A Flock of Black Swans
Global Interdependence Center
Rome - April 2011
Constance Hunter
Managing Director and Chief Economist
203-326-6895
2
Global Equity Markets: Past, Present and Future
2003-2006 It’s a Wonderful Life
2007 The Tide Changes
2008 A Year of Reckoning
2009 A Rising Tide Lifted All Boats
2010Low Rates, Refinancing and Top-Line
Growth
2011Low Rates, Stock Buy Backs, M&A and
Black Swans
3
• Earthquake/Tsunami in Japan
• Middle East Uprisings
• European Debt Woes
• US Debt Woes
• Chinese Hard Landing Fears
• Rising Commodity Costs
Wind in the Sails of Equity Markets... Black Swans on the Horizon
• Low Interest Rates
• M&A to Accelerate
• Share Buy Backs are Starting in Earnest
• Cash on the Sidelines
• Earnings Growth Momentum
• Profit Margins High but not Peaked
4
M&A Activity off to a Robust Start for Q1
Source: Bloomberg
High cash levels and low interest rates will buttress M&A activity this year
M&A Activity Breakdown
Target Industry Volume ($bn) Count
Oil & Gas 60.45 174
Telecommunications 59.46 169
Electric 45.39 72
REITs 41.52 85
Chemicals 24.45 117
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Significant Amount of Cash on the Sidelines… a Powerful Technical Factor
Money Stock: Savings Deposits, including Money Market Deposit Accounts (SA, Bil $)
Source: Federal Reserve Board/Haver Analytics
Money Stock: Savings Deposits, including MMDAs
SA, Bil.$
100908070605040302010099989796
6000
5000
4000
3000
2000
1000
6000
5000
4000
3000
2000
1000
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Outperforming Equity Markets are in Growing Economies
Source: Haver Analytics
Strong growth and inflation trump rate increases; markets outperforming
40
60
80
100
120
140
160
180
200
220
Sep
-08
Dec
-08
Mar
-09
Jun
-09
Sep
-09
Dec
-09
Mar
-10
Jun
-10
Sep
-10
Dec
-10
Mar
-11
Countries in Rate Hiking Mode
Indonesia Turkey South Korea China
Brazil Norway Canada
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Quantitative Easing has yet to help equities as much as organic growth
Source: Haver Analytics
50
60
70
80
90
100
110
120
130
Sep
-08
Dec
-08
Mar
-09
Jun
-09
Sep
-09
Dec
-09
Mar
-10
Jun
-10
Sep
-10
Dec
-10
Mar
-11
QE Countries Equity Market Performance Since LEH
UK Germany US Japan
It does not help that countries engaging in QE also have high debt
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Quantitative Easing Can’t Overcome the Burden of High Debt
Source: Haver/Bloomberg
40
50
60
70
80
90
100
110
120
Sep
-08
Dec
-08
Mar
-09
Jun
-09
Sep
-09
Dec
-09
Mar
-10
Jun
-10
Sep
-10
Dec
-10
Mar
-11
Countries with High Debt - Performance Since LEH
US Portugal Japan Ireland Greece
High debt hampers market performance, the US is underperforming Canada
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Market Performance Since Lehman Brothers Collapse
Countries with lower government debt are outperforming
Source: Haver/Bloomberg
Indonesia
Brazil
Canada
Turkey
Germany
Norway
UKUS
Japan
Greece
Spain
Ireland
Portugal
ChinaSouth Korea
-60.00%
-40.00%
-20.00%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
0% 50% 100% 150% 200% 250%
Ret
urn
sin
ce L
ehm
an
Gross Debt Level
Government Debt and Equity Market Returns Post LEH
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When will U.S. Debt Levels Weigh on Profit Margins and Share Prices?
