Investment Outlook: Navigating Through Risky Waters

Investment
Outlook
private banking - investment strategy
June 2011 Navigating through risky waters
Investment Strategy
Contents
Introduction..........................................................................................................................5
Summary................................................................................................................................6
Portfolio strategy..................................................................................................................8
Theme: Identifying risks................................................................................................... 11
Theme: Navigating through risky waters....................................................................... 16
Themes: Tools for stock market choices........................................................................ 19
Macro summary................................................................................................................. 23
ASSET CLASSES
Equities............................................................................................................................... 25
Fixed income...................................................................................................................... 28
Hedge funds....................................................................................................................... 30
Real estate.......................................................................................................................... 32
Private equity..................................................................................................................... 34
Commodities...................................................................................................................... 36
Currencies........................................................................................................................... 38
Investment Outlook - JUNE 2011 3

Investment Strategy
This report was published on May 31, 2011.

Its contents are based on information and analysis available before May 23, 2011.
Hans Peterson Carl Barnekow

Global Head of Investment Strategy Global Head of Advisory Team
+ 46 8 763 69 21 + 46 8 763 69 38
hans.peterson@seb.se carl.barnekow@seb.se
Lars Gunnar Aspman Reine Kase

Global Head of Macro Strategy Economist
+ 46 8 763 69 75 +352 26 23 63 50
lars.aspman@seb.se reine.kase@sebprivatebanking.com
Rickard Lundquist Daniel Gecer

Portfolio Manager Economist
+ 46 8 763 69 27 +46 8 763 69 18
rickard.lundquist@seb.se daniel.gecer@seb.se
Victor de Oliveira Cecilia Kohonen

Portfolio Manager and Head of IS Luxembourg Global Head of Communication Team
+ 352 26 23 62 37 +46 8 763 6995
victor.deoliveira@sebprivatebanking.com cecilia.kohonen@seb.se
Johan Hagbarth Liza Braaw

Investment Strategist Communicator and Editor
+ 46 8 763 69 58 +46 8 763 69 09
johan.hagbarth@seb.se liza.braaw@seb.se
Esben Hanssen
Head of IS Norway
+ 47 22 82 67 44
esben.hanssen@seb.no
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4 Investment Outlook - junE 2011

Introduction
A humble attitude in a moderate growth market

A period of rapid stock market gains and eco- This is actually not such a dramatic process, yet it represents
nomic upturn is now being followed by a calmer a further progression in the economic cycle. It is normal to
see continued growth in stock market value, shrinking yield
trend in both cases. This is not so dramatic, but spreads between corporate and government bonds and good
investors should lower their return expectations growth in various other capital market segments. So it does
a bit. Those who properly assess and manage the not represent any significant shift in direction, but investors
prevailing market risks can earn a lot of returns. should lower their return expectations a bit.
Asset management is always a combination of long-term In addition to our customary review of opportunities in various
thinking and short-term tactical deliberations. The markets asset classes, this issue of Investment Outlook also pays extra
send continuous signals. It is thus a matter of determining attention to a few specific questions: What are the risks that
when these signals are a forecast of future trends, and when affect capital market pricing today? What characterises the
they are a reaction to a specific event that only temporarily current phase of the economic cycle from the perspective of
changes market sentiment. returns? How do we build up a country allocation model for
stock markets?
As the summer approaches, we have a relatively optimistic
view of capital markets in general. The global economy is in With some justification, we can draw the conclusion that
a period characterised by growth in most major countries, in most markets are not particularly expensive. One reason why
many cases solid growth. Many countries are pursuing sup- markets are not overpriced may be the existence of a number
portive and accommodative monetary policies. The inflation of risk scenarios that adversely influence the desire to invest
outlook is fundamentally favourable in many places around capital. In recent weeks, sovereign bond yields have again
the world. This lays the groundwork for a rather positive view fallen substantially, a market reaction that is a sign of caution
of the capacity of the stock market − and other cyclically de- and perhaps a lack of faith in economic growth among inves-
pendent markets − to generate higher value. tors. This is why we consider it important to discuss the exist-
ing economic and market risks. Those who assess and manage
The economy now appears to have passed a point in the eco- these risks properly can earn a lot of returns.
nomic cycle that is attractive from an investment perspective.
The upward journey of leading indicators has probably peaked We have further refined the country model we launched in
and may have passed, which can be interpreted as the inter- the last issue of Investment Outlook (February 2011). The
ruption of a trend. These indicators are now levelling out, but justification for creating this type of model is a systematisa-
this is occurring at a high level − signalling that companies tion of efforts to illustrate driving forces and risks in our asset
foresee a bright future for the economy and their own opera- management.
tions.
Market analysis is often described as an art form. But in reality,
Stock markets rise fastest in the initial upturn phase, when it is mostly a matter of structured work and a humble attitude
indicators are also moving rapidly upward. After peaking, there towards a constantly changing and occasionally risky financial
is a period when they both transition to a calmer journey. It world, which continuously generates business opportunities.
can be described as moving from a strong bull market to a
more moderate growth market. Hans Peterson
CIO Private Banking
and Global Head of Investment Strategy
Investment Outlook - junE 2011 5

