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Investment Investments when the

Outlook September 2010

private banking - investment strategy
financial environment
changes colour
Investment Strategy

Summary_ ______________________________________________________________6
Portfolio strategy ________________________________________________________8
Theme: A change of engines in the American economy_______________________ 11
Theme: Investments when the financial environment changes colour___________ 15
Theme: A dualistic world_ _______________________________________________ 18
Macro summary _______________________________________________________ 21

Equities_______________________________________________________________ 23
Fixed income__________________________________________________________ 26
Hedge funds __________________________________________________________ 28
Real estate____________________________________________________________ 30
Private equity__________________________________________________________ 32
Commodities__________________________________________________________ 34
Currencies_ ___________________________________________________________ 36

Investment Outlook - september 2010 3

Investment Strategy

This report was published on September 14, 2010.

Its contents are based on information and analysis available before September 3, 2010.

Hans Peterson Carl Barnekow

Global Head of Investment Strategy Global Head of Advisory Team
+ 46 8 763 69 21 + 46 8 763 69 38

Lars Gunnar Aspman Reine Kase

Global Head of Macro Strategy Economist
+ 46 8 763 69 75 +352 26 23 63 50

Rickard Lundquist Cecilia Kohonen

Portfolio Strategist Global Head of Communication Team
+ 46 8 763 69 27 +46 8 763 69 95

Victor de Oliveira Liza Braaw

Portfolio Manager and Head of IS Luxembourg Communicator and Editor
+ 352 26 23 62 37 +46 8 763 69 09

Johan Hagbarth
Investment Strategist
+ 46 8 763 69 58

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4 Investment Outlook - september 2010


Generating value even in times of uncertainty

Decelerating growth in industrialised countries Companies with a presence and good sales in fast-growing
has created uncertainty in financial markets, economies, as well as the industries these companies belong
to, are in a class by themselves. The economic world is divided
but changing market environments offer − dualistic − and will remain so during the foreseeable future.
opportunities for returns. Two key concepts Emerging economies will continue to grow and will increas-
today are low valuations and exposure to ingly trade with each other. Demand from the old OECD indus-
emerging markets. trialised countries will decline in global importance.

Our challenge as investors is to navigate properly in today’s

Financial markets are driven by the generation of value in the
financial world − divided, perhaps discounted and partly
real economy. When the real economy sputters, as it has now
bubble-prone. Opportunities for returns exist in all market
been doing for a while, this creates uncertainty. Markets have
scenarios. We should thus not let ourselves become overly dis-
reacted as they should: risks premiums have risen, valuations
tracted by crises, but should instead maintain an open mind
have fallen and safe assets have become a focus of attention.
about where to seek returns. This is what we are trying to do in
This type of economic environment creates both opportuni-
this issue of Investment Outlook.
ties and bubbles. Stable assets become overvalued, and other
assets become discounted by historical measures. Today’s Strategically attractive stock market conditions
long-term bond yields might be an example of such a bubble.
One of our most important conclusions is that a double dip
recession in the US and other Western countries is unlikely,
This is where we are today. Stock markets have unusually low
which implies that the overall world economy will grow by
valuations, especially in relation to the profits we foresee.
4-4.5 per cent annually during the next couple of years. This
Government bonds are more expensive; in other words, their
means that conditions in the stock market are strategically at-
yields are historically low. Stock markets are now in a valuation
tractive, even though there are risks. Many governments face
interval that has caused some observers to speak of a new
major fiscal challenges, and there is a risk of new debt crisis
paradigm for the valuation of equities. The theme is that after
discussions in southern Europe, the US, Japan and elsewhere
ten years of poor returns, investors will now demand a much
as sovereign bond issues grow in size.
higher risk premium for owning equities. The future will show
what happens when the economic situation improves. But
One thing is worth keeping in mind: risks have eased in Europe
experience tells us that as soon as a new paradigm is declared,
partly because of improved northern European economic per-
something usually happens.
formance. In addition, real crises rarely occur during periods
Emerging markets take over as global growth engine when growth is good, which is the case at global level. This
provides a degree of hope that markets will stabilise and can
What is new today is that the world’s largest economy, the
gradually begin to discount better economic growth.
United States, has lost some of its dynamism and is weighed
down by heavy debts and weak government finances. This will

mean a slow recovery. The American consumer – once regard-
Hans Peterson
ed as the world’s growth engine − will not deliver the demand
CIO Private Banking and Global Head of
to which we have become accustomed. Also new is the relent-
Investment Strategy
less growth surge in new emerging market (EM) countries. The
importance of the EM sphere is continuously increasing, which
has been especially clear in the six-month interim reports of

Investment Outlook - september 2010 5


Expected 1-year
return risk Reasoning
PositivE. The prevailing high risk premiums are one argument for equities, but uncertainty about
macroeconomic perspectives is hampering investor willingness to take risks. Companies with exposure to
Equities 9% 17% growth, such as emerging markets and capital goods, should perform well in the prevailing range trading.
negativE towards government securities, positivE towards High Yield. The macro map indicates continued low
key interest rates and government bond yields in Western countries, making government securities unattractive.
The yield spread over Investment Grade has also narrowed, and from a risk/return standpoint High Yield is now
by far the most attractive. Emerging market (EM) debt also remains appealing due to high yields and possible
Fixed income 6%* 6% exchange rate appreciation.
PositivE. Continued focus on strategies with sources of returns other than the stock market. Global Macro
and CTA strategies should perform well in volatile markets, while Event Driven is likely to benefit from
increased merger and acquisition (M&A) activity. Continued arbitrage opportunities make Credit L/S and
Hedge funds 7% 6% Distressed strategies attractive.
neutral/positivE. Continued economic recovery still favours this asset class, but the real estate market
will recover more slowly. Hard-to-interpret housing market data and prevailing macro uncertainty are fuel-
Real estate 4,5% 3% ling uncertainty and risk.
pOSITIVE. This asset class took a beating during last spring’s financial worries but still has a 30-40 per
Private cent discount on already conservative net asset values. New regulations may trigger new flows, making the
Equity 15% 22% secondary market attractive.
neutral/POSITIVE. At present, risk appetite is driving the market instead of fundamentals. Looking ahead,
sustained economic recovery will boost demand for industrial metals, while low interest rates should
Commodities 6% 18% further benefit gold.
neutral/NEGATIVE**. As worries about a US and global double dip recession fade, interest rate differentials
will once again drive currency flows. High interest rate (EM) currencies will strengthen against low interest
Currencies 3% 3% rate currencies in developed markets (DM) as risk appetite returns.
* Expected return on corporate bonds that are weighted about 1/3 Investment Grade and 2/3 High Yield.
** This opinion refers to the alpha-generating capacity of a foreign exchange trading manager.

Private equity
14% 14%
12% 10%
10% 6%
Equities 4%
Expected return

Hedge funds
Fixed income* Commodities -2%
Real estate -4%







Equities Fixed income* Hedge funds Real estate
Private equity Currencies Commodities
0% 5% 10% 15% 20% 25% 30%
Expected volatility
(AUGUST 31, 2000 TO JULY 30, 2010)
Private equity

Fixed income

Hedge funds

Real estate


Fixed income

Real estate Hedge funds
Equities 1.00
Historical return

Equities Commodities

-2% Fixed income 0.09 1.00

Hedge funds 0.65 0.08 1.00
Private equity
Real estate -0.18 0.00 -0.01 1.00

-10% Private equity 0.81 -0.17 0.54 -0.17 1.00

0% 5% 10% 15% 20% 25% 30%
Historical volatility
Commodities 0.38 0.12 0.53 0.00 0.32 1.00

Currencies 0.01 0.33 0.18 -0.07 -0.09 -0.05 1.00

Historical values are based on the following indices: Equities = MSCI AC World. Fixed income = JP Morgan Global GBI Hedge. Hedge
funds = HFRX Global Hedge Fund. Real Estate = SEB PB Real estate. Private equity = LPX50. Commodities = S&P GSCI TR. Currencies = BarclayHedge Currency Trader.

6 Investment Outlook - september 2010



0% 35%
Equities Equities

83.5% 25.5%
Fixed income Fixed income

7.5% 21%
Hedge funds Hedge funds

2% 0%
Real estate Real estate

0% 10%
Private equity Private equity

0% 5%
Commodities Commodities

Currencies 5% Currencies

Cash 2% Cash

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 0.0% 10.0% 20.0% 30.0% 40.0%

Previous Current Previous Current


Equities 25% 1

30% 0.8
Fixed income

26% 0.6
Hedge funds
Real estate
Private equity 3%
Commodities 4%
Currencies -0.4
5% -0.6
2002 2003 2004 2005 2006 2007 2008 2009
0% 10% 20% 30% 40%
Fixed income Hedge Real estate
Previous Current Private equity Commodities Currencies

Changing engines in the American economy: the US will avoid a double dip recession, provided that underlying demand

Investments when the financial environment changes colour: A focus on assets with stability in the form of low valuations and
revenue streams

A dualistic world: Micro and macro reflect different aspects of economic life


Contributions to GDP, percentage points

5 5 5 5
4 4
3 3 3 3
2 2
1 1
1 1
0 0 -1 -1
Per cent

-1 -1
-2 -2 -3 -3
-3 -3 Source: Ecowin
-4 -4 -5 -5
-5 -5
2000 2002 2004 2006 2008
-7 -7
Q1 Q3 Q1 Q3 Q1 Q3 Q1
Investment Account, Change in Private Inventories, Overall
Investment Account, Private Fixed Investment, Nonresidential 2007 2008 2009 2010
Investment Account, Private Fixed Investment, Residential National Income Account, National Product Account [ar ma 1 quarter]
Personal Outlays, PCE, Overall
Source: Reuters EcoWin National Income Account, National Product Account [c.o.p 4 quarters]

During the past year, the inventory cycle (green) has been a crucial The American economy seems to be accelerating if its growth is meas-
growth engine in the US, but now other forces must take over in order ured year-on-year, largely because the first half of 2009 was character-
to avoid a new recession. They include corporate capital spending ised by a deep economic slump. But on a quarterly basis the economy
(blue), residential construction (brown) and private consumption has decelerated, reflecting a weaker cyclical upturn.

Investment Outlook - september 2010 7

Portfolio strategy

Turbulent markets, but Modern Investment

programmes are stable
Concerns about a possible double dip recession drove many investment markets in the second
quarter as well as through the summer. This resulted in turbulent markets. During this period, we
chose to increase the cash portion of our programme portfolios in order to reduce risk. The risk
diversification we achieve by investing in several asset classes provides good protection. Hedge
funds and High Yield bonds, for example, have offered good downside protection. On the whole we
are satisfied with the nature of these programmes.

MODERN Protection managers in Modern Protection. We are nevertheless sticking

The financial drama that began late in April continued to currencies as an asset class, but since the movements were
throughout the summer. World stock exchange performance a bit too dramatic for our taste, and to protect the portfolio,
was volatile, with a negative tilt. During the period May- we chose to replace half our Multimanagement Currency hold-
August, the MSCI World Index in local currencies was down ing with a lower-risk currency strategy. The hedge fund portion
12.5 per cent at most. After some corrections and further tur- of Modern Protection remained defensive, with Market Neutral
bulence, it closed down about 9 per cent for the period. exposure only. Unfortunately we can see that the contribu-
tion from these investments did not match our expectations.
Fixed income markets were not spared from the turbulence The fundamental principle for the hedge fund portfolio is to
in any way. At the core of market worries was the financial have holdings with low expected volatility and several types
strength or weakness of individual countries, which created of management strategies that drive returns in the desired
tensions in the foreign exchange market and a flight to the direction. During the spring and summer, we experienced an
safest government bonds at the expense of corporate bonds undesired high correlation in one of our Equity Market Neutral
and the government securities of financially weaker countries. funds. We sold it off and have instead adopted new strate-
But although most of the fixed income portfolio in Modern gies: Global Macro and Multistrategy. These may actually have
Protection consists of investments with short-term maturities, somewhat higher volatility, but we can see that their correla-
the level of yield is too low to offset the downturn in our cau- tion with stock markets in particular was less.
tious risk assets.
Looking ahead, we will devote a lot of time to analysis about
Despite the market turbulence, Modern Protection was up 0.5 hedge funds and “cash plus” funds. Our view of High Yield
per cent (NAV in SEK on July 30) during 2010, but we continu- securities has become more positive, and we may increase our
ously re-examine our holdings. During this turbulent period, holdings in this segment. After the latest changes, a new over-
we had the opportunity to study our active risk mandate all risk assessment must be carried out.
closely. This led to some changes in the fixed income portfolio.
We reduced our positions in the lowest-return segment in
2% 5%
favour of more “cash plus” and “absolute return” securities. 2%
We feel very comfortable with our choice of managers, and 7.5%

we have seen evidence that this management has worked

extremely well from a portfolio perspective, and not only as
independent management mandates. Cash
Currency rate movements were rather large during the period. Real estate
The euro weakened by 8-14 per cent against such currencies Hedge funds
83.5% Fixed income
as the CHF, GBP, JPY and USD. Although certain corrections
occurred, these movements were costly to our active currency

