Global Equity Research Summary July abc. Summary

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2 2 MSCI All Country World Index regions MSCI Indices Developed market Emerging market Europe Europe ex UK Asia ex Japan Latin America EMEA Weight in MSCI AC World 85.38% 14.62% 22.42% 14.27% 1.28% 3.4% 2.96% Key sub-sectors Financials (18%) Financials (25%) Financials (18%) Financials (19%) Financials (31%) Financials (24%) Energy (28%) IT (13%) Energy (13%) Cons Stap. (15%) Health Care (14%) IT (18%) Materials (2%) Financials (25%) Industrials (11%) IT (13%) Health Care (12%) Industrials (14%) Industrials (1%) Cons Stap. (16%) Materials (16%) Three largest stocks Apple (2.3%) Samsung Electronics (3.8%) Nestle (3.2%) Nestle (5.1%) Samsung Electronics (5.4%) AMX (6.6%) Gazprom (7.4%) Exxon (1.7%) Taiwan Semicon (1.7%) HSBC Holdings (2.7%) Novatis (3.9%) Taiwan Semicon (2.4%) Vale (5.%) Lukoil (4.6%) Microsoft (1.1%) Gazprom (1.5%) Novatis (2.5%) Roche Holding (3.1%) China Mobile (2.%) Petrobras (4.7%) Novatek (4.1%) Trading data Market cap. (USDbn) Average daily trading value (past 12 months, USDbn) Performance in past 1 years (USD) Absolute 33% 175% 24% 25% 118% 345% 184% Relative to MSCI AC World -5% 96% -11% -1% 56% 218% 13% *Correlation MSCI Index returns (5yr) with MSCI ACWI US ISM *Beta MSCI Index returns (1yr) with MSCI ACWI Key country stats 12M-forward EPS growth 13% 12% 8% 1% 15% 9% % Long-term average 12M-forward PE 16.1x 13.4x 14.x 14.2x 12.x 1.6x 9.8x 12-month-forward PE 11.1x 9.5x 9.6x 9.7x 1.5x 1.3x 7.3x Long-term average PB 2.2x 1.8x 2.x 1.9x 1.8x 1.8x 2.1x Current PB 1.6x 1.5x 1.3x 1.2x 1.5x 1.6x 1.2x Long-term average 12M-forward ROE 14% 14% 16% 15% 14% 19% 15% 12-month-forward ROE 13% 14% 13% 12% 13% 14% 14% Global Equity Research Note: All the above calculations are on MSCI USD indices. * calculated on monthly changes Source: HSBC, MSCI, IBES, Bloomberg, Thomson Reuters Datastream

3 MSCI All Country World Index Top 8 countries MSCI Indices US Japan United Kingdom Canada Australia Switzerland Germany China Weight in MSCI AC World 45.14% 8.5% 8.15% 4.26% 3.15% 3.6% 2.77% 2.19% Key sub-sectors IT (2%) Industrials (21%) Energy (2%) Financials (33%) Financials (45%) Health care (34%) Cons disc. (17%) Financials (39%) Financials (14%) Cons Disc. (2%) Financials (18%) Energy (26%) Materials (23%) Cons stap. (25%) Materials (16%) Energy (17%) Health care (12%) Financials (17%) Cons stap. (17%) Materials (2%) Cons stap. (8%) Financials (17%) Financials (16%) Telecom (12%) Three largest stocks Apple (4.3%) Toyota Motors (5.4%) Royal Dutch Shell (9.5%) Royal Bank Canada (6.6%) BHP Billiton (12.5%) Nestle (23.7%) Siemens (9.8%) China Mobile (9.4%) Exxon (3.3%) Mitsubishi UFJ (2.8%) HSBC Holdings (7.3%) Toronto Dominio Bank (5.8%) Commonwealth BK. Of Australia (9.9%) Novatis (18.2%) BAFS (8.5%) China Construction BK. (9.2%) Microsoft (2.