the woo group rbc wealth management hong kong usa: markets brace for ecb move

R B C W E A L T H M A N A G E M E N T

P E R S P E C T I V E S F R O M T H E G L O B A L P O R T F O L I O A D V I S O R Y C O M M I T T E E

JUNE 2014

GLOBAL INSIGHT

I N T H I S I S S U E > >

SPECIAL REPORTJAPAN: ABE, ABE, & AWAY

CURRENCY SPOTLIGHTAVOID CROWDED TRADES

GLOBAL EQUITYMARKING TIME

GLOBAL FIXED INCOMEMARKETS BRACE FOR ECB MOVE

For Important Disclosures, see page 20

U.S. HoUSing Speculators have jolted the housing market

back to life; now it’s time for traditional buyers to get back in.

Matt BaraScH | Page 4

2 GLOBAL INSIGHT | June 2014

taBle of contentS

4 U.S. HoUSingHome prices have surged nearly 30% and the number of distressed properties has plummeted. For the recovery to persist, traditional homebuyers need to take the baton from real estate investors. The handoff is not without challenges.

7 Abe, Abe, And AwAyProgress has been made to break the deflation cycle and significantly weaken the yen, but equity investors are giving Prime Minister Abe the cold shoulder so far in 2014. Is Japan’s long-awaited comeback on the horizon or just another mirage?

9 MArking TiMeAngst about the economy seems unwarranted. Stocks should deliver worthwhile gains as growth rebounds and earnings advance.

InsIde the Markets

3 rBc’S inveStMent Stance

9 gloBal eqUity

13 gloBal fixed incoMe

15 coMModitieS

16 cUrrencieS

17 Key forecaStS

18 MarKet Scorecard

Global InsightJune 2014

All values in U.S. dollars and priced as of market close, May 30, 2014, unless otherwise stated.


Global Asset Class View

EquitiEs – AvErAgE PErformAncE =�� In 2014, major equity markets should deliver high single-digit returns plus

dividends, the approximate long-term average.

�� The U.S. economic rebound and firmer European growth should moderately

lift corporate profits. Valuations could expand as confidence improves.

�� But, markets would be hard pressed to rise in a straight line. Our operating

assumption is that a correction could occur this year.

�� We believe neither a U.S. recession nor a renewed global economic downturn

is likely. Any equity market correction would likely provide opportunities to

buy high-quality stocks at attractive prices.

fixEd incomE – BElow-AvErAgE PErformAncE –�� The global bond market’s strong year-to-date performance is unlikely to

repeat for the remainder of 2014. We expect interest rates to rise gradually,

and coupons to represent the main source of returns.

�� Market expectations are high for additional ECB stimulus. Yields continue to

signal the Fed and other major central banks will maintain loose policies for

some time.

�� Rewards are not commensurate with the risks investors are taking on in

many fixed income sectors. Greater vigilance about interest rate risk and

valuations is warranted.

�� We would position portfolios defensively and would take advantage of

the steep yield curve by concentrating on short- to intermediate-duration

securities in 3- to 7-year maturities.

rBc’S inveStMent Stance

View Explanation (+/=/–) represents Global Portfolio Advisory Committee’s (GPAC) view over a 12-month investment time horizon.

+ Positive implies the potential for better-than-average performance for the asset class or for the region relative to other asset classes or regions.

= In-line implies the potential for average performance for the asset class or for the region relative to other asset classes or regions.

– Negative implies the potential for below-average performance for the asset class or for the region relative to other asset classes or regions.

Global Asset View

Source - RBC Wealth Management

Asset Class

View

— = +Equities

Fixed Income

See View Explanation below for details

Expect below average

performance

Expect above average performance


U.S. HoUSing MarKet: SeeKing new deMand

U.S. home prices have advanced substantially since 2012 with the help of high demand from all-cash investors. But investors are increasingly stepping to the sidelines. For the recovery to persist, the housing market will need to shift back to basics and find more support from traditional buyers. The transition may be easier said than done.

Focus Article

House prices have risen nearly 30% from their 2012 lows, while the inventories of unsold homes and especially so called “distressed properties” are down sharply and approaching more-normal levels. Recently, however, sales have softened while inventories have increased. Some of this weakness is related to severe winter weather; but, other forces are at work. In particular, all-cash investor demand, the impetus behind much of the recovery to date, is beginning to wane, making the market more reliant on traditional buyers, who tend to utilize mortgage debt. This transition may take some time to play out. We expect further recovery in the housing market and in its contribution to the U.S. economy, but at a less-dynamic, more-uneven pace.

mArkEt is clEAring

The median U.S. home price dropped 33% from the 2006 peak to the early 2012 low. Since then, it has risen 28%, leaving it about 14% below its prior peak. Along the way, the so-called “shadow inventory”—homes that have a mortgage in some level of distress ranging from 30 days in arrears to foreclosure—has fallen by more than one-half to nearly 2.6 million units from just below 5.4 million. RealtyTrac estimates the median sale price on foreclosed homes is about 35% lower than non-distressed sales. Thus, lifting this overhang should have a further positive effect on pricing as new listings have to compete less and less with lower-priced distressed homes.

mAtt BArAsch Toronto, Canada [email protected]

Shadow Inventory

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

Dec '99 Dec '01 Dec '03 Dec '05 Dec '07 Dec '09 Dec '11 Dec '13

Source - RBC Dominion Securities Inc., Bloomberg, data through March 2014

Strong investment demand and a rise in prices have reduced shadow inventories to less than one-half the levels of 2010.


