Economy, Capital Markets & Strategy

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1 Sébastien Mc Mahon, CFA Economist Member, Asset Mix Committee Economy, Capital Markets & Strategy 2014 National Business Conference October October 23, 2014

2 Disclaimer Opinions expressed in this presentation are based on actual market conditions and may change without prior warning. The aim is in no way to make investment recommendations. The forecasts given in this presentation do not guarantee returns and imply risks, uncertainty and assumptions. Although we are comfortable with these assumptions, there is no guarantee that they will be confirmed. Industrial Alliance Insurance and Financial Services Inc. 2

3 World: Synchronisation eroding (0.0) 3 Source : Capital Economics

4 China: An important piece of world economic growth ontribution to world growth in 2014 orld Economic Outlook, IMF, April 2014 China: Urbanization rate % of population living in urban areas 50% 46% 48% China 31% Developped countries 28% 40% 30% 25% 29% 34% 40% Emerging countries (excl. China) 41% 20% 10% 18% 19% 21% 0% Source : IMF and IA Economics, data via Bloomberg

5 China: significant risk factors China: Prices are falling in 67 of 70 cities surveyed Number of cities where residential housing prices are falling on a monthly basis Existing residential appartments New residential appartments Source : IA economics, data via Bloomberg and BCA Research

6 Europe: «QE» to the rescue? Europe: Credit is still contracting Annual growth, % Source : NBF Economy & Strategy and IA Economics, data via Bloomberg Loans to households Loans to non-financial corporations

7 Europe: some deep structural problems Europe: Unemployment rates % Spain & Greece Italy & Portugal Europe Source : IA Economics, data via Bloomberg and NBF Economics & Strategy World : still challenges in the Eurozone Working-age population (20 to 54) a/a (%) ch Canada Eurozone Japan NBF Economics & Strategy (Data from IMF and OECD) U.S. 8

8 UNITED STATES BACK ON TRACK AND STRONGER THAN EVER 8

9 9 Source : RBC U.S.: A lackluster recovery?

10 U.S.: Uneven path since 2009, but important progress nonetheless Jan-67 Jan-70 Jan-73 Jan-76 Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15 U.S.: GDP growth revised higher Annualized quarterly growth, % European crisis Fiscal cliff Weather U.S. Unemployment Rate, Capacity Utilization & Tightening Cycles Periods of Fed Tightening U.S. Capacity Utilization (%) - LHS U.S. Unemployment Rate (%, inverted) - RHS Source: Scotiabank GBM Portfolio Strategy, Bloomberg. 10 Source : IA Economics, data via Bloomberg

11 U.S.: Clean balance sheets and sky high profit margins U.S.: Household balance sheet's best shape in 30 years Ratio of financial obligations to personal disposable income 19 % U.S.: Profit margins have topped out Corporate profits / GDP 14% 13% 12% 18 11% 10% 17 9% 16 8% 7% Source: IA Economics, data via Bloomberg 6%

12 U.S.: Jobs recovery and wealth effects stimulating the market for big ticket items U.S.: Strong housing starts and vehicle sales 3-month MA U.S.: Business investment picking up Capital goods new orders nondefense ex. aircraft, value and 3-month M.A., $ millions Vehicle sales (millions) (RHS) Housing starts ('000s) (LHS) Source : IA Economics, data via Bloomberg

13 Labour market: Many jobs open but few qualified applicants U.S.: Jobs openings on the rise JOLT survey, jobs openings, 000s Source : IA Economics data via Bloomberg

14 U.S.: Experts having problems keeping up with the ongoing energy revolution U.S.: EIA still can t keep up with technological change! Actual and projected production of energy in the U.S. by forecast vintage Quadrillion Btu Dec NBF Economy & Strategy (data via EIA) Dec 2012 Jun 2012 Jun 2008 U.S.: Imports impacted the most U.S. volume energy imports, actual and forecast by vintage Quadrillion Btu NBF Economy & Strategy (data via EIA) Jun 2008 Jun 2012 Dec 2012 Dec Source : NBF Economy & Strategy

15 Jan-94 Nov-94 Sep-95 Jul-96 Fed: towards normalization of its monetary policy May-97 Mar-98 Jan-99 Nov-99 Sep-00 Jul-01 May-02 Mar-03 Jan-04 Nov-04 Sep-05 Jul-06 May-07 Mar-08 Jan-09 Nov-09 Sep-10 Jul-11 May-12 Mar-13 Jan-14 Nov-14 Taylor Rule Target with U6 and U3 Unemployment Rate vs Fed Fund Rate 8 6 Taylor Rule U3 Taylor Rule U6 Fed Rate Source: Scotiabank GBM Portfolio Strategy, Bloomberg.

16 16 U.S: With QE soon behind us, when will rates nomalize?

17 Divergence in monetary policies should support the greenback U.S. dollar: appreciation vs major world currencies DXY index of USD vs basket of major world currencies Source: IA Economics, data via Bloomberg

18 18 WHAT ABOUT CANADA?

