WEEKLY MARKET VIEW. Liquidity vs. sceptics. 2 March Contents MACRO OVERVIEW FIXED INCOME EQUITIES COMMODITIES CURRENCIES

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1 WEEKLY MARKET VIEW 2 March 2012 Contents Macro overview Pg 2 Fixed Income Pg 3 Equity Pg 3 Commodities Pg 5 FX Pg 5 Conclusion Pg 6 Technical analysis Pg 7 Economic & Market Calendar Pg month Market Outlook Pg 9 LTRO helped bring down Italy, Spain yields Italy, Spain 10y yields(%) % Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Italy Spain Benchmark (USD) performance w-o-w* JP Morgan Cash MSCI AC World Citigroup World BIG DJ UBS Commodities DXY ADXY *week of Feb 23 to Mar 1 Steve Brice Rob Aspin, CFA Manpreet Gill Suren Chelliah LTRO1 > Chief Investment Strategist Senior Investment Strategist Senior Investment Strategist Investment Strategist LTRO2 > % Liquidity vs. sceptics ECB provided more liquidity in Europe but the Fed failed to signal new easing measures. We believe further US quantitative easing remains possible later this year should the economy disappoint. Significant cash holdings mean any correction may be shallow and/or short-lived, though rising oil prices are a concern. We are biased to use any weakness to raise portfolio risk, but continue to see a VIP strategy as the most appropriate lens through which to view potential investments this year. MACRO OVERVIEW ECB Long Term Lending Operation (LTRO) was largely priced in, but a rise in number of borrowing banks was a key highlight Fed Chairman Bernanke gave no signal of further monetary easing at testimony, disappointing markets Data remains consistent with our muddle-through scenario FIXED INCOME The LTRO had a muted impact on sovereign bonds, but credit spreads continued to compress at a rapid pace Default rates in Asia may creep higher in 2012, but this is off a zero-default base and would be consistent with tighter spreads EQUITIES We are cognisant short-term weakness risk, but the Group Investment Council holds the view that a correction may be shallow Our focus continues to be on blue chip names, Asia ex-japan & emerging markets, gold & energy equities. In Asia we prefer sectors linked to domestic consumption: insurance, transportation, consumer discretionary and staples. COMMODITIES Gold exhibited its largest one-day fall since 2008, but central bank liquidity supports our view to stay overweight We are Overweight energy both as a geopolitical risk hedge, but also due to continued strength in fundamental demand CURRENCIES USD strength was the key FX market theme after Bernanke failed to provide clear signals on future monetary easing AUD remained supported, however, by commodity prices and stronger Chinese and domestic economic data