8 Investment Outlook - september 2010

Portfolio strategy

MODERN Growth have recently also seen a trend towards decoupling from
The second quarter of 2010 and most of the summer were the stock market, making the segment even more attractive.
dominated by worries, at first consisting of fears that global Mounting concerns about a double dip recession of course
growth would be hampered by government budget austerity. include uncertainty about corporate profits, but meanwhile
This gradually shifted to dread of a renewed global recession. we are seeing a steady decline in bankruptcy risks. Compared
Unexpectedly weak US economic statistics as well as ques- to other bond markets, yields on corporate bonds with some-
tions about Chinese growth strengthened the arguments for what lower credit ratings also seem more attractive. Here, too,
the most widely used economic term of the summer − double we have boosted our expected return and are thus choosing
dip − meaning that the world (or the US in particular) would to increase our High Yield holdings by adding one more bond
slide into another recession within 12 months of the previous fund. This is being financed in part from the large cash reserve
one. we built up during the spring and summer, and in part from
the hedge fund portion of Modern Growth.
Equities, private equity and commodities were the weakest-
performing asset classes during the period. We made various Currency rate movements were rather large during the period.
changes in our share portfolio based on analysis from our The euro weakened by 8-14 per cent against such currencies
fund analysts, then strengthened an already robust portfolio. as the CHF, GBP, JPY and USD. These movements adversely af-
Our shareholdings also did extremely well compared to the fected the currencies asset class. Just as in Modern Protection,
overall stock market, thanks to both our choice of the right we chose to replace half our holding with a lower-risk currency
managers and our exposure to emerging markets. strategy. We are doing further research on additional foreign
exchange market concepts that may contribute better returns
In absolute figures, we did not suffer especially great dam- to the portfolio.
age from either commodities or private equity either, since
together their weighting in Modern Growth is about 7 per cent. In May, when volatility rose sharply, a number of hedge funds
We will retain this exposure, since our assessment is that the demonstrated a similar negative growth pattern and correlat-
climate for mergers and acquisitions is favourable (to private ed significantly more than desired, although their movements
equity companies) and that in a slightly longer perspective, were far smaller than those of equities. In June, portions of our
commodities will continue to benefit from structural changes hedge fund holdings recovered relatively well, while others
and demand from emerging markets. We are replacing our continued to perform negatively. No major drama, but in order
commodities ETF with an actively managed fund that, in our to avoid being dependent on stock market developments, we
judgement, has good potential to beat underlying indices. chose to sell our Equity Long/Short holding. And since we are
dissatisfied with the return that our Market Neutral strategies
Corporate bonds were hurt by the flight to safer govern- have delivered, we are reducing these holdings and gradually
ment securities that market turbulence generated. We have replacing them with Global Macro and Multistrategy. We still
thus chosen to supplement the fixed income portion of the have a positive view of hedge funds, although we have adjust-
portfolio with government securities from emerging market ed our expected return slightly downward. We are increasing
countries. We are sticking to our view that the risk-adjusted our focus on the choice of strategies, which we believe will be
return potential of the corporate bond segment is high. We of greater importance ahead.

25% 4%
3% Cash
2.5% Currencies
Private equity
26% Real estate
Hedge funds
Fixed income

Investment Outlook - september 2010 9

Portfolio strategy

MODERN Aggressive turbulence, but we regard the yields on corporate bonds with
Modern Aggressive suffered the same adverse impact from somewhat lower credit ratings as attractive. We have also
the various risk asset classes as the Modern Growth portfolio, adjusted our expected return upwards and are considering
but downturns in the equities and private equity portions were increasing our holdings in this segment within the near future.
more dramatic, since holdings of these asset classes comprise While there is greater uncertainty about corporate profits as
a larger percentage of our total allocation. Just as in Modern worries about a double dip recession mount, bankruptcies are
Growth, we have made some changes in our shareholdings steadily decreasing (for example there were only two bank-
based on fund analysis. We marginally increased our share- ruptcies in the High Yield segment in the US during June).
holdings in emerging markets, compared to mature markets.
Our assessment is that growth in these parts of the world will Our hedge fund portfolio bounced back quite nicely during
be superior to that of mature markets. In Modern Aggressive, June and July. In May, when market volatility rose sharply,
we thus dare to increase the proportion of overall holdings in a number of hedge funds demonstrated a similar negative
this historically riskier market segment. The portion of Modern growth pattern, correlating significantly more than desired.
Aggressive consisting of equities has demonstrated very good In order to avoid being dependent on stock market develop-
portfolio characteristics, and our holdings have performed ments, we chose to sell our Equity Long/Short holdings. We
extremely well in comparative terms. During the period, the are dissatisfied with the return, especially in a rising market,
MSCI World Index measured in euros lost 5.03 per cent, while and will replace these holdings with other types of strategies.
our equities portfolio decreased by 1.73 per cent in the same We will also increase or decrease our exposure to the stock
currency. market with the help of normal equity mutual funds when
we consider this suitable. Extensive analytical work on hedge
Since our assessment is that the climate for acquisitions and funds and their various characteristics and behaviours is cur-
mergers is favourable, we are leaving our private equity hold- rently under way.
ings intact. We increased our expected return on commodities
and are thus restoring our holding to its original 5 per cent At most, the cash holding in Modern Aggressive reached
of the portfolio. We are doing this by adding a new actively about 10 per cent during the period. This was mainly because
managed fund and replacing our ETF with active commodity we abstained from investing when the market climate deterio-
management. rated. We are choosing to gradually invest this surplus liquid-
ity, with a cautious wait-and-see attitude.
The fixed income portion of the portfolio − which largely con-
sists of High Yield securities − was hurt by last spring’s market



21% Commodities
Private equity
Hedge funds
Fixed income
25.5% Equities

10 Investment Outlook - september 2010

A change of engines
in the American

Heavy odds against double dip recession

• The deceleration in the US economy since last For this reason, the focus of market worries moved across the
spring… Atlantic to the American economy, which was then about to
decelerate sharply, according to numerous statistics. In late
• … has increased worries about a double dip June, the “double dip” concept thus appeared frequently both
recession in the media and in analyses of the US economic outlook.

• History and the prevailing demand outlook During July and early August, however, risk appetite in fi-
clearly indicate this is unlikely nancial markets rebounded thanks to surprisingly upbeat
European economic news, strong earnings reports from coun-
tries around the world, speculations that China − in response
The rally in risk asset markets last spring was primarily fuelled to less vigorous national macro data during the summer − will
by surprisingly good company earnings and higher growth steer its economic policy away from a tightening bias, and
expectations, both among macro forecasters and market play- thanks to the growing likelihood that the US Federal Reserve
ers. For the first time since the recovery began shortly after (Fed), will resume quantitative easing through large-scale
mid-2009, market players revised their future outlook more Treasury bond purchases.
than macroeconomists did. But in mid-April, the European
sovereign debt crisis burst into full flower. This led to a long, Stock market upswing after ISM report
large price decline for risk assets, with equities not bottoming Weak US economic data also dominated the peak summer
out until early July. period, but since expectations before their publication had
been lowered, downside surprises were less distressing to the
Initially, financial market worries in June still focused on gov- markets than during the late spring. Nevertheless, days when
ernment fiscal problems and the health of the European bank- unexpectedly weak American economic figures were reported
ing system. But these concerns faded when several countries were generally characterised by falling share prices on US
− especially Greece, Spain and Portugal − launched sizeable stock exchanges.
budget-tightening programmes. Markets also liked the results
of the stress tests of European banks.

MSCI World Index, local currencies

315 The late June bear market, caused by in-
310 creased concerns about a US economic slump,
305 was followed in July by splendid stock market
weather, mainly because of fewer worries
about government finances and strong Euro-
pean macro data. In August, the stock market
Jan Mar May Jul fell again in response to fears of a US double
2010 dip recession.
Source: Reuters EcoWin

Investment Outlook - september 2010 11

Theme: A change of engines in the American economy

By early August, macro expectations seemed to have been ad- naturally arises is whether double dip recessions have usually
justed sufficiently downward, as reflected in a strong positive followed in the wake of burst housing bubbles.
stock market reaction on August 2 when the July ISM purchas-
ing managers’ index for July fell a bit less than estimated. This Here the statistics show that none of the 18 major collapsed
was the first time in two months that important US economic bubbles − home price declines exceeding 15 per cent − in the
data catalysed a significant stock market upswing. industrialised countries of the OECD since the early 1970s
were followed by a double dip recession. What has instead
But shortly afterward, the situation changed when a series of typified periods after the bursting of housing market bubbles
American economic reports − including labour market, retail has been several years of slow growth and large idle economic
sales and home construction data − fell short of predictions capacity, which together have laid the groundwork for low
while the Fed lowered its economic forecasts. During subse- inflation and low interest rates.
quent weeks, surprisingly downbeat macro news dominated
US markets; the trade deficit soared, initial unemployment Double dip without recession
insurance claims rose to their highest level since autumn The usual cyclical pattern is also that an initially rapid upswing
2009, the Philadelphia Federal Reserve unexpectedly reported is followed by a deceleration, similar to what it now happen-
declining industrial activity, manufacturing order bookings ing in the US − a kind of double dip without a recession. It is
turned out to be shaky, new home sales plunged to an all-time also more of a rule than an exception that risk assets such as
low and so on. As a result, the term “double dip” was soon be- equities, corporate bonds, hedge funds, private equity and
ing heard again everywhere. commodities enter a weaker phase once the recovery has
been under way for a few quarters. And after a while, as the
REVERSAL IN PHILADELPHIA INDEX economy has progressed further, the prices of risk assets have
40 generally begun a new upturn phase.

Historical probabilities thus indicate that the US is not on the
verge of a new recession. But can a double dip happen, even
with the odds stacked against it?

-10 Since the latest American recession ended late in the summer
-20 of 2009 (though no official dating of the economic cycle has
been presented yet), annualised Q/Q GDP growth has been
1.6, 5, 3.7 and 1.6 per cent. This growth profile has essentially
2000 2002 2004 2006 2008 2010 been attributable to the degree of stimulus from the inventory
Source: Reuters EcoWin
cycle and fiscal measures. From the third quarter of 2009 to
the first quarter of 2010, these forces accounted for nearly 100
Contrary to the anticipated acceleration, industrial activity
per cent of total GDP growth, and during the second quarter
in the Fed’s Philadelphia district fell markedly in August.
of 2010 for about 50 per cent.
Many other American macro reports were also unexpectedly
weak, fuelling worries about a double dip recession. RECOVERY BY ARTIFICIAL RESPIRATION
The meaning of the term “double dip” is ambiguous (there
is no official definition). But assuming that it refers to a new 7.5

recession in the US economy − usually implying at least two 5.0

% Q/Q annualised

quarters of falling GDP − that starts at least 12 months after

the previous recession, the last time there was a double dip
recession was in 1981-1982 and before that in 1921. Over the 0.0
past 90 years, the US has thus experienced only two such -2.5
recessions. Even looking at the economic history of other
countries, the phenomenon seems rare; in 14 industrialised -5.0
Source: Ecowin
countries that recorded a total of 80 recessions during the -7.5
post-war period, double dip recessions have occurred only six 2000 2002 2004 2006 2008 2010

times, four of them in Ireland. ar ma 1 quarter

A burst housing market bubble, this time starring sub-prime Virtually all US GDP growth during the second half of 2009
mortgages, was the fundamental cause of the dramatic finan- and early in 2010 was due to temporary stimulus effects.
cial and economic crisis in the US − and elsewhere in the world Now that these factors are leading to slower growth, final
− that dominated 2008 and part of 2009. One question that demand must take over as the economic engine.