19 Canada: Resilient but uneven growth Q Real GDP compared to pre-recession peak 8% 6.7% 8.4% 6% 4% 2.9% 2% 0% -2% -4% % -2.4% Euro zone Japan Germany US Canada Source : IA Economics, data via Bloomberg

20 Canada: Strong performance of last 10 years based on interior demand Canada: Exports will eventually have to take over Real final domestic demand, GDP and exports Index, 2000= Real final domestic demand Real GDP Real exports Source: IA Economics, data via Bloomberg

21 Yellow flags: Household debt and overheating construction sector! Canada: Disaster in the making? Construction jobs as a share of total payroll employment* % Canada U.S. *Payroll basis (for Canada: tables and NBF Economics and Strategy (data from Statistics Canada) 21 Source : NBF Economy & Strategy

22 Competitiveness: Canada losing ground 22 Canada's rank Pillars Change Institutions Infrastructure Macroeconomic Environment Health & Primary Education Higher Education and Training Goods Markets Efficiency Labour Market Efficiency Financial Market Development Technological Readiness Market Size Business Sophistication Innovation Total Source : World Economic Forum

23 Canada: Loonie devaluation helping exports Canada has lost market shares in the last 10 years % of imports coming from Canada, 12-month M.A. 21% 20% 19% 18% Canada's market share in the world (rhs) 4.8% 4.3% 3.8% 17% 16% 15% 14% Canada's market share in the U.S. (lhs) 3.3% 2.8% 2.3% 23 13% Source : IA Economics, data via Bloomberg 1.8%

24 Loonie: Our 90 cents target reached faster than expected Canada: Exchange rate and 5-year rate spread CAD/USD (lhs) & spread between 5 yearrates, Canada - U.S. (rhs) Lower commodities prices pressuring the loonie $ 1.05 $ 1.00 $ 0.95 $ 0.90 $ 0.85 $ 0.80 $ CAD/USD (RHS) CRB, 1995Q1 = 100 (LHS) $ CAD/USD Spread (Can-US) Source: IA Economics, data via Bloomberg

25 25 CAPITAL MARKETS

26 26 Equities: What to expect after QE?

27 Bull markets usually ended by a recession 27 Source: RBC

28 U.S. stock market still fairly valued S&P 500: Three different peaks Characteristics Mar 2000 Oct 2007 Sep 2014 Index level 1,527 1,565 2,011 P/E ratio 25.6x 15.2x 16.0x Dividend yield 1,1 % 1,8 % 1.9 % 10-yr Treasury 6,2 % 4,7 % 2.6 % Sep 18, 2014 P/E (fwd) = 16.0x 2, Mar 24, 2000 P/E (fwd) = 25.6x 1, % -49 % +101 % -57 % Oct 9, 2007 P/E (fwd) = 15.2x +197 % Dec 31, 1996 P/E (fwd) = 16.0x Source: IA Économie, données via Bloomberg Oct 9, 2002 P/E (fwd) = 14.1x 777 Mar 9, 2009 P/E (fwd) = 10.3x 677

29 Volatility at all-time lows: Complacency according to the BIS # of Day with Variation > 1% - Last 250 Days of Trading TSX S&P Note: Shaded area represent periods of fed tightening Source: Scotiabank GBM Portf olio Strategy, Bloomberg.

30 30 Before the first Fed hike

31 Rising rates are not necessarily bad for equities 31 Source: RBC

32 TSX performance based on commodities Relative performance, S&P/TSX vs S&P = TSX outperformance is always linked to commodities Source: IA Economics, data via Bloomberg

33 33 TSX: Largest inflows in 14 years

34 After a rise in 2013, long rates fell this year Canada: Yield curve bps bps M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y 1 mai déc sept 2014 Source: IA Economics, data via Bloomberg

35 Canadian bonds: Avoiding a second consecutive negative year? 2014 YTD: 6,3 % 35 Source : JP Morgan

36 U.S.: For the first time since 2001, the correlation between short and long rates turned negative 36 U.S.: Long rates influenced more by bunds than short rates Correlation, daily data, 90 days U.S. rates vs Germany Source: IA Economics, data via Bloomberg 10 year vs 2 year rates

37 What would be the «normal» rate of interest? 37 U.S.: 10 year rates approximately follow nominal GDP growth % year rates Source: IA Economics, data via Bloomberg Nominal GDP growth 4,6% in 2014 Q2 *

38 Asset class returns : Performance in 2014 (as at September 30) Canadian bonds FTSE TMX Universe : +5.9% FTSE TMX Long: +11.6% Corps : +5.6% Asset allocation FU040 Money market 9.0% EAFE Equities 8.0% RRB : +11.7% Equities (total return) S&P/TSX : +12.2% TSX small cap.: +7.0% S&P 500 : +8.3% (+14.2% en CAD) EAFE : +1.7% (+3.9% en CAD) US Equities 19.0% Can Small caps 6.0% Bonds 33.5% MSCI - Emerging : +2.9% (+5.7% en CAD) CAN Diversified funds* : Can Equities 24.5% Diversified (FU040) : +8.9% YTD 2014 (+14.9% in 2013) Diversified security (FU240) : +8.7% YTD 2014 ( + 8.0% in 2013) Diversified opportunity (FU250): +10.8% YTD 2014 (+17.5% in 2013) 38 *: Gross return

39 Our investment strategy Asset allocation: Equities over fixed income Equities: Biased towards U.S. vs EAFE (for now) Bonds: Short duration, overweight corporate bonds Sectors: Careful on commodities Positive on technology (Capex) Forex: Long position on the U.S. dollar (index: DXY) 39

40 Conclusions U.S.: Finally on a sustainable path with a lot of momentum building in the second half of the year. Europe: A still fragile recovery with tensions ahead! Canada: Loonie devaluation starting to benefit exports. Interest rates: With imminent end to QE in the U.S., debate is turning to the «timing» of rate normalization. Stocks: On a risk/return basis, the U.S. market remains attractive relative to other markets once converted to $CAD. Risk factors: Prolonged slowdown in China and Ukraine conflict 40

41 41 Visit us:

42 42 THANK YOU!

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