2 Macro overview Weekly Market View ECB balance sheet has grown rapidly Size of Fed and ECB Balance sheets EUR Trn Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 ECB Balance Sheet All Assets Fed Balance Sheet (RHS) Central banks globally easing policy incrementally Central Bank Monetary Policies Change in Policy rates (since Sep Central Bank 2011) Other Policy Initiatives Operation Twist, Extended low interest rate Fed No Change through to end 2014 Expected LTRO of EUR 500 ECB 50 bps to 1.00% 750bn Set minimum exchange SNB No Change rate at CHF 1.20 per Euro Adopted inflation target of 1% & additional JPY 10trn BOJ No Change of QE BOE No Change QE of GBP 50bn Cut required reserve ratio (RRR) for large banks by a PBOC No Change total of 100bps to 20.5% Central Bank of Russia 25 bps to 8.00% NA Banco Central do Brasil 150 bps to 10.50% NA THB 350bn flood relief Bank of Thailand 50bps to 3.00% package Bank Indonesia 100bps to 5.75% NA Bangko Sentral ng Philipinas 50bps to 4.00% NA Surprises in data beginning to edge lower US Economic Surprise Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Citigroup, Bloomberg, Standard Chartered USD Trn Liquidity and economic data reverberated through markets last week, helping keep risk appetite elevated. The ECB s second 3-year Long Term Lending Operation (LTRO) was the most anticipated event of the week. The final lending amount itself (at EUR 529.5bn) approximately matched consensus expectations, but more significantly the number of banks utilising the borrowing facility rose to 800, compared with 523 at the December operation. No doubt the final outcome is positive in terms of helping banks and sovereign bond markets avoid a squeeze in liquidity, but the relatively muted reaction in yields, equities and the Euro suggests this was largely priced in. Across the Atlantic, Fed Chairman Bernanke was sending somewhat different signals. At a regular semi-annual testimony, Bernanke reaffirmed that rates were likely to stay low through 2014, but did not offer any details on the possibility of further quantitative easing. He said higher oil prices could push up inflation temporarily, but noted that the labour market remained far from normal. The lack of a clear signal on further monetary easing measures introduced a subdued tone into many risky assets despite the ECB s LTRO. We maintain our view that further easing remains possible later this year, though the final outcome is likely increasingly dependent on the path of economic data in coming months. Economic data maintained its consistency with a muddle-through scenario: US economic data surprises remain high, but have arguably edged down a little from recent peaks. The ISM manufacturing index surprised on the downside, falling to 52.4 as new orders slowed. The Fed Beige Book regional survey of economic activity, however, noted the economy continued to expand at a modest to moderate pace as manufacturing output rose steadily. Durable goods orders, however, unexpectedly fell. Q4 GDP growth was revised upwards slightly to 3.0%. In Asia, India s GDP growth slowed by more than expected to 6.1% in Q4 2011, while China s PMI manufacturing rose very slightly to 51. January industrial production fell -8.8% YoY in Singapore and -2.0% in South Korea, though production in both cases was higher than that in December. Industrial production in Japan continued to contract by -1.2% YoY, albeit at a slower pace than December, while UK GDP grew by 0.7% in Q4, slightly lower than consensus expectations. The ECB and BoE both hold their monthly policy meetings next week. US labour market data and the ISM non-manufacturing are both scheduled for release. South Korea, Malaysia and Indonesia s central banks also meet to set policy rates while China releases key monthly data on inflation, retail sales, trade and industrial production. Conclusion: Incrementally easing monetary policy and economic data consistent with our muddle-through scenario support our stance of selectively raising risk in equities and commodities. 2

3 Rapid Asia HY spread compression continued JACI HY Corp Spread JACI HY Corp Blended Spread Median +1 std dev -1 std dev 0 Dec-05 Dec-07 Dec-09 Dec-11 Source: JP Morgan, Bloomberg, Standard Chartered Bonds Muted LTRO impact The second ECB LTRO had a much more muted impact on European sovereign yields than the first operation. While Italian and Spanish yields did tighten slightly, the magnitude of lending appeared to have been largely priced in during the days leading up to the second LTRO. The lack of any clear signal from Fed Chairman Bernanke meant 10-year Treasury yields continued their climb back to the 2% level, resulting in marginally higher real (net of expected inflation) yields. Credit spreads continued to narrow for yet another week. Regionally, US investment grade (IG) spreads tightened more quickly than high yield (HY), no surprise considering IG spreads are much wider relative to history than HY. In Europe, however, the pace of tightening in HY spreads continued to outpace IG. US HY spreads still narrowing BarCap US HY OAS BarCap US HY OAS Median +1 std dev -1 std dev Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Source: Barclays Capital, Bloomberg, Standard Chartered The same trend was witnessed in Asia. HY spread compression outpaced that in IG, with most of the compression occurring in quasi-sovereigns and corporate. Financials were largely flat while sovereign spreads widened. Moody s forecast a rise in Asia HY defaults to just over 2%, but we note this is a low rate by itself, and comes off a base of zero defaults in Conclusion: Central bank liquidity, low expected defaults and a search for yield in an environment of low interest rates cause us to maintain our strong overweight on IG and HY corporate credit. We remain biased to use any correction in the weeks ahead to continue to average in. Equity Staying with key themes As we highlighted in our Global Market Outlook, our stance on equities is Neutral on a 3m horizon and Overweight on a 12m horizon. Selected equity market performances over the last week (USD)* MSCI World MSCI Emerging Markets MSCI US MSCI EMU MSCI Asia ex Japan MSCI Japan-0.73 *week of Feb 23 to Mar % The case for being Overweight equities on a 12m view does not mean that we are taking the view that a new bull market in equities has begun. Rather, our view is that equities offer a more attractive return relative to other asset classes G3 sovereign bonds trade at record low yields while cash effectively offers zero. A continued commitment by central banks to provide cheap and bountiful liquidity is an additional support especially over a relatively shorter time horizon. On a 3m basis, however, we maintain a Neutral stance. We are cognisant that many short term indicators (from measures of risk appetite to technicals) suggest that the current market rally may be stretched, implying the possibility of short-term weakness. This weakness may, however, be shallower and more short-lived than some of these indicators suggest. Given the levels of cash on the sidelines and the broad-based scepticism in the rally (and thus limited participation), any pullback may be limited. 3