U.S. Housing Market

Some potential challenges are

access to credit, first-time buyers

under pressure, possible Fannie and Freddie reform, and

rising prices.

cAsh hAs BEEn king

The housing market bottomed, in part, because affordability reached very attractive levels. Investor demand also played an important role, helping to clear bloated distressed and non-distressed inventories. Investment buying usually entails all-cash transactions. RealtyTrac estimates that more than 40% of housing transactions were all-cash in 2013 versus less than 20% in 2012 and less than 10% at the height of the market in 2005-06.

trAditionAl BuyErs nEEdEd

As investor buying and rising prices whittle down the number of distressed properties, bringing more homeowners into a positive equity position, we expect investment demand to decline. A transition period lies ahead in which traditional buyers, using mortgage financing, will need to take the baton from investor buyers to drive demand. However, the handoff is not without potential challenges:

�� Access to Credit Has “Issues”: Banks’ mortgage lending standards have loosened from 2011’s ultra-tight conditions, but they are far from “easy.” Meanwhile, mortgage lending regulations are potentially becoming more restrictive. As of January 10, new rules for “qualifying mortgages” require that a householder’s total monthly debt service payments—all loan payments, property taxes, and insurance—not exceed 43% of monthly income. So far, few mortgages would be affected because those backed by government agencies such as Fannie Mae or Freddie Mac or other government agencies are exempt (Fannie and Freddie until they come out of conservatorship, and the others until 2021 or until they write new rules).

�� First-Time Buyers Under Pressure: For the 25- to 34-year-old cohort, the primary driver of household formation and new home buying, the unemployment rate sits at 6.6%, above the overall unemployment rate of 6.3% and significantly higher than the rate for older cohorts. This is also the age bracket that owes much of the more than $1T in student loans outstanding, directly subtracting from its capacity to take on mortgage debt.

�� Changes to Fannie Mae and Freddie Mac a Longer-Term Issue: Congressional debate about reforms at the Government-Sponsored Enterprises to ensure

Median Home Prices

$100

$120

$140

$160

$180

$200

$220

$240

2000 2002 2004 2006 2008 2010 2012 2014

(000

s)

Source - RBC Dominion Securities Inc., Bloomberg, data through March 2014

Home prices bottomed in 2012 and have risen 28% since then.


Positive factors include

improving employment, balance sheet

repair, and rising prices.

U.S. Housing Market

taxpayers will not be on the hook in another crisis may produce changes that reduce the capacity of the agencies to lend, insure, or subsidize and/or raise qualification standards.

�� Rising Prices a Two-Edged Sword: Price increases that have restored home equity for owners and boosted consumer confidence to seven-year highs from 30-year lows have also reduced affordability to levels that are shutting out some first-time and move-up buyers.

Against these potential headwinds are some positive factors:

�� Employment Improving: While unemployment remains high for the 25- to 34-year-old cohort, it has improved (from 7.8% last August and 9.2% at year end 2011). Looking at other data, for the first time, initial claims for unemployment benefits are lower than before the recession started. Both the number of employees saying their employers are hiring and the number of small businesses saying they intend to hire have been on the rise for some time.

�� Balance Sheet Repair Continues: The recovery in home prices coupled with the approximate 150% rise in equity markets has pushed household net worth, under siege in 2008 and 2009, up almost $12T beyond its pre-recession peak. The Federal Reserve’s Financial Obligations Ratio—a measure of consumer ability to service home- and auto-related monthly payments—at its best level in 30 years.

�� Rise in Prices: More than 31% of U.S. homeowners with a mortgage were in a negative equity position at the worst point in early 2012, according to Zillow, but that number fell to less than 20% by Q1 of this year. While many homes were lost to foreclosure, the vast majority of homeowners found ways to “fight through” the crisis and kept current on their payments despite the fact they may have owed more on their mortgages than their home was worth. This had a chilling effect on the ability of affected homeowners to move to new or better jobs and on their willingness to spend. Measures of mobility and consumer confidence have improved as the number of homes under water has shrunk.

onwArd, But morE slowly uPwArd

The housing market has recovered much of what it lost between 2006 and 2012. However, much of the impetus has been from investment demand, which we believe is already waning in response to fast-rising prices and a diminishing number of distressed properties on offer. Going forward, we expect investor purchases to account for a shrinking share of overall transactions. For the recovery to continue, investors will have to be replaced by traditional buyers accessing conventional mortgages. However, for now, access to credit remains a barrier for some. That said, high readings for consumer confidence sustained by solid employment gains and impressive improvement in household balance sheets are likely to allow for a continuation in the housing recovery, albeit at a less-dynamic and more-uneven pace than has prevailed for the past two-and-a-half years.


JaPan: aBe, aBe, and away

Following is an executive summary of a special report, Japan: Abe, Abe, and Away. The full report is here.