12 Investment Outlook - september 2010

Theme: A change of engines in the American economy

The overall stimulus effect in the American economy is thus The fiscal pendulum thus seems to be swinging towards sup-
in the process of fading and is likely to turn negative starting port for greater austerity. Operative indications of this are that
in the third quarter of 2010. The reason is that the pace of President Barack Obama’s plan for another large-scale stimu-
inventory build-up is clearly slowing − the second derivative lus package underwent radical cuts and that the extension of
(change in the pace of change) is turning negative − while the unemployment benefits to 99 weeks was pushed through only
growth impulse from fiscal policy will also change from plus to with great difficulty.
President Obama’s public approval rating has also fallen
Nor will this shift from acceleration to deceleration effect be sharply. This is jeopardising continued Democratic control of
temporary. Instead, all indications are that it will dominate the the House of Representatives following the November 2 con-
economy over the next few years. Inventories may occasionally gressional election. With a weakened president, Washington
make small temporary positive contributions to growth, but risks political paralysis until the autumn 2012 presidential
the need to pursue tighter fiscal policies in order to shrink the election. The bottom line is thus that events in the political
federal budget deficit will have a stronger impact in the op- landscape have made it more difficult to assess US fiscal poli-
posite direction. cy, but there are many indications that there will be no further
additional stimulus to speak of during 2010-2012. Looking
Underlying demand must grow further ahead, US politicians − in any event − face sizeable
During the remainder of 2010, the average negative effect of cost-cutting needs.
these factors can be estimated at about 1 per cent of GDP, and
during 2011 around 1.5 per cent. In order for the US to avoid Private sector will shoulder responsibility
a double dip recession (prevent GDP from falling), underlying In the private sector, however, there is potential for faster
economic demand − demand that is not dependent on inven- growth in demand during the coming year.
tory effects and fiscal stimulus − must grow by more than 1
percentage point during the second half of 2010. First, both long-term US bond yields and short-term market
interest rates have fallen to historically low levels. Despite
In order to achieve SEB’s forecast of a GDP increase averaging its appreciation since the beginning of 2010, the US dollar is
just below 2 per cent (quarter-on-quarter annualised growth) still undervalued against the euro on the basis of purchasing
during the second half of 2010, underlying demand must power parities (PPP). Financial conditions are thus unusually
consequently grow by about 3 per cent. But where will this stimulative, which will benefit private sector demand.
demand come from?
The Fed’s latest Senior Loan Officer Survey of the US bank-
It will hardly come from the public sector. For some time, US ing system is also showing a gradual easing of lending terms
domestic politics has been dominated by growing discord and and higher demand for loans in most fields of business. In
by Republican attempts to stop or delay reforms. There is also addition, we expect the Fed to leave its key interest rate − the
disagreement as to whether the economy actually needs fur- federal funds rate − unchanged at a record-low 0-0.25 per
ther stimulus, or whether belt-tightening is required instead. cent until 2012. Nor should we rule out the possibility that the
The Republicans oppose further fiscal stimulus and also ques- Fed will resume quantitative easing later this year. Overall, this
tion the size of the positive impact from earlier stimulus pack- indicates that the low interest rate environment in the US will
ages. Even among Democrats and the general public, there are continue for longer than we previously forecasted.
also doubts about the need for new budget measures to prop
up the economy.
Contributions to GDP, percentage points

5 5
4 4
3 3
1 1
0 0 During the past year, the inventory cycle
-1 -1
(green) − a shift from a large-scale inventory
-2 -2
-3 -3
run-down to a build-up − has been a crucial
-4 -4 growth engine in the US economy, but now
-5 -5 other forces must take over in order to avoid a
2000 2002 2004 2006 2008
new recession. These include corporate capital
Investment Account, Change in Private Inventories, Overall
Investment Account, Private Fixed Investment, Nonresidential
Investment Account, Private Fixed Investment, Residential
spending (blue), residential construction
Personal Outlays, PCE, Overall
Source: Reuters EcoWin (brown) and private consumption (lilac).

Investment Outlook - september 2010 13

Theme: A change of engines in the American economy

Secondly, last year American businesses cut their capital Employment, in turn, is a key factor for both income and
spending so much that they largely covered only wear-and- household sentiment − two important private consumption
tear (depreciation). In net terms (expansion investments), cap- parameters − and so far the trend has been weak. This is why
ital spending totalled an almost negligible 0.7 per cent of GDP, many observers have dusted off the expression “jobless re-
the lowest level since the Second World War. In the corporate covery”. Yet in the private sector, job growth has been on a par
sector, there is thus reason to anticipate an upswing in capital with the job growth during the 1991-1992 cyclical recovery,
spending. This has in fact begun, judging from second quarter and well above that of the 2002 recovery. Looking a bit further
2010 statistics (+17.6 per cent quarter-on-quarter, annualised). ahead, hiring will also increase when businesses can no longer
squeeze the existing workforce further (productivity falls) in
Thirdly, residential construction has fallen to an extremely low order to meet final demand and any inventory build-up.
level, both historically and factoring in the housing demand
resulting from the shape of the population pyramid (demo- No double dip recession
graphics). There is a large supply of unsold homes at the na- Judging from historical experience as well as the currently
tional level, but this may be misleading. In some regions there prevailing demand outlook in the private sector, our conclu-
is indeed an oversupply of homes, but in many others there sion is that the probability that the US will end up in a double
is a shortage − one reason for the latter being that Americans dip recession is very low. Some of the recent American macro
move unusually often. figures − for example the ISM manufacturing index, home pur-
chase contracts and non-farm payrolls − have also surpassed
Worn-out consumer capital goods expectations.
Fourthly, households have cut back dramatically on buying
capital goods; net purchases of cars, furniture, kitchen equip- Meanwhile there is reason to expect slower growth during the
ment and so on fell to 0.5 per cent of GDP last year − the third second half of 2010 than in the first half − entirely in keeping
lowest level since the Second World War. As with business with the usual pattern 4-5 quarters into a cyclical recovery − as
capital spending, there should thus also be pent-up demand well as modest GDP growth over the next couple of years. No
here. matter what, both fiscal and monetary policy must begin to be
normalised, which will decelerate the economic expansion. If
One key factor is what happens to the household savings ratio this occurs, however, it is well in line with the usual situation
(saving as a percentage of disposable income), which has during the recovery period following burst housing market
climbed to about 6 per cent from about 2 per cent at the end bubbles.
of 2007. If the savings ratio does not increase further, or if it
declines, this will favour such purchases as consumer capital
goods. The savings ratio is a bit higher than it usually is when
total household balance sheets and income statements look
the way they do now − an indication that the savings ratio may
possibly fall somewhat.

60 17.5
50 15.0
Year-on-year percentage change

Year-on-year percentage change

40 12.5
10 5.0 US economic history shows that the stock
0 2.5 market and the economic cycle have usu-
-10 0.0 ally begun recoveries with large share price
-20 -2.5 increases and rapid growth, and then − about
-30 -5.0 4-5 quarters into the recovery − have taken
-40 -7.5 a pause for breath. After that, both the stock
-50 -10.0 market and the economy have usually re-
1980 1990 2000
gained their energy, and this has usually been
National Income Account, National Product Account, Gross Domestic enough for a long period of share price and
Product, Overall, Total, Constant Prices, AR, SA, 2005 prices [c.o.p 4 quarters]
Standard & Poors, 500 Composite, Index, Average [c.o.p 4 quarters] economic upturn.
Source: Reuters EcoWin

14 Investment Outlook - september 2010

Investments when the
financial environment
changes colour

Asset management in a volatile world

• A focus on high-growth regions… The other major driving force in the world economy is actions
aimed at preventing deflation. Central banks around the world
• …and assets with attractive valuations… hate deflation and stagnation like the plague and will do what
is required to counteract this risk. This problem is most acute
• …while waiting for double dip risks to fade in the US, whose central bank (the Fed) is combating the risk
of deflation by communicating that it will maintain very low
Capital markets must deal with a mixed scenario. The world interest rates for an extended period. Nor can it be ruled out
economy is more complex than before, with rapid growth in that the Fed will resume its monetary policy of quantitative
emerging economies and debt problems in mature industrial easing.
countries. Meanwhile there are more opportunities and alter-
natives than ever. It is possible to generate returns in today’s Liquidity a key factor
market climate too. But it is crucial to maintain a selective The supply of liquidity is a key issue in ensuring that capital
approach and a conviction that valuations are reasonable and markets can function. Liquidity helps bring about underly-
that no “double dip” recession will materialise. ing economic growth. Normally, liquidity triggers market
movements ahead of the real economy − a process we have
Today’s capital markets are driven by worries about a dramatic observed in various places during the past few months. There
weakening in growth, especially in the US but also in other are many indications that liquidity will remain good in many
parts of the world. Although we are humble about the risk that regions. The US has shown strong determination, China is
such worries could be justified and might eventually lead to a probably moving towards loosening its austerity measures,
double dip, we do not believe that such a scenario will unfold. and the situation of banks in Europe and the US is improving.
However, we see an obvious and likely risk that the US will The new Basel III-related rules in Europe are less stringent
undergo a period of very weak growth. Many other countries than feared, and the money supply has cautiously begun to
will grow quite nicely during the next few years, and emerging rise in the US. Overall, we foresee a continuously improving
markets in Asia and elsewhere will continue to deliver satis- liquidity situation.
factory growth figures. All this is enough to enable the global
economy to show a moving GDP growth rate of 4-4.5 per cent.

2 Source: Bloomberg


-2 Liquidity, measured as broad money supply,
2000 2002 2004 2006 2008 2010 looks set to bounce back both in the US and

US Money supply, change y/y ECB Money supply, change y/y

Investment Outlook - september 2010 15

Theme: Investments when the financial environment changes colour

These issues, and the factors commented on above, are cru- as commodities have recently shown gradually improved
cial when we search for sources of investment returns. One performance, consistent with a more stable growth scenario.
guiding principle in scenarios such as the one we are now When more and more investors believe that the risk of a dou-
experiencing − characterised by uneven, geographically imbal- ble dip recession is receding, this type of sectors will see an
anced economic growth − is to focus on the healthy parts of upswing.
the world. We are also looking at portions of the capital mar-
ket where valuations are attractive. During bouts of worrying In stock markets, the focus will be on a few key areas.
like the one that dominated markets late this summer, even Emerging markets are one, and companies with exports to
sound assets are affected to some extent by downturns, often countries with stable high growth and demand are another.
creating good investment opportunities for the persistent. Stress-tested banks in more positive liquidity climates can also
be mentioned. These key areas have the advantage that even
Generally speaking, the stock market was in a negative phase if we undergo a general recovery − which appears likely during
during the second quarter of 2010, rose in July and fell again in the coming winter − these sectors will perform like the stock
August after growth-rate problems materialised. This pattern market as a whole.
has been relatively uniform, but with certain divergences. The
Swedish stock market is an example of how assets with good EM FIRMS EXPECTED TO GROW FASTER
fundamentals can perform relatively better than others. 20

Signs of a shifting trend
During 2010 the trend has been that economic sectors with
low cyclical sensitivity have been good investments. To some 5
extent, we can say that this trend is now relatively mature, and 0
we are seeing early signs of a shift towards more cyclical sec-
tors. But in order to achieve sustainably positive performance, Source: Bloomberg
the risk of double dip recession must disappear from the radar -10
screen. While awaiting this, we are focusing on the portions 2004 2005 2006 2007 2008 2009 2010
of the stock market with the best potential in terms of growth MSCI THE WORLD - 12 months forward sales growth
and valuations. MSCI EM - 12 months forward sales growth

Emerging market-based companies are expected to show

sales growth of about 14 per cent during the coming 12
1.2 months, compared to about 7 per cent for their Western
counterparts. Companies in the West with EM exposure
should also benefit during this period.
On the whole, stock markets in emerging countries have
recently performed as well as − or somewhat better than −
0.4 global stock markets (in comparable currencies). Investments
Source: Bloomberg
in emerging markets can be justified by stable growth and
relatively attractive valuations compared to Western countries,
0 which in some cases are stagnating. China has been a source
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 of concern, but there are many indications that Chinese au-
EM/DM Discount thorities are easing their economic tightening measures as
they gain control over bank lending and price trends. China
The emerging market (EM) ratio, measured here as the
should then revert to a higher growth rate, and the market
price-earnings (P/E) ratio for the EM sphere divided by the
will perform well. The country is also an important engine of
P/E ratio for the Western world, has gradually risen over the
overall Asian trade and now buys a sizeable proportion of the
past decade and is at about 0.9 today − a sign that emerg-
exports of most Asian countries. The role of the US is gradually
ing markets are considered less risky than before and that
capital is continuing to flow to countries with higher growth
Stock market sectors with exposure to good geographic de-
mand are another key area. In this past summer’s quarterly
When the economic pattern eventually changes, an increas-
reports, there was a dividing line between companies that
ingly cyclical portfolio strategy will be justified. To some
export to emerging markets and other areas. It is crucial to be
extent, we can see that these shifts have begun. Sectors such
invested in this part of the market.

16 Investment Outlook - september 2010

Theme: Investments when the financial environment changes colour

Plenty of liquidity in companies Corporate bonds offer attractive possibilities. Those with the
Investment goods producers are another attractive area. very highest credit quality are depressed, but in our assess-
Businesses around the world are probably underinvested after ment the High Yield segment is very attractively priced. The
many years of thrift, and companies also have plenty of liquid- volatility of returns is also lower than in the stock market,
ity. Given this combination, capital spending may be a factor which makes this segment interesting.
worth monitoring in the near future.
During periods when the world is in a phase where a variety
Banks are a sector that stimulates thoughts. Improving liquid- of factors are influencing the market, with a negative under-
ity often leads to better risk appetite and credit expansion. On tone and uncertainty about the future, it is extra important
the whole, the European sovereign debt crisis is now limited or to invest in assets that are stable in terms of low valuations
“quarantined”. Although there are still sizeable budget deficits, and revenue streams. In a situation like this, the market risk
their impact is currently being offset by unexpectedly strong premium rises and we require lower valuations in terms of
economic conditions in Europe. In the US we foresee a slight price/earnings ratios, bond yields etc. This hurts securities
trend towards higher lending, and in a normalised scenario, with uneven returns and quality more than others. But phases
banks valuations are not high. like these are succeeded by new periods, when today’s higher
risk premium may be replaced by a lower premium. The stock
Unreasonably low bond yields market will boost the value of all companies to a higher P/E
In mature industrialised countries today, government bond ratio, since it will have more confidence in the future. Viewed
yields are extremely low. By all indications, these yields reflect in this perspective, today’s relatively low valuations and thus
worries about deflation and weak economic conditions. Good high risk premiums may be regarded as offering good invest-
liquidity in capital markets probably means that yields have ment opportunities.
been squeezed to unreasonably low levels. It is thus difficult to
see any point in investing in them. Around the world there are If we do not undergo a double dip recession and if the world
other fixed income investment opportunities. We have previ- economy continues to grow by 4-5 per cent annually until
ously singled out the government bonds of emerging markets, 2012, consistent with a slow global recovery, this autumn may
where we continue to see a combination of attractive yields very offer good investment opportunities. Investors are buy-
and potential currency rate appreciation. Here it is important ing bonds on a large scale today, and as a result the yields on
to take one’s base currency into account. If we are moving to- shares of many good companies are higher than bond yields.
wards a sharp appreciation in the krona, there may be reason Historically, this is often a good buying opportunity. But when
for Swedish-based investors to be extra careful in evaluating worries subside and risk appetite increases again, this situa-
their opportunities. Investors that use the euro as their base tion will be corrected.
currency still have even greater potential.