4 Cyclical sectors continued to gain MSCI World GICS Sector performances over the last week (USD)* Cons Staples Health Care Utilities Telcos Material-0.30 Technology Industrials Financials Energy Cons Discretionary *week of Feb 23 to Mar % We advocate investors remain selective about adding risk by staying invested in high quality names across various sectors. Specifically we believe in four key investment themes: Preference for blue chip names with high return on assets (ROA), with great franchises and brands and EM exposure Regionally we prefer emerging markets and Asia ex-japan on a 12m basis We like gold miners as a hedge against uncertainty, heightened geopolitical risk and future inflation We are bulish on energy majors as a play on economic growth as well as a hedge against heightened geopolitical risk in the Middle East On energy and gold equities, while we do expect them to continue outperforming, it won t necessarily be plain sailing. There will be periods of underperformance and significantly higher levels of volatility ahead as the ongoing battle between consumer deleveraging and deflation is tackled by various developed market Treasuries and central banks. Within such an environment, it is important to be able to manage through periods of elevated volatility and take a long term view. In terms of sectors, in addition to Energy and Precious Metals, we continue to favour Technology (particularly in the US and Korea), a number of the Consumer Staples (particularly in the US and EU) and, selectively, Consumer Discretionary (either in, or focussed on, Asia). While we do not like Financials in the US and EU, we take the view that a number of them offer good value in Singapore, China and Hong Kong. Asia ex-japan valuations inexpensive MSCI Asia ex-japan 12m Fwd P/B chart Forward PBx x 12m Forward PB 1.713x Median PB Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Source: Datastream, Standard Chartered Asia is a very diverse region, with immense scope and potential for growth, especially given the low base. For instance, GDP per capita in China is still only around one tenth that of the US, despite growing at a blistering pace of 17% p.a over the past 10 years. In this region we like those companies which are exposed to growth in domestic consumption, which includes the Financials (particularly in the area of Insurance), Energy, Industrials (with a focus on transportation) and, in certain markets, Consumer Staples and Discretionary. In Korea and Taiwan we like the IT sector. Sector performance is very much driven by country specific factors and sectors valuations do vary significantly across various markets in the region, making it more beneficial to focus on individual stock picks across the different markets. Conclusion: We are Overweight equities on a 12m view as we expect equities to outperform other asset classes such as cash and sovereign bonds which already have very low yields. We maintain a Neutral 3m view as we are cognisant of the risk of a correction in the short term. Our preferences remain: high quality, blue chip names, Asia ex-japan and broader emerging markets and gold and energy equities. 4

5 Commodities Gold & Oil Commodities sub-sector performances over the last week (USD)* DJ UBS Agriculture DJ UBS Precious Metals DJ UBS Energy DJ UBS Industrial Metals *week of Feb 23 to Mar % Gold prices led a decline in commodities over this past week. Bernanke s less than supportive signals towards further monetary easing led to a sharp drop in gold prices. The drop in prices was the commodity s largest one-day fall since December 2008, but prices quickly bounced thereafter. The lack of an obvious trigger yet more central bank easing in the short term mean that a pause in gold s run is possible in the short term. However, we have repeatedly made the point that we are in an environment where central banks clearly remain ready to provide more liquidity when required in an effort to avoid deflation (even if this risks high inflation). Gold will likely, in our view, provide a hedge against the risk of more quantitative easing and the risk of higher inflation. Dollar reacted negatively to Bernanke testimony DXY and ADXY Oil prices were affected by lower US quantitative easing expectations, but geopolitical concerns and strong fundamental demand helped temper weakness. South Korea, the world s fifth largest oil importer, reported that its crude oil imports grew 13.2% YoY in February. This underscores the fact that fundamental demand remains strong and any risks of supply disruptions due to Middle-East geopolitical risks can lead to a sharp rise in prices. We maintain an overweight position due to strong global liquidity, strong underlying demand and its role as a hedge against a rise in geopolitical risks Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 ADXY DXY Curncy (RHS) Base metals fell over the early part of the week, but modestly positive Chinese PMI data helped prices rebound somewhat later in the week. Copper led the move higher. Conclusion: We are overweight gold and oil. Gold is likely to stay supported by policymaker bias towards further monetary easing, while oil should additionally benefit from strong underlying demand conditions and a volatile geopolitical environment in the Middle East. Lack of triggers after LTRO for the EUR EUR Currency EUR-USD FX US Dollar the main driver Bernanke s lack of commitment towards further monetary easing unsurprisingly had a sizeable impact on the US Dollar. The Dollar (DXY) strengthened sharply before easing somewhat on the following day, but notably stayed below its 100-day moving average. Relatively stronger economic data may keep expectations of further quantitative easing contained in the short term, supporting the US Dollar. We do, however, believe further quantitative easing remains possible and expect the US Dollar to weaken over the course of the year Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 EUR 50 dma 100 dma 200 dma The Euro s weakness was one of the obvious outcomes of Dollar strength, particularly its drop on the day of Bernanke s testimony. However, the completion of the ECB s second LTRO likely played an additional role as further monetary easing in Europe contrasted with no clear signal of further monetary easing in the US. The magnitude of the impact was, however, limited as the amount lent out through the LTRO was largely along expected 5