Source: Bloomberg
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6
7
8
9
10
11
12
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15
500
700
900
1100
1300
1500
1700
Mar
-00
Sep
-00
Mar
-01
Sep
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Mar
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Sep
-10
Mar
-11
Pro
fit Marg
inS
&P
500
S&P 500 and Profit Margins
S&P 500
Profit Margin
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The Spanish Market is Weighed Down by the Poor Economy
Source: Bloomberg
0
5
10
15
20
25
4000
6000
8000
10000
12000
14000
16000
18000
Mar
-01
Sep
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Sep
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Sep
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Mar
-11
Pro
fit Marg
inIB
EX
Spanish IBEX and Profit Margins
IBEX
Profit Margin
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Diverging Economies Will Lead to Diverging Markets
Country / Region
GDP Q/Q Annualized %
Industrial Production
CPIBudget Balance as a % of GDP*
Current Account as a
% of GDPPMI Reading
US 3.1% 5.3 2.2% -8.8 -3.4 59.9
Canada 3.3% 5.93 2.2% -2.1 -2.5 69.3
UK -1.9% 3.9 4.3% -9.0 -1.7 55.0
Japan -1.3% 1.8 0.1% -7.9 3.3 51.0
EUR Area 1.1% 5.92 2.4% -4.1 -0.3 58.2
China** 10.1% 27.69 5.0% -1.7 4.1 51.7
Brazil 3.0% 2.75 5.9% -2.5 -2.9 52.7
India** 2.6% 9.4 8.8% -5.0 -2.7 56.5
Russia 11.4% 6.5 9.4% -3.4 4.8 55.2
South Africa 4.4% 1.7 3.7% -5.3 -5.5 54.8
South Korea 2.0% 17.3 4.5% -1.6 2.0 53.4
Mexico 5.1% 7.2 3.5% -2.1 -1.0 n/a
*The Economist poll or Economist Intelligence Unit Estimate FY2010 ** Y/Y data, not SAAR
Source: Bloomberg, Haver, The Economist
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Consensus Forecasts not Aligned with Fundamentals
P/EForward
P/EMean
ForecastMax
ForecastMin
Forecast
US 14.2 12.7 11.45% 27.43% -7.11%
Japan 17.6 16.7 23.72% 48.60% 1.68%
Norway 13.3 11.1 7.54% 36.93% -14.18%
Turkey 11.0 10.0 14.63% 39.02% -5.93%
Spain 9.4 10.6 11.71% 38.01% -14.29%
Portugal 12.5 13.0 14.11% 34.23% -7.40%
Greece 27.3 11.3 11.25% 44.99% -6.53%
Ireland neg 17.8 11.64% 45.25% -3.24%
Source: Bloomberg Consensus Forecasts
It does not help that countries engaging in QE also have high debt
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Divergent Performance over Past Two Years
(1) Annualized standard deviation of monthly returns ending with February 2011 (2) 23 months
Source: Barclays, Credit Suisse, Bloomberg, Aladdin Capital
Annualized Return versus Volatility (2)
S&P 500
Independent Credit
Fund
Barlays U.S. Credit
Total Return
Barclays U.S. Credit
Excess Return
FTSE 250
CS Leveraged Loan
Index
Commodities
5%
10%
15%
20%
25%
30%
35%
40%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%
Ret
urn
Volatility
High
Low
Safe Risky
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US Forecast: Above Trend Growth for the Next Two Years
Year Annual Rate Year-End Forecast
GDP PCEPrivate
InvestmentResidentialInvestment
Unemployment Inflation 10-yr Yield
2010 2.4% 1.7% 6.2% -4.2% 9.7% 1.6% 3.30%
2011 3.5% 3.1% 10.7% -3.1% 8.0% 1.8% 3.65%
2012 4.3% 2.7% 11.0% 9.0% 7.5% 3.5% 5.10%
2013 2.6% 2.7% 5.0% 7.5% 7.0% 2.8% 4.50%
2014 2.9% 2.9% 4.9% 8.5% 6.5% 3.1% 4.80%
Source: Aladdin Research
Fiscal and Monetary Stimulus producing higher growth….. But can it last?
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Conclusion
• Equities have strong tailwinds… But caution is warranted
• Strong GDP growth is necessary for equity markets to grow at rates that compensate for the volatility
• QEII and Bush tax cut extensions function as a massive stimulus for the U.S. in 2011
• The U.S. economic recovery continues and gains momentum (3.5% real GDP for 2011).
• High debt levels borrow from future growth and equity markets seem to discount this.
• Restructuring and stimulative government policies continue to support markets…
• … But Black Swans hover on the horizon
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Constance Hunter - Bio
CONSTANCE HUNTER, Managing Director & Chief Economist. Prior to joining Aladdin,
Ms. Hunter was with Galtere Ltd., a global macro hedge fund, where she served as a Chief
Economist. Prior to and concurrently with, Galtere Ltd., she was the Managing Member and
Chief Investment Officer of Coronat Asset Management. In that role, Ms. Hunter identified
macro themes and invested in global equity and FX markets to capitalize on these themes.
Prior to founding Coronat, Ms. Hunter was a Partner and Portfolio Manager at Quantrarian
Capital Management, a hedge fund that invests in Asian markets. In addition, she has
worked as a Portfolio Manager at Salomon Smith Barney, Inc., and Firebird Management,
LLC. Ms. Hunter received a Bachelor of Arts from New York University, as well as a Masters
of International Affairs from Columbia University.
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