1100 1100
1000 1000
900 900
800 800
Basis points

600 600
500 500 CDS spreads for emerging market debt and
400 400 High Yield bonds − in other words, what inves-
300 300 tors must pay to protect themselves against
200 200 bankruptcy in underlying fixed income securi-
100 100 ties − have fallen dramatically since Septem-
0 0 ber 2008. Although we foresee EM bonds offer-
2006 2007 2008 2009 2010
ing return potential similar to HY bonds, the
Emerging Markets, CDX Index, EM North America, CDX Index, HY, BB Rated market views EM securities as less risky.
North America, CDX Index, IG
Source: Reuters EcoWin

Investment Outlook - september 2010 17

A dualistic world

Micro and macro are out of step

• Economic growth is slowing but... the economic world from a micro (“bottom-up”) or a macro
(“top-down”) perspective?
• ...share prices reflect more than GDP growth
Different comparative methods
• Ample cash reserves, low debt and high One possible explanation is that there are certain differences
productivity will create good potential in how we choose to study data. To avoid seasonal patterns,
corporate analysts generally choose to compare the results
As the number of downside American macro surprises has from one quarter to the same quarter a year earlier, that is,
increased, worries have emerged about a major slump − espe- year-on-year. This is also a common method of reporting
cially in the US economy. Due to America’s leading role in the changes in GDP growth around the world. But in the US, GDP
world economy, a sharp economic slowdown there would not growth is reported as an increase or decrease compared to the
pass unnoticed in other countries. Although our assessment is preceding quarter, that is, quarter-on-quarter.
that a double dip recession is highly unlikely to occur (see the
theme article “Heavy odds against double dip recession”), sta- At present, these methods are leading to different results. For
tistics published in recent months indicate low growth during example, if we report American GDP statistics year-on-year,
the second half of 2010. As a consequence, growth forecasts the result is that growth continued to accelerate at 3.0 per
have been lowered on a broad front. cent during the second quarter of 2010. This is because the
comparative period − the second quarter of 2009 − was par-
Despite the relatively gloomy macro picture, there are many ticularly weak. But on a quarter-on-quarter annualised basis,
bright spots in the crystal balls of corporate analysts. Profit growth peaked at 5 per cent in the fourth quarter of 2009
forecasts have generally been revised upward in recent and then gradually decelerated to 1.6 per cent in the second
months. Companies have ample cash reserves, profit growth quarter of 2010.
is accelerating and productivity is high. In both the first and DIFFERENT METHODS, DIFFERENT RESULTS
second quarters of 2010, about 50 per cent of US listed com-
panies surpassed analysts’ expectations by a wide margin. The 5 5
same pattern applies to many listed companies elsewhere. 3 3

1 1
During the summer, however, macro statistics largely set the
-1 -1
Per cent

market tone. According to a recent analysis from Goldman

Sachs, the S&P 500 index of US shares fell by an average of -3 -3
0.8 per cent on days when important American macro statis- -5 -5
tics were published. On other days, the index instead rose by Source: Ecowin
-7 -7
an average of 0.3 per cent. Q1 Q3 Q1 Q3 Q1 Q3 Q1
2007 2008 2009 2010
National Income Account, National Product Account [ar ma 1 quarter]
It is rare for outlooks to diverge as clearly as macro and micro National Income Account, National Product Account [c.o.p 4 quarters]

perspectives have done. The last time this happened was

when the financial crisis broke out, and we are painfully aware The US seems to be accelerating if its growth is measured
of the subsequent course of events in the world’s financial year-on-year, largely because the first half of 2009 was charac-
markets. Conditions are not the same today as then, however. terised by a deep economic slump. But on a quarterly basis the
By all indications, there is no gigantic asset bubble of the “sub- economy has decelerated, reflecting a weaker cyclical upturn.
prime” variety waiting to explode in the near future. But why
is the picture is so different, depending on whether we look at

18 Investment Outlook - september 2010

Theme: A dualistic world

Another explanation is that in some respects, macro statistics tion of financing themselves with the help of corporate bonds
may be regarded as more current than company reports. The as an alternative to traditional bank loans. Since corporate
final company reports for the second quarter were published analysts focus on the portion of the business sector that is
in late August. These reports thus reflected activity in compa- currently performing best − large companies − it is reason-
nies that occurred nearly 5 months earlier. Most macro statis- able that their future scenario is brighter than that of macro
tics, however, are published on a monthly basis − for example analysts.
employment, inflation and home price statistics. Hints of a
deceleration in the American economy began to be discernible Decoupling firms from national economies
in May macro data, so the negative macro signals of recent In the past year, a rather clear connection has been noted be-
months should not have fully impacted corporate second tween the economic health of countries and the performance
quarter reports. of their respective stock markets. The financial insolvency of
many Western countries has had a particularly large impact.
Cost-cutting behind profit growth The economic slowdown in the OECD countries and the
Furthermore, there are many indications that the impressive launching of gigantic bail-out packages have dug deep holes
growth in corporate profits has not primarily been due to in many Western government treasuries. Investors have con-
sharply higher sales, but has instead been a consequence of sidered it risky to put their money into companies that operate
aggressive cost reduction. This cost reduction has occurred in weak economies. Among other things, these companies risk
mainly by means of employee cutbacks, pay reductions, fewer lower demand and higher taxes than competitors based in
working hours and postponements of capital spending. The economies that are on more stable financial ground.
effect has been sharply higher productivity, which in turn has
generated rising profits.

Looking ahead, however, it will not be possible to maintain 20

rapid profit growth by means of cost reductions alone, since 15

there is a limit to how much a company’s operations can be
streamlined. If higher sales do not gradually contribute more Source: Ecowin
and more to corporate profits, the gloomier scenario painted -5
by macro data risks materialising. On the other hand, con- -10
sumption will take off sooner or later after every recession, so -15
the upward adjustments in company profit forecasts may be -20





Apples and pears

In some respects, however, comparisons of corporate and In the past year, investors have prioritised stock markets in
macro analyses are like comparisons of apples and pears. The countries with sound finances (such as Denmark, Sweden
purpose of macroeconomic analyses is to explain and forecast and Finland), while stock markets in countries with large
economic activity at an aggregate level, for example the out- debt burdens have been at a disadvantage (Japan, the
put of all goods and services in a country. Corporate analyses United States and the United Kingdom).
− on the other hand − track activities at the enterprise level,
and large listed companies are the primary focus of study. One old fundamental principle − which ought to be partly re-
Since different data are being analysed, it is actually not so assessed − is that corporate earnings or share prices should
remarkable that their view of the future may diverge. reflect the performance of a country as a whole. In the long
term, share prices are determined by corporate profits and
Recently, for example, large companies have performed sig- expectations about what will happen to them in the future.
nificantly better than small businesses. Looking at the 500 Profits, in turn, are dependent on underlying economic per-
largest companies in the US as measured by the S&P 500 formance in the market where the company operates. But be-
index, profits rose nearly 100 per cent during the first quarter, cause of globalisation during the past decade, companies and
compared to the first quarter of 2009. If smaller US companies their shares have an ever-weaker connection to the economy
are also included, however, profits rose by “only” a bit above of their “homeland”.
30 per cent. The reasons for the success of larger companies
are that, firstly, a relatively high percentage of their production For example, an investor achieves relatively little exposure to
is often exported and they can thus target their sales to areas the Swedish economy by purchasing a Sweden fund. About 50
where demand remains high, and secondly, they often have a per cent of everything produced in Sweden is exported, and
far easier time gaining access to lending. Smaller businesses among the companies with Swedish stock market listings, all
have fewer contacts in the financial sector and lack the op- indications are that the proportion of exports is even higher.

Investment Outlook - september 2010 19

Theme: A dualistic world

This is because listed companies are significantly larger and We expect the global economy to grow by nearly 4.5 per cent
more international than the average company in Sweden. The this year and nearly 4 per cent in 2011, which is above the
same reasoning also applies to investors who choose to put historical trend. Viewed from a global perspective, we are thus
their money in the German, American or Chinese stock market not in an economic slowdown at all. Coupled with the fact that
− although the share of exports in these countries is lower. companies have ample cash reserves, low debt and record-
high productivity, this will set the stage for good economic
China and Brazil are also examples of how share prices are conditions ahead.
related to more than just the GDP growth of a country. China
is a growth engine that can boast annual GDP growth rates The companies with the greatest potential are those that have
of nearly 10 per cent since 1994, while Brazil’s annual GDP the world as their playing field and can target their sales to
growth has only reached 3 per cent during the same period. areas with high demand. This is primarily a matter of exposure
Although China thus easily wins the growth competition, to emerging markets, but also to prosperous OECD markets
Brazil’s stock market has performed significantly more strong- such as the Nordic countries. However, the corporate giants
ly than the Chinese stock market during the period. are not alone in realising that demand also exists outside their
national boundaries. Many medium-sized companies are also
Winners in a weakening economy steadily expanding their exports as a share of total sales. In
At the aggregate level, there are many indications that the US addition, the outlook appears bright for companies with well-
economy, but also the global economy, is about to decelerate. tested, successful business models, for which cyclical fluctua-
GDP growth is now slowing in many places as the contribu- tions are of minor importance.
tions from government stimulus measures and company
inventory build-up fade. So far, final demand is also showing
a rather weak trend. The slower economic upturn is likely to
have an adverse impact on the order books and profit growth
of many companies. But having said this, there are also numer-
ous companies that have good potential to meet corporate
analysts’ high profit forecasts.






5 The Brazilian stock market has performed

Source: Bloomberg significantly better than that of China, even
0 though economic growth has been far higher
1994 1996 1998 2000 2002 2004 2006 2008 2010 in the Chinese economy than in Brazil. In other
words, share prices need not always reflect
GDP growth.
Brazil vs China

20 Investment Outlook - september 2010

Macro summary

Much depends on shift to final demand

• The economic outlook is uncertain, and in the upswing, led by Germany, was driven by exports and to some
extent by capital spending. Household demand remains un-
OECD the key will be… certain, however, and the upswing may have been partly due
• ... how the shift from stimulus to final demand to positive effects from the inventory cycle, which − as is now
occurring in the US − is likely to shift from positive to negative
will go later this year. Sharp budget tightening in the Mediterranean
• Decent world growth thanks to ultra-loose region will also restrain growth. Our forecast for the euro zone
thus includes an economic slowdown, but it appears unlikely
monetary policy in major industrialised to be too pronounced. Euro zone GDP growth may average
countries and dynamism in the emerging about 1.5 per cent during the coming year.
market sphere
British GDP also climbed more than expected during the
second quarter. Tough fiscal tightening will hamper expan-
World economic prospects have become significantly more
sion, yet our forecast path for growth until next summer is bit
uncertain lately, since numerous macro statistics − especially
higher than in the euro zone.
in the US − have been surprisingly weak. Looking ahead, the
key to economic growth in the industrialised countries (OECD)
The Nordic countries are characterised by public finances that
will be the shift in emphasis from stimulus attributable to the
are in relatively good shape and by low central government
inventory cycle and fiscal policy measures to final demand in
debts. Combined with sizeable current account surpluses, this
the form of capital spending and private consumption. Our
bodes well for a decent economic upturn. In Sweden, growth
main scenario is that this shift will occur fairly satisfactorily
will remain very rapid in the near future, while in other Nordic
but will not be good enough to keep the OECD countries from
countries growth will occur at a more moderate pace. The
moving into a slower growth phase during the second half of
Danish economy is still being hampered by the repercussions
2010 and the early part of 2011.
of the housing market crash.
Inflation will continue to fall in the OECD countries during the LOWER OECD INFLATION AHEAD
coming year as low pay hikes, coupled with good productivity
growth, squeeze production costs at companies. In the emerg-
ing market (EM) sphere, however, inflation will not slow. The
Year-on-year percentage change

reasons are high growth and faster pay increases. Since many 12.5

EM currencies appear likely to appreciate in the near future, 10.0

export goods from these countries will also become more 7.5
expensive in the global market, reducing the risk of deflation 5.0
(generally falling prices) around the world. 2.5

After last winter’s rapid upswing, the world’s largest economy
− the United States − will grow very slowly during the remain- 1980 1990 2000
der of 2010 and early in 2011 (see the Theme article on page c.o.p 12 months

11), then gain a little better momentum. Source: Reuters EcoWin

Since the early 1980s, inflation in the industrialised OECD

While many macro figures in the US have caused disappointed countries has trended downward. Today consumer prices
reactions, some other influential industrialised economie have are rising at less than 2.5 per cent year-on-year. Thanks to
presented upside surprises this summer. In the euro zone, low pay increases and good productivity growth at compa-
growth speeded up significantly in the second quarter. This nies, inflation may fall below 1 per cent in 2011.