Focus Article

JAy roBErts Hong Kong, China [email protected]

kin lok lEE Hong Kong, China [email protected]

yufEi yAng Hong Kong, China [email protected]

When Shinzo Abe returned to the scene as prime minister in December 2012 he rode in as a white knight with an aggressive plan to get Japan back on track. In this report, we assess developments across Japan’s economy, policy, and equity market. Equity investors have been more enamored of a weaker yen than of any indications that the deflationary tide is turning. We think more credit is due at this stage and maintain our Overweight stance on Japanese equities.

Since emerging from the Great Recession in 2009, the recovery in global growth has been tentative and uneven. Japan has continued to labour under major headwinds, including deflation. Against this challenging backdrop, as of the end of December 2013, the Japanese economy was approximately 12% larger than it was in the dark days of 2009, an expansion similar to that of the U.S. and 4x that of the eurozone, despite the catastrophic nuclear disaster of 2011.

Breaking the deflation cycle remains Abe’s “at all costs” mission. Indeed, prices may have reached an inflection point. Core inflation has risen above 0%, there are limited signs of wage inflation, and inflation expectations are positive, albeit muted. But this has come at a price: a weaker yen and increasing costs are de facto taxes on the Japanese consumer, who is also dealing with the first sales tax increase in 17 years.

Source - RBC Dominion Securities Inc., Bloomberg; data through 3/31/14

Japan Percentage Change in CPIs (Y/Y)

-3

-2

-1

0

1

2

3

1994 1998 2002 2006 2010 2014

Perc

enta

ge (%

)

CPI

Core CPI

Japan’s core inflation is at its highest level since the 1990s.

1 The monetary base is the sum of the money circulating in public plus bank reserves held at the central bank. The BoJ’s policy has meant expanding its balance sheet by approximately 1% of GDP per month. This compares to the approximate expansion of 0.5% of GDP per month by the Federal Reserve’s quantitative easing program before it began reducing its asset purchases recently.

Bank of Japan (BoJ) Governor Haruhiko Kuroda came to office in April 2013. In his first speech as governor, he delivered a clear message the BoJ would no longer pursue “gradualism” to end deflation. The goal was, and still is, simple: end deflation and achieve an inflation level of 2% by mid-2015. Kuroda aims to achieve this by:

�� Doubling Japan’s monetary base by adding ¥60-70T per year;1

https://www.rbcinsight.com/WM/Share/ResearchViewer/?SSS_C106006F41992F4C8D4882397A2F2B80


Japan

Against this challenging

backdrop, as of the end of December

2013, the Japanese economy was

approximately 12% larger than it was in

the dark days of 2009.

�� Doubling the BoJ’s holdings of Japanese government bonds (the main method to increase the monetary base); and

�� Doubling the average maturity of those bonds, i.e., buying longer-term bonds.

The BoJ has successfully engineered a weaker yen, and core inflation has moved higher. But it has been less successful in other goals. There has been minimal domestic portfolio rebalancing. Japanese investors are still positioned for deflation.

Meanwhile, June marks an important month as the government plans to announce further reforms, such as a reduction in corporate tax rates. In our view, reform of the Government Pension Investment Fund (GPIF), the largest retirement fund in the world, has the potential to be significant.

Equity investors have liked the weak yen, but not much else. Japanese equity valuations have declined relative to global stocks as investors have become less willing to pay for earnings in Japan than elsewhere.

One can argue that the rally in Japanese stocks has been predominantly due to a tactical global trading strategy rather than improving fundamentals in the country and its companies. International investors, themselves beholden to the direction of U.S. stocks and the dollar/yen currency pair, account for approximately 75% of trading volume. Domestic investors have remained stubbornly on the sidelines, an absence that speaks volumes.

However, from an equity perspective, we are encouraged by three factors:

�� We find that Japanese stocks are inexpensive. Share prices have failed to track earnings increases as one would expect, and the market may not be rewarding the progress made by the government.

�� The Japanese equity market remains heavily cyclical in composition. With global growth likely to accelerate this year for the first time in several years, export-oriented economies and cyclically-weighted markets like Japan’s stand to benefit.

�� We expect more from the current administration. Abe and his allies are determined to succeed “at all costs,” but they still have a long way to go.

Therefore, we maintain our Overweight stance on Japanese equities for global investors. (Full report here)


MSCI Japan Forward P/E vs. MSCI World

Japanese equities trade at a discount to global equities.

65%

85%

105%

125%

145%

165%

185%

Apr '10 Oct '10 Apr '11 Oct '11 Apr '12 Oct '12 Apr '13 Oct '13 Apr '14

MSCI Japan Forward Price-to-Earnings Relative to MSCI WorldAverage (+/- 1SD)



MarKing tiMe

After weather side-swiped U.S. Q1 growth most equity markets have been range-bound. April and May data are confirming earlier weakness was a “one-off.” The economic outlook is consistent with worthwhile equity returns for the year driven by reasonable profit growth.

Global Equity

Jim Allworth Vancouver, Canada [email protected]

We have a constructive outlook for global equities.

In a “data-dependent” world, a lack of data can be unnerving. That’s where equity investors find themselves. The U.S. economy was expected to lead a global acceleration this year and next. But with Q1 growth obliterated by severe weather, markets are stuck waiting for mid-summer confirmation that confidence in this trajectory is not misplaced.