6 Commodity prices supported AUD AUD Currency and RBA Commodity CPI AUD-USD May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 AUD-USD RBA CPI Comdty USD (RHS) lines. The lack of an obvious trigger after the second LTRO likely implies weaker support for the currency. The Australian Dollar was buoyed by recent data. The latest monthly reading of the RBA commodity price index (representative of Australian commodity export basket) began to move higher in February. China s slightly higher PMI manufacturing reading was also supportive by raising expectations of higher commodities demand. Finally, Australian retail sales printed stronger than expected. We maintain our view that a pullback to resistance levels in the short term is possible, but continued central bank liquidity and still-strong demand for commodities will provide strong medium term support for the currency. Conclusion: The completion of the LTRO and the lack of a clear signal for more quantitative easing in the US mean a short bout of US Dollar strength. Continued central bank commitment towards providing liquidity, however, means that currencies such as the Australian Dollar will likely do well thereafter. Conclusion Policymakers clearly have become more pro-active in fighting any signs of slower growth or declines in inflation. We believe this will support risky assets over the coming months, and have therefore increased our 12m stance on portfolio risk. We continue to believe, however, that the VIP Strategy is the best framework to use when making investment decisions: 1. manage portfolio Volatility (gold and macro strategies/commodity trading advisers). 2. protect against Inflation (gold and their related equities) and 3. be Paid (corporate bonds and high quality, high dividend equities) 6

7 Technical Analysis Weekly Market View DXY - US Dollar Trade-Weighted is finding some underlying support at 78, both its 30 WMA and lower trendline support. It remains oversold at a time when its momentum indicator has just turned positive. However, its MACD is still weak. So, we would not get too bullish on the USD yet, capping its upside at to 80 in the near-term Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 DXY 50 dma 100 dma 200 dma Gold Spot gold has formed an inverse S-H-S from last September, and has failed to break its important neckline resistance at US$1800 on its recent rallies. This technical failure implies further price weakness in the short-term, especially when the metal remains overbought and its momentum indicator is falling and showing bearish divergence. We expect gold to retest support level at $ , and if this is violated; $ $/Oz S S 1700 H Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Gold 50 dma 100 dma 200 dma S&P 500 The S&P 500 broke its April 29, 2011 closing high of But, this happens only on 45% of its 3- year average volume and near-resistance momentum. While we are not ruling out 1400, such a breakout may be suspect Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 SPX 50 dma 100 dma 200 dma 7

