GLOBAL EQUITY STRATEGY

The overall macro climate has definitely improved, with less possible “black swan” events that could trigger a massive sell-off in risk assets. Indeed, conditions in the financial markets are still benign as most stress indices are on a general downtrend.

The us economy is showing signs of improvement. This is especially the case for household consumption and investments. The US housing market is clearly improving, as seen from the builders’ confidence surveys. In terms of household balance sheets, the US enjoys lower household debt relative to its peers, and the shale gas discovery is a structurally positive development for the country.

In europe, most countries are still in contraction mode as the purchasing managers’ index (PMI) hovered below 50. Furthermore, credit recovery remains lacklustre, and private debt to GDP ratio is still high by historical standards. There is still much deleveraging ahead for Europe.

overweight position in equities

– n + developed

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Asia (ex Japan)

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In Japan, debt relative to GDP is still an issue, while the country grapples with a serious demographic challenge. The latest round of QE by the Bank of Japan (BoJ) could prove to be a game-changer, though we still need to keep a close watch on that front.

We continue to be overweight on Asia ex Japan as the region is expected to fare better than the more developed markets. However, we note that growth is slowing and therefore, we will focus on structural opportunities and on companies with strong cash flow.

We continue to like latin America as its long-term structural growth story remains intact. This is partly underpinned by domestic demand and expansion in household borrowings.

We are constructive on the fundamentals of the US market. Economic activity, which had originally been supported by housing, continues to broaden. Cosumer-related activities such as credit lending, automobile sales, residential construction and consequently employment continue to be supportive. As a result, consumer confidence is at a five-year high. Business spending trends, while more moderate, are still up from a year ago. Meanwhile, we believe that it should continue to trend upwards as lending standards ease. Historical evidence suggests that the “Banks Tightening C&I Loans” index has a high correlation to various economic indicators including the Non-Residential Fixed Investments (commonly known as capex) (chart 1), non-farm employment (chart 2) and S&P revenue growth. While the manufacturing ISM fell below 50 in the last reading in May, the non-manufacturing version has stayed comfortably above 50 since the beginning of 2010 (chart 3).

Corporate earnings have had a flat and uneventful last twelve months. The S&P500 revenues (ex-financials) ticked up 3.5 per cent in 4Q 2012, only to fall back to 1.2 per cent in 1Q this year. Likewise, earnings, after decelerating for six quarters in a row, grew 3.0 per cent in 4Q 2012, only to see a deceleration to 0.5 per cent in 1Q. We expect S&P 500 earnings to reach USD107 in 2013, representing four

per cent earnings per share (EPS) growth over 2012. The estimate reflects the fairly stable 2013 GDP growth forecasts of between 2.25 to 2.75 per cent, increasingly favourable cyclical tailwinds from consumption and a firmer capital expenditure outlook, which are helping to offset headwinds from a financially weak Europe.

In terms of risk premium, the market has enjoyed abating risks in the past two years. Going forward, the probability of risk premium picking up rather than fall further is very high. Hence, we are keeping our discount model price target set last quarter at 1700, representing about 7 per cent upside from here. Translating this to multiple valuations, 1700 on the S&P 500 implies a 15x 2013 PE ratio.

Although the upside to our target appears limited, we view that there are various ways we can participate in the US market. One of the ways includes investing in companies with a focus on shareholder yield or shareholder return. S&P 500 companies now hold a total of USD1.2 trillion in cash and continue to generate strong cash flows. As the global growth environment slows and as companies find it hard to source for more attractive ways to invest, it has become one of the key goals of these companies to return capital to shareholders. This can be in the form of dividends and share repurchases.

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Bank Lending Standard vs Employment

Source: Bloomberg, 5 June 2013

-6 -5 -4 -3 -2 -1 0 1 2 3 4 -40 -20 0 20 40 60 80 100 Apr-90 Nov -90

Jun-91 Jan-92 Aug-92 Mar-93 Oct-93 May-94 Dec-94 Jul-95 Feb-96 Sep-96 Apr-97 11-97 6-98 1-99 8-99 3-00 10-00 5-01 12-01 7-02 2-03 9-03 4-04 11-04 6-05 1-06 8-06 3-07 10-07 5-08 12-08 7-09 2-10 9-10

4-11

11-11

6-12 1-13

Total Nonfarm Employees (Y/Y)

Tightening - Inverted

Banks Tightening C&I Loans to Large Firm (%) (left) All Employees: Total Nonfarm Y/Y

Bank Lending Standard vs Capex

Source: Bloomberg, 5 June 2013

ISM Manufacturing PMI ISM Non-Manufacturing PMI

31 May 13, 49.0 31 May 13, 53.7 30 35 40 45 50 55 60 65

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 The proportion of S&P 500 companies that pay a dividend

has risen from a low of approximately 71 per cent in 2002 and 2009 to 81.6 per cent as at April 2013. Companies that practice share repurchases are also important contributors to shareholder returns. In 2011, total shareholder payments were at USD935 billion, of which dividends made up USD256 billion, while net share repurchases contributed an even larger amount of USD352 billion.