Investment Outlook - september 2010 21

Macro summary

In Finland there is good potential for an export-led recov- highest figure in the world after Western Europe (more than
ery, but so far the upturn has been modest. The Norwegian 70 per cent).
economy is being held back by a strong currency. In the Nordic
countries as a whole, the GDP growth rate will be about 2.5 Latin American economic expansion looks set to slow some-
per cent during the next few quarters. what in late 2010 and early next year − with GDP increases
averaging some 5 per cent − as growth figures in the dominant
Japan − today only the third-largest economy in the world − Brazilian and Argentine economies decelerate from their unu-
seems to have lost most of the vitality and dynamism that sually high early 2010 rates (7-9 per cent).
characterised the 1970s and 1980s. Developments in recent
years have occasionally been reminiscent of the country’s Broader-based expansion in Eastern Europe
years in the economic wilderness during the 1990s. Unlike In Eastern Europe − which is lagging the global recovery −
Europe, second quarter 2010 GDP largely stagnated. Among expansion is now broadening and accelerating as private
today’s challenges are the strong yen, which is detrimental to consumption joins the upturn that has characterised the
exports, fading budget stimulus effects and higher unemploy- manufacturing sector for some time. GDP may increase by
ment. On the other hand, Japan is being helped by higher around 4.5 per cent in the coming year. Meanwhile inflation is
demand elsewhere in Asia (where more than 30 per cent of falling and macroeconomic balance with other countries and
Japanese exports end up). Japan nevertheless appears to be in the public sector is improving. In the Baltic countries, both
the most uncertain card in the world economic deck, with GDP Estonia and Lithuania have recently reported positive GDP fig-
growth averaging 1-1.5 per cent until next summer. ures, while Latvia has lagged behind. The Baltic economies are
being sustained by strong exports, but domestic markets re-
Room for stimulus in China main sluggish. Deflation pressure is gradually easing, financial
As in the US, growth in China − now the world’s second largest stability is strengthening and Estonia will join the euro zone on
economy − has decelerated. But in China’s case the slowdown January 1, 2011.
was from GDP growth of nearly 12 per cent in the first quarter
of 2010 (year-on-year) to a still very good level of nearly 10.5 We expect the emerging market sphere as a whole − which
per cent in the second quarter. Macro data for July indicate accounts for nearly 50 per cent of world GDP (in purchasing
further deceleration, but unlike such countries as the US, power parities, PPP) − to grow by nearly 7 per cent this year,
Chinese authorities have considerable room to stimulate the 6 per cent in 2011 and around 6.5 per cent in 2012. Largely
economy using both monetary and fiscal policy. There are also due to this macroeconomic vigour and ultra-loose monetary
signs that they are making a U turn from the tightening policy policies in major industrialised countries (see pages 26-27),
that began in January 2010. China’s growth may end up at the global economy will be able to steam ahead at an annual
around 9.5 per cent during the coming year. rate of about 4-4.5 per cent in 2010-2012 (since 1990, yearly
world GDP growth has averaged less than 3.5 per cent), even
In India − Asia’s second largest economy − domestic demand though the world’s still-largest economy − the US − has moved
remains strong. Although monetary policy has been further into a clear short-term slowdown and will grow very slowly in a
tightened, GDP has a chance of growing at about an 8.5 per somewhat longer perspective.
cent pace in the next few quarters. High growth in China and
India will benefit smaller economies in Asia, since Asian intra-
regional trade is a full 50 per cent of total trade − the second


Year-on-year percentage change


10 The financial and economic crisis of 2008/2009

8 also affected growth in China and India, but the
deceleration was mild − to annual GDP increases
of 6.5-7 per cent. Since then the growth rate has
again accelerated. Although its fastest growth
2 period is now past, China’s GDP may grow nearly
0 10 per cent in the coming year and India’s by
2005 2006 2007 2008 2009 2010 about 8.5 per cent. Smaller neighbouring econo-
China, Total, growth rate
India, Overall, Total at factor cost, 2004-2005 prices mies will thus benefit as well.
Source: Reuters EcoWin

22 Investment Outlook - september 2010

Asset class:

Waiting for better stock market times

• It will be a while before the macro picture be parts of the world and the prospect of economic policy stimu-
comes clear... lation in China as well more easing by the American central
bank, the Federal Reserve (Fed). The third phase started sev-
• the best-positioned equities in terms of eral days into August, when a period of many negative macro
growth and valuation... surprises in the US began and the risk of a double dip reces-
sion (see Theme article, page 11) topped financial headlines,
• ...will now determine our investment strategy in causing share prices to fall on a broad front.
the stock market
Divergent regional stock market outcomes
During the period June 1-August 31, the world stock market
During the summer, the global stock market was dominated (measured as the MSCI World Index in local currencies) fell
by three distinct phases. The first was in June, when a good about 1.5 per cent. The summer’s best outcomes were in
start to the month − a rebound after dramatic share price emerging market (EM) stock markets, with Russia, India and
declines in late April and during May − was followed by a Hong Kong among the leaders. In China, the stock market
renewed sharp downturn, first due to lingering worries about mood was occasionally weighed down by macro statistics
European government finances and later due to nascent con- showing a deceleration in growth. Several European stock ex-
cerns about the state of the US economy. changes, among them Frankfurt and Stockholm, recorded fine
upturns this summer following unexpectedly good economic
The second phase was in July and early August, when risk ap- figures. Among the laggards were Japan − where an undesir-
petite returned to risk asset markets and stock markets rose. ably strong currency and a weak domestic market contributed
This occurred thanks to reduced worries about European gov- to weaker share prices − and the US, where concerns about a
ernment finances and banks, unexpectedly positive economic double dip dominated stock exchanges.
data from Europe, strong company earnings reports in many


15.0 15.0
-16.8216718242 9 9

12.5 12.5
1.3865530126 7 7
10.0 10.0
5 5
Per cent

7.5 7.5
Per cent

3 3
5.0 5.0
1 1
2.5 2.5

0.0 0.0 -1 -1

-2.5 -2.5 -3 -3
Sep Nov Jan Mar May Jul Sep Sep Nov Jan Mar May Jul Sep
2009 2010 2009 2010
perf %, - World, MSCI, All Countries USD Index, Gross Total Return, perf % perf %, - World, MSCI, All Countries USD Index, Gross Total Return, perf %
perf %, - World, MSCI, All Countries USD Index, Gross Total Return, perf %, ma 20 perf %, - World, MSCI, All Countries USD Index, Gross Total Return, perf %, ma 20
Source: Reuters EcoWin Source: Reuters EcoWin

Last spring the American stock market (right-hand chart) outperformed the World Index, among other things
because macro statistics were still good. Since then the US market has performed considerably worse than the
World Index, due to rising concerns about a double dip recession. Meanwhile equities in emerging markets (left-
hand chart) did far better than the global share price index, largely due to continued high economic growth.

Investment Outlook - september 2010 23

Asset class: Equities

On the whole, financial market patterns in recent months have and clear deceleration that might ultimately lead to a global
closely matched the assessments we made in this year’s pre- double dip recession.
vious issues of Investment Outlook (March and May 2010). At
that time we foresaw continued sideways price movements for Furthermore, the profit outlook remains good. In the US and
risk assets, in the context of “range trading”. In the stock mar- Europe (including Sweden), forecasts show more than a 20
ket, we predicted comparatively better returns for sectors and per cent profit increase during the next 12 months, while the
companies that usually perform well without strong support equivalent figure for China and Brazil is about 25 per cent.
for the economic cycle (assets characterised by quality and This profit outlook, along with share price declines during
low beta). Sectors with low cyclical sensitivity − and thus de- the past month, has resulted in low share valuations. In itself,
fensive in nature − have been good investments. They include this lays the groundwork for higher share prices. In the OECD
telecommunications, food, pharmaceuticals, biotechnology countries, stock markets are trading at price-earnings ratios of
and utilities. about 10-13 (expected 12-month profits), and valuations are
about the same in many EM stock markets.
In general terms, cyclical companies performed worse than
stock market indices during the summer, but in both the US EQUITIES HAVE LOW VALUATIONS
and Sweden the shares of industrial companies did fairly well. 19 19
This was essentially true of companies that have a large pro- 18 18
portion of their sales targeted to the EM sphere. Companies 17 17
with sizeable exposure to Europe were also favoured by the P/E ratio 16 16
stock market, while sales focusing on the US domestic market 15 15
were no recipe for success. The summer’s prices movements 14 14
in the stock market thus appear to have reflected a macro 13 13
12 12
scenario that includes a decoupling between a weak American
11 11
− as well as Japanese − economy and a strong world economy
10 10
otherwise (the EM sphere, Europe). Aug Oct Dec Feb Apr Jun Aug
2009 2010
DJ EuroStoxx 12MTH FWD P/E S & P 500 12MTH FWD P/E
At present, stock markets and other risk asset markets are OMXS 12MTH FWD P/E
Source: Reuters EcoWin
characterised by rather low risk appetite and great uncertainty,
primarily due to the danger of a renewed US recession. The Share prices have fallen since last spring. Together with
risk that other parts of the world economy may be infected good profit forecasts, this has resulted in declining price-
by an American double dip − in other words, that decoupling earnings ratios in many stock markets. In the US and Europe
might not work − has also been discussed by market players. (including Sweden), stock markets are trading at P/E ratios
of between 10 and 13, which shows that equities have low
Market players gloomier than macro analysts valuations.
In this context, market players now appear to be more pes-
simistic than macro analysts. But in order for a double dip These low valuations are illustrated by the Swedish stock mar-
recession to occur, in theory American GDP must decline both ket, where the yields on equities are more than 7 per cent, or
during the third and fourth quarter of 2010. According to the around 4.5 percentage points higher than on 10-year govern-
current Blue Chip macroeconomic consensus outlook, GDP is ment bonds. This 4.5 per cent risk premium is very high and
instead expected to grow by an average of 2.5 per cent during was surpassed most recently during the winter 2008/2009
the second half. SEB’s forecast is that American GDP will grow financial crisis.
by an average of nearly 2 per cent.
The spread between the yield on equities and on certain
From an investor perspective, it is naturally advantageous if corporate bonds is also wider than normal. Measured in this
the market has discounted a worse American autumn scenario way (yield on S&P 500 shares compared to yield on BAA-rated
than macro analysts have done, since this reduces the risk of bonds), the risk premium is also the largest since the financial
large negative share price movements when weak economic crisis, among other things because the recent search for re-
statistics are published. As long as worries about a double dip turns (see pages 26-27) has resulted in falling corporate bond
recession persist and signs that final demand will take over yields. In a longer historical perspective, however, these vari-
as an economic engine are weak, some US economic data is ables have tracked each other closely.
nevertheless likely to result in disappointed reactions in stock
markets during the next few months. Considering the prevailing uncertainty about the macroeco-
nomic outlook, however, high risk premiums are not sufficient
Meanwhile there is no clear evidence yet that other parts of reason to increase the proportion of equities in our portfolios
the world economy − except for Japan − face an immediate right now.

24 Investment Outlook - september 2010

Asset class: Equities

Stock markets are also currently being propped up by excep- residential construction published around the same time were
tionally stimulative monetary policies in much of the OECD more or less dismal. The stock market was probably speculat-
and by historically low government bond yields in many in- ing that the housing sector might bottom out fairly soon. Part
dustrialised countries. In the US, however, the association be- of the picture is that US residential construction has fallen to
tween the stock market and the government bond market has an extremely low level, taking into account both history and
been highly erratic since mid-2010. In July, share prices rose national demographic trends (see also page 14).
concurrently with bond prices (bond yields fell), while August
was characterised by falling share prices and a continued up- Range trading for another while
turn in bond prices (yields kept falling). But since it will probably be some time before the macro
picture becomes clearer – the shift from stimulus to final de-
The level of government bond yields is thus not the important mand is successful in the OECD, led by the US, and emerging
thing. What instead is important is the reason behind the market growth remains high – our forecasted stock market
decline in yields. In July, yields fell on expectations that the scenario, characterised by range trading and a focus on alpha
Fed would ease monetary policy further, which is ordinarily companies that hold their own on the stock market when risk
welcomed by the stock market. But in August, worries about a appetite is feeble, will apply for another while.
double dip recession − something that hurts the stock market
− pushed down bond yields. Our investment focus is on regions and economic sectors with
the best potential in terms of growth and valuations, such as
In July, the US fixed income yield curve thus became steeper emerging markets and companies in industrialised countries
as short-term interest rates fell more than longer yields (the with a large proportion of exports targeted to countries with
two-year yield hit a new record low), but in August the curve high growth and demand. What is happening in China’s econ-
flattened as long-term yields fell the most. omy and economic policy has occasionally worried the stock
market this year, but there are signs that Chinese economic
Our conclusion is that changes in the slope of the yield curve policy will ease. This would set the stage for renewed growth
are a very important stock market variable, and the latest acceleration, thus benefiting the stock market.
movement in the curve has thus not benefited the stock mar-
ket, but a look at history shows that the yield curve must be Sectors specialising in investment goods are also attractive.
flat or have a negative slope before a recession is foreseeable. Especially in the OECD countries, companies sharply reduced
their capital spending during the economic and financial crisis
To some extent, the defensive trend in the stock market has and in many places capital spending is only equivalent to
begun to approach the mature stage. There are early signs of wear-and-tear (depreciation). Together with large liquidity in
increased interest in more cyclically sensitive economic sec- the corporate sector, this increases the likelihood of stronger
tors. Recently, for example, housing-related US equities per- capital spending ahead.
formed better for a while than the American stock market as
a whole, even though statistics on both housing demand and