8 Economic & Market Calendar 2 March 2012 Next Week: Mar 5 - Mar 9 This Week: Feb 27 - Mar 2 Event Period Expected Prior Event Period Actual Prior MON EC PMI Composite FEB F EC Euro-Zone M3 s.a. (YoY) JAN 2.50% 1.60% EC PMI Services FEB F US Dallas Fed Manf. Activity FEB EC Sentix Investor Confidence MAR EC Euro-Zone Retail Sales (YoY) JAN -1.60% -1.30% US ISM Non-Manf. Composite FEB US Factory Orders JAN -0.90% 1.10% CH China HSBC Services PMI FEB TA CPI YoY% FEB 1.30% 2.37% TUE EC Euro-Zone GDP s.a. (YoY) 4Q P 0.70% 0.70% JN Retail Trade YoY JAN 1.90% 2.50% TH Total Exports YOY% JAN % EC Business Climate Indicator FEB TH Total Imports YOY% JAN % EC Euro-Zone Consumer Confidence FEB F US Durable Goods Orders JAN -4.00% 3.20% US Durables Ex Transportation JAN -3.20% 2.20% US Cap Goods Orders Nondef Ex Air JAN -3.10% 2.80% US Consumer Confidence FEB US Richmond Fed Manufact. FEB JN Industrial Production YOY% JAN P -1.20% -4.30% JN Vehicle Production (YoY) JAN 18.60% 13.40% JN Construction Orders (YoY) JAN 24.60% 1.50% WED JN Leading CI JAN P EC Euro-Zone CPI (YoY) JAN 2.60% 2.70% SK South Korea Money Supply M2 JAN % US Core PCE QoQ 4Q S 1.30% 1.30% MA Exports YoY% JAN 2.80% 6.10% US Chicago Purchasing Manager FEB MA Imports YoY% JAN 5.30% 10.40% SK Industrial Production (YoY) JAN -2.00% 2.80% THUR JN Machine Tool Orders (YoY) FEB P % US Fed's Beige Book GE Industrial Prod. YoY (nsa w da) JAN 0.60% 0.90% UK PMI Manufacturing FEB UK BOE Asset Purchase Target MAR 325B 325B EC Euro-Zone Unemployment Rate JAN 10.70% 10.60% UK BOE ANNOUNCES RATES 8-Mar 0.50% 0.50% US PCE Core (YoY) JAN 1.90% 1.90% EC ECB Announces Interest Rates 8-Mar 1.00% 1.00% US Initial Jobless Claims 25-Feb 3.51K 353K SK South Korea 7-Day Repo Rate 8-Mar 3.25% 3.25% US ISM Manufacturing FEB ID Bank Indonesia Reference Rate 8-Mar % CH PMI Manufacturing FEB TA HSBC Manufacturing PMI FEB FRI GE Consumer Price (YoY) FEB F 2.30% 2.30% JN Jobless Rate JAN 4.60% 4.50% UK Industrial Production (YoY) JAN -3.10% -3.30% SK Consumer Price (YoY) FEB 3.10% 3.40% US Change in Nonfarm payrolls FEB 206K 243K SK HSBC Manufacturing PMI FEB US Trade Balance JAN -$49.0B -$48.8B UK PMI Construction FEB 51.4 US Unemployment Rate FEB 8.30% 8.30% EC Euro-Zone PPI (YoY) JAN 4.30% CH Consumer Price (YoY) FEB 3.40% 4.50% CH Industrial Production (YoY) FEB 12.40% 12.80% CH Retail Sales (YoY) FEB 17.30% 18.10% MA Overnight Rate 9-Mar 3.00% 3.00% Previous data are for the preceding period unless otherw ise indicated Data are % change on preivous period unless otherw ise indicated Data are % change on preivous period unless otherw ise indicated p- preliminary data, f- final data, sa - seasonally adjusted p- preliminary data, f- final data, sa - seasonally adjusted YoY - year on year, MoM - month-on-month YoY - year on year, MoM - month-on-month 8

9 3-12 Month Market Outlook Central bank policy rates Spot Q Q Q Q Q Q US Europe UK Japan Australia China Taiwan Malaysia Indonesia South Korea India Philippines Thailand Forex Spot Q Q Q Q Q Q EUR/USD GBP/USD USD/JPY USD/CAD USD/CHF AUD/USD NZD/USD USD/CNY USD/SGD USD/MYR USD/IDR ,100 9,200 9,000 8,700 8, USD/KRW ,160 1,155 1,095 1,050 1, USD/TWD USD/INR USD/THB USD/PHP Commodities Spot Q Q Q Q Q Q Gold Silver WTI Crude Oil Copper Aluminium Corn Soybeans Wheat *Blue (Red) indicates upward (downward) revision Global Research (2 Mar 2012 Economics Weekly publication) * Period averages for each quarter. 9

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