%) Honda Motors (2.6%) Vodafone (6.8%) Bk of Nova Scotia (4.8%) Westpac Banking (7.6%) Roche Holding (14.6%) SAP (7.1%) Ind. & Coml. BK. Of China (6.7%) Trading data Market cap. (USDbn) Average daily trading value (past 12 months, USDbn) Performance in past 1 years Absolute 35% 7% 23% 143% 123% 65% 41% 221% Relative to MSCI AC World -3% -24% -12% 74% 59% 18% 1% 129% *Correlation MSCI Index returns (5-year) with MSCI ACWI US ISM *Beta MSCI Index returns (1-yr) with MSCI ACWI Key country stats 12M-forward EPS growth 11% 57% 6% 9% 1% 11% 14% 11% Long-term average 12M-forward PE 15.4x 3.5x 13.7x 14.7x 13.5x 14.3x 15.6x 12.7x 12M-forward PE 12.x 11.2x 9.4x 11.4x 11.1x 11.7x 9.1x 8.6x Long-term average PB 2.6x 2.2x 2.1x 1.9x 1.8x 2.3x 2.x 2.x Current PB 2.1x.9x 1.5x 1.7x 1.6x 2.x 1.2x 1.5x Long-term average 12M-forward ROE 16% 8% 16% 14% 16% 17% 12% 16% 12M-forward ROE 15% 8% 15% 13% 13% 16% 13% 15% Global Equity Research Note: All the above calculations are on MSCI USD indices. * calculated on monthly changes Source: HSBC, MSCI, IBES, Bloomberg, Thomson Reuters Datastream. 3

4 4 MSCI All Country World Index Sectors MSCI Indices Energy Materials Industrials Consumer Consumer staples Health Care Financials Information Telecom services discretionary technology Weight in MSCI AC World 11.13% 7.85% 1.51% 1.16% 1.47% 9.3% 19.33% 12.72% 5.2% 3.79% Key sub-sectors Oil Gas & Consumable Fuels (89%) Energy equip & services (11%) Metals & mining (5%) Chemicals (4%) Construction materials (5%) Industrial conglom (19%) Media (22%) Food products (25%) Pharmaceuticals (64%) Industrial Automobiles (18%) Beverages (22%) Health care machinery (19%) services (13%) Aerospace & Specialty retail Food & staples Health care defense (14%) (14%) retailing (22%) equipment (12%) Diversified banks (45%) Multi-line insurance (19%) Diversified capital markets (1%) Computers & peripherals (22%) Diversified telecoms (62%) Utilities Electric utilities (53%) Semiconductors Wireless telecoms Multi utilities (18%) (38%) (3%) Software (17%) Gas utilities (7%) Global Equity Research Three largest stocks Exxon Mobil (13.2%) BHP Billiton (8.%) General Electric (7.5%) Toyota Motor (4.5%) Nestle (6.9%) Johnson & Johnson (7.2%) Wells Fargo (3.1%) Royal Dutch Shell BASF (3.%) Siemens (2.6%) McDonalds (3.2%) P&G (6.1%) Pfizer (7.%) HSBC Holding (7.%) (3.1%) Chevron (6.5%) Rio Tinto (2.6%) United Walt Disney Coca Cola (5.5%) Novartis (6.2%) JP Morgan Chase Technologies (2.9%) (2.6%) (2.2%) Trading data Apple (15.3%) AT&T (15.4) Southern (4.1%) Microsoft (7.1%) IBM (6.%) Vodafone Gr. (1.2%) Verizon Communications (9.2%) E ON (XET) (3.7%) National Grid (3.3%) Market cap. (USDbn) Average daily traded value (past months, USDbn) Performance in last 1 years Absolute 12% 111% 5% 47% 8% 42% -16% 59% 46% 47% Relative to MSCI AC World 44% 5% 7% 5% 28% 2% -4% 14% 4% 5% *Correlation MSCI Index returns (5 year) with MSCI ACWI US ISM *Beta MSCI Index returns (1yr) with MSCI ACWI Key country stats 12M-forward EPS growth 4% 11% 15% 34% 1% 5% 13% 17% 5% 23% Long-term average 12M-forward PE 14.x 13.6x 16.2x 18.x 17.3x 18.6x 13.3x 22.3x 19.8x 14.1x 12M-forward PE 8.6x 9.5x 11.3x 12.2x 15.x 11.9x 9.3x 11.6x 11.7x 14.x Long-term average PB 2.5x 2.x 2.5x 2.3x 3.9x 4.8x 1.9x 4.1x 2.4x 1.7x Current PB 1.4x 1.5x 1.8x 2.x 3.1x 2.5x.9x 2.6x 1.6x 1.2x Long-term average 12M-forward ROE 17% 17% 14% 12% 19% 19% 12% 17% 13% 11% 12M-forward ROE 14% 14% 15% 15% 19% 19% 9% 19% 13% 8% Note: All the above calculations are on MSCI USD indices. * calculated on monthly changes Source: HSBC, MSCI, IBES, Bloomberg, Thomson Reuters Datastream.