Summary
Expected, 1-2 years

(annual averages)
return. risk Reasoning
Positive. Risk appetite is increasing in the global stock market and the long-term trend still points
upward. There is a risk of short-term downward revisions due to softer economic signals, but various risk
Equities 8% 16% factors are already priced into the market.
Positive towards High Yield and EM Debt; negativE towards government bonds. Various OECD countries will
be financing large budget deficits, and government bond yields will rise. In EM countries, expect higher key inter-
est rates and gradually less resolute tightening measures. The global economic upturn will continue to favour
Fixed income 5%* 6% the High Yield segment.
Positive. Normalisation of financial markets will open the way for a larger number of mergers and acquisi-
tions, benefiting several strategies. The improved investment climate will create potential for good returns,
Hedge funds 6% 5% without managers having to take unnecessary risks.
Neutral/positive. Rental levels are rising at an accelerating pace, and the number of unleased proper-
ties is decreasing. Better borrowing opportunities will benefit the market. Some concerns about bubble
Real estate 4% 4% tendencies in China, while the American housing market remains weak.
Private Positive. Today’s valuation levels are still attractive, but companies are no longer cheap. There is some
equity 10% 20% financial instability, but strong economic and earnings growth is making this asset class appealing.
PositivE/Neutral. Somewhat greater worries about the world economic situation as well as recent USD
appreciation have contributed to a downward correction after the commodities rally of the past year. More
normal weather conditions may continue to push down agricultural prices. It should be possible for oil
Commodities 6.5% 18% prices to fall when calm is restored in the Middle East and North Africa (MENA).
Neutral/ NegativE**. Taking advantage of interest rate spreads (the “carry trade”) and global imbalances
Currencies 3.5% 4% are factors that are driving this asset class. The revaluation of the Chinese yuan is likely to continue.
* Expected return on corporate bonds that are weighted about 1/3 Investment Grade and 2/3 High Yield.
** This opinion refers to the alpha-generating capacity of a foreign exchange trading manager.
EXPECTED RISK AND RETURN (1-2 YEAR HORIZON,

ANNUAL AVERAGES) CHANGE IN OUR EXPECTED RETURN
12%
16%
Private equity 14%
10% 12%
10%
Equities 8%
8%
6%
4%
Expected return
Hedge funds Commodities

6% 2%
0%
Fixed income*
Real estate -2%
4%
-4%
Currencies
2008-11
2009-02
2009-05
2009-08
2009-12
2010-02
2010-05
2010-09
2010-12
2011-02
2011-05
2%
0% Equities Fixed income* Hedge funds Real estate

0% 5% 10% 15% 20% 25% 30%
Private equity Currencies Commodities
Expected volatility
HISTORICAL RISK AND RETURN HISTORICAL CORRELATION

(MAY 31, 2001 TO APRIL 30, 2011) (MAY 31, 2001 TO APRIL 30, 2011)
8%
Commodities
Fixed income
Commodities
Hedge funds
Real estate
Currencies
6%
Equities
Private
equity
Fixed income
4%
Historical return
Hedge funds
Currencies Equities 1.0
2%
Real estate
Fixed income -0.47 1.00
0%
Equities Hedge funds 0.52 -0.24 1.00
Private equity
-2%
Real estate -0.16 0.12 -0.07 1.00
-4% Private
0.85 -0.35 0.61 -0.18 1.00
0% 5% 10% 15% 20% 25% 30% equity
Historical volatility
Commodities 0.24 -0.16 0.65 -0.11 0.37 1.00
Historical values are based on the following indices: Equities = MSCI AC
Currencies -0.17 0.16 0.12 -0.12 -0.04 0.05 1.00
World. Fixed income = JP Morgan Global GBI Hedge. Hedge funds = HFRX
Global Hedge Fund. Real estate = SEB PB Real Estate. Private equity =
LPX50. Commodities = DJ UBS Commodities TR. Currencies = Barclay-
Hedge Currency Trader.

