery is still on the cards. This means that interest rate rises are predicted to happen earlier than the MPC s current guidance. Despite its recent turmoil, the Indian rupee has bounced back from its lows and stabilised, gaining 1.8% against the dollar since the beginning of October. The Federal Reserve s decision to maintain stimulus allowed for more foreign purchases of emerging market stocks, of which India was a beneficiary. The new RBI Governor, Raghuram Rajan, also surprised markets by increasing interest rates for a second straight month, which immediately impacted the currency. BONDS Following the sharp rise in US and UK government bond yields between May and July this year, bond markets have stabilised and have been trading in a range between 2.5% and 3%. Investors had plenty to consider over the eventful month of October including the shutdown of the US government, the

3 fraught negotiations over the debt ceiling and the nomination of Janet Yellen as the next chair of the Federal Reserve. Whilst a US default was never really a serious possibility the Treasury bills maturing in October did see relatively wild yield movements, rising from 0% to 0.5% at one point. After the deal to raise the debt ceiling the focus quickly moved from fiscal policy back to monetary policy and the likely knock-on effects on the timing of the tapering of quantitative easing (QE). It has been our view for a while that economic growth is likely to be weaker than consensus and whilst the economic news has been mixed it appears likely that tapering will be pushed into the New Year. Credit markets performed very strongly last month, with spreads on investment grade and particularly high yield tightening significantly. Default rates have been very low by historic standards and this has underpinned the market. Non-financial investment grade spreads are now back to pre-crisis levels in many cases. We continue to favour credit over government bond exposure but are cognisant of the additional risk. We also continue to keep duration low to limit exposure to the risk of rising bond yields COMMODITIES Commodity prices declined during the month in response to concerns around Chinese demand for industrial metals, while oil prices were impacted by growing stockpiles and geopolitical issues. As. result, the benchmark Thompson Reuters/Jefferies CRB index declined 2.69%. Despite China s latest Purchasing Manager s Index (PMI) data indicating a modest economic recovery, the unwillingness by its central bank to inject liquidity into the system has seen inter-bank money market rates rise beyond 5% to their highest since June. This led the price of copper to decline over the month by 0.73% to $7,249/ton as the metal is bought by importers using bank financing. Moreover, Eurozone manufacturing activity eased unexpectedly in October while US manufacturing data also fell below expectations. The price of US crude oil declined below $97 a barrel, its lowest since July, with its discount to European Brent widening to the most in six months due to increasing stockpiles and declining demand from refineries undergoing seasonal maintenance. In contrast, Brent crude has remained largely unchanged, finding some relative support from supply outages. This is most noticeable in Libya, where strike action had caused a decline in oil exports of two-thirds compared to Q1 this year. Gold finished a volatile month relatively unchanged, at $1,323/oz. Since its low in mid-october, the price trend has been positive amid a weaker US Dollar and expectations that the Federal Reserve would delay tapering until With US employers adding fewer jobs than expected during the month, those expectations were strengthened. Agricultural commodities were the worst performing constituent of the index, with cotton declining almost 10% for the month to $77/lb. Global stockpiles are predicted to top demand for a fourth straight season amid ample supply due to ideal growing conditions and a near halving of imports by China.

4 POLICY SUMMARY CHART The chart set out below is a summary of our current policy stance on the various equity and bond markets which we monitor. It is not intended as anything other than a guide on where we stand and we will change the content as our views alter. Cash exposure is a residual and will tend to be high when negatives outweigh positives and vice versa. REGULATION Past performance is not indicative of future performance. This document is for information purposes only and does not constitute an offer or solicitation of products or services where prohibited by Law. The information contained herein is not intended as specific investment, financial, accounting, legal or tax advice and the Bank will accept no responsibility for any reliance on the information contained herein. More comprehensive information is available upon request. Butterfield Asset Management Limited is licensed to conduct investment business by the Bermuda Monetary Authority. Registered Office: 65 Front Street, Hamilton HM12, Bermuda. Butterfield Bank (Cayman) Limited is licensed to conduct securities investment business by the Cayman Islands Monetary Authority. Butterfield Bank (Guernsey) Limited is licensed and regulated by the Guernsey Financial Services Commission under The Banking Supervision (Bailiwick of Guernsey) Law, 1994, as amended, and The Protection of Investors (Bailiwick of Guernsey) Law, 1987, as amended. Company registration No Butterfield Bank (UK) Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: 99 Gresham Street, London EC2V 7NG. Registered in England No Butterfield Private Bank is the name used by Butterfield Bank (UK) Limited for private banking and wealth management services. Telephone calls are recorded for security purposes.

5 MARKET PERFORMANCE All performance numbers show % changes except for bond yields which show yield changes. Now - 1 mth - 3 mth - 12 mth CURRENCIES (VS USD) GBP CHF JPY EUR BOND YIELDS (10 yr) UK US Germany Japan EQUITIES UK. FTSE 100 (GBP) US. Dow Jones (USD) Japan. Nikkei Dow (JPY) China. Shanghai A (CNY) MSCI Pac ex Jap (USD) MSCI Eur ex UK (Local) MSCI Lat Am Free (USD) MSCI World (USD) MSCI World (GBP) COMMODITIES Oil (WTI) Gold Source: Bloomberg as at 31 st October 2013