5 Global overview Introduction This section analyses the characteristics of the global equity market, its composition, recent history and key drivers, and describes some of the tools that HSBC s strategy team uses to call turns in the market and to make allocation decisions between different countries and sectors. We focus on the overall world market (using the MSCI All Country World Index, or ACWI, as our benchmark) and provide detailed information on the regional breakdown (developed versus emerging markets, Europe, Asia ex Japan, for example) as well as the eight largest countries (US, Japan, UK, Canada, Australia, Switzerland, Germany and China). Readers interested in more details on smaller country markets should refer to the overviews in the companion Nutshells on Europe, Asia and Latin America, where the information is presented in a similar format to here. Garry Evans* Strategist The Hongkong and Shanghai Banking Corporation limited garryevans@hsbc.com.hk Raj Purswani* Associate, Bangalore *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The past 15 years have been a volatile period for global equities (Chart 1). After a steady run-up in equity prices that began in 1982, the period since 2 has, in the view of many investors, been a structural bear market, with stock prices rising and falling cyclically but showing no trend appreciation. The TMT (technology, media and telecoms) bubble of took valuations to very high levels (with the forward PE for MSCI ACWI peaking at 23x). Stocks have been derated since, and the PE fell to around 1x over the following decade. The rally of 23-7, driven by strong growth in emerging markets and by a housing boom in the US and parts of Europe, took the ACWI Index to a new high, but was derailed by the global financial crisis of Global equities rebounded in 29, helped by unprecedented monetary easing around the world, but have struggled to make further progress since then. 1. MSCI AC World price index (in USD terms) 5 MSCI AC World Source: HSBC, MSCI, Thomson Reuters Datastream. 2. Largest stocks in MSCI ACWI Stock rank Stock name Index weight 1 Apple 1.9% 2 Exxon Mobil 1.5% 3 Microsoft.9% 4 General Electric.8% 5 AT&T.8% 6 IBM.8% 7 Chevron.7% 8 Nestle.7% 9 Johnson & Johnson.6% 1 Procter & Gamble.6% Top 1 9.4% Top % Top 5 26.% Source: HSBC, MSCI, Thomson Reuters Datastream. 5

6 Market structure The US remains by far the largest stock market in the world, with a 45% weight in the ACWI Index. It is followed by Europe (22%) and Japan (9%). Eurozone markets, individually, are not that important: the largest, Germany, comprises less than 3% of world market capitalisation. The weight of emerging markets has increased substantially over the past decade, to 14.6% from 4.8% in 2. Within Global Emerging Markets (GEMS), China is the largest country, with 18.%, followed by Korea (15.5%), Brazil (13.1%) and Taiwan (11.2%). Asian markets comprise 6.2% of GEMS. The US is very over-represented in the ACWI Index relative to the size of its economy, which makes up only 24% of global GDP (in purchasing power parity, PPP, terms). Europe, at 29% of global GDP (larger than the US), is somewhat under-represented, mainly because of its valuation discount to the US (the forward price/earnings ratio for Europe is 9.6x versus 12.x for the US). Emerging markets, however, account for 39% of the world economy but less than 15% of the index. This is mainly because the free float of many emerging markets (on which the MSCI indexes are calculated) is small for example, 54% in Brazil and 33% in India (compared with 95% for the US and 76% for Japan). Moreover, MSCI China does not include the Chinese domestic A-share market, which has total market cap of USD3trn (close to Japan s market cap of USD3.3trn). As more emerging market companies list in the coming years, foreign access to domestic markets such as China s increases and governments and