20 20
15 15
10 10
5 5
0 0
-5 -5
-10 -10 In August, stock markets were dominated
by worries about an American double dip
-15 -15
recession. As a result, defensive sectors
Sep Nov Jan Mar May Jul
(such as health care and consumer staples)
2009 2010 performed better than cyclical sectors (for
Consumer Discretionary [perf %, - 500 Composite, perf %]
Industrials [perf %, - 500 Composite, perf %] example industrials and health care) on US
Materials [perf %, - 500 Composite, perf %]
Consumer Staples [perf %, - 500 Composite, perf %] stock exchanges, but late in the month there
Health Care [perf %, - 500 Composite, perf %] was increased interest in cyclical companies.
Source: Reuters EcoWin

Investment Outlook - september 2010 25

Asset class:
Fixed income

HY benefiting from search for returns

• Yields on government securities are historically Since early summer, yields on US Treasury bonds have fallen
low… substantially more than the equivalent yields in Germany and
Sweden, for example. This can be viewed as indicating that
• investors searching for high effective the foremost source of concern this summer was the risk of a
returns... US double dip recession (see the Theme article on page 11),
while worries about government finances in many European
• ...have no alternatives other than High Yield countries are no longer in the spotlight.
and EM bonds
Government bond yields in industrialised countries are indeed
likely to rise during the next couple of years, but by all indica-
Government bond yields on both sides of the Atlantic have tions this upturn will be modest.
fallen sharply since last spring, reaching historically low levels.
There are several reasons − increased worries about the eco- Inflation pressure will remain very low and growth will conti-
nomy, falling inflation expectations and signals from various nue to be relatively slow. Central banks have strong motives
central banks that they are prepared to prop up their eco- to preserve their ultra-loose monetary policies for a long time.
nomies with exceptionally low interest rates for an extended Looking ahead a few years, deflationary forces (a squeeze on
period. A rapid rise in household savings ratios in the OECD prices) will also dominate the OECD countries and southern
industrialised countries during the past few years − partly European countries will be especially grateful for low govern-
channelled into government securities − has also contributed ment bond yields over a long period, enabling them to correct
to low yields. the prevailing imbalances in their competitiveness and public
In addition, government bond markets in influential indu-
strialised countries have functioned as “safe harbours” when There will also be major consequences if premature interest
financial worries have escalated. This was most apparent last rate hikes should halt the economic recovery, since many
spring, when a government financial crisis with its epicentre in countries have very little room for manoeuvre in fiscal policy
southern Europe was the focus of attention. and their monetary policy weapons are essentially exhausted.
It thus appears as if the Federal Reserve, the European Central

8 8

7 7


5 5
A key interest rate (brown) close to zero and
Per cent

4 4 possible further easing by the Fed, greater

3 3 concern about the economy, less concern
2 2 about inflation and increased appetite for
1 1
“safe” government securities resulted in a size-
able decline in US Treasury bond yields (blue)
0 0
2004 2006 2008 2010 this summer. Although yields on corporate
Corporate Benchmarks, BBB Rated, 5 Years, Yield
bonds (green) have also fallen, they remain
Government Benchmarks, Bid, 5 Year, Yield, Close
Policy Rates, Fed Funds Target Rate very attractive.
Source: Reuters EcoWin

26 Investment Outlook - september 2010

Asset class: Fixed income

Bank and the Bank of Japan will keep their key interest rates Prospects also remain bright, at least during the remainder of
unchanged until 2012 and then begin to raise these rates 2010 and the first half of 2011. Corporate bonds will benefit
very cautiously. Nor should it be ruled out that within a few from the world economic upturn, and if uncertainty about
months, the Fed will start buying Treasury bonds on a large the growth outlook increases − illustrated by the speculation
scale (quantitative easing). The Bank of England, however, about a US double dip − corporate bonds are in a far better
may use its interest rate weapon somewhat earlier − late in situation than equities.
2011 − since British growth and inflation are both predicted to
be higher than in the US, the euro zone and Japan. Rapidly falling bankruptcy levels
The percentage of companies that go bankrupt is falling rap-
Divergent conditions for central banks idly on both sides of the Atlantic. According to SEB’s forecast,
The divergences in conditions surrounding major OECD cen- the share of European issuers of High Yield bonds going bank-
tral banks and the central banks of commodity-producing rupt (12-month figures) will fall from the current 6 per cent
countries like Canada, Australia and New Zealand as well to 1.5 per cent this coming winter, while corresponding US
as Norges Bank in Norway and the Riksbank in Sweden are figures are 6 and 3 per cent, respectively. The total number of
becoming ever clearer. While the major central banks have companies whose bonds are classified as High Yield is about
reasons to hold off for a very long time before beginning their 250 in Europe and more than 1,500 in the US.
key rate hikes, stronger economic conditions, certain inflation
risks and in places somewhat overheated real estate markets During the coming year, our expected return on High Yield
give the other central banks reasons to gradually ratchet up bonds is considerably above that of Investment Grade bonds.
their key rates during the next couple of years. Effective yield is far higher and the room for narrower yield
spreads against government securities − and thus for price
In the emerging market (EM) sphere, too, many central banks gains − is larger, especially after last spring’s widening of yield
are confronted with high economic growth and mounting risks spreads.
of overheating, for example in India and Brazil, where contin-
ued rate hikes are in the cards. In China, however, the econ- The wide yield spreads in the High Yield segment also provide
omy has begun to slow down, though from very high gear, a sort of “cushion” in the event that US and European govern-
and inflation pressure excluding food is apparently starting to ment bond yields (the benchmark for yield spreads) should
ease. This means that the need for further monetary tighten- unexpectedly begin to rise rapidly, while the yields on the
ing in China has diminished, and instead the authorities will highest-rated Investment Grade bonds − which today are mar-
probably soon ease the country’s economic policy a bit. ginally above the equivalent government bond yields − would
be forced upward, with price declines as a consequence.
High Yield remains attractive
Government bond yields in the EM sphere are still substantial-
ly higher than in the OECD countries. This means that effective ADVANTAGE: HIGH YIELD
yields are far more attractive. EM government bond yields may
indeed rise somewhat as a result of key interest rate hikes, During the past 25 years, the average annual
relatively rapid price increases and other factors, but result- return on US High Yield bonds has been 9.7 per
ing bond price risks are nevertheless regarded as fairly small. cent and on equities (S&P 500) 10.4 per cent,
while the corresponding volatility figures were
Thanks to the prospects for stronger EM currencies, emerging 8.5 and 15.6 per cent.
market debt as an asset class thus appears attractive to inves-
tors with such currencies as the euro or Swedish krona as their Also worth noting is that a portfolio of US High
base currency. Yield bonds in the B and BB segments had a his-
torical correlation of less than 50 per cent with
equities. Such bonds are thus a good alternative
Corporate bonds − meaning High Yield − also remain attrac- to equities, especially when the economic out-
tive. The downturn that dominated risk assets during the look is more uncertain than usual.
second quarter of 2010 also affected corporate bonds − yield
spreads against government securities rose and bond prices
narrowed − but the decline in value was far less than for equi-
ties. In July, when risk appetite returned to financial markets,
corporate bonds again performed strongly, and August was
another good month.

Investment Outlook - september 2010 27

Asset class:
Hedge funds

Hedge funds withstood turbulence

• The rules of the game are changing… have been major divergences in market performance between
different strategies and also between different hedge funds.
• …in a volatile market…
So far this year, hedge funds as a group have generally per-
• …but good portfolio characteristics can be formed in ways that have preserved present value for those
found who have been invested in the asset class. This is more than
stock markets, for example can boast. At the end of August,
In this year’s first Investment Outlook (March), we wrote that global stock markets measured as the MSCI AC World index
“Looking ahead, it will be substantially more important for in- in local currencies was down about 5 per cent from the begin-
vestors to take advantage of qualitative funds that thoroughly ning of 2010. Looking at the second quarter, the same index in
hedge their downside…”. Most of 2009 consisted of a recovery local currencies was down about 11 per cent, while the HFRX
after the financial crisis − a relatively simple market from a Global Hedge Index lost 2.8 per cent.
hedge fund management perspective. We expected 2010 to
Better risk-adjusted return
be more difficult, giving genuine quality hedge funds an op-
In portfolio terms, our hedge funds have provided good pro-
portunity to prove their merit and value.
tection in a difficult market climate. This asset class is helping
us improve the odds in our overall investments and is provid-
The financial market year began well and then underwent a
ing a better risk-adjusted return. As usual when it comes to
crisis period in late January and early February. This was fol-
hedge funds, there is a wide divergence in results between
lowed by a very good period, then a government finance crisis
hedge funds, and it is crucial to invest in the “right” hedge
in which Europe was the main focus of attention. Worries
fund. Our collaboration with Key Asset Management helps
about overheating in China, the oil leak disaster in the Gulf of
enable us to identify good hedge funds with sound character-
Mexico and the risk of double dip recession were other events
istics over time and to build portfolios with the characteristics
that made the investment climate more difficult. Hedge funds
we are looking for. The chart below shows the performance of
were naturally affected by their surroundings, like all other as-
hedge funds compared to the VIX volatility index.
set classes, and this year has been challenging to date. There

10 1190
15 1185
20 1180
25 1175
Per cent


35 1165
40 1160
Most hedge funds have had a difficult time
45 1155 coping with volatile markets this year, with ma-
50 1150 jor fluctuations in returns as a consequence.
55 1145 The chart shows how hedge fund returns
60 1140 occasionally followed (un)willingness to take
Jan Feb Mar Apr May Jun Jul Aug risks, as measured by the VIX index (inverted in
2010 the chart).
World, HFR, Global Hedge Fund Index United States, CBOE, Volatility Index (VIX)
Source: Reuters EcoWin

28 Investment Outlook - september 2010

Asset class: Hedge funds

Considering the market we expect in the near future − a we see M & A deals being announced here and there, includ-
modest recovery − we will focus even more on hedge funds ing some fairly large transactions. In this type of climate,
that are “genuinely” diversified. Absolute return and driving Event Driven hedge fund strategies will deliver good earnings.
forces other than stock markets are characteristics we look for Although the world economy is recovering, it will do so at
among managers. This will mean that we will focus more on an uneven pace. Some countries still face major challenges,
Global Macro, CTA, Event Driven, Credit L/S and Multistrategy and in the short term their situation may even become a bit
funds. We are reducing our focus on Equity L/S, since we be- tougher. Because of the uneven pace of recovery, companies
lieve we can now achieve a stock market allocation cheaper will encounter divergent conditions. Some companies are hav-
and better via “ordinary” equity funds, but we can benefit from ing a slightly tougher time, while other companies are doing
Equity L/S funds with more neutral elements such as trading. very well − a good breeding ground for Distressed and Credit
L/S transactions. We believe that opportunities in the wake
The market has been unstable so far this year. This has caused of crisis will remain very good in parts of the investment uni-
difficulties for hedge funds, whose managers generally like verse. Correct analysis by hedge funds is important if they are
trends and predictability. The market battle between micro to contribute to good returns in relation to the risk they take.
(company profits) and macro (weak economic statistics) has For these strategies, such analysis is extra important because
been a theme during the year, with hedge funds still success- hedge fund liquidity is often poorer. This means it takes longer
fully manoeuvring through these problems in a satisfactory to sell our holding if we are unable to achieve the desired re-
way. There are naturally disappointments here and there, but turn profile.
on the whole our chosen investments have performed well.
In terms of competition, hedge funds are still able to operate
There is potential in the wake of crisis relatively undisturbed since the competition from banks is still
At the strategy level, we expect Global Macro and CTA low. New legislation (including the Volcker rules) will affect
(Commodity Trading Advisors) to function nicely. They have hedge funds − especially their ownership − but in investment
the potential to cope with short-term volatility and worries, terms, this need not be a disadvantage. Stable returns (even if
while benefiting from trends. Looking ahead, we believe that a they may be considered a bit boring) are exactly what we are
modest recovery will continue should favour these strategies. looking for, and this is also what we think hedge funds will de-
liver in the future. Hedge funds are thus an asset class that we
Another consequence of the nascent world economic im- are more than pleased to include in our Modern Investment
provement will be mergers and acquisitions. More and more programmes.
such transactions between companies will occur. Even today


New US legislation on who may own hedge funds may potentially be impor-
tant to this asset class. The legislation has been debated during 2010. The
question is whether it will matter very much. According to documents sub-
mitted to American authorities, Goldman Sachs and Morgan Stanley alone
have nearly USD 20 billion invested in hedge funds, private equity, credits
and real estate. In order to comply with the new Volcker rules, which spec-
ify that a maximum of 3 per cent of a bank’s Tier 1 capital may be invested
in hedge funds etc., this would mean that Goldman Sachs and Morgan
Stanley must reduce their exposure by more than 60 per cent during the
coming decade. The alternative would be to increase their Tier 1 capital.