Summary
WEIGHTS IN MODERN PROTECTION WEIGHTS IN MODERN AGGRESSIVE
0% 40%
Equities Equities
78.0% 25%
Fixed income Fixed income
13.5% 19.5%
Hedge funds Hedge funds
2.0% 0%
Real estate Real estate
0.0% 9.5%
Private equity Private equity
0.0% 5%
Commodities Commodities
Currencies 4.5% Currencies

0%
Cash 2.0% 1%
Cash
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 0% 10% 20% 30% 40% 50%
Previous Current Previous Current
WEIGHTS IN MODERN GROWTH ROLLING 36-MONTH CORRELATIONS VS. MSCI WORLD

(EUR)
Equities 29% 1
27%
0.8
Fixed income
0.6
24.5%
Hedge funds 0.4
2.5% 0.2
Real estate
5% 0
Private equity
-0.2
Commodities 5%
-0.4
4%
Currencies -0.6
Cash
3% -0.8
2002 2003 2004 2005 2006 2007 2008 2009 2010
0% 10% 20% 30% 40%
Fixed income Hedge Real estate
Previous Current Private equity Commodities Currencies
Identifying risks: The economic and stock market upturn may go on for another 2-3 years; there are risks but they are
manageable
Navigating through risky waters: The market is moving from a strong growth phase to a calmer expansion phase
Tools for stock market choices: Factors we are focusing on in this phase are growth, inflation/monetary policy, valuations and
currencies
THEME: IDENTIFYING RISKS THEME: TOOLS FOR STOCK MARKET CHOICES
17.5 17.5 1600 1600
15.0 15.0 1500 1500

Per cent, year-on-year
12.5 12.5 1400 1400
10.0 10.0
S&P 500 index
1300 1300
S&P 500 index
7.5 7.5 Phase 1 Phase 2 Phase 3

1200 1200
5.0 5.0
1100 1100
2.5 2.5
1000 1000
0.0 0.0
-2.5 -2.5 900 900

2005 2006 2007 2008 2009 2010 2011
800 800
Russia, consumer prices Source: Reuters EcoWin 2003 2004 2005 2006 2007
Brazil, consumer prices
China, consumer prices Source: Reuters EcoWin
US, S&P500, USD
India, wholesale prices
Inflation in the BRIC countries (Brazil, Russia, India and China) has ac- A bull market can generally be divided into three phases. Our as-
celerated significantly since the global recovery began in the autumn sessment is that at present, the market is in phase 2, where investors
of 2009. Rapid growth, shortages of spare production resources increasingly distinguishS&P
between
500 asset classes and stock exchanges
and the commodity price rally are the main reasons, but the upturn based on their respective potential.
has levelled off recently, due especially to tighter economic policies. OMXS
Together with the prospect of lower food prices, this should mean
gradually slower inflation ahead.