founders float more shares, the weight of EM is likely to rise further. The US also has nine of the top 1 stocks globally (Table 2), the only exception being Nestlé of Switzerland. The US is also one of the most diversified markets, with the top 1 stocks comprising only 21% of the index (Table 3), and the largest sector, financials, only 2%. By contrast, Switzerland has 8% of its index weight in just 1 stocks, and Australia is heavily skewed to just two sectors, financials and materials, which comprise 68% of the index between them. Trading volumes globally have fallen since the global financial crisis, down 22% compared with the fiveyear average (Table 4). The US represents 31% of total global stock market trading, implying that it has less rapid turnover than, for example, emerging markets (16% of global turnover). 3. MSCI ACWI: Region/country weights of top-1/top-25 stocks 4. MSCI ACWI: Indices average daily traded value (USDbn) Top 1 Top 25 Current 5Y Average Developed markets 11.% 2.2% Emerging markets 15.2% 26.7% Europe 22.1% 37.6% Europe ex UK 25.2% 41.2% Asia ex Japan 19.3% 3.4% Latin America 39.8% 6.3% EMEA 36.% 57.8% US 2.6% 35.6% Japan 22.9% 38.2% United Kingdom 48.6% 72.4% Canada 39.% 63.2% Australia 61.4% 82.2% Switzerland 8.% 95.4% Germany 59.9% 87.2% China 53.4% 7.7% MSCI ACWI 9.4% 17.3% Source: HSBC, MSCI, Thomson Reuters Datastream Developed markets Emerging markets Europe Europe ex UK Asia ex Japan Latin America EMEA US Japan United Kingdom 4 46 Canada 19 2 Australia Switzerland Germany China 13 2 MSCI ACWI Source: HSBC, MSCI, Bloomberg, Thomson Reuters Datastream 6

7 5. Earnings and index volatility MSCI Indices Trailing earnings volatility* Market returns volatility* 1 years 5 years 1 years 5 years Developed markets 75% 64% 17% 21% Emerging markets 72% 47% 25% 3% Europe 121% 99% 21% 26% Europe ex UK 145% 118% 23% 27% Asia ex Japan 31% 24% 24% 29% Latin America 322% 152% 29% 32% EMEA 32% 2% 27% 32% USA 56% 54% 16% 19% Japan 252% 269% 17% 18% United Kingdom 86% 79% 19% 23% Canada 97% 51% 22% 27% Australia 52% 39% 24% 31% Switzerland 249% 252% 17% 21% Germany 176% 147% 27% 31% China 5% 3% 29% 34% MSCI ACWI 19% 16% 18% 22% Source: HSBC, MSCI, Thomson Reuters Datastream; Note: *calculated as the annualised standard deviation of monthly changes The US is also the most defensive of the major markets. This was most clearly demonstrated by the way it outperformed in 28, although the roots of the global financial crisis were in the US. The US has a beta to ACWI of.84x, compared with 1.28x for Europe ex UK and 1.36x for emerging markets. The annualised volatility of the US has been 16% over the past 1 years and 19% over the past five years, compared with 23% and 27%, respectively, for Europe ex UK (Table 5). Switzerland and the UK are also relatively defensive, partly because of their sector composition (in the case of Switzerland, heavy weightings in health care and consumer staples), and Japan s beta has also fallen in recent years, after two decades of low economic growth. Among sectors, the financials sector remains the largest globally, despite its problems over recent years. It comprises 19% of the ACWI Index and is among the top-three sectors in each of the eight biggest countries. It is especially large in emerging markets, where it represents 25% of the index, led by China where it accounts for as much as 39%. Information technology is not as significant as at the height of the TMT bubble in 2, but it still represents 13% of the global index and is particularly important in the US (where it is the largest sector, with 2%) and in Asia ex Japan (18%). Cyclical sectors (IT, industrials, consumer discretionary and materials), comprising 41% of the index, have a much bigger share than defensives (consumer staples, health care, telecoms and utilities) at 28%, which helps to explain why equities in general have a tendency to move