Andbank corporate review august & september 2015 by Andbank

GLOBAL OUTLOOK ECONOMY & FINANCIAL MARKETS

Monthly Corporate Review August & September 2015

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Contents Executive Summary ……………………………………………………………………………………………………………3 The World at a Glance

………………………………………………………………………………………………………4

Market Outlook. Summary Table of Expected Performance

……………………………………5

Asset Allocation Proposal …………………………………………………………………………………………………6 Country Pages USA: Equities well supported but we see less of an impetus ……………………………………7 Euro zone: As we already warned, Not flee the market despite Greece …………………8 Asia: On the verge of an unprecedented infrastructure boom …………………………………9 China: The authorities remain broadly supportive of the market …………………………10 India: The country is likely to continue its gradual recovery into 2017 …………………11 Japan: Going through a post industrial renaissance? Brazil: Black days in Brazil, but no Black Swan

……………………………………………12

…………………………….………………………13

Mexico: Mexico is well positioned to face turbulence risk ………………………………………14 Other Markets: EMEA & LatAm …………………………………………………………………………………15 Equity Markets Short-term Assessment ……………………………………………………………………………………………17 Fundamental Assessment …………………………………………………………………………………………17 Fixed Income Markets Fixed Income, Core Countries …………………………………………………………………………………18 Fixed Income, European Peripherals ………………………………………………………………………18 Fixed Income, Emerging Markets ……………………………………………………………………………19 Fixed Income, Corporate bonds ………………………………………………………………………………19 Commodities ……………………………………………………………………………………….……………………………20 Forex ……………………………………………………………………………………………………………………………………22

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Executive Summary -

Economic & Financial Market Outlook

USA – Equities well supported but we see less of an impetus. We stick with our prediction of at least one rate hike as early as September, with the possibility of another quarter-point hike by yearend. We certainly have seen lower but apparently sustainable growth in the US economy. And this is what we foresee for the years ahead. Targets: FY2015 GDP growth at 2.5%, 2015 CPI at 1%, 10yr Treasury at 2.25%, S&P’s target at 2,204. Eurozone – As we already warned, Not flee the market despite Greece. A last-minute agreement was reached with Greece, allowing the European Union to provide a financial bridge for the most immediate financial needs. Though some hurdles persist, risks seem manageable now “under the umbrella” of a third bailout package. GDP forecasts have kept an upward trend for 2015, and stabilized for the coming year. Targets: FY2015 GDP EZ growth at 1.75%. CPI 2015 at 0.75%. 10yr Bund at 1% (strategic view) and Spanish & Italian bond yields at 1.5%. Portuguese bond at 1,8%. Irish bond at 1,25%. MSCI EMU with 8% upside potential. Target for the EUR/USD at 1.00. EM Asia – With the launch of the US$100bn AIIB in June 29 and the US$40bn Silk Road Fund, China is fighting Japan for regional influence. Japan continues to be the most lavish donor in Asia, as a means of maintaining its regional influence, but China is growing rapidly in its contributions. In this tit-for-tat financing war between China and Japan, Asia is set to benefit from a burgeoning infrastructure “arms race”. Targets: FY2015-2016 Regional GDP >6%. Government bond yields (10yr): -70 bps average decline to target. Equity MSCI Asia Em ex Japan with >20% upside potential. Fx Asia EM basket with >10% upside potential (vs the USD). China – Job openings keep the pace. The government found itself forced to manipulate the market in order to restore investors’ confidence. Prior tightening operations were aimed precisely at smoothing and control the crazy boom seen in the last 12 months, but our perception is that the authorities remain broadly supportive of the market. China is rapidly moving up the value chain. Targets: FY2015 GDP at 7%. Government bond yield (10yr): -100 bps to target in yields. Equity China 0%-5% upside potential until year end. Target for the CNY/USD at 6.10. India – India’s economy is likely to continue its gradual recovery into 2017. India is fixing the cause of its economic sclerosis by transferring more powers to state governments in a broad platform dubbed “competitive and cooperative federalism”. India has initiated powerful reforms, signaling that a substantially changed business environment is right around the corner. Targets: 2016 GDP near 7%, Gov. bond yield (10yr): -60 bps to target in yields. Equity India: 10% upside potential. Japan – The country’s awful demographics could become one of the biggest factors supporting Japanese equity values. Pension funds can only meet their obligations by boosting investment returns. As such, they allocate resources to the companies that maximize shareholder value best. This could explain why Japan is going through a post-industrial renaissance. Targets: Nikkei: 20,019. JPY/USD target at 130. LatAm – Brazil: The political system looks close to paralysis. Continued tightening of monetary and fiscal policy makes a second year of economic contraction a possibility in 2016. But on the whole it is hard to see a big solvency problem. Targets: Bovespa at 53,220. Yield on the 10yr Gov bond: 12% (loc) and 4% (USD). BRL-USD: 3.30. Mexico – Both inflation environment and domestic consumption remain supportive. We consider that Mexico is well positioned to face turbulence risk amidst an eventual flow reversion, due to its close relationship with the U.S. economy. Targets: Equity IPC: 47,500. 10yr Gov. Bond: 5.75-6.0% (loc) and 3% (USD). MXN: 15.40. 3

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

The World at a glance

â&#x20AC;&#x201C; Latest quarterly report. GDP rate (%y/y)

North Ame rica

-2.0

The figures are from the latest official quarterly report (% y/y growth rate). Most of them relate to 1Q2015.

2.1%

2.9%

0.0

2.5%

2.0

Sou th Ame rica

-2.3% 2.8% 3.0%

-1.6%

4.0

1.7%

6% 4.2%

2.1%

4% 1.3%

6.0

EU28

2.9% 4.1%

2.5% 0.8%

1.5%

2.7%

8.0

-0.2%

2.7 %

3.5%

2.3% 2.4% 2.7%

1% 0.1% 3.3% 0.1%

4.1% 2%

0.2%

Asia 2.7% -1 % 7.0% 5.5%

6.5% 7.5% 2.2%

5.2%

5.6% 4.7%

2.3%

NZ 3%

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Market Outlook â&#x20AC;&#x201C; Fundamental Expected Performance Performance Performance Current Fundamental Expected Last month YTD 29/07/2015 Target Performance*

Asset Class

Indices

Equity

S&P 500 (USA) MSCI EMU MSCI UK Spain - Ibex 35 Asia Pac x Japan - Factset Japan - Nikkei 225 China - Factset Mkt Index India - Factset Mkt Index Mexico - IPC Brazil - Bovespa

2,5% 2,6% -0,1% 4,0% -6,0% 1,0% -7,6% 2,1% -0,5% -5,2%

2,4% 15,3% 0,4% 9,8% 10,0% 16,3% 41,9% 6,7% 3,1% 0,5%

2.109 215 1.940 11.283 323 20.303 407 548 44.471 50.245

2204 232 2012 12505 397 20019 414 601 47503 53220

4,5% 7,8% 3,7% 10,8% 23,0% -1,4% 1,8% 9,7% 6,8% 5,9%

Fixed Income Core countries

US Treasury 10 year govie German Bund 10 year govie

0,5% 1,0%

0,3% -0,8%

2,29 0,67

2,25 1,00

2,59% -1,94%

Fixed Income Peripheral

Spain - 10yr Gov bond Italy - 10yr Gov bond Portugal - 10yr Gov bond Ireland - 10yr Gov bond