Bank Lending Standard vs Capex

Source: Bloomberg, 5 June 2013

-25 -20 -15 -10 -5 0 5 10 15 20 -40 -20 0 20 40 60 80 100

91 Jul-91 92 Jul-92 93 Jul-93 94 Jul-94 95 Jul-95 96 Jul-96 97 Jul-97 98 Jul-98 99 Jul-99 00 Jul-00 01 Jul-01 02 Jul-02 03 Jul-03 04 Jul-04 05 Jul-05 06 Jul-06 07 Jul-07 08 Jul-08 09 Jul-09 10 Jul-10

Jan-11

Jul-11

Jan-12 Jul-12 Jan-13

Capex (Y/Y)

Tightening - Inverted

Banks Tightening C&I Loans to Large Firm (%) (left) Private Nonresidential Fixed Investment YoY Recession

chart 1

chart 2

chart 3

We continue to underweight European equities. While the year-to-date performance of European equity markets has been positive, this has been based on a perceived reduction in tail risks given ongoing support from the European Central Bank (ECB). In particular, low interest rates and accommodative monetary policies from the ECB and other central banks have prompted a general reduction in peripheral European sovereign debt yields, supported by the search for high yields by global investors. Yet, actual economic performance continues to be weak in Europe. Many countries reported negative GDP growth in the first quarter of 2013 and overall European GDP growth is likely to be negative for 2013 as a whole.

The weak economic environment was evident in the 1Q2013 results season, which saw revenues drop 1.7 per cent year-on-year (y-o-y) and earnings contract 9.2 per cent y-o-y for European non-financial stocks. This was the worst quarterly results season since the 2008 financial crisis and it led to further downward revisions in 2013 consensus estimates for European equities. Given continuing depressed levels of new lending to both corporate and consumer customers, we expect companies will struggle to grow revenues and that there will a further downgrade of prospects for 2013.

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The ECB’s supportive policy action, spearheaded by ECB President Mario Draghi, is an important reason why investors have overlooked the downward pressure on earnings and have assigned a higher PE ratio rating to European equities. Since becoming the ECB President in November 2011, Mr Draghi has overseen a continual reduction in key ECB policy rates, with the most recent rate cut in May 2013. He has coordinated emergency funding to Eurozone governments and various national banks and now the ECB is playing a major role in developing the framework for a European Banking Union. Recent comments by the ECB suggest a continued willingness to boost European economic activity by providing loans directly to small and medium-sized enterprises (SMEs), relaxing collateral requirements and potentially even moving to a negative interest rate environment. All of these have helped to reduce sovereign bond yields.

Although the ECB is attempting to do “whatever it takes” to support Eurozone growth, there are political limits to the extent of its action. We do not expect aggressive action ahead of the German election in September 2013 and the German Constitutional Court has already indicated that changes to the German Constitution may be required to accommodate further policy activism by the ECB or the

European Commission. Elsewhere in the Eurozone, opinion polls are showing reduced support for the European Union in the face of high unemployment, increased taxation and forced reductions in fiscal deficits.

Unemployment is a particularly acute problem, reaching a new high of 12.2 per cent in the Eurozone in May 2013, and over 15.0 per cent if Germany is excluded. Youth unemployment is even more pronounced, having climbed to the 60 per cent level in countries such as Spain and Greece. An improvement in the macroeconomic environment is required to prevent this from having wider social and political implications. Despite an uptick in May 2013 PMI data, there is still no evidence of improving economic trends. For this reason, we view that it is prudent to maintain a defensive investment approach. We continue to focus on value companies (high ROEs, consistent growth) as well as companies with a high degree of export sales and those that have a high, sustainable dividend yield. In terms of sector allocation, we are overweight the consumer discretionary, consumer staples, healthcare and industrials sectors. We are underweight the basic materials, financials, and telecom sectors. We are neutral on the energy, technology and utilities sectors.

Our main overweight is the consumer discretionary sector. A number of companies in this sector benefit from relatively high levels of non-European sales, either via exports or by tourists making purchases in Europe. We are also overweight on the consumer staples sector, where companies have been able to generate solid returns through positive earnings momentum and sustainable dividend growth. We remain overweight on the healthcare sector, which has defensive qualities through solid dividend payments.

We have moved to an underweight position in basic materials. Continued weak economic growth has seen a de-rating of the mining stocks and steel companies continue to suffer from overcapacity. We remain underweight on financials, with many European banks still needing to raise capital to protect against further non-performing loans. We are also underweight telecoms, based on possible dividend cuts and concern that higher capital expenditure requirements may not be supported by future revenue growth.

