Capital Market Presentation

July 2011:
Giving money away

Hans-Jrg Naumer, Dennis Nacken, Stefan Scheurer

Not for circulation to private investors

Giving money away

Nominal and real return of government bonds in Europe, USA and Japan (5-year maturity).
5-year German Bundesanleihe 2,50% 2,00% 1,50% 1,00% 0,50% 0,00% -0,50% -1,00% -1,50% -2,00% -2,50% Nominal return Real return -0,54% -2,02% 2,16% 1,55% 0,12% 0,42% 5-year US-treasuries 5-jhrige Japanese government note

Source: Datastream; Allianz Global Investors Capital Market Analysis

Fear of escalation of European debt crisis

Risk premia of 10y European government bonds vs. German government bonds (-2 years)
2 8/06/11 16

16

14

14

12

12

10

10

0 J A S O N D J F S prea d Ital y - Germ any (10y) S prea d S p ai n - Germ any S prea d Gree c e - Germ an y M A M J J A S O N D J F M A S prea d P o rtugal - Ge rm a ny S prea d Irel and - Germ any S prea d B e l g i um - Ge rm a ny M J

Source: Datastream; Allianz Global Investors Capital Market Analysis

Debt reduction in Europe: Nothings impossible!

Europe: Successful debt reduction in the past 30 years (Debt/GDP ratio)

160,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 0,0 Belgium 1994-2007 Denmark 1994-2007 Netherlands 1996-2002 Spain 1997-2007 Sweden 1996-2008 UK 1985-1990 26,8 84,0 134,2

80,1

76,1 66,8 50,5 36,2

72,1 52,4 38,0 33,3

before debt reduction

after debt reduction

Source:: ECB, "Major Public Debt Reductions. Lessons From The Past, Lessons For The Future", Working Paper 09/2010, Allianz GI Capital Market Analysis

Central banks: Lender of last resort?

Treasury holdings of the FED and major foreign creditors (in USD billions)
1800 1600 1400 1200 1000 800 600 400 200 0 Purchases since August 2010

Br Ca az rib il ia n B an ks

Sw i tz er la nd

ED

US -F

Ki ng

Ta iw

Ho ng

Ru ss i

-200

Source: Federal Reserve, US Treasury Departement; Allianz Global Investors Capital Market Analysis

Un ite d

O il E

Lu xe

m bo ur g G er m an y

an

xp or te rs

Ch in a

Ja pa n

Ko ng

do m

Ca na da

Fear of subsequent recession

Sentiment indicators point to a cooling but still suggest expanding economic growth.
28/6/11 140 140

130

130

120

120

110

110

100

100

90

90

80

80

70

70

60

60

50

50

40

40

30 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

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ifo W or ld E conomic S ur v ey: Business Climate ifo W or ld E conomic S ur v ey: Cur r ent As sessment ifo W or ld E conomic S ur v ey: Business E xpectations

S our ce: T homson Datastream

Source: Datastream; Allianz Global Investors Capital Market Analysis

Germany is becoming the economic driving force

Global economic engine is firing on (almost) all cylinders.

15 10 5 0
-1,1 -1,2 13,3 9,6 6,3 5,2 4,7

3,7

3,4

2,6 -0,1

-5 -10 -15
-12,3

C hin a* G er m an y

Eu ro zo ne R us si a

In di a

It a ly

Fr an ce

U K

Industrial production April 2011 vs. previous year (in % )

* May 2011 Source: Datastream; Allianz Global Investors Capital Market Analysis 7

Ja pa n

Br az il

Sp ain

U SA

The turnaround in monetary policy has taken place.

Central banks will continue to tighten monetary policy, especially in the emerging markets.
2 8/6 /1 1 16 16

14

14

12

12

10

10

0 2 00 6 2 00 7 E CB S ho rt T erm Re po Rate Fed Fu nd s T arge t Rate J ap an T arg et Rate 2 00 8

0 2 00 9 2 01 0 2 01 1 Chi n a T a rget Rate B razi l T a rg e t Ra te S ourc e: T hom s on Da ta s tre a m

Source: Datastream; Allianz Global Investors Capital Market Analysis

When will the capital markets react?

Yields of German, Japanese and US 10-year government bonds (30 years and 1 year)
28/6/11 14 14 4.00 28/6/11 4.00

12

12

3.50

3.50

10

10

3.00

3.00

2.50

2.50

2.00

2.00

1.50

1.50

1.00

1.00

0 81 83 85 87 89 91 93 95 Y ield 10y Germ an government bond Y ield 10y US government bond Y ield 10y J apanes e government bond 97 99 01 03 05 07 09

0.50 J A S O N D Yield 10y German government bond Yield 10y US government bond Yield 10y Japanese government bond J F M A M J

0.50

S ourc e: T homs on Datas tream

Sourc e: T homs on Datas tream

Source: Datastream; Allianz Global Investors Capital Market Analysis

Investment theme: Flexible bond strategies

The longer the maturity, the deeper the fall. If the rates go up, prices come down

interest rates

bond price

Price movements of bonds when interest rates rise by x basis points (theoretical) Duration2 -3 1,47 2,90 5,70 -2 0,99 1,96 3,85 -1 0,50 0,99 1,96 +50Bp +100Bp +200Bp Interest rate rise1 +1 -0,50 -0,99 -1,96 +2 -0,99 -1,96 -3,85 +3 +4 Duration2 +5 -2,36 -4,65 -9,03 +6 -2,77 -5,45 +7 -3,16 -6,21 +8 -3,53 -6,92 -13,27

-1,47 -1,93 -2,90 -3,81 -5,70 -7,44

-10,54 -11,96

Interest rates

bond prices

It is possible to gain from a rise in interest rates: short duration

Assumption: parallel shift of the yield curve based on Bund-yields by X basis points. 2 Macaulay Duration; In this example bond price movements are determined by the change of the fair value (present value of future cash flows) with an initial face and market value of 100 and different Macaulay durations. A success of the strategy can not be guaranteed and losses are not excluded.

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Valuations are still in favour for equities

Sharpe Ratio (excess return in relation to risk) has never been so high since 1989 for US-stocks.
28/6/11 0.30 0.30

0.25

0.25

0.20

0.20

0.15

0.15

0.10

0.10

0.05

0.05

- 0. 05

- 0. 05

- 0. 10

- 0. 10

- 0. 15 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

- 0. 15

S har pe Ratio US -S toc ks ((S toc k r etur n - 10 y US T easur ie s)/V IX ) . r

S our ce: T homson Datastream

Source: Datastream; Allianz Global Investors Capital Market Analysis

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Decisive Insights:

 Bond investors seem to be paying a high price for the flight to safe havens. Real returns on 5year German and US bonds have recently slipped into negative territory.  While the markets will presumably continue to be held in thrall by Europes debt crisis for a while yet, the basic global economic trend seems to be upwards.  In view of the continued high levels of uncertainty on the markets, it could be advisable to maintain a somewhat more defensive portfolio orientation.  But the attractive valuations of equities compared to bonds, the increase in global Merger & Acquisitions speculation, the prevailing desperation of investors to find a home for their money and the risk of a turnaround in interest rates, all still point to a recommendation to stay slightly overweight in equities.

Equities should strategically remain overweight compared to bonds.

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Disclaimer
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