3,1% 4,0% 4,2% 2,7%

-1,9% 0,7% 2,8% 0,1%

1,96 1,90 2,52 1,31

1,50 1,50 1,80 1,25

5,61% 5,12% 8,25% 1,77%

-2,2% 4,1%

-8,9% 31,1%

9,57 10,38

8,00 12,00

22,09% -2,56%

-0,2% 0,1%

1,2% 0,6%

1,06 1,07

0,70 0,80

3,86% 2,09%

India - 10yr Gov bond Indonesia - 10yr Gov bond (Local & hard crncy) China - 10yr Gov bond Philippines - 10yr Gov bond Thailand - 10yr Gov bond Malaysia - 10yr Gov bond

1,6% -1,4% 1,6% 0,4% 1,4% 0,9%

3,1% -1,3% 3,5% -1,6% 1,7% 3,5%

8,03 8,65 3,47 4,34 2,83 3,99

7,25 7,00 2,50 4,00 2,50 3,50

14,29% 21,84% 11,27% 7,04% 5,48% 7,89%

Fixed Income Latam

Mexico Mexico Brazil Brazil -

0,5% 0,2% -3,1% -1,9%

1,4% -1,3% 0,4% -3,6%

6,07 3,74 13,15 4,96

5,90 3,00 12,00 4,00

7,42% 9,66% 22,37% 12,64%

Commodities

Oil (WTI) Gold

-16,4% -6,8%

-8,8% -8,5%

48,77 1.097

40,00 900

-17,98% -17,94%

EUR/USD JPY/USD JPY/EUR CNY/USD MXN/USD BRL/USD GBP/USD GBP/EUR ASEAN Currency Basket (Index)

-1,1% -0,5% -0,9% 0,0% -3,7% -6,5% -0,6% 0,5% -1,1%

-8,8% -2,5% 6,7% -0,1% -10,1% -25,6% 0,4% 9,2% -4,8%

1,10 123,54 136,71 6,21 16,22 3,34 0,64 0,70 95,22

1,00 130,00 130,00 6,10 15,40 3,30 0,68 0,68 105,00

-9,35% -5,23% 4,91% 1,76% 5,08% 1,17% -6,43% 3,53% 10,27%

Fixed Income Turkey - 10yr Gov bond EM Europe (Loc) Russia - 10yr Gov bond Fixed Income IG & HY (Swap spread)

Investment Grade USD Investment Grade EUR

Fixed Income Asia

- 10yr Govie (Loc) - 10yr Govie (usd) 10yr Govie (Loc) 10yr Govie (usd)

* For Fixed Income instruments, the expected performance refers to a 12 month period

Upward revision

Downward revision

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Monthly Global Asset Allocation Proposal Conservative

Moderate

Balanced

Growth

< 5%

5%/15%

15%/30%

30%>

Max Drawdown

Strategic Tactical (%) (%)

Asset Class

Strategic (%)

Tactical (%)

Strategic (%)

Tactical (%)

Strategic Tactical (%) (%)

Money Market

15,0

16,2

10,0

5,0

4,8

5,0

4,5

Fixed Income Short-Term

25,0

16,2

15,0

9,0

5,0

2,9

0,0

Fixed Income (L.T) OECD

30,0

32,4

20,0

15,0

14,3

5,0

4,5

US Gov & Municipals & Agencies

8,1

5,0

3,6

1,1

EU Gov & Municipals & Agencies

0,0

European Peripheral Risk Credit (OCDE)

24,3 20,0

15,0 20,0

20,0

10,7 15,0

14,3

3,4 5,0

4,5

Investment Grade USD

4,3

4,0

2,9

0,9

High Yield USD

8,6

8,0

5,7

1,8

Investment Grade EUR

2,2

2,0

1,4

0,5

High Yield EUR

6,5

6,0

4,3

1,4

Fixed Income Eerging Markets

5,0

6,8

7,5

9,4

10,0

11,9

15,0

17,0

Latam Sovereign

1,7

2,3

3,0

4,3

Latam Credit

1,7

2,3

3,0

4,3

Asia Sovereign

1,7

2,3

3,0

4,3

Asia Credit

1,7

2,3

3,0

4,3

Equity OECD

5,0

6,8

20,0

25,0

32,5

38,7

50,0

56,8

US Equity

1,7

6,3

9,7

14,2

European Equity

5,1

18,8

29,1

42,6

Equity Emerging

0,0

5,0

6,3

10,0

11,9

10,0

11,4

Asian Equity

0,0

4,7

8,9

8,5

Latam Equity

0,0

1,6

3,0

2,8

Commodities

0,0

2,5

0,6

5,0

1,2

5,0

1,1

Energy

0,0

0,16

0,3

0,28

Minerals & Metals

0,0

0,00

0,0

0,00

Precious

0,0

0,47

0,9

0,85

Agriculture REITS

21,6

0,0 0,0

0,0

0,0 0,0

0,0

0,0 2,5

0,0

0,0 5,0

0,0

This recommended asset allocation table has been prepared by the Asset Allocation Committee (AAC), made up of the directors of the portfolio management departments and the directors of products in each of the jurisdictions in which we operate. The recommended weights in each asset class are aligned with the conclusions of the Andbank Investment Committee (AIC), which are reflected throughout this document. Likewise, the distribution of assets within each customer profile meets the risk control requirements established by regulation.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

USA:

Equities well supported but we see less of an impetus

Economy & Policy The Fed, When?: Yellen’s semi-annual monetary US Banks: Bank Credit, Industr & Commerc loans 2.000 policy testimony contained all the ingredients one 16 would need to prepare for a rate hike in the 1.600 months ahead, although she also emphasized that 8 the course of the economy and inflation remains 1.200 uncertain. 0 We certainly have seen lower but apparently 800 sustainable growth in the US economy, and this is -8 what we foresee for the years ahead. Bank loans 400 are growing, and borrowers are prime clients (see -16 0 the charts). '06 '07 '08 '09 '10 '11 '12 '13 '14 We stick with our prediction of at least one rate US Loans, Commercial and Industrial (bn $) (Left) hike as early as September, with the possibility (% 1Q , MOV 3M) US Loans, Commercial and Industrial (Right) of another quarter-point hike by year-end. (% 1YR)US Loans, Commercial and Industrial (Right) The Fed knows it has to start at some point, even Federal Reserve System ©FactSet Research Systems if the hikes are more for show than out of necessity. External environment remains supportive, providing additional support for U.S. economic activity. The boost to consumer spending from low oil prices seems more definitive now. Forecasts: Macro & Markets Fed rates: First hike in Sept. 15. GDP forecast 2.5%. CPI y/y at 1%. Unemployment forecast: 5.3%. 10Yr Treasury: 2.25%. Equities: S&P Target raised to 2,204. We expect 2015 EPS growth to be around 5% for FY2015. With 18% of companies having reported, the 2Q yoy EPS stands at 4.6%. Our expectation of positive surprises, relative to the depressed consensus expectations (of 1.4%), stems mainly from a different assessment regarding the impact of the dollar and oil prices. Further, we expect strong buyback activity to have supported EPS growth. Healthy earnings growth is an essential ingredient of the equity rally from here, as US - INFLATION (CPI ex Shelter) 8 8 multiple expansion is becoming less of a driver. So while we expect earnings to remain supportive 6 6 of equity markets, given the flattish trend in quarterly EPS, we see less of an impetus 4 4 compared to previous years. 2 2 Sectors: Industrials, Tech HW & Equipment, Semis & Semis equipment, Energy, Personal 0 0 products, Utilities, Banks & diversified financials, Software services. -2 -2 Recommendations for Financial Markets -4 -4 Equity: “BUY” '06 '07 '08 '09 '10 '11 '12 '13 '14 Gov. Fixed Income: “HOLD” (% 1YR) CPI-U All Items Less Shelte r U.s High Grade: “SELL” 7 Andbank, US Dept. of Labor ©FactSet Research Systems HY: “HOLD”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Euro zone:

As we warned, Not flee the market despite Greece

CENTRAL BANKS’ BALANCE SHEETS

BoJ 91%

(as a % of GDP)

ECB 30%

FED 20%

Greece A last-minute agreement was reached with Greece, allowing the European Union to provide a financial bridge (7 bill. euros) for the most immediate financial needs and paving the way to further discussions about a third bailout. Greece will receive up to €86 bill., including 10-25 bill. for banking recapitalization, in exchange for a broad list of measures (tax increases, pension reforms, etc.). Greece will remain an issue for the markets, but it seems to lose importance relative to other issues (second quarter results, FED, China?). Outlook: Though some hurdles persist, “under the umbrella” of a third bailout package, the risks seem manageable now. Debt relief in Greece? Draghi has spoken loud and clear: “it is uncontroversial that it is necessary”. The IMF supports the idea of longer maturities, along with a nominal haircut. Germany points to some sort of restructuring, after the conclusion of the first review of the bailout program. Economics GDP forecasts have kept an upward trend for 2015, and stabilized for the coming year. The latest positive surprise has come from France, with its manufacturing PMI entering expansionary territory. Sound expected demand for loans, along with less restrictive financing conditions (as shown in recent ECB surveys), should underpin growth prospects for the Eurozone. On the inflation side, disinflation persists. Both from the core price index levels (0.8% YoY vs. 0.9% prior) and general index (0.2% YoY vs. 0.3% prior). Deflation fears have clearly receded, but inflation may stay low in the months ahead. ECB The ECB remains committed to the total accomplishment of its QE, running linear weekly purchases. The ECB widened the list of eligible assets, with new agencies, utilities and infrastructure sectors being included under the APP. Recommendations for Financial Markets Equity (MSCI EMU): “BUY” Core Gov. Fixed Income: “SELL” Peripheral bonds “BUY” Inv. Grade Credit: “SELL” 8 HY: “HOLD”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Emerging Asia:

On the verge of an unprecedented infrastructure boom

Capital Economics, Thomson Datastream

Risks are well anchored from de credit perspective

Capital Economics, Thomson Datastream

Economics & Politics With the launch of the US$100bn AIIB in June 29 and the US$40bn Silk Road Fund, China is fighting Japan for regional influence in a battle of financial aid for countries in the region. Japan is responding by pumping out even more development finance. Abe has announced a whopping US$110bn over five years for “high quality” Asian infrastructure projects. Cambodia and Vietnam are examples of the benefits coming from this “battle for influence”. Twin bridges soar over the Mekong River in the capital of Cambodia and a spectacular new bridge (Neak Loeung) was opened 60 km downriver in April, built and financed by Japan. These infrastructures are viewed as a vital link in building a “southern economic corridor”. In Vietnam, China Railway Group is building part of Hanoi’s new urban rail system. Japan has built (and funded) Hanoi’s new US$1bn airport terminal, connected to the city by a six-lane expressway and a 9km bridge over the Red River. Investment expectations are large enough to justify the optimism. In addition to the AIIB’s funds and the Silk Road Fund (US$150bn combined), most of the Chinese cash will continue to come from China’s vast policy banks, which have a much higher lending capacity than the World Bank and the ADB combined. The ADB estimates that Asia needs to invest nearly US$800bn in infrastructure every year to 2020, so there will be no shortage of demand for Chinese financing. Risks are well anchored: Loan growth remains below the risky threshold (30% of GDP within a decade). Furthermore, credit growth has been slowing across the region, since real rates have been rising (despite the fall in nominal rates) and given that private banks want to limit a rise in NPLs (which average 1% in the region). The region is well positioned: No big external imbalances. Well placed to benefit from US growth. Big winners from lower oil prices. Well anchored inflation means loose monetary policy. Vietnam (cheap location) and Philippines (reforms boost manufactures) should do well. Indonesia and Malaysia will lag (due to commodities and Widodo’s difficulties in tackling problems). Recommendations for Financial Markets Equity (MSCI Asia x-Japan): “BUY” Core Gov. Fixed Income: “BUY” Inv. Grade Credit: “BUY” Fx: “BUY”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

China:

The authorities remain broadly supportive of the market

Capital Economics, Thomson Datastream

Key Forecasts

Reforms Taking the reins: The government found itself forced to manipulate the market in order to restore investors’ confidence. (1) Suspension of new share issues. (2) The capital of the CSFC has been increased by RMB100bn (4) Crackdown on short sales. Long-term view: The goal of a strong but sustainable equity market is an important component of President Si Jinping’s “China Dream”. Prior tightening operations were aimed precisely at smoothing and controlling the crazy boom seen in the last 12 months. But our perception is that the authorities remain broadly supportive of the market, aiming to (1) facilitate their broader policy of economic liberalization, (2) cushion the adverse impact of a slower growth trajectory, (3) make it easier for Chinese companies to raise equity capital, reducing reliance on bank lending and improving capital allocation, (4) ease the privatization of state assets, and (4) smooth China’s transition to an economy governed more by market forces than by official diktat. Authorities announced a fresh investigation into “malicious” trading. Larger investors, which hold multiple accounts to disguise holdings, may be more responsible for the market swings. The CSRC instructed brokers to review trades and require the use of real names and national identity. No impact on the economy: (1) Any wealth effect from falling stock values will be small. (2) Past booms in stock prices did not provide any boost in spending. (3) Only 50 million investors (or 7% of households) owned A shares. (4) Losses of investors are far smaller than assumed, since only 33% of the stock market is owned by private investors. (4) Although Chinese firms raised money by selling shares, equities account for only 5% of total private sector funding. (1) There is no liquidity stress in the banking system (SHIBOR 3-mths at 3.19%). Outlook Positive in the long term. Job openings keep the pace. This correction has led to very attractive valuations on the Hong Kong stock market (PE now at 8.2x). The MSCI China is trading at 10.4x PE and Shanghai A share market is trading at a PE of 17.8x. Recommendations for Financial Markets Equity: “HOLD” Fixed Income: “BUY” Inv. Grade Credit:“BUY” Fx: “HOLD”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

India

is likely to continue its gradual recovery into 2017

Capital Economics, Thomson Datastream

Economic prospects India’s economy is likely to continue its gradual recovery into 2017, helped by lower interest rates and a more stable macro-economic environment (inflation looks set to remain low, while the sharp fall in the current account has made India less vulnerable to shifts in global risk sentiment). Politics India is fixing the cause of its economic sclerosis in recent years: Delhi sets policy and dictates the terms of big projects, while state governments do the implementation, although they have traditionally lacked the resources to deliver the planned projects and the political incentive for local governments has been to create bureaucratic hindrances which ensure that projects never get built. A key plank of Modi’s strategy to remedy this dysfunction: Transfer more powers to state governments in a broad platform dubbed “competitive and cooperative federalism”. Modi’s idea is (1) for states to have the capacity to deliver rather than be incentivized to look for excuses. (2) Having been given the power and funds to do the job, a process of competition would hopefully ensure that states engage in a race to the top, rather than the bottom. (3) Not only will state governments get more money, but the proposal is to increase their borrowing capacity by 0.5% of GDP on the qualifying proviso that debt levels are less than 25% of GDP. States are legally mandated to keep their fiscal deficits below 3%. The current average level stands at 2.4% Fiscal consequences: This fiscal rebalancing between Delhi and the states pave the way for a simplification of the tax code (a single tax for national goods and services). Business consequences: Improvement of the business climate and private sector investment. General Assessment: India has initiated powerful reforms, which should have the cumulative effect of signaling to business that a substantially changed business environment is right around the corner. India is headed in the right direction, but a number of pieces still need to fall in place. China is also making friendly noises. Recommendations for Financial Markets Equity: “BUY” Fixed Income: “BUY” 11 Fx: “BUY”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Japan: 20

Going through a post industrial renaissance?