We don’t think it is. Business activity measures suggest U.S. GDP growth will rebound in Q2. Consumer and CEO confidence are both moving higher and leading indicators suggest strength should extend into the second half and probably into 2015. Most other developed economies are also moving forward—Europe slowly and unevenly, the U.K. with surprising vigour, and Canada more or less in synch with the U.S.

Q2 will not unequivocally answer all the questions and concerns about the health of and outlook for the global economy. China’s slowdown has not yet levelled off, Japan’s “Abenomics” experiment is reaching a more-problematic juncture (see our special Japan report, Abe, Abe, and Away), and European politics as well as geopolitical flashpoints offer new opportunities for risk and investor concern. At the same time, the U.S. housing recovery, which has been the main driving force behind the steady climb in consumer attitudes, looks to be entering a more-challenging phase (see page 4 in our look at the U.S. housing market “Seeking New Demand”).

Source - RBC Wealth Management, Bloomberg, data through 5/23/14.

Developed Market Indexes

80

90

100

110

Jan '14 Feb '14 Mar '14 Apr '14 May '14 Jun '14

S&P 500

S&P/TSX

Eurostoxx

FTSE All-Share

TOPIX

Equity market performance restrained so far this year.



All that said, with U.S. GDP growth likely to post a strong result for the quarter and with credit conditions in North America and Europe continuing to ease—even beleaguered eurozone banks are showing a renewed interest in lending—there is no U.S. recession or renewed global downturn anywhere on the horizon. For us, that means corporate earnings are likely to grow and share prices advance over the coming 12 months.

Most developed economy equity indexes have been posting or are near new highs. The small-to-mid-cap components of these markets, trading at rich valuations early in the year and perhaps with the most to lose if Q2 GDP growth disappoints, have corrected 5%–10% since March. Some unseasoned, high-profile new issues have fared even worse. Large-cap markets may find something of substance to worry about later in the summer. That would not be unusual.

However, we expect the high-probability outcome will have prevailed by year-end: stocks will have delivered worthwhile appreciation comprised of reasonable earnings growth together with a modest uptick in price-to-earnings multiples reflecting growing confidence the global economy has found firmer footing.

Source - RBC Capital Markets, RBC Wealth Management

Developed Economies PMIs

40

45

50

55

60

65

May '11 May '12 May '13 May '14

U.S. PMI (ISM)Eurozone PMIU.K. PMICanada PMI

Growth building in the developed economies.

Global Equity


Equity Views

Source - RBC Wealth Management; View Definitions can be found on page 3

Global =United States =Canada –Continental Europe =United Kingdom –Asia (ex Japan) =Japan +

kElly BogdAnov San Francisco, United States [email protected]

mAtt BArAsch Toronto, Canada [email protected]

frédériquE cArriEr London, England [email protected]

JAy roBErts Hong Kong, China [email protected]

Equity highlights

unitEd stAtEs

�� While a correction could materialize if overvalued small caps and new technology and biotech momentum stocks pull back further, we believe the S&P 500 can deliver average returns in 2014 as long as recession risks remain low (less than 5% currently). For more about how to navigate corrections, see this article.

�� We continue to favor large caps over small caps because the valuation disparity remains above historical norms despite the recent small-cap pullback.

�� The S&P 500’s forward price-to-earnings ratio of 16.3x is above the long-term average of 14.1x, but should be supported by a modest pickup in Q2 earnings growth compared to Q1’s 5.5% y/y pace.

cAnAdA

�� Canada’s heavy exposure to commodities keeps us cautious, although low prices should eventually lead to production discipline and better supply-demand balances.

�� Canadian banks are trading near the mid-points of historical valuation ranges. While housing has been resilient, it is unlikely to provide as strong a tailwind for loan growth and earnings.

�� The global hunt for yield has been especially acute in Canada as a dearth of names has driven up valuations in select sectors well beyond historical ranges. While this strength may continue until bond yields back up, we remain cautious on high-payout dividend payers in Canada and continue to focus on those businesses that can grow their dividends over time.

continEntAl EuroPE

�� The eurozone continues to struggle with weak growth and deflationary risks. As a result, bank shares continue to retreat, grappling with large rights issues, while lending is held back by continued deleveraging efforts and weak borrowing demand.

�� Two catalysts could improve the sector’s outlook: (1) stress test results in October could restore confidence in the banking system, even though the risk of rights issues for poorly capitalised banks remains; and (2) a potential targeted quantitative easing programme could improve growth prospects and bolster investor confidence in the region.

�� For now, equity markets have to overcome the “sell in May” sentiment, not an easy task, given the lack of corporate earnings growth and uninspiring valuation levels.

unitEd kingdom

�� The trend of large-cap underperformance, which prevailed over the last four years, reversed during the month. The divergence between the large-cap FTSE 100 and small- and mid-cap FTSE 250 indexes exceeded 5% at one point.

�� Overly stretched mid-cap valuations and concerns robust economic

Global Equity

https://www.rbcinsight.com/WM/Share/ResearchViewer/?SSS_EBB1E5AD308464D629A493556900F0CB


Chinese stocks are at historically low valuations, despite historically high earnings, reflecting pessimism over the economy. Asian equity valuations are undemanding relative to earnings growth.