This should not be a disaster in a hedge fund market, where a total of more
than USD 2 trillion is invested. The market should be able to swallow the
expected future assets offered for sale. This will change the market, but
there will be positive elements as well. For example, hedge fund ownership
structure will become more transparent, which might benefit investors.

Investment Outlook - september 2010 29

Asset class:
Real estate

Better and worse

• Bad US statistics but… In China, the economy is slowing down and pessimists who
warned about a real estate bubble during the first half of 2010
• …their reliability is still unclear are starting to fall silent. There are still cities with high resi-
dential and commercial real estate price levels, but the steps
• Asian initiatives to cool the market are working taken by Chinese authorities have meanwhile worked well, so
a decelerating economy is good for real estate markets in this
The world economic recovery has improved the situation situation. The alternative would be an unwanted price crash.
of real estate. Meanwhile recently published US real estate Incidentally, an economic deceleration in China only means
statistics were nearly catastrophic − the worst figures in 15 that growth will fall by a few percentage points to around 9 per
years. On August 24, statistics on existing US home sales in cent instead of double digits.
July were released and were significantly worse than expected,
scaring world stock markets silly. On August 25, statistics on
July new home sales were published and were also abysmal.
These sales figures are worrisome, but in our view they were
instead in fact largely an expected effect. The federal tax January 18, Central bank raises capital reserve re-
credits enjoyed by first-time home buyers in America during 2010 quirement for lenders − the first of three
the spring created a real estate market on steroids and caused hikes.
many buying decisions to be accelerated from the third to the March 18, 2010 State-owned firms that are not real
second quarter of 2010. It is thus completely natural that the estate companies are ordered to
statistics turned worse once the tax credit has expired. withdraw from the real estate market.
April 11, 2010 Banks may not lend to speculators.
Before we can draw any relevant conclusions about how
Americans are dealing with the housing situation after the end April 15, 2010 The cash down payment for second-
of the tax credit, we will probably have to wait until the end of home buyers is increased from 40 to 50
September or maybe until early next year to see clear trends in per cent.
the US real estate market.
April 30, 2010 In Beijing, families are prohibited from
During the prevailing phase of worrying about the world econ- buying more than one new house.
omy, American consumers are naturally hesitant. Their worries
will have to subside and consumers will have to become more The table shows the actions that Chinese authorities have
comfortable with their situation before we can count on any taken to help cool off the market. One result has been a
major upswing in home sales. The labour market is important falling rate of increase in home prices, exactly what was
to consumer confidence and will thus be a key factor in the wanted.
housing market, which in turn is important to the labour mar-
ket. To make consumers eager to buy again, something will Aside from the very largest cities, there are many cities and
have to trigger a market upturn. We rank better labour market regions in China that have much better market conditions and
statistics as the most important factor. If the labour market real estate prices at more reasonable levels. Their population
improves, or at least stabilises, we expect consumers to regain also has a household financial situation that is more in phase
their willingness to buy. This will probably not be a rapid recov- with prices (and they will simply have more money left over).
ery, but a clear trend for the better. This trend could accelerate Looking at China specifically, we note that some large inves-
during 2011 if the world economic situation turns significantly tors, including private equity companies, chose to buy proper-
better, but this is not our main scenario. ties during the summer. We also regard this as a sign that the

30 Investment Outlook - september 2010

Asset class: Real estate

market has become more reasonable and that the bubble The upturn we have seen so far has been investor-led (see
tendencies that have existed are largely under control. Investment Outlook, May 2010). The next stage might be
that the world economy stabilises and that final demand
Varying credit opportunities may boost profitability among real estate companies. If the
Since the financial crisis raged at its worst during 2008, a lot economy improves, we anticipate that businesses can hire
has happened. Starting with zero availability of credit, the more people and that private consumption will increase. This
situation today is far better. A large majority of the real estate would significantly improve rental markets, and the ball would
investors we meet confirm that there is no major difficulty get- be rolling again.
ting loans in the banking system, but banks and other credit
institutions have maintained a more cautious attitude towards Somewhat lower forecasted returns
the size of the loan-to-value ratio. It is not possible to borrow Recent real estate market statistics, together with other world
as much today as previously. Loans totalling a bit above half economic data, have led to a somewhat more sombre recov-
the purchase price seem fully obtainable, however, and this is ery scenario. One consequence of this is that on the margin,
vastly better than no loan at all. In 2008, real estate investors we are lowering our forecasted returns for the real estate asset
were even finding it hard to roll over their loans. Today the class. At present, this will have no actual consequences from
situation is completely different. an investment standpoint. Instead, we still believe that it will
still make sense to own real estate in the future, though with
The precarious conditions then prevailing have been replaced marginally lower returns than we had expected just over one
by a kind of normalcy that is generally supportive of the real quarter ago.
estate market. At present, borrowing costs are also low and
prices have stabilised. Investors also have more confidence in For financial investors who have not yet bought into the real
the market, as evidenced by higher transaction volume. estate market, it may be suitable to start building up an alloca-
tion. Our recommendation is to begin with cautious, broad real
Yet it is still not entirely clear what this new normalcy is. What estate funds and later to add more niche-oriented, higher-risk
will credit opportunities be like when we have left the crisis investments. Certain real estate investments that carry slightly
completely behind? We believe this is the core of the uncer- higher risks may be suitable investments even today, provided
tainty still found in the real estate market. that one is able to identify quality managers with a high level
of asset and real estate management skills.
One risk that we believe exists in the market is that risk ap-
petite among investors is becoming dramatically worse. This
factor grew in strength during the second half of August and
today poses a genuine danger. But our main scenario of mod-
est global economic recovery is an argument in favour of real
estate investments.

Financing cost, %


Transaction volume has risen since the crisis
Source: Bloomberg raged, but is showing a brief pause at the
0 moment. Low financing costs together with
2005 2006 2007 2008 2009 2010 economic recovery mean good potential for
real estate, if this scenario proves correct.
US Interest rate swaps, ask, 5 year Bank margin (assume 0.5%)

Investment Outlook - september 2010 31

Asset class:
Private equity

A winner as the economy stabilises

• A functioning financing market and strong Senate has not yet approved. General partners are companies
reports are good for private equity that do not invest directly in PE but instead get a return in the
form of a portion of the revenue that PE companies generate
• But financial worries are hurting the PE market when they sell portfolio companies at a profit. The listed com-
pany Blackstone is one example. Since they are dependent on
• Good macro growth and big discounts to NAV such divestments to generate revenue, it is especially hard on
make PE investments attractive such companies when the transaction market grinds to a halt,
as it has done several times during the summer.
The fundamentals underlying the private equity (PE) industry
It is thus not surprising that the share prices of listed PE com-
have improved in many ways. For example, the economy is
panies, like the stock markets, fell this past spring and summer
stabilising, corporate profits are increasing and the financing
when the European sovereign debt crisis culminated (or at
situation has improved.
least the market’s focus on the crisis). During the late summer,
when markets were fretting about the US economy, share
During various bouts of worrying in economies and in finan-
prices of PE companies held up relatively well.
cial markets this summer, however, we have seen evidence
that the situation is still fragile, which seriously hurts the PE A better functioning market now in place
market. Transaction activity has lost momentum, and several
Aside from the economic and regulatory situation, the financ-
initial public offers (IPOs) had to be cancelled or postponed.
ing situation has previously been singled out as an uncertainty
Meanwhile share prices of listed PE companies have fallen.
factor for the PE industry. Although it is too early to declare an
end to such problems, the picture has nevertheless improved
Although the picture is gradually improving, there are several
faster than expected. Banks are once again lending money to
sources of concern for PE companies. The most central, of
the PE sector, and the corporate bond market is again open
course, is how the economy is performing. The flare-up of wor-
to PE companies. Another signal that PE is now past the worst
ries about a US double dip recession affects the PE industry in
obstacles is that a number of new funds have been created
several ways. Firstly, a weaker economy would in itself mean
this year, after a completely “dead” 2009. Blackstone, men-
that businesses owned by PE companies will perform more
tioned above, recently started a fund that has raised USD 13
weakly, which may become critical if they are highly lever-
billion − admittedly only half of what its predecessor fund
aged. Secondly, economic worries generally mean weaker risk
brought in a few years ago, but still a confirmation that pros-
appetite, which directly impacts the share prices of listed PE
pects are improving and there is growing willingness to invest.
companies and the ability of these companies to carry out
good transactions.
There are other signs of strength as well. Although the US
economy is a cause for concern, other parts of the world are
In addition to these economic developments, the risk of rule
showing decent to good rates of economic growth. In Europe,
changes is on the radar for the PE sector. Various initiatives
the economy showed upside surprises this summer, and the
are underway, among them the Volcker rules, meaning that
PE industry’s portfolio companies generally delivered strong
American banks will not be allowed to own PE investments on
second quarter earnings. The acquisition and merger market
a large scale. When this reform is implemented, it will increase
has also sprung to life again (except for brief spells of uncer-
the holdings available in the secondary market by the equiva-
tainty). Various transactions took place during the spring and
lent of nearly 10 per cent of existing PE holdings in the US.
summer. Large PE firms such as 3i and KKR carried out divest-
This summer the US House of Representatives also approved
ments, with sale prices ended up 30-40 per cent above the
a “carry tax” − a tax increase on general partners − which the
reported net asset value (NAV) of the companies sold.

32 Investment Outlook - september 2010

Asset class: Private equity

The latter is especially encouraging, bearing in mind that listed cases, the investment periods specified by the funds are draw-
PE firms are still traded with a 30-40 per cent discount to NAV ing to a close, which will create buying pressure.
(the historical average is around 10 per cent). These net asset
values are often conservatively calculated, with many compa- Due to the market turbulence of recent years, prices of PE
nies giving their investments an “illiquidity discount”. portfolio companies have fallen substantially. Sellers are also
now beginning to accept the new price levels. Together with
These large discounts are also a source of opportunities. the large supply and high discounts, this creates good busi-
Apollo Alternative Assets (AAA), a listed company, was traded ness opportunities, perhaps mainly among “secondaries” −
earlier this year at a discount of well above 50 per cent on its purchases of existing PE investments or obligations.
NAV. The company carried out a share repurchase, resulting in
a higher share price. Various other market players are now tak- Those who have a long-term perspective and capital to invest
ing initiatives to take advantage of the big discounts − a busi- in PE thus have good opportunities, probably better than for
ness opportunity for those with money to invest. This should a very long time. As we described earlier, the period after a
help increase valuations as the discounts shrink. recession is often the best time for PE investments − there
are opportunities here for a skilled PE investor to generate
Room for shrinking discounts large value. In this context, however, it is worth pointing out
Assuming that the world economy continues to grow de- the importance of investing with the right PE market player.
cently, the value of portfolio companies should grow the near One study* shows that while world stock markets provided a
future, which means rising net asset values. Assuming that long-term return of around 10 per cent, the average PE firm
more transactions can be carried out at valuations similar to has generated similar or slightly higher returns, 10-15 per cent,
the above example − 30-40 per cent over NAV − the market but the most successful one quarter have generated annual
should be reasonably willing to shrink the discount signifi- returns in the 20-25 per cent range over time.
cantly, once financial uncertainty eases.
Decent economic growth leading to rising NAV and simulta-
One important factor in PE market performance is flows – ac- neously shrinking discounts to NAV, coupled with continued
cess to investable capital and a supply of investments. As low interest rates, should lead to very good PE investment
mentioned earlier, the implementation of the Volcker rules will performance in the future. But in a short-term perspective,
result in a large quantity of PE investments in the secondary worries about the economy, regulatory fears and continued
market being sold off by American banks. In order not to dis- transaction market uncertainty may hold back the market.
rupt the market excessively, however, the banks will probably We are prepared to increase the proportion of private equity
have a lengthy period to divest their PE holdings. At the same investments in our portfolios as soon as the market situation
time, there will be an underlying investment need, fuelled in becomes clearer.
part by newly established funds and those that were created
in recent years. These funds have so far only carried out a frac- * Source: EVCA: Venture Economics and Banncock Consulting
tion of the investments they intended to make. In a number of

275 275
250 250
225 225
200 200
175 175

150 150
100 100
After doubling during the 2009 rebound,
75 75
share prices of listed PE firms have run into
50 50 headwinds. Financial market worries have hurt
2003 2004 2005 2006 2007 2008 2009 2010 share prices, but fundamentals are steadily
LPX50 TR Index, 2003-01-01 = 100 improving.
MSCI World Gross Index, 2003-01-01 = 100
Source: Reuters EcoWin

Investment Outlook - september 2010 33

Asset class:

Economic recovery lifting commodities

• Moderate price increases due to decent world driven primarily by the risk appetite of market players rather
than by changes in the fundamentals underlying this asset
economic conditions
• Low interest rates and an uncertain economic
Marginally rising oil prices
outlook favour gold In recent months, the historically strong association between
• Oil prices will remain in the USD 70-90 per the dollar and oil prices has loosened. While the dollar has
fluctuated significantly, oil prices have remained fairly calm in
barrel interval the USD 70-80/barrel range. There is large reserve capacity
for oil production − especially in Saudi Arabia − which gives
Commodity prices large follow global economic perform- the Organisation of Petroleum Exporting Countries (OPEC)
ance. Like most other risk assets, in recent years the price the muscle to control prices by controlling supply.
trends for commodities have resembled a roller-coaster ride.
After a sharp slide at the time of the credit crisis, commodity For example, Saudi Arabia can boost production and push
prices rebounded early in 2009 (somewhat before the stock down oil prices if global economic growth turns out to be
market). Since last spring, however, a continuous series of slowing down too rapidly. Iran and Iraq also have major
storm clouds and questions about the strength of the global potential to increase the oil supply, but in the prevailing
recovery have caused commodity prices to level off. uncertain political situation they are hardly likely to make any
big changes in production.
Our scenario of global growth exceeding 3 per cent during the
next couple of years points towards rising commodity prices From OPEC’s perspective, oil prices are welcome to move
ahead. Today’s extremely low interest rates and high liquidity as high as possible before they hamper GDP growth in the
in the banking system also signal rising commodity prices. emerging market sphere or in the OECD countries (an oil
In a short-term perspective, however, it looks as if the global price ceiling). But oil prices should not fall to levels where
economic pulse will slow a bit. The commodity price increase demand exceeds production (an oil price floor). In such a
will thus be modest. Prices are likely to remain volatile as long situation there is no reserve capacity and OPEC thereby loses
as we are in a fragile situation, with great uncertainty about its ability to control prices.
the economic trend. At present, commodity prices are being

500 500
450 450
400 400
350 350
200 200
150 150 Commodity prices have followed the pattern of
100 100 the global recovery. We foresee decent global
50 50 GDP growth during both 2010 and 2011, which
2000 2002 2004 2006 2008 2010 is likely to increase the demand for commodi-
Agri-commodities Industrial metals Energy ties.
Source: HWWI

34 Investment Outlook - september 2010

Asset class: Commodities

Our current assessment is that OPEC will try to keep oil prices The gold price increase during the past six months was about
in the USD 70-90/barrel interval. So far this year, the average 12 per cent. In order for gold prices to continue climbing at
price has in fact been USD 80/barrel. Considering its reserve the same pace, however, market storm clouds (the Euro-
capacity, OPEC looks likely to be able to keep prices within pean debt crisis, the US double dip or tightening measures
its desired interval during the rest of 2010. This means that in China) would have to grow in strength, or a new danger
around USD 70 is a good buying situation and USD 90 is a would have to appear. A modest price increase is neverthe-
good selling situation. less in the cards, since interest rates are low, demand for
jewellery among consumers in the emerging market sphere
But there are external factors that may cause oil prices to is high and central banks would like to expand the share of
break out of this interval. Right now we are in the middle gold in their foreign exchange reserves. In addition, financial
of the Atlantic hurricane season, which lasts from June to worries are likely to persist for a while, which is the factor that
November. According to forecasts, this year’s hurricane has driven gold prices to today’s high levels.
season is expected to be intensive, so there is a sizeable risk
of major disruptions in gas and oil production in the Gulf of Agricultural prices levelling off
Mexico over the next few months. Although US oil stockpiles A heat wave and drought in the major wheat-producing
are at record levels, oil prices will probably climb if important countries of Russia and Ukraine led to a 70-80 per cent rise
production areas are affected. The anatomy of the recov- in wheat prices during July and August. To ensure domestic
ery is another factor that may have an impact. If the global supplies and prevent price increases at the consumer level,
economy sinks back into a recession or climbs due to final Russia banned continued exports of wheat during the rest of
demand, this is likely to be reflected in oil prices. 2010. The introduction of trade restrictions in one country
WEAKER LINK BETWEEN OIL PRICES AND USD has a tendency to spread to other countries, which in that
case would lead to sharply rising agri-commodity prices.
150 1.70
Oil, Brent
EUR/USD A similar scenario occurred a few years ago, following poor
130 1.60
harvests. The result was agri-commodity price increases that
110 1.50 affected food prices worldwide. The difference, however, is

90 1.40 that stockpiles were low at that time, whereas today there is
70 1.30 a grain surplus after two years of good harvests. According to
50 1.20
a report published by the US Department of Agriculture on
August 12, there are large stockpiles − especially in the US −
30 1.10
2005 2006 2007 2008 2009 2010 that more than offset the year’s meagre Russian and Ukrain-
Source: Reuters EcoWin ian harvests. A price shock is thus unlikely this time around,
but grain prices will probably remain at today’s levels because
a high risk premium for extreme weather is justified. The
Since oil is traded in US dollars, there has been a strong
natural phenomenon known as “El Niño” has been replaced
association between the dollar and oil prices. When the
by “La Niña”, increasing the likelihood of extreme weather
dollar declines, producers demand higher payment for their
and hurricanes during the winter of 2010-2011.
commodities in dollar terms, resulting in rising commodity
prices, and vice versa. This association has not been appar- WHEAT PRICE RALLY IS OVER
ent during the past six months.
Demand for industrial metals taking off 1200 1200
Like oil prices, industrial metal prices are sensitive to changes
in economic growth forecasts. These prices fell steadily when 1000 1000

the southern European financial crisis broke out. During the

800 800
summer, prices remained low due to worries about the Ameri-
can economy and when China’s efforts to slow economic 600 600
growth began to have an impact. Today, however, demand for
industrial metals is increasing in most OECD countries, as evi- 400 400
denced by falling stockpiles. But the unclear future outlook is 200 200
likely to keep prices at today’s levels at least during the third 2006 2008 2010
quarter. Late in 2010, however, there are prospects of price
Source: Reuters EcoWin
increases as the economic recovery regains strength.
Extreme drought has led to sharply rising wheat prices, but
Gold was the big winner amid fluctuating risk appetite in the since there are ample stockpiles a price shock can probably
first half of 2010. When markets were at their stormiest, gold be avoided.
and American government securities were virtually the only
assets that investors wanted to buy.

Investment Outlook - september 2010 35

Asset class:

Shift in driving force ahead

• Risk appetite has driven currency rate trends… connected to risk appetite and tends to control medium-term
trends. High-interest rate countries are found mainly in the
• …but interest rate differentials may take over emerging market (EM) sphere, while the euro zone, Japan
as a driving force and the US are among the low-interest rate areas. As a con-
sequence, fixed income and foreign exchange traders will be
• Emerging market currencies are ready to soar demanding EM currencies, causing them to appreciate.
Some three months ago, our assessment was that countries
1.15 100
whose government finances were in relatively good shape
1.20 90
would see their currencies appreciate. Looking back, today
1.25 80
we can note that concerns about European sovereign debts
1.30 70
caused the euro to plunge and the US dollar to rise – at the
1.35 60
bottom, a euro was worth USD 1.19. Results of the stress tests
1.40 50
of European banks showed that worries about the banking
1.45 40
sector were exaggerated, and since mid-July the market focus
1.50 30
has shifted to the US budget deficit and slowing economic
1.55 20
growth; the euro regained ground, while the yen strengthened
1.60 10
and reached a 15-year high against the USD late in August. Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul
Countries with strong government finances have resumed 2008
United States, CBOE, Volatility Index (VXO), USD
2009 2010
Euro Zone, Spot Rates, EUR/USD
their currency appreciation path since mid-June. Source: Reuters EcoWin

Risk appetite, measured here as the VIX index, has largely

The foreign exchange market is driven mainly by three factors: determined the performance of the US dollar (measured
risk appetite, interest rate differentials and the fundamental against the EUR). As risk appetite returns, the dollar is likely
strengths of countries. Over time, these three forces vary in to weaken against smaller emerging market currencies.
their impact on short- and long-term currency trends. During
the first half of 2010, the strengths of countries dominated for- Meanwhile countries with strong government finances and
eign exchange markets, and sound government finances were good economic growth will see continued inflows of foreign
rewarded (with powerful downward pressure on the euro as a currencies, both via the stock market and via direct invest-
consequence), but late in June resurgent risk appetite became ments by companies. In this respect, too, the EM countries are
the main driving force. That trend was reversed late in July best positioned. The South Korean won, Singapore dollar and
when worries about an American double dip recession caused Indonesian rupiah should be among Asian winners, while the
safe currencies like the yen and the US dollar to strengthen. Swedish krona and the Norwegian krone as well as the Polish
zloty have the best potential in the West.
Interest rate differentials will set the tone
Our main scenario is that worries about a double dip recession Countries whose economic growth is mainly due to exports,
in the US and globally is exaggerated and that markets will such as South Korea, are nevertheless unhappy about seeing
eventually normalise (see page 11). As concerns about the US their currencies appreciate. These countries thus have incen-
and global economy fade and risk appetite recovers, interest tives to try to “talk down” their currencies through political ac-
rate differentials will again dominate the currency rate trend. tions or employ quantitative easing measures to influence the
The “carry trade”, in which investors borrow in low-interest exchange rate in their favour.
rate currencies and invest in high-interest rate countries, is

36 Investment Outlook - september 2010

Asset class: Currencies

Weaker yen again? diversification towards the east and away from the US dollar.
As concerns about the US and Europe have escalated, the The question is whether the US, which is seeing its economy
Japanese yen has seemed more and more like a safe currency. decelerate rapidly right now, will try by political means to force
Late in August, the exchange rate fell below 84 yen per US dol- a further appreciation of the CNY in the neat future.
lar, the highest value in 15 years. Various factors now indicate HARDLY ANY EFFECT
that the yen will weaken in the future. 8.50 8.50

8.25 8.25
Japan − whose economy is strongly dependent on exports −
would like a weak currency. On several occasions the govern- 8.00 8.00

ment has expressed its interest in a depreciation of the yen, 7.75 7.75

and this has caused the market to predict interventions or
7.50 7.50
other quantitative measures.
7.25 7.25
7.00 7.00
160 125
150 100 6.75 6.75
2000 2002 2004 2006 2008 2010
140 75
Source: Reuters EcoWin
130 50
120 25 The renminbin (yuan) was revalued against the US dollar


110 0 in mid-June but has only risen by around 1 per cent. This
100 -25 should be regarded as more of a political goodwill gesture
90 -50 than as a serious attempt to reduce global imbalances.
80 -75
70 -100
Euro under pressure
1996 1998 2000 2002 2004 2006 2008 2010 The euro zone economies continue to be pulled between two
Exports, Total, SA, JPY [ar 1 quarter] Spot Rates, USD/JPY, Close
Source: Reuters EcoWin
forces: zero or slow growth accompanied by deflation in the
PIIGS countries (Portugal, Ireland, Italy, Greece and Spain)
The Japanese yen appreciated significantly during the and high export-led growth in Germany. These two forces are
financial crisis, from about 120 yen to less than 85 yen per putting pressure on the European Central Bank (ECB) from
USD, and is close to a historical high. A strong yen hurts two directions. Because of the low ECB key interest rate and
Japan’s export sector, creating incentives for politicians and/ the cheap euro, the German economic machine is spinning
or the central bank to take steps to weaken the currency. ever faster and risking higher inflation. Meanwhile a higher key
In addition, Japan − with its enormous government debt and rate and a stronger euro would risk pushing down the PIIGS
political paralysis – will continue its zero interest rate regime economies even further, with protests and political instability
for a long time. This will make it one of the most attractive as a consequence. In order not to risk renewed worries about
countries in which to borrow money when risk appetite and the sustainability of the euro, the overall assessment of the
the carry trade resume. ECB is that it must keep its refi rate unchanged for a long time,
with possible expansion of quantitative easing ahead in order
As long as the market is worried about the health of the to prop up southern European countries. The euro will remain
American economy, the yen will remain strong. Japan will try cheap in German terms, and Germany’s economy will continue
to counter yen appreciation through political actions and/or to pull ahead, with German exporters as the main winners.
quantitative easing by the central bank. As the market begins
to realise that the US is only facing a slowdown, not a double Today all three economic superpowers − the US, the euro zone
dip recession, the yen is likely to weaken − though slowly. and Japan − would like their currencies to be at low levels in
order to stimulate exports. If one of them takes steps that
China no longer a currency manipulator directly or indirectly affect their currency, such as quantitative
As we predicted, in mid-June China began an appreciation of easing, this would disrupt the currency rate balance between
the renminbin (or yuan, CNY) against the US dollar. The risk them. Steps taken by Japan, for example, are thus likely to be
that China will be branded a “currency manipulator” by the US followed by similar steps in both the US and the euro zone.
has diminished. But so far, the CNY has only climbed about 1
per cent against the dollar. This currency movement should be A resumption of risk appetite late this year will generally fa-
regarded more as a symbolic gesture, not as a serious attempt vour stronger EM currencies. However, there are large global
to reduce global imbalances. There are also reports that China imbalances and investors are jittery. We can thus expect a
has begun to purchase Asian government securities, espe- volatile foreign exchange market for another while.
cially Japanese and Korean bonds. This indicates a policy of

Investment Outlook - september 2010 37




2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010




Equities Fixed income Hedge funds Real estate

Private equity Commodities Currencies

- Return in 2010 is until July 31.

- Historical values are based on the following indices: Equities = MSCI AC World. Fixed income = JP Morgan Global GBI Hedge. Hedge
funds = HFRX Global Hedge Fund. Real estate = SEB PB Real Estate. Private equity = LPX50. Commodities = S&P GSCI TR. Currencies = BarclayHedge Currency Trader.