NIKKEI - SALES (% Change Y/Y)

10 5

0 -5 -10

-15 -20 -25

'06

'07

'08

'09

'10

'11

'12

'13

'14

(% 1YR) Japan Nikkei 225 - Sales Andbank, Factset Research System

5,5

©FactSet Research Systems

NIKKEI - NET MARGIN (%)

4,5

24 22

3,5

2,5

'12

'13

'14

'15

Japan Nikkei 225 - Net Margin (Left) Japan Nikkei 225 - Price to Earnings R atio (R ight) Andbank, Factset Research System

1.000

©FactSet Research Systems

NIKKEI - EPS (LOC)

1.000

800

600

400

200

-200 -400

-200 '06

'07

'08

'09

'10

'11

'12

'13

'14

-400 '15

Japan Nikkei 225 - Earnings per Share Andbank, Facts et Research Systems

©FactSet Research Systems

Policy Ironically, one of the biggest factors supporting Japanese equity values could now be one favored by the bears: the country’s “awful” demographics. Because Japanese live so long yet have become so infertile the current Japanese pension system no longer works, and the Japanese can only meet their obligations by boosting investment returns. Yes, pension managers take more risk, but they allocate their resources to the companies that maximize shareholder value best. This could explain why Japan is going through a postindustrial renaissance built around technologies (robotics) and clean energy. The result is that new well-paying jobs are now being created (evidence that complex industries are developing), which should boost the amount being paid into the pension system. The bears issue warnings on gross public debt (240% of GDP), but factoring in the fact that (1) net debt is at 129% and (2) bonds buried in the BoJ’s basement will never get repaid, this ratio shrinks to 80%. Furthermore, most of this debt is owed domestically and the fiscal position is improving since the draft budget for fiscal 2015 envisages ¥4.4trn less JGB issuance than in 2014. Is this Japanese turnaround the result of a “beggar-thy-neighbor” devaluation that could eventually run out of steam? Japanese equities have decoupled from currency influences. Wage raises average 2.23% across almost 4,500 unions in 2015 (vs 2.08% in 2014), the job-toapplicant ratio is at 1.19 (a 23-year high) and unemployment remains at a low 3.3%. There is some evidence that Abe is getting serious about deregulation. The current session of parliament has been extended until 27th September in an effort to push through legislation. Markets Another key factor comes from reduced corporate taxes (lowered by 2.5% in April, and another 3.3% planned for next year). However, with projected growth in sales now at 7% (down from 10%), margins at 5% (up from 4.8%), profit growth will be smaller (9.9% vs 10.7%). Keeping PE at 22 results in a target of 20,000. Recommendations for Financial Markets Equity: “HOLD” Fixed Income: “SELL” Fx : “SELL” (vs. USD)

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Brazil:

Black days in Brazil, but no Black Swan

Capital Economics, World Bank

Fx Reserves (% of GDP) (Capital Economics, Thomson Datastream)

Capital Economics

Policy & Reforms The political system looks close to paralysis, as corruption scandals taint both Dilma and Lula, and the ruling party’s coalition partner talks of ending the alliance and launching an impeachment. Economics The macro situation has played out as we expected. Fiscal and monetary tightening is necessary to rein in government profligacy and keep inflation under control, but it also compounds the problem of weak domestic demand. The seasonally adjusted economic activity index was down -3% YoY in June, and the current consensus forecast for full-year GDP growth is 1.7%, Outlook Continued tightening of monetary and fiscal policy makes a second year of economic contraction a possibility in 2016. The question now is, how much worse can the economy get and what impact would this have on asset prices in Brazil? Such a vicious cycle only ends when: (1) The CA and Fx stabilizes through a contraction of import demand, while the economy remains solvent, and (2) Monetary easing becomes feasible. Solvency is not a big issue. The government debt level will stay close to its long-term average of around 65% of GDP. Public external debt is just 6% of GDP, so the depreciation of the real will not be a problem. Fx reserves, at US$350bn, are enough to cover all short-term debt plus 18 months of imports. The banking system does not suffer from a significant currency mismatch. Meanwhile, the CA deficit has yet to reach a meaningful turning point (now hovering around 4.5% of GDP as a result of outflows on the income and services account. The economic slowdown could alleviate pressures on this front. Some more currency depreciation will be needed before the external balance stabilizes. Inflation rise is not as bad as it sounds. Nearly all of the increase comes from long-overdue increases in administered prices (utility charges, transport, gasoline and diesel), which is part of Levy’s fiscal consolidation plan. Recommendations for Financial Markets Equity: “HOLD” Fixed Income (Loc): “BUY” Fixed Income (USD): “BUY” Fx: “HOLD”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Mexico: 5 4 3 2 1 0 -1 -2 -3 -4 -5

Mexico is well positioned to face turbulence risk

GDP GROWTH - US vs MEXICO

8 6 4 2 0 -2 -4 -6

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14

-8

(% 1YR) MEX - Economic Activity Indicator (as a Proxy for GDP) (Right) (% 1YR) US - GDP (Left) Andbank, INEGI, US Bureau of Economic Analysis

12 11

©FactSet Research Systems

MEXICO - CAPITAL FLOWS (Quarterly, bn$US)

10 9 8 7 6

5 4 3

10 5

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14

-5

(MOV 12M) FDI Mexico ($bn) (Left) (MOV 1Y) Foreign Investment Portfolio, Mexico ($bn) (Right) Andbank,Bank of Mexico

7.00

©FactSet Research Systems

CONSUMER PRICES - MEXICO (%y/y)

7.00

6.00

5.00

4.00

3.00

2.00

1.00

'06

'07

'08

'09

'10

'11

'12

'13

'14

'15

(% 1YR) Cpi, Total, 2012m12=100 - Mexico Andbank, Bank of Mexico

©FactSet Research Systems

Economics Supportive inflation environment: Prices continued their downward trend. In June the CPI reached its lowest historical level on an annual basis, standing at 2.87%. Supportive domestic consumption backdrop: Consumption data continues its growth path. In June supermarket and department store sales expanded at a rate of 5.0%, while we saw 6.7% YoY growth in production of autos during June. Favorable external dynamics: Exports were 5.3% higher than in the same month of 2014. Reforms The historic first bidding process for hydrocarbon resources after the energy reform disappointed, as only 14% of 14 areas up for grabs in Round 1.1 were assigned. The assignment rate was even below the 30-50% rate expected by the government. After the bitter experience, we expect the government to react so as to have better subsequent rounds. Policy & Markets Equity: We keep our IPC 2015 target at 47,500, supported by gradual recovery in consumption, auto industry growth and remittances, the correlation with the US economy and favorable comparative corporate results. We consider that Mexico is well positioned to face turbulence risk amidst an eventual flow reversion, due to its tight relationship with the U.S. economy. Preferred sectors: retail, auto parts, construction, industrial. Fx: Mexico’s currency has been falling to record levels against the dollar, illustrating the downside of popular emerging-market trades at a time of anxiety about higher interest rates in the U.S. The lack of internal factors that might give strength to the Mexican currency extend the expectation that the peso will not return to lower levels by the end of the year. Bonds: 10-year yield target in the local currency bond in a trading range between 5.7% and 6.1%. There is no chance of a rate hike by Banxico before the Fed. The bank confirmed this by delaying its remaining policy meetings. Target for the 10 yr USD govie bond in the 3.00% area. Recommendations for Financial Markets Equity: “BUY” Fixed Income (Loc): “BUY” Fixed Income (USD): “BUY” Fx: “BUY”