JAPAn

�� We remain Overweight Japanese equities, which are inexpensive relative to global peers. TOPIX earnings are close to the previous cycle high, while the index is 50% lower.

�� In our view, the Bank of Japan (BoJ) will maintain highly accommodative monetary policy. However, it has refrained from expanding policy even further in recent months. Consequently, the yen has strengthened against the dollar in 2014 and equities have underperformed. But there is an expectation in the market that the BoJ will move again in coming months. Also, the government will likely announce additional economic reforms in June. For more about Japan, see this article.

Chinese equity valuations

are quite low, reflecting

pessimism about the domestic

economy.

growth will force the Bank of England to raise rates ahead of time led investors to take profits in mid-cap positions. This may continue as valuations trend back to long-term averages.

�� The correction in small- and mid-cap stock prices was indiscriminate. With many prices off by more than 30%, good entry points for select names may be developing.

AsiA Ex-JAPAn

�� We are neutral on Asia ex-Japan equities. Asian equities are now flat for the year after a tougher start. The ongoing tapering of asset purchases by the Federal Reserve appears to be having little bearing on Asian equity markets. Concerns are mostly focused on China’s slowdown.

�� Equity performance remains divergent among markets, with some stronger than others. The Sensex index in India reached a new all-time high as Narendra Modi won the general election.

�� China remains a major swing factor in our assessment of the outlook.

Global Equity


China’s Market vs. Earnings (in renminbi)

25

50

75

100

125

150

175

200

225

250

2004 2006 2008 2010 2012 2014500

1500

2500

3500

4500

5500

6500Trailing 12-mo EPS (left axis)Shanghai Composite (right axis)

China’s stock market has fallen even though earnings have soared.



MarKetS Brace for ecB Move

Global fixed income markets are pricing in yet another round of unconventional monetary policy from a major central bank. Expectations are high the European Central Bank (ECB) will pursue extraordinary monetary policy intervention when it meets on June 5. The ECB possesses a broad range of options, and global fixed income markets have already re-priced in anticipation of a major policy initiative.

At the security-selection level, the implications differ for each geographic market. Yet this is the latest reminder that unconventional policies in any one jurisdiction can affect global markets, given how intertwined the global financial system and economy have become.

In Europe, we believe fresh monetary stimulus will fuel a rally in peripheral government bonds and a modest sell-off (higher yields) in core-Europe. We continue to see select opportunities throughout the corporate market, and note issuers from the financial sector would likely benefit the most from stimulative monetary policy. In the U.K., the looming risk of changes to the Bank of England’s bias could create volatility and higher yield levels across the U.K. Gilt yield curve.

Higher relative yields in the U.S. versus Europe led to a recent rally in Treasury securities. We caution that complacency appears to be rising at a time investors should be more vigilant with regards to interest-rate risk. The real yield of a 10-year U.S. Treasury has fallen nearly 50 basis points (bps) this year and sits nearly 200 bps below the historical average. We prefer intermediate maturity bonds with fixed-to-floating rate preferreds as attractive ways to enhance portfolio yield within the corporate sector.

Canada has not been immune from the rally on government bonds and tighter credit spreads. We believe investors should reduce the term of their bond ladders in acknowledgement of a worsening risk/reward trade-off. Within the preferred share space, investors should sell some preferred shares, in our view, given recent strength attributed to a supply-demand imbalance in the market that will likely prove temporary.

rAJAn BAnsi Toronto, Canada [email protected]

*1-yr base lending rate for working capital, PBoC Source - RBC Investment Strategy Committee, RBC Capital Markets, and Global Portfolio Advisory Committee (GPAC), Consensus Economics

Central Bank Rate (%)

5.70*

0.10

0.50

0.25

1.00

0.25

Japan

China

U.K.

Eurozone

Canada

U.S. Today1-Year Out

6.00*

Global Fixed Income


U.S. 10-Year Real Yields (Treasury Yield Minus Inflation)

-2

-1

0

1

2

3

4

5

Jun '89 Jun '93 Jun '97 Jun '01 Jun '05 Jun '09 Jun '13

(%)

25-Year Average = 2.32%

Current level of real yields points to premium valuation of government bonds.


fixEd incomE highlights

unitEd stAtEs

�� For three months credit markets’ outperformance has confounded market expectations (and our own) with 10-year Treasury yields falling 50 basis points. The Q1 GDP undershoot, the likelihood of reduced government bond issuance, the need of many investors to lock in long-term yields, and the broad collapse in eurozone bond yields have all contributed. These factors could be with us for some time.

�� Valuations are stretched in corporate, emerging market, and municipal credit. Positive fund flows and reduced new issuance will likely tighten conditions further.

�� Portfolios should be positioned in intermediate maturities. Fixed-to-floating rate preferreds are attractive ways to enhance portfolio yield. Extension swaps and cushion-kicker bonds continue to make sense in munis.

cAnAdA

�� Unlike other recent instances of bond yields falling, this one has not provoked the market to anticipate any rate cuts from the central bank.

�� The recent rate slump is an opportunity to reduce average term in bond ladders, as we believe rate normalization has been delayed not called off.