pro-cyclically. Correlations Correlations between markets, and between stocks within a market, have risen considerably in recent years. The average correlation between each of the 49 countries in MSCI ACWI and the overall index has risen to 7-8% from about 4% over the past 1 years (Chart 7). The correlation between stocks in the US S&P5 Index (as indicated by the implied correlation contract traded on the Chicago Board Options Exchange) has similarly risen to about 8% (Chart 8). The main reasons for this are the increasing popularity of exchange-traded funds (ETFs), which enable investors to take a view on a market without buying the individual stocks, and the phenomenon of risk-on/risk-off, whereby investor sentiment has oscillated between extremes over the past few years. 7

8 6. MSCI AC World: Market correlations Economic factors Global index US ISM (5Yr US ISM (1Yr) MSCI ACWI (1yr) MSCI ACWI (5yr) MSCI ACWI (1yr) Developed markets Emerging markets Europe Europe ex UK Asia ex Japan Latin America EMEA USA Japan United Kingdom Canada Australia Switzerland Germany China Source: HSBC, MSCI, Thomson Reuters Datastream Of the largest markets, China (77%) and Japan (82%) have the lowest correlations with the world index, but these numbers still imply that both markets move closely in line with global stocks. To find relatively uncorrelated markets, one has to go down to small emerging countries such as Thailand (54%) or Sri Lanka (15%). 7. Average country correlation to MSCI ACWI 8. Implied correlation of S&P5 index stocks Av erage Implied correlation Source: HSBC, MSCI, Bloomberg Source: HSBC, Bloomberg Earnings and ratings Earnings have grown fairly steadily over the past 2 years, albeit with cyclical ups and downs (Chart 9). This contrasts with market returns which, as we saw above, were good in the 199s but have been volatile and poor since 2. Since 2, for example, earnings per share (EPS) for ACWI have grown at a compound rate (CAGR) of 7%, compared with the total return from the index of -.9%. The lesson here is that, over the long term, equity markets are driven less by earnings growth than by valuation, ie, the multiple applied to the earnings. Since 2, emerging markets have experienced the strongest earnings growth, at 14%, led by China (22% CAGR) and the commodities-heavy markets of Latin America (15%). Europe has seen the weakest growth, at 5% for Europe ex UK and 7% for the UK. 8

9 9. MSCI AC World: Actual EPS versus trend 1. MSCI AC World: EPS growth CAGR since % 15% 1% 5% % Annualised grow th rate M T rail EPS (Log) Trend EM EA LatAm EM Asia-ex-JP Japan AC World DM Europe USA Europe Ex UK Source: HSBC, MSCI, Thomson Reuters Datastream Source: HSBC, MSCI, Thomson Reuters Datastream How useful are earnings trends for forecasting the direction of equities? Historical earnings are not so relevant when thinking about the future, since markets tend to discount in advance. But analysts forecasts can be helpful, as long as they are used with care. Analysts tend to be over-optimistic about earnings (Chart 12). They typically miss earnings recessions: in mid-28, for example, consensus was still forecasting 14% EPS growth for the year ahead, whereas in reality earnings were about to slump. In expansions such as 24-7, for example, analysts estimates tend to be fairly accurate. But this is not so useful when markets are derating: In the past three years, for example, analysts have been correct in predicting solid earnings growth, but this has not helped stock markets, where performance has generally been disappointing. More sensitive indicators of the change in analysts estimates are, however, often a good guide to the direction of the stock market. Both earnings momentum (ie, the change in 12-month forward EPS forecast over the past six months Chart 11) and the revisions ratio (analysts upward earnings revisions as a percentage of all forecast changes Chart 12) merit watching carefully. Turning points in these second derivative indicators often signal a switch in market direction. In late 27, for example, the revision ratio turned sharply negative, even though analysts still expected earnings growth, presaging the market slump. 