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Others: EMEA & LatAm Russia -

Monthly News Flow: (12 negatives, 4 neutral, 7 positives)

Andbank’s Assessment for Russian Assets: A LESS STRESSFUL ENVIRONMENT. The tension between the West and Russia has relaxed markedly during the last month. Intense diplomatic relations that have resulted in a final agreement on Iran have also led to other diplomatic meetings to discuss topics such as Syria, ISIS and Ukraine. All this seems conducive to stability in Russian assets.

Russia (information is displayed according to its date of publication, the most recent first) (+) The Kremlin said that conversations between Putin and Obama do not remove disputable issues but they are useful and demonstrate readiness to settle disputes by dialogue (Interfax) (-) Russian deputy foreign minister says proposal for an international tribunal on the MH17 disaster is untimely and counterproductive (MFA_Russia, 15 Jul). Dutch Government seeks UN support to investigate MH17 disaster. (-) Russia to upgrade submarine forces of Black Sea Fleet in 2016 (Navy Commander, 14 Jul) (-) The Kremlin says that implementation of Minsk agreements stalled (Interfax, 7 Jul) (=) Russia is studying possibilities of direct fuel deliveries to Greece (Interfax, 13 Jul) (+) Kremlin welcomes steps to normalize US-Cuba ties (Tass agency, 2 Jul) (+) Lavrov to meet Kerry to discuss Syrian crisis (NYTimes, 1 Jul) (=) Russia considering giving Belarus a loan to refinance its external debt (RIA news, 30 Jun) (+) White House: President Putin called Obama to discuss ISIS, Syria, Iran and Ukraine (26 Jun) (=) Putin: Russia support for Syrian leadership is unchanged (Reuters, 29 Jun) (-) Russian ban on Western food imports extended by 1 year (Reuters, 5 Jun)

Ukraine (++) Only 1 Ukrainian serviceman has been killed in the past month (vs the 28 dead the previous month), according to records published monthly in Breaking News. (-) Rally in Kiev urging war on eastern Russia-backed rebels (BBC News, 4 Jul) (-) Putin says that Oil drop means Kiev will no longer get gas discounts (Sputnik, 25 Jun) (-) Russia halts gas supply to Ukraine after collapse of pricing talks (AP, 1 Jul)

EU, Germany & OSCE (-) EU extends sanctions against Russia to January 2016 (Business, 23 Jun)

USA (+) White House: Obama thanked Russian president Putin for role in Iran nuclear talks. “Both presidents expressed a desire to work together on reducing regional tensions, particularly in Syria” (Breaking News, 16 Jul) (-) Marine General J. Dunford confirmed that Russia is the top US national security threat (Reuters, 10 Jul) (-) US ambassador to the UN criticized Russia’s use of the privilege of permanent membership to block marking Srebrenica as a genocide (Ambassador Power, 9 Jul). Vitaly Churkin deems resolution as “not constructive and confrontational”. China abstained. (-) Defense secretary Ash Carter: US to give weapons and troops to NATO to defend against Russia (AO, 23 Jun)

Other nations (-) Australia and Netherlands “sickened” at purported new MH17 footage showing Russianbacked rebels rummaging through dead passengers’ luggage (AFP, 17 Jul) (=) China’s ambassador says Russia and China not going to form a military union, but to 15 continue military cooperation (Interfax, Jul 5)

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Others: EMEA & LatAm Argentina Economic Activity: Indicators pointed to a recovery during 2Q15, but this came as a result of higher public spending. Industrial production was sluggish (-0.7% YoY through May). Upward revision for 2015 GDP growth estimate to 0.5% (from -0.5% in the previous quarter), on the back of higher than expected public spending Fiscal / Monetary Policy: Primary spending accelerated at 41.1% YTD, further worsening the deficit. Money printing to finance the deficit has grown so far this year, despite the government’s sale of more bonds in the local market (the treasury has received ARS 93 billion YTD). This means the financial gap has more than doubled compared to the same period of 2014. Due to the higher money base expansion and the lower sterilization efforts of the BCRA, the monetary base accelerated to around 33% YoY in June, from 22% YoY in Dec-14. External imbalances & Fx Reserves: Bond issuances and financing received from China have offset the current account deficit this year. Bond sales have totaled USD 3.9 billion so far this year (USD 1.4 billion issued by the central government, USD 1.5 billion by YPF, USD 0.5 billion by the City of Bs As and USD 0.5 billion by the Province of Bs As) plus the USD 7.3 billion coming from China since October 2014. Without these two factors the FX reserves would have fallen by about USD 4.7 billion since last October. This figure reflects the weak performance of exports (lower commodities prices), in contrast to the sustained USD demand from individuals. Meanwhile, imports also remain relatively weak (suggesting that the domestic situation remains subdued). FX: Official @ 9.15, Blue 15.00. Year-end target (official): 10 pesos per USD. Continued Central Bank’s FX policy of depreciating the Peso at a 1% MoM pace. We would expect a stronger FX adjustment with Macri and a softer one with Scioli. Fixed Income market: Argentina bonds sold off in June after the news that Zaninni was running as VP of Scioli (avg. 6 USD). Main news came from new order issued by Judge Griesa, which allowed holdouts to seek to block the Bonar24 and other External Debt. Parties would still have to discuss the case. In the short term this is bad news, as another govt bond could be blocked. In the long term it could force the government to reach an agreement. Recommended Strategy: Be cautious on Argy bonds (expensive at current levels). In order to play Argentina high yields we prefer the New YPF 25 Bond YPFDAR 8 ½ 07/28/25 @ 100.50 YTM: 8.41%. Good liquidity and no legal risk. Equity ADRs HOLD, favor large caps. High volatility expected for the coming months.