�� In the preferred share market, redemptions have exceeded supply in 2014, helping the S&P/TSX Preferred Share Total Return Index to establish an all-time high in early May. We believe investors should use the improved technical backdrop to reduce exposure into strength.

continEntAl EuroPE & u.k.�� Upcoming European Central

Bank meetings are likely to dictate the eurozone’s yield trends. New unorthodox policies (QE) would benefit peripheral countries and financials, whereas core countries would likely see higher yields.

�� The U.K. unemployment rate is at recent lows, and house prices are increasing; yet, the Bank of England maintains a dovish tone. Risk of changes to its tone could lead to higher yield levels on the U.K. Gilt yield curve.

�� Corporate spreads have tightened recently. A recent bout of M&A talks has had limited impact on the broader markets, suggesting current levels are well supported.

crAig BishoP Minneapolis, United States [email protected]

mikhiAl PAsic Toronto, Canada [email protected]

hAkAn Enoksson London, England [email protected]

Global Fixed Income

1.00

3.75

2.60

3.25

3.50

0.60

4.10

2.55

1.35

2.25

2.48

n/a

Japan

China

U.K.

Eurozone

Canada

U.S.

Today1-Year Out

10-Year Rate (%)

Source - RBC Investment Strategy Committee, RBC Capital Markets, and GPAC

Source - RBC Wealth Management, Bloomberg

Sovereign Yield Curves

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

1Yr 5Yr 9Yr 13Yr 17Yr 21Yr 25Yr 29Yr

U.K.U.S.

Canada

Relative steepness of the curves indicates no central bank tightening is in sight; find value in intermediate maturities.


mArk AllEn Toronto, Canada [email protected]

gold

�� Demand trends were mixed in Q1.

�� Central bank buying moved higher, after a generally weaker 2013.

�� Bar and coin investing softened in Q1, with sizeable declines from both China (-55% y/y) and India (-54%). This marks a reversal from the demand strength seen in 2013.

�� The small uptick in winter’s ETF buying has faded with gold ETF holdings back down near the lows around year-end 2013.

�� We are neutral on the outlook for gold given the mixed demand trends.

EnErgy �� Shale oil production from the four

largest U.S. plays is up more than 400,000 barrels per day (bbl/d) since the start of 2014.

�� Steady demand growth and geopolitical turmoil should keep oil near the upper end of its $75–$100/bbl trading range of recent years.

�� Natural gas prices have softened as storage levels rise. But, inventories are about one-half of where they normally would sit at this time of year, providing a more-constructive set up for the average price through this year. We expect gas prices to

range between $3.50 and $5.00/thousand cubic feet (mcf), with summer weather the key near-term driver.

coPPEr And industriAl mEtAls �� RBC Capital Markets forecasts a

surplus for copper in 2014 and 2015.

�� Copper prices should remain near $3/lb, given concerns about growth and fixed asset investment trends in China, balanced against a shortage of scrap supply. Meaningful additional demand weakness or credit concerns in China could trigger further price downside.

corn And Ag commoditiEs �� Corn prices have fallen as USDA

reports showed corn planting caught up to seasonal norms by early/mid-May.

�� The USDA now projects higher-than-generally-expected year-end corn stocks.

�� Wheat prices declined with improved weather in the U.S.

�� For potash, strong demand in Brazil may permit a modest price increase in Q3. A reconstitution of the eastern bloc cartel could result in higher prices near term. Further out, we remain cautious on potash given surplus capacity.

2014E 2015E

Oil (WTI $/bbl) 96.00 92.00

Natural Gas ($/mmBtu) 4.54 4.50

Gold ($/oz) 1,375 1,400

Copper ($/lb) 3.25 3.00

Corn ($/bu) 4.74 4.94

Wheat ($/bu) 6.30 6.40

Source - RBC Capital Markets forecasts (oil, natural gas, gold, and copper), Bloomberg consensus forecasts (corn and wheat).

Commodities


Wheat and Corn Prices

Corn and wheat prices have ebbed lower on moderating weather conditions.

$400

$450

$500

$550

$600

$650

$700

$750

Jan '14 Feb '14 Mar '14 Apr '14 May '14

Wheat

Corn

Commodity Forecasts


AlAn roBinson Seattle, United States [email protected]

u.s. dollAr �� The biggest impediment to a

near-term dollar rally may be positioning, as consensus forecasts are overwhelmingly bullish.

�� Low summer volumes tend to depress the dollar too as central bank diversification can have an outsize effect, but a major pick-up in U.S. GDP growth should stir the bulls.

Euro �� Euro weakness since the ECB’s May

meeting was due to expectations of asset purchases or even negative interest-rate policies at June’s meeting.

�� While such changes may prompt a knee-jerk sell-off in the euro, we don’t expect a sustained drop until U.S. interest rates rise further.

cAnAdiAn dollAr �� June is typically a big month for

Canadian bond maturities. We see a risk overseas investors may redeploy these funds outside Canada, leading to a new round of loonie weakness.

British Pound �� Now that market expectations have

caught up to the reality of strong

growth, we expect further gains from sterling—the best-performing G10 currency over the last 12 months—will be difficult.

�� Uncertainty over Scottish independence and next year’s general election should keep a lid on the pound into 2015.