11. MSCI ACWI: Earnings momentum* versus y-o-y returns 12. MSCI ACWI: 12-month forward EPS growth versus returns % % Momentum MSCI AC World Index YoY (RHS) MSCI ACWI EPS Gr MSCI ACWI YoY (RHS) Note: *Earnings momentum is defined as the 6 month % change in 12M-forward EPS forecast Source: HSBC, MSCI, IBES Thomson Reuters Datastream Source: HSBC, MSCI, IBES, Thomson Reuters Datastream 9

10 Conversely, both momentum and the revisions ratio turned up sharply in early 29 ahead of the rebound in stocks. 13. MSCI ACWI: EPS revisions ratio* versus y-o-y return 14. MSCI ACWI recommendation consensus score % % 2. more bullish more bearish Recommendation consensus score (RCS) Av erage ACWI earning rev isions MSCI ACWI YoY (RHS) ±2SD Note:- *Number of EPS estimates up as a % of total number of revisions in estimates Source: HSBC, IBES, MSCI, Thomson Reuters Datastream Source: HSBC, IBES, MSCI, Thomson Reuters Datastream We also use analysts recommendations as a useful (contrarian) indicator. Analysts tend to be most bullish at market tops, and most bearish at bottoms. Chart 14 shows the recommendation consensus score, the average rating on stocks globally (where a Strong Buy scores 1, Neutral 3 and Strong Sell 5). Analysts were at their most bullish in early 2, at the peak of the TMT bubble. They have become generally more cautious since then, partly because of regulatory changes. But the two occasions when their recommendations have been two standard deviations more bearish than the long-run average, mid-23 and early 29, would have been good times to buy stocks. Currently, neither the sensitive earnings indicators, nor the recommendation consensus score give a strong signal in either direction. 1

11 Valuations Global equity valuations have steadily derated over the past 12 years. ACWI currently trades at around 11x 12-month forward earnings, compared with an average of 14.4x since 21 and 16x since Every major market and every region is currently cheaper than the historical average over both these periods with the one exception of Latin America, which is slightly above its post-21 average, pulled up by Mexico (on 15x). A simple comparison of valuation relative to history is dangerous, however. The period since 1982 is unusual in financial history, since it contained a 2-year structural bull market. Current valuations are the cheapest they have been at any time since the mid-198s, with the exception of a few months around the market bottom in early 29. But in the 197s (and the 195s and 191s), US stocks often traded on single-digit PEs, compared with 12x now and a low of just below 1x in 29. If the current global economic malaise continues, a further derating of global valuations cannot be ruled out. At the country level (Table 15), too, historical comparisons may not be meaningful if they indicate merely a change in prospective growth. No one, for example, believes that Japan should trade anywhere close to its 2-year average PE of 29x, but many cite its big discount to history as a reason to buy this market. We prefer to compare Japan with Europe, with similarly depressed growth: Japan still trades at a 17% premium to Europe and therefore, in our view, is not particularly cheap. Likewise, Europe s 2% discount to the US is not that significant, being similar to the average discount over the past 1 years. 15. MSCI ACWI: 12M-forward PE PE Now Avg Diff Avg Diff 16. MSCI ACWI: Earnings yield (EY) versus US 1Y bond yield (BY) Developed markets 11.1x 14.8x -25% 16.6x -33% Emerging markets 9.5x 1.7x -12% 12.7x -26% Europe 9.6x 13.3x -28% 14.9x -36% Europe ex UK 9.7x 13.1x -26% 15.1x -36% Asia ex Japan 1.5x 12.2x -14% 12.2x -14% Latin America 1.3x 1.1x 2% 1.7x -4% EMEA 7.3x 9.6x -24% 9.9x -27% US 12.x 15.4x -22% 16.3x -27% Japan 11.2x 18.2x -38% 28.8x -61% United Kingdom 9.4x 13.9x -33% 14.7x -36% Canada 11.4x 14.2x -2% 15.4x -26% Australia 11.1x 13.9x -2% 14.5x -23% Switzerland 11.7x 14.1x -17% 15.3x -24% Germany 9.1x 13.2x -31% 16.3x -44% China 8.6x 12.4x -31% 12.8x -33% MSCI ACWI 1.9x 14.4x -25% 16.3x -33% Source: HSBC, IBES, MSCI, Thomson Reuters Datastream. 12% 1% 8% 6% 4% 2% % EY BY Source: HSBC, MSCI, Bloomberg, Thomson Reuters Datastream, Bloomberg 11