Turkey Politics: Doors wide open with CHP. Not closed with MHP. And definitely closed with HDP. The first round of coalition talks has clearly shown the Republican People’s Party (CHP) was eager to join the ruling Justice and Development Party (AKP) in a coalition government. Prime Minister Davutoğlu made a general assessment of his talks with the three opposition parties and described the first round as “successful”, particularly the CHP. CHP’s Kiriçdaloglu said, “Our teams will work and enter into details next week”, recalling the 14 principles outlined earlier. How far are we from a government coalition? AKP’s Davutoğlu said that “eight or nine of these principles are those the AKP agrees to conceptually, two or three are negotiable and one or two could be problematic”. Geopolitics: Vienna agreement on Iran’s nuclear future will have a positive impact on TehranAnkara economic relations (while Rouhani thanked Turkey for its cooperation on the nuclear issue in recent years). Why? (1) Bilateral trade will be boosted (trade is now almost zero). (2) Turkey will benefit from cheap oil and gas. Iran has the 4th largest proven reserves of oil and the 2nd largest reserves of gas. (3) Iran is now Turkey's second largest gas provider (Turkey meets 30% of its oil demand, 5.2mn tons, from Iran. Before sanctions, the figure was 50%, or 10mn tons) and sector representatives predict that Turkey’s energy imports from Iran could increase dramatically. (4) Iran signaled potential gas discounts if Turkey buys more gas. It is even willing to sell its Southern 16 Persian gas to Europe through Turkey.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Equity Markets SHORT-TERM ASSESSMENT. RISK-OFF PROBABILITY: LOW

Andbank's Global Equity Market Composite Indicator (Breakdown)

Buy signals Positive Bias Neutral Negative Bias Sell signals FINAL VALUATION

Current

Month

2 0 13 0 1 0,6

2 0 12 0 2 0,0

Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets

-5

-10 Overbought

Area of Neutrality

Market is

Sell bias

Buy bias

+10 Market is Oversold

Reading: The current score of Andbank’s GEM composite indicator remains neutral at 0 (from 0.6 prior) in a +10/-10 range. The current level suggests an absence of stress in the equity markets. We therefore consider that a sudden, deep and sustained risk-off shift in the equity markets during the coming weeks is unlikely. If a correction takes place, it should prove short-lived. The slightly negative tilt from the sentiment part is balanced by the positive signs in the flows area. Flows: The most remarkable fact is the big outflows seen in EM (in both Equity and FI), most probably due to the China effect. Meanwhile, the last few weeks have been positive for European and US equity. Japan Equity continues to receive heavy inflows (inflows in 20 of the past 21 weeks). HY is beginning to regain some flows after a difficult month and remains positive YTD. Positioning: From the GFMS of Merrill, we highlight the extreme level of cash hold by asset managers in their portfolios. Cash at 5.5%, which is the highest level since 2008, while at the same time managers say they have the highest level of protection since Feb ’08. These bearish moves are in fact bullish signs (under a contrarian perspective) and contrast with an aggressive positioning towards high beta sectors such as Banks (at record highs) and Discretionary, which might indicate that investors do not consider there to be any major macro risks. Investors keep delaying the probable first hike date: 45% of investors think it will be in 4Q 2015 (45%), rather than 3Q (only 38% of respondents). In line with these flows, portfolio managers remain OW in Japan and Europe, while clearly underweight EM and almost flat in US (UW since the beginning of the year). Liquidity: EMs have suffered large outflows in terms of capital and financial flows, primarily in China, where the outflows of the last 5Qs wipe out all previous capital inflows back to 2011. The capital outflows are bigger than those suffered in the Lehman crisis or in 2012. FUNDAMENTAL ASSESSMENT: “HOLD” 2014 2015 2014 2015 2015 2014 2015 Sales E[Sales] Net E[Net E[Profit] Index EPS E[EPS] Index % Ch y/y % Ch y/y Margin Margin] % Ch y/y Local* Local* S&P 500 (USA) 2,43% 4,86% 10,03% 10,03% 4,9% 119,45 125,3 MSCI EMU 0,52% 2,50% 4,77% 5,25% 12,8% 10,28 11,6 MSCI UK 1,68% 0,00% 6,57% 5,91% -10,0% 117,65 105,9 Spain - Ibex 35 -8,10% 5,50% 4,39% 6,50% 56,2% 500,33 781,6 Asia Pac x Japan - Factset 7,91% 8,70% 7,60% 7,98% 14,1% 19,34 22,1 Japan - Nikkei 225 10,73% 7,00% 4,87% 5,00% 9,9% 828,30 909,9 China - Factset Mkt Index 8,38% 7,54% 7,95% 8,35% 12,9% 17,47 19,7 India - Factset Mkt Index 3,80% 8,00% 7,05% 7,05% 8,0% 26,52 28,6 Mexico - IPC 5,00% 6,04% 8,79% 9,00% 8,6% 2400,00 2605,8 Brazil - Bovespa 6,96% 8,00% 7,04% 7,74% 18,8% 3733,00 4435,0

2014 2015 INDEX PE ltm E [PE ltm] CURRENT PRICE 17,22 17,60 2.109 18,21 20,00 215 16,54 19,00 1.940 20,60 16,00 11.283 20,90 18,00 323 22,50 22,00 20.303 24,22 21,00 407 21,70 21,00 548 18,59 18,23 44.471 14,84 12,00 50.245

* Except for the fol l owi ng ma rkets : As i a Pa c x Japan, Chi na and Indi a, where EPS ha ve been reported in US$.

Upward revision

Downward revision

2015 2015 TARGET E[Perform.] PRICE % Ch Y/Y 2204 4,5% 232 7,8% 2012 3,7% 12505 10,8% 397 23,0% 20019 -1,4% 414 1,8% 601 9,7% 47503 6,8% 53220 5,9%

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Fixed Income Markets FIXED INCOME – CORE COUNTRIES UST 10Yr BOND: “HOLD”. Entry point above 2.25% yield. 1. Treasury yields have decreased (from 2.41% to 2.27%) and Swap rates also fell (from 2.51% to 2.39%). Swap spread fell to 7bp. For this spread to normalize at 30-40bp, with inflation expectations (swap rate) anchored in the 2%-2.25% area, the 10T yield should move to 1.80%. 2. The slope in the UST yield curve has flattened (from 172bp to 157bp). With the short end in the 0.75% area, to reach the LT average spread (120bp), the 10T yield should go to 1.95%). 3. Given the “new normal” (ZIRPs globally), a good entry point in the US 10yT could be when Real Yield is at 0.75% (real yield is currently 2.27%). Therefore, Treasuries are cheap. EURO BENCHMARK 10Yr BOND: “SELL”. Entry point at 1.0% yield. 1. Bund yields have decreased (from 0.86% to 0.70%) and Swap rates also fell (from 1.66% to 1.53%). Swap spread has increased and now stands at 83bp. For this spread to normalize at 30-40bp, with inflation expectations (swap rate) well anchored in the 1.5% area, the 10T yield should go to 1.15%. 2. The curve has flattened (from 106bp to 93bp). With the short end in the -0.2%-0.0% range, to reach the LT average spread (116bp), the 10T yield should move to 1.06%). 7

US D - 10 Y r SWAP SPREAD

1.00 0.80

0.60

2,5

0.40

0.20

0.00 '06

'07

'08

'09

'10

USD 10Y Swap R ate (Le ft) USD 10Y Treas ry Y ield (Le ft)

'11

'12

'13

'14

1, 5

1 0, 5 0

1,5

- 0,5

-1

0,5 0

-0.20 '15

'11

Swap Sp re ad 10Y USD (Rig ht)

Andbank, Tullet Prebon

3,5

EUR - 10 Yr SWAP SPREAD

'12

'13

'14

'15

- 1,5

Swa p Sp re a d 10Y EU R (Rig ht) EUR 10Y Go v b o nd Y i e ld ( Le ft) EUR 10Y Swa p R a te (L e ft)

USD - YIELD CURVE SLOPE 10/2 Yr (bps)

Andbank, Tullet Prebon

EUR - Y IELD CURVE SLOPE 10/2 Yr (bps)