JAPAnEsE yEn �� The yen has been stuck in a narrow

range most of 2014. We think the BoJ’s outlook for inflation to hit its 2% target by 2016 may frustrate yen bears looking for more easing.

�� With the market already short, we believe a stronger yen is likely over the short term before moderate yen weakness takes hold in 2015 as the global economy improves.

EmErging mArkEt currEnciEs �� Investor flows turned positive in Q1

as interest-rate spreads between developed and emerging currencies seemed high enough to offset the higher risk of emerging markets.

�� This carry trade—borrowing in a low yielding currency to invest in a high yielding one—may continue if currency market volatility stays low.

Currency Pair

Current Rate

Forecast Jun 2015 Change*

USD Index 80.37 84.90 6%

CAD/USD 0.92 0.85 -8%

USD/CAD 1.08 1.17 8%

EUR/USD 1.36 1.27 -7%

GBP/USD 1.68 1.65 -2%

USD/CHF 0.90 0.98 9%

USD/JPY 101.77 105.00 3%

AUD/USD 0.93 0.88 -5%

NZD/USD 0.85 0.83 -2%

EUR/JPY 138.74 133.35 -4%

EUR/GBP 0.81 0.77 -5%

EUR/CHF 1.22 1.24 2%

* Defined as the implied appreciation or depreciation of the first currency in the pair quote. Examples of how to interpret data on page 18 Source - RBC Capital Markets, Bloomberg

Note: Normalized currency rates against the U.S. dollar, weekly data. Source - RBC Wealth Management, Thomson Reuters; data through 5/16/14

Emerging Market Currencies Are Finding Their Feet

Major emerging market currencies appear to have reversed their multi-quarter declines as the carry trade returns.

Currency Forecasts

70

80

90

100

110

Dec '12 Mar '13 Jun '13 Sep '13 Dec '13 Mar '14

IndonesiaBrazilRussiaIndiaSouth Africa

Currencies


Canada — Moderate Improvement�� Q1 growth was solid, but slower than Q4 due to

weather. Inventories building on the back of strong new orders. PMI weaker in May.

�� Mfg. unfilled orders at record with ex-aerospace strengthening sharply in April. Capital spending intentions rising. Housing construction easing. Energy development outlook somewhat better.

Eurozone — Uneven, Fragile Recovery�� Q1 was 4th successive quarter of positive growth, still

mostly due to Germany. Italy, France, Netherlands lagging. Unemployment at 11.8%, worse in Spain and periphery.

�� Composite PMI ticked lower in May. Germany off highs. Italy/Spain readings positive for several months. France now in contraction. Ukraine adds risk dimension.

United Kingdom — Strengthening�� GDP up 0.8% q/q in Q1, 4th consecutive quarter of

trend growth. Manufacturing leading. PMI strong as were new orders. Business confidence buoyant.

�� Employment firm, wages now keeping pace with inflation. Retail sales strong. Look for further good GDP growth for rest of 2014 and for 2015.

China — Slowing�� Q1 GDP up 7.4% y/y, slightly better than expected.

PMI appears to be stabilizing. Infrastructure accounting for most of growth. Exports strengthening. Leadership talking up growth but, so far, policy initiatives have been targeted.

�� Loan growth decelerating, some house prices weaker. Government may be easing liquidity squeeze.

Japan — Volatile�� Q1 GDP was very strong ahead of April sales tax hike.

Exports need a stronger China. Corporate profits and business confidence high and rising.

�� Buying/spending on autos and machinery ahead of sales tax increase making for weak Q2 comparisons but, so far, holding up better than expected.

United States — Strengthening�� Severe weather wiped out Q1 growth, but a bounce-

back begun in March was sustained in April/May. Consumer confident and spending. Housing activity moderating. Leading indicators and CEO confidence elevated.

�� ISM up again in May, fourth month running. New orders also up, employment off highs. Inventories steady.

2.2% 1.9%2.8% 3.2%

1.7% 1.5% 1.8% 1.8%

2012 2013 2014E 2015E

2.2% 1.9% 3.2% 3.2%1.8%1.8%1.5%1.7%2012 2013 2014E 2015E

Real GDP Growth Inflation Rate

(

1.7% 2.0% 2.3% 2.3%

1.5% 1.0% 1.8% 2.0%

2012 2013 2014E 2015E

0.0%

3.0% 3.0%

1.7%2.3%2.0%

2.6%2.7%

2012 2013 2014E 2015E

7.8% 7.8%7.0% 6.8%

3.0%2.8%2.6%2.5%

2012 2013 2014E 2015E

-0.4%-0.5%

1.2%1.0%

1.5%1.0%1.3%

2.5%

2012 2013 2014E 2015E

2.0% 1.5% 1.5%1.5%0.3%0.0%

1.8%2.8%

2012 2013 2014E 2015E

Source - RBC Investment Strategy Committee, RBC Capital Markets, and Global Portfolio Advisory Committee