Asia markets continue to face headwinds from a weaker external growth environment and increasing signs of moderating growth in China. Uncertainty over how and when the US Fed will step back from its QE programme will likely result in heightened market volatility. We expect that the performance of Asian equity markets in the second half of the year will hinge on developments in China where a rebalancing of the economy continues to present key challenges. Growth within Asia, while expected to slow, is still among the fastest in the world with the ASEAN region showing relatively stronger prospects.

Our tactical positioning in 2Q2013 to focus on the ASEAN markets worked well with the region outperforming year to date to May. We remain vigilant in tracking operating conditions across the region and will re-assess our tactical positioning with a view to paring down some of the gains in ASEAN should perceptions of rising risk or mis-valuation arise.

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Our strategy is to remain focused on structural opportunities by investing in companies that have sound business models, are positioned in segments offering attractive growth and have demonstrated operational and financial discipline in the way they manage their businesses. We continue to look for opportunities to invest in companies that are benefitting from the rising purchasing power of the region’s consumers. The consumer and IT sectors offer leverage into this trend of rising purchasing power, but in both sectors, stock selection remains critical. Valuations remain attractive and so long as earnings revisions remain benign, we expect the market to rate higher over time. We continue to adopt a quality growth style approach in our stock selection.

In China, the key challenge has been the slowing of economic growth momentum even as debt levels rise. The latest HSBC PMI unexpectedly fell to 49.2 in May from 50.4 in April against market expectations for continued expansion from its bottom in October. This suggests that manufacturing growth momentum has weakened and once again cast doubt on China’s recovery. The latest consumption-related data such as retail sales and disposable income growth has also shown a softening trend. At the same time, while the household debt level in China is low, there has been a rapid rise in overall debt levels since 2009, especially through the non-bank financial channels. Equity valuations seem to have taken most of these concerns into account as the market is now trading at well below the historical average both on a price-to-earnings and price-to-book basis and close to the lows of the global financial crisis in 2008. Our strategy in China is to avoid policy-driven sectors that would be hit by the economic restructuring and to focus on opportunities that ride on the tailwinds of government initiatives such as in the consumer, ‘green energy’, technology and internet sectors.

The structural growth opportunities in Asia remain underpinned by rising affluence, a huge population and favourable demographics. In terms of sector allocation, we are overweight the consumer sector and underweight the industrials, materials, real estate and telecommunication sectors. Across markets, we are overweight in Hong Kong, China and selective ASEAN markets. In our bottom-up stock selection, we focus on opportunities in areas such as the consumer sector, where the rise of the middle income population will benefit casino operators and retailers. We also favour Asia’s emerging global brands in technology and automobiles, well-established Asian leaders within the financial and technology/foundries space as well as companies in the technology supply chain that cater to the increasing penetration of low-cost handsets.

Since the start of 2013, Japanese equities have risen strongly before experiencing a correction in the second half of May 2013. The factors that led to the sharp sell-down included the weaker-than-expected Chinese PMI data, expectations that the US would taper off the pace of QE and a moderation in expectations over “Abenomics”.

Our view is that Japanese equities may experience one to two months of consolidation in the short term. We expect increased volatility on uncertainty over how the US Fed will step back from its QE programme and this will dampen near-term market returns. Volatility in currency rates caused by the unwinding of Japanese yen-short positions could also dampen sentiment. Our base case is that the amount of “Fed tapering” will be gradual given the expectations of low inflation and relatively fragile economic data in the US. Hence, the rise in US bond yield over the next year is likely to be gradual. Consequently, the Japanese government bond (JGB) yield should eventually stabilise in our opinion.

Meanwhile, the macro backdrop and government policies remain supportive of Japanese equities. Leading indicators such as the Japan manufacturing PMI are trending upwards, while positive data on income growth, bonus payments and

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Japanese companies has stayed positive so far. Prime Minister Abe’s reflation and growth policies are expected to remain aggressive especially with the decline in equity prices and volatility in the bond market.

On the political calendar, the next key event to watch is the Upper House elections on 17 July 2013. We expect an LDP led victory resulting in a cabinet reshuffle and the restart of pro-growth economic reform agenda. This, along with the likelihood of further monetary easing by the BoJ, could help Japanese equities regain some ground.

After the sharp market correction, valuations of Japanese equities are no longer excessive. Price-to-book (PB) ratio of 1.2x is lower than the 5-year historical average of 1.47x. Prospective PE of 14.4x for FY13 is also lower than the historical average of 16.2x. We are currently overweight consumer discretionary and consumer staples, neutral industrials, financials, telecommunications and technology, and underweight materials, utilities and energy.