350

300

250

200

150

100

350

0 - 50

'07

'08

'09

'10

'11

'12

'13

'14

0 '06

300

-50

- 50 '15

0 '06

'07

'08

(10Y Y ie ld - 2Y Y ie ld ) Tre nd lin e : A ve ra ge

'09

'10

'11

'12

'13

'14

-50 '15

10Y Yield - 2Y Yield Trendline: Average

Andbank, Tullet Prebon

FIXED INCOME – EUROPEAN PERIPHERALS: “BUY” 20 18 16 14 12 10 8 6 4 2 0

10 Yr GOVIES - EUROPEAN PERIPHERALS

Oct

Jan

Apr Ita ly Spain

Andbank, JPM Chase

Jul Po rtugal Ire land

Oct

Jan

Apr

Jul

20 18 16 14 12 10 8 6 4 2 0

•

A more benign government auction calendar should help QE forces to develop. Peripheral spreads have improved, but the question is whether the 90 bp spread over bund represents a hurdle for investors. We stick with our old projection for yield declines in peripheral bonds. Our targets for the 10 year Spanish and Italian bonds are 1.50% respectively. For the Portuguese bond 1,8% and 1.25% for the Irish bond.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Fixed Income Markets FIXED INCOME – CORPORATE BONDS: USD CORPs IG: SELL The headwind is the vola in the UST. Spreads peaked in July on heavy supply, China, Greece and M&A. Retail funding has turned negative. The Fed will remain as an ongoing source of volatility. Potential widening of +10bps. HY: HOLD. HY continues to outperform, with Energy and Materials being the worst performers. Default rate stable at 1.88%. We like Media and Retail. And OW BB vs CCC. Buy at USD IG CORPORATE BOND SPREAD (ML 1-10 YR INDEX) 5-10 bps wider. 2,5 2 1,8

EUR CORPs: IG: SELL. Spreads widened on Greece but rallied after the agreement, with all sectors moving in parallel. New issuance far below trend, but once markets stabilize new issuance should increase. HY: HOLD. High Yield credit has proved more resilient and is now closer to 2015 best readings. The relative stability of the yield and the lack of urgency to tighten monetary conditions should mean favorable conditions. 3.5

EUR IG CORPORATE BOND SPREAD (ML 1-10 YR INDEX)

2.5

3.0

1,6

1,5 1

1,4

2.5

1,2

2.0

2.0 1.5

1.5

0,8

0,5

0,6

'13 Corp ora te s (R ight) Financia ls (Le ft)

Andbank, Merril Lynch

'14

'15

0,4

1.0

1.0 0.5

Ind ustria ls (Le ft) Utilities (Le ft)

Corp ora te s (Right) (R ight) Industria ls (Le ft) Financia ls (Le ft) Utilities (L e ft)

Andbank, Merril Lynch

FIXED INCOME - EMERGING MARKETS (GOVIES): “SELECTIVE BUY” CPI (y/y) Andbank's Estimate

10 Year Yield Real

2,37%

0,68%

1,69%

Taiwan

1,48%

-0,56%

2,04%

Thailand

2,86%

-1,07%

3,93%

Malaysia

3,91%

2,54%

1,37%

Singapore

2,66%

-0,34%

3,00%

Indonesia

8,34%

4,59%

5,00%

3,34%

Philippines

4,38%

1,22%

3,16%

China

3,52%

1,39%

2,12%

India

7,77%

5,40%

2,37%

Turkey Russia

9,43% 10,36%

7,61% 15,28%

6,00% 13,00%

3,43% -2,64%

Brazil Mexico Colombia Peru

13,06% 6,08% 7,09% 6,40%

8,89% 2,87% 4,42% 3,54%

7,00% 2,87% 4,42% 3,54%

EM ASIA

S.Korea

EME

10 Year CPI (y/y) Yield Last Govies reading

LATAM

Our rule of thumb for EM bonds so far has been “buy” when (1) US Treasuries are cheap or at fair value and (2) real yields in EM bonds are 175bp above the real yield in UST. Is the UST cheap or at fair value? Historically, a good entry point in the 10Y UST has been when real yields are at or above 1.75%. However, given the “new normal” (ZIRPs globally), a good entry point in the US 10yT could be when the real yield is at 0.75% (today’s real yield is 2.27%). Thus, Treasuries are cheap. Do Real Yields in EM bonds provide sufficient spread? Given the “new normal” (ZIRP), a good entry point in EM bonds could be when EM real yields are 75bp above the real yield in the UST. Since the UST real yield is currently 2.27%, we should buy EM bonds that have a real yield of 3.02% (see table).

Cheap valuations

6,06% 3,21% 2,67% 2,85%

Expensive Valuations

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Commodities ENERGY (OIL): “HOLD”. Fundamental Target range ($30-50). Iran will be able to ramp up its crude output from the current 2.8mn barrels daily to the 3.6mbd it produced until the latest tightening of sanctions in 2012, and ultimately to its peak production of 6mbd attained in the 1970s, when Iran’s oil industry enjoyed the benefits of Western technology, know-how and finance. More importantly, the advances in production technology since the 1970s suggest that “Iran should be quite capable of producing more oil in the long run than it did 40 years ago”. Given that Iran has the fourth largest proven oil reserves and that those reserves are geographically as accessible as Saudi Arabia’s, restoring (or exceeding) 1970 production levels seems a very modest long-term objective, according to some sources. Short-term Outlook 1. In order to make room in the market for all this extra oil, Iran must compete fiercely not only with the burgeoning production from Saudi Arabia, Kurdistan (both producers pumping at record rates), Libya and Nigeria, but also with the Iraqi production capacity (which keeps improving, according to the EIA). 2. The price war among OPEC producers, which adds to the war between OPEC and US shale oil, is bound to intensify as Iran rejoins the global economy. This will keep the oil price at very moderate levels, hovering around $50 per barrel. Long-term Outlook 1. If Iran reaches its 1970 production level in the mid to long term, Iran will add about as much to global oil output in the second half of this decade as the US shale revolution did in the first half. 2. The oil market has definitely shifted from monopoly price setting by OPEC to competitive pricing, and in normal competitive markets the price is set by the marginal cost of production of the highest cost producers (in this case, the US frackers, whose marginal costs seem to be in the region of $50-$60 per barrel but are falling rapidly as the cost of drilling falls). 3. If the marginal cost is set at around $50, we could expect this level to be a ceiling rather than a floor for the price of oil in a competitive pricing system. 4. Therefore, in this new and competitive oil market, oil prices will fluctuate between a ceiling (determined by the break-even point of the high-cost swing producers, i.e., US frackers and Canadian tar sands) and a floor (determined by the lowest-cost producers among the Middle East OPEC members, Azerbaijan, Kurdistan, Russia, etc.). 5. I share the view of some old rockers in the sector, according to which the oil market is reentering a competitive pricing period similar to 1986-2004, where $50 per barrel could perfectly well be a ceiling. 6. Some still believe that OPEC countries (or Saudi Arabia) can set oil prices at whatever level they wish (as they did during the “monopoly periods” of 1974-85 and 2005-14). In a world where oil demand is constrained by advances in non-fossil fuel technologies and oil supplies keep expanding as a result of new production techniques, such monopoly power is now a mirage. 7. Energy substitution (higher demand for oil at current cheap prices) is a very long-term phenomenon and it is inconceivable that such behavior could have already responded to cheaper oil. 8. Optimism based on possible cuts in oil supply in the US (shale) is not well founded. The US Energy Information Administration predicted that US production would fall by 160k bpd in 2016 (due to cuts in investment), but a global increase of 720k bpd is projected for 2015. Even if US production is cut, this reduction could be dwarfed by increases in Saudi’s output of 1m bpd this year, its announcement of further developments that could add another 1m bpd in 2016, or the additional 1-3m bpd that Iran is likely to add.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Commodities • GOLD: “SELL” (Target US$ 900/oz) Negative drivers: 1. Gold in real terms. Gold at constant 2009 prices is now at $1,014 (-$67 in the month and above its LT average of $700). Given our global deflator (base year 2009) at 1.08, for the price of gold in real terms to stay near its historical average, the nominal price of gold must remain near US$756. 2. Gold in terms of Oil (Gold / Oil): The ratio has increased to 22.65 (from 19.62 previously) and remains above its LT average of 13.87. If the oil price stays at $50, the nominal price of gold must approach US$700 for this ratio to be near its LT average level. 3. Gold in terms of Equity (Gold / S&P): The ratio has moved to 0.52 (from 0.56 previously) and is now clearly below its LT average of 0.58. Given a target price for the S&P of $2,204, the nominal price of gold must approach US$1,278 for this ratio to be near its LT average level. 4. Gold in terms of Equity (Dow Jones / Gold): This ratio (inverse) has moved to 16.1 (from 15.3 previously), still below its LT average of 20.3. Given our target price for the DJI ($18,825), the price of gold must approach US$927 for this ratio to be near its LT average. 5. Positioning in Gold points to further falls: CEI 100oz Active Future non comm. contracts: longs 191k from prior 203k. Shorts 143k from 107k => Net of +48k (from +95k). (Speculators are still long.) 6. Financial liberalization in China. Higher “quotas” each month in the QFII are widening the investment alternatives for Chinese investors (historically focused on gold). Positive drivers: 1. Central Bank Activity: Every single central bank has been increasing gold stocks recently. 2. The Money Stimulus is continuing (now from the ECB and BOJ). 3. The Ban on India’s imports of gold has been lifted. Many retailers have been stockpiling, fearing that the ban on gold imports would be re-applied. 4. Amount of gold in the world: The total value of gold in the world is circa US$6.9tn, a fairly small percentage (3.2%) of the total size of the financial cash markets (212tn). The daily volume traded in the LBMA and other gold marketplaces is around US$173bn (2.5% of the world’s gold and just 0.08% of the total in the financial markets).