Key Forecasts


Index (local currency) Level 1 Month YTD 12 Month

S&P 500 1,923.57 2.1% 4.1% 18.0%

S&P/TSX Comp 14,604.16 -0.3% 7.2% 15.4%

FTSE All-Share 3,655.01 1.0% 1.3% 5.2%

Hang Seng 23,081.65 4.3% -1.0% 3.1%

Dow (DJIA) 16,717.17 0.8% 0.8% 10.6%

NASDAQ 4,242.62 3.1% 1.6% 22.8%

Russell 2000 1,134.50 0.7% -2.5% 15.3%

STOXX Europe 600 344.24 1.9% 4.9% 14.4%

German DAX 9,943.27 3.5% 4.1% 19.1%

Nikkei 225 14,632.38 2.3% -10.2% 6.2%

Straits Times 3,295.85 1.0% 4.1% -0.5%

Shanghai Comp 2,039.21 0.6% -3.6% -11.4%

Sensex 24,217.34 8.0% 14.4% 22.6%

Brazil Bovespa 51,239.34 -0.8% -0.5% -4.2% Bond Yields 5/30/14 4/30/14 5/31/13 12 mo chg

U.S. 2-Yr Tsy 0.373% 0.410% 0.293% 0.08%

U.S. 10-Yr Tsy 2.476% 2.646% 2.128% 0.35%

Canada 2-Yr 1.049% 1.061% 1.081% -0.03%

Canada 10-Yr 2.246% 2.404% 2.064% 0.18%

U.K. 2-Yr 0.666% 0.687% 0.374% 0.29%

U.K. 10-Yr 2.570% 2.663% 2.002% 0.57%

Germany 2-Yr 0.064% 0.141% 0.069% -0.01%

Germany 10-Yr 1.358% 1.469% 1.505% -0.15% Commodities (USD) Price 1 Month YTD 12 Month

Gold (spot $/oz) 1,249.73 -3.2% 3.7% -10.0%

Silver (spot $/oz) 18.82 -2.0% -3.3% -15.5%

Copper ($/ton) 6,919.00 3.9% -6.2% -5.0%

Uranium ($/lb) 28.25 -8.1% -22.1% -30.2%

Oil (WTI spot/bbl) 102.71 3.0% 4.4% 11.7%

Oil (Brent spot/bbl) 109.41 1.2% -1.3% 9.0%

Natural Gas ($/mmBtu) 4.54 -5.7% 7.4% 14.0%

Agriculture Index 389.58 -8.1% 10.8% -9.4% Currencies Rate 1 Month YTD 12 Month

U.S. Dollar Index 80.37 1.1% 0.4% -3.6%

CAD/USD 0.92 1.1% -2.1% -4.3%

USD/CAD 1.08 -1.1% 2.1% 4.5%

EUR/USD 1.36 -1.7% -0.8% 4.9%

GBP/USD 1.68 -0.7% 1.2% 10.2%

USD/CHF 0.90 1.7% 0.3% -6.3%

USD/JPY 101.77 -0.5% -3.4% 1.3%

AUD/USD 0.93 0.2% 4.4% -2.7%

NZD/USD 0.85 -1.4% 3.5% 7.0%

EUR/JPY 138.74 -2.1% -4.1% 6.2%

EUR/GBP 0.81 -1.0% -2.0% -4.8%

EUR/CHF 1.22 0.0% -0.6% -1.7%

USD/SGD 1.25 0.0% -0.7% -0.8%

USD/CNY 6.25 -0.2% 3.2% 1.8%

USD/BRL 2.24 0.4% -5.1% 4.7%

Equity returns do not include dividends, except for the German DAX. Equity performance and bond yields in local currencies. U.S. Dollar Index measures USD vs. six major currencies. Currency rates reflect market convention (CAD/USD is the exception). Currency returns quoted in terms of the first currency in each pairing. Examples of how to interpret currency data: CAD/USD 0.92 means 1 Canadian dollar will buy 0.92 U.S. dollar. CAD/USD -4.3% return means the Canadian dollar has fallen 4.3% vs. the U.S. dollar during the past 12 months. USD/JPY 101.77 means 1 U.S. dollar will buy 101.77 yen. USD/JPY 1.3% return means the U.S. dollar has risen 1.3% vs. the yen during the past 12 months.

Source - RBC Wealth Management, Bloom-berg; data through 5/30/14.

India surged on Modi election optimism.

Canada’s TSX outperforming until recently.

Falling European rates pressured other yields.

Copper rally signals economic improvement.

Market Scorecard

Dollar regains momentum as recent high flyers stall.


This document is produced by the Global Portfolio Advisory Committee within RBC Wealth Management’s Portfolio Advisory Group. The RBC WM Portfolio Advisory Group provides support related to asset allocation and portfolio construction for the firm’s Investment Advisors / Financial Advisors who are engaged in assembling portfolios incorporating individual marketable securities. The Committee leverages the broad market outlook as developed by the RBC Investment Strategy Committee, providing additional tactical and thematic support utilizing research from the RBC Investment Strategy Committee, RBC Capital Markets, and third-party resources.

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reSearcH reSoUrceS


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As of March 31, 2014

Rating Count Percent Count PercentBuy [Top Pick & Outperform] 822 52.49 303 36.86Hold [Sector Perform] 654 41.76 170 25.99Sell [Underperform] 90 5.75 11 12.22

Investment Banking Serv ices Prov ided During Past 12 Months

Distribution of Ratings - RBC Capital Markets, LLC Equity Research


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