The longer term growth trajectory will continue to be influenced by developments in Europe and the US where headwinds remain. As such, we would remain highly selective and target

We remain underweight on Canada. We have a continued preference for investing in North American economic growth through the more broadly-based, geographically diversified US equity market. This has been the appropriate strategy in recent quarters with the Canadian equity market under-performing domestic US equities. Given that the pace of Canadian earnings growth is slipping below historical norms, we believe that the market is unlikely to produce any meaningful out-performance despite the rebound in May. Canada remains reliant on the US economy for its export growth and recent data indicating that Mexico is gaining US export market share at the expense of Canada will continue to be an ongoing concern.

While FY13 GDP forecast for the Canadian economy is generally above 2.0 per cent, consensus GDP forecasts for the US economy are slightly stronger, with the US having lower inflation forecasts and a faster decline in unemployment rates. This can be seen from the current positive trend in US house sales, construction activity and house prices. In contrast, Canadian house prices are generally believed to be in “bubble” territory with re-sale activity flat at best and construction activity being in a sharp decline for almost six months. The weak Canadian housing market appears to be having a negative impact on consumer spending, with the downward trend in consumer loan growth throughout 2012 continuing.

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Canadian resource companies can be expected to benefit from stronger growth in both the US and Chinese economies. While global monetary conditions remain supportive, it is still uncertain that QE has produced sustainable growth in the world’s two largest economies. Commodity prices remain range-bound, with investors watching for signals of economic strength. Gold companies are an important component of the Canadian resource sector but these companies continue to de-rate on expectations of further falls in gold prices and a future rise in interest rates. It would be appropriate to have a neutral weighting on commodity-related sectors until there is a clearer trend in global demand.

From a sector perspective, we have moved to an overweight position in the industrial sector by the addition of a Canadian railway company. Along with their US counterparts, Canadian railway stocks are seeing strong traffic volumes based on increased energy and foodstuff transportation. We have funded this position by moving to neutral sector weightings in the energy and basic materials sectors, both being overweight previously. Continued weakness in the Canadian housing sector means that the financial sector remains vulnerable to negative news flow and more stringent mortgage and home equity lending guidelines. As noted before, the sector appears to have very modest potential for earnings growth and valuation expansion.

We are underweight on Australia. Prior to the recent 1Q reading, GDP growth was at a run rate of 2.5 per cent, with the composition of growth shifting away from mining investment and engineering construction towards broader consumption and demand sectors that are interest rate sensitive. The most recent release of a 0.6 per cent quarter-on-quarter (q-o-q) growth in 1Q was more troubling. After accounting for the strength in net exports which contributed one percentage point to growth, final domestic demand contracted 0.3 per cent sequentially.

Given the likely contraction in fiscal policy, monetary policy will be required to support economic growth in 2013. The Reserve Bank of Australia is expected to continue its easing bias, exerting pressure on the Australian dollar, that has now broken the parity against the US dollar. Household sentiment will likely remain weak due to job insecurity, declining wealth and rising costs. We expect discretionary consumption and housing to remain soft.

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Valuations for the core Australian market (excluding resources and banks) are not particularly cheap, with forward PE ratio trading around the historical average of about 15x. With the resources and financials sectors included, the market trades in excess of 13x forward PE ratio, which is a premium to the historical average and regional peers.

Overall, our key underweight is the materials sector and the key overweight is the consumer discretionary sector. We are slightly overweight the consumer staples, telecommunications, industrials and healthcare sectors, with the latter two sectors being more geographically diversified.

We remain positive on the Latin America (Latam) markets as we view the secular growth story to be intact and corporate earnings to remain resilient. Our strategy is to adopt a defensive positioning within domestic plays.

The 2013 GDP forecast for Latam is about 3.5 per cent, largely driven by the peripheral countries such as Chile and Peru. Inflationary pressures are moderating across most of the Latam markets with the exception of Brazil. Employment continues to be very strong with low unemployment rates and an increasing working population, which gives rise to strong real wage and income growth in the region. This bodes well for the domestic consumption story.

The fiscal balance of Latam remains strong and the central bank interest rates for most countries are now back to neutral rate with the exception of Brazil (where we are underweight) which is at an all-time low. This provides the central banks with monetary policy tools to stimulate the economy in an event of any global slowdown.

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Latam equities are currently fairly valued in our view, with the market trading at 12.3x consensus forward PE, a 20 per cent premium against the historical average of 10.3x. Earnings revisions have since troughed and we are expecting positive revisions moving forward, in line with global economic growth. The key risks are inflation, political stability and a global economic downturn. Recent data have shown inflationary pressures picking up in Brazil, though still way off from the previous peaks. We continue to expect the tight labour market and wage inflation to be an issue.

We view that the long term structural growth story of the Latam economies remains intact, underpinned by strong domestic demand and an underleveraged population. Our strategy is to add on dips with a preference for domestic cyclical sectors. We are overweight the financials, industrials and consumer discretionary sectors and underweight the consumer staples, energy and materials sectors.