100

GOLD STOCK - CENTRAL BANK RESERVES (%Y/Y, Monthly) 100

80 60

0 -20

-40 -60

'12 India Thailand

'13 Sing Philipp

Andbank, National Res erve Banks

Japan UK

'14 Ch ile Ch ina

'15 Rus s ia

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Currencies • EUR/USD: MT Target (1.00) According to JPM’s IMM report, the USD 3-yr Z-score rose to +0.8 (from 0.6 the previous week). Despite this increase in speculators’ positioning, current data does not reflect particularly heavy nor broad long USD positioning. Not heavy, since long USD positioning is only 0.85 standard deviations above its 3-year mean. Not broad, since only NZD and MXN positioning screen more than 1.5 s.d. short vs USD. This suggests that the USD positioning far below the extremely stretched +2.3 Z-score seen in late 2014, which means that the USD rally could have legs. The EUR 3-yr Z-score decreased to -0,6 (from prior -0.4). Though speculators have increased their EUR shorts, these positions are still above the stretched -2.0 we saw in March, suggesting that there is still a lot of room for speculators to open new short positions intensively. Interpreting 3-yr Z-scores in JPM’s report: the 3-yr Z-score is a summary statistic telling us how far (measured in standard deviations) the positioning is from “normal” (the 3-yr mean). o A Z-score in the -1.0 to +1.0 range implies that positioning is not a barrier to underlying price trends. o A Z-score in the 1.0 to 1.5 range suggests increasingly stretched positioning. o A Z-score absolute value of 1.5 to 2.0 implies that the elastic band has become extremely stretched and may be on the verge of snapping back. o At a Z-score of 2.0 “everyone” has the position on, creating a dauntingly high hurdle to continued price momentum (at that point it takes an exceptional policy event or data release to surprise the market so that the trend is maintained).

• JPY/USD: MT Target (130) • JPY/EUR: MT Target (130) Specs have thrown in the towel on Abenomics. Specs have closed all the shorts they put on since Abe became PM at end-2012. The Z-score is +0.5 (vs. -1.1 in December).

• GBP/USD: MT Target (0.68) • GBP/EUR: MT Target (0.68) • ASIAN CURRENCY BASKET (Vs. USD): >10% POTENTIAL APPRECIATION According to our Asian Currency Diffusion Index, these currencies are still cheap compared to the USD. Macro risks have profoundly shifted since the late 1990s as a result of mercantilist policies (less external debt and better CA balances). A recovery in sync means that Asia is ready to start a new phase of growth linked to a US recovery. Preferred: CNY, IDR, PHP, MYR, INR. Asian Currency Diffusion Index

Diffusion Index 3mth smoothed (lhs) Asian curr Index (rhs)

1,150

0,40

STRONG BUY

0,30

1,100

Factors considered in the Asian Currency Diffusion Index: •

0,20 BUY

SELL

1,050 0,10 1,000

0,00

0,950

-0,10

• •

-0,20 0,900 -0,30

STRONG SELL 0,850

-0,40

•

Feb-15

May-15

Nov-14

Aug-14

Feb-14

May-14

Nov-13

Aug-13

Feb-13

May-13

Nov-12

Aug-12

Feb-12

May-12

Nov-11

Aug-11

Feb-11

May-11

Nov-10

Aug-10

Feb-10

-0,50 May-10

0,800

•

S&P Vola (Stability in the global system. Asian assets are the first on the auction block. Asia is very much linked to the global USD funding market. Reading >25 turns negative.) Kospi Vola (Captures concerns specific to Asia. Reading >23 is negative.) RMB Trend (When appreciates less than 80 pips in 2 months, turns negative. Strong Peg with RMB.) JPY Trend (If depreciates >300 in 2m, it turns neg.) Global Velocity (Asian ec. see an increase in demand for their products and currencies.) OECD Asian LEI (When falls in the big 5, it turns negative. CBs use exchange rate policies to counter short-term dynamics.) 22

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

Principal Contributors

Alex Fusté. – Chief Global Economist – Global & Asia: Macro, Rates & Fx. +376 881 248 Giuseppe Mazzeo. – CIO Andbank US – U.S. Rates & Equity. +1 786 471 2426 Eduardo Anton. – Portf. Manager US – Credit & Quasi governments. +1 305 702 0601 J.A Cerdan. – Equity strategist Europe – European Equity. +376 874 363 Antoni Melero. – Fund Manager Europe – European Equity. +376 874 366 Renzo Nuzzachi, CFA. – Product Manager LatAm – Rates & Fx. +5982-626-2333 Jonathan Zuloaga. – Analyst, Mexico – Macro, bonds & Fx. +52 55 53772810 Albert Garrido. – Portfolio Manager Luxembourg – Volatility. +352 26 19 39 25 Luiz Secco. – Product Analyst Brazil – Equity. + 55 11 3095 7042 Gabriel Lopes. – Product Analyst Brazil – Products. +55 11 3095 7075 Andrés Davila. – Head of A. Management Panama – Venezuela. +507 2975800 Mª Angeles Fernández. – Product Manager, Europe – Macro & Rates. +34 639 30 43 61 David Tomas. – Wealth Management, Spain – Spanish Equity. +34 647 44 10 07

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW AUGUST & SEPTEMBER -15

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