12 17. MSCI ACWI: 12M-forward PE bands 18. MSCI ACWI: Price to book MSCI PI 5x 1x 15x 2x 4.x 3.5x 3.x 2.5x 2.x 1.5x 1.x MSC I AC World Source: HSBC, MSCI, IBES, Thomson Reuters Datastream. Source: HSBC, MSCI, Thomson Reuters Datastream. This is not to argue, however, that valuations are anything other than attractive currently. In particular, the long-run decline in the risk-free bond rate (for which we use the 1-year US Treasury yield) should arguably justify a higher PE than history, not a lower one. The earnings yield on equities (the reciprocal of the PE) is currently almost 6pp higher than the risk-free rate (Chart 16), something that has rarely happened in history. Even the dividend yield on global equities, currently 3.4%, is well above the bond yield something than has not happened for a sustained period since the 195s. As we argued above, while valuations may not help short-term market movements, they are a significant factor in determining long-run equity returns. The current level suggests, in our view, that returns from equities should be significantly better than those from government bonds over the next 1 years. 19. MSCI ACWI :12M-forward PE versus 1-year average and standard deviations from average Current PE Rolling 1Yr Avg Rolling 1Yr SD # ST Dev from avg. Cons. disc. 12.2x 15.8x Cons stap. 15.x 15.8x Energy 8.6x 11.5x Financials 9.3x 11.5x Health care 11.9x 15.x Industrials 11.3x 14.7x IT 11.6x 17.8x Materials 9.5x 12.5x Telecom 11.7x 17.4x Utilities 14.x 13.4x MSCI ACWI 1.9x 13.7x Source: HSBC, MSCI, IBES, Thomson Reuters Datastream. 12

13 Fund flows/holdings The poor performance of equities since 2 has hurt investor sentiment towards the asset class. In the 23-7 stock market rally, individual investors did put more of their savings into stocks: in the US, for example, they invested over USD7bn in equity mutual funds (Chart 17). But, after the global financial crisis, they lost all confidence. Even during the rebound in stocks in 29, they hesitated to buy equity funds, and over the past three-and-a-half years they have withdrawn a total of USD2bn. Where has the money gone? Not to money market funds (unsurprising, since cash yields zero) but to bond funds, which have seen net inflows of USD9bn since the end of 28. Some types of investment vehicles have fared a little better. Emerging market equity funds saw a big selloff during the global financial crisis, as US and European retail investors (as often happens) panicked and pulled their money home (Chart 18). But they saw a renewed bout of buying in 29 (with investors hoping that emerging markets would see better growth and less risk than developed ones). But, after EM returns turned out to be poor in 21 and 211, this fad faded and these funds, too, have seen outflows over the past two years (although not as big as the sell-off in DM funds). Currently, the only funds with strong inflows are income or dividend funds, as investors search for yield in the low interest rate environment. This trend may have some way to go since only 3% of US equity mutual funds, for example, are income funds (compared with 45% for growth funds). 2. Cumulative net flows into US mutual funds (USDtrn) 21. Cumulative net flows into global equity mutual funds (USDbn) Equity funds Bond funds MMFs EM DM Source: Investment Company Institute, HSBC Source: EPFR 13