Portfolio strategy
Steady portfolios in a tumultuous market

Our portfolios have remained steady during a turbulent spring. Due to minor adjustments in our
long-term market view, we have made some shifts within certain asset classes, but without a need
for major re-allocations between them. Modern Growth and Modern Aggressive remain positioned
towards global recovery, while Modern Protection is gaining a somewhat higher expected return.
MODERN Protection rates. This segment was hard hit during the financial crisis, but
While the yield curve for American government securities as the underlying companies show stronger balance sheets,
remained largely unchanged during the February-April period, the risk of bankruptcies has decreased. In addition, these
higher European/German short-term interest rates created a loans have higher collateral than traditional bonds, and the
somewhat flatter yield curve. The movement in German inter- risk level is quite suitable for Modern Protection. The variable
est rates is explained, among other things, by the European interest rate component also means low interest rate risk.
Central Bank’s key rate hike in April. Inflation accelerated
somewhat in a number of countries due to rising commod- The portfolio’s allocation to hedge funds increased, using
ity prices, and inflation worries are slowly creeping into the a low-risk, market-neutral manager − the hedge fund sub-
market. portfolio now accounts for about 14 per cent of Modern
Protection. The portfolio’s currency managers succeeded in
In the fixed income market, we foresee risk rather than return turning around the trend; this sub-portfolio rose about 1 per
in government bonds, and we are instead finding potential for cent from February to April.
returns in corporate bonds. Since February, we have gradually
reduced the Modern Protection portfolio’s holdings of short- All asset classes in Modern Protection have made positive
term fixed income funds and shifted to corporate bonds. To contributions so far in 2011, and the portfolio is well equipped
preserve the capital-protecting investment profile of the fixed for an environment of potentially rising interest rates.
income sub-portfolio, we are cautiously positioned in both
Investment Grade and High Yield, attracted by higher coupons
and possible price gains, but without thereby increasing inter-
2.0% 4.5%
est rate risk. We have also increased the share of absolute/ 2.0%
total return funds, which now account for about half of the
13.5%
sub-portfolio. Each individual fund in this segment implies a
somewhat higher risk, but the combination of managers’ dif-
ferent investment strategies results in an acceptable risk level, Cash
which is on a par with the risk profile of the overall portfolio. Currencies
Real estate
Hedge funds
Looking ahead, we plan to further reduce holdings of short- 78.0%
Fixed income
term interest-bearing bonds in favour of senior secured lever-
aged loans − loans issued to companies with low creditworthi-
ness but with better underlying collateral and variable interest

Portfolio strategy
MODERN Growth thus intend to replace our position in convertibles with these.
During the first four months of 2011, financial markets have The portfolio should thereby also achieve a somewhat lower
been difficult to navigate. Worries about sovereign debt on the correlation with the stock market.
periphery of Europe have caused ebbs and flows in the mar-
kets for equities, fixed income and currencies. Unrest in North In hedge funds, we are also continuing to strive for a sub-
Africa paved the way for rising oil prices, and the earthquake/ portfolio that better complements Modern Growth as a whole,
tsunami disaster in Japan impacted the energy sector, among while contributing potential returns. At this writing, we have
others. The market’s general view that there is an underlying begun the process of divesting one of our Global Macro funds
global recovery nevertheless persists. while looking into adding a new strategy to the sub-portfolio:
Credit Long/Short. This strategy should benefit from tensions
Environments like this really put our Modern Investment pro- in the global credit market, and the strategy as such should
grammes to the test. While global equities fell in euro terms contribute nicely to our risk diversification. Our overall alloca-
between February and April, the Modern Growth strategy suc- tion to hedge funds decreased during the period, but this is
ceeded in gaining more than 1 per cent − a result of our broad primarily because we prefer to invest in such assets as High
diversification philosophy. The equities sub-portfolio per- Yield bonds during the period while our search for new hedge
formed somewhat better than the world index, yet ended up in fund managers is under way.
the red, while all the other asset classes contributed positively
to the portfolio’s performance. While the real estate sub-portfolio continued to chug along in
good shape, our currency managers also succeeded in turn-
Our long-term view of the world economy and our as- ing around the trend and this asset class gained more than
set classes is generally unchanged. Emerging market (EM) 1 per cent during February-April. From a portfolio strategy
countries are still growing at a rapid pace, while some OECD standpoint, we are satisfied with our position in currencies
countries are struggling to regain control of sovereign debt. (about 2.5 per cent), but we are continuing to analyse the
Since February, EM countries have performed better than currency fund market and search for managers who may
OECD countries. This has benefited our equities sub-portfolio. perhaps be able to further enhance the diversification of this
Meanwhile our commodities sub-portfolio has risen by more sub-portfolio.
than 5 per cent. An ever-weaker US dollar caused commodity
prices to rise generally, and uncertainty about global monetary Given the planned adjustments in the fixed income sub-port-
systems boosted the demand for gold. Uncertainty about the folio as well as in the hedge fund sub-portfolio, the risk/return
future of nuclear power and about global oil supplies in con- profile of Modern Growth should improve, further positioning
junction with unrest in Libya paved the way to rising oil prices, the portfolio to benefit from the global economic recovery.
among other things.
During February, we increased our allocation to private equity

in Modern Growth from 3 to 5 per cent. Since then, this sub-
portfolio has climbed about 5 per cent measured in euros.
Private equity companies are still trading at a discount larger
than the historical average, and valuations are still good. The
outlook remains positive, and at present we see no reason to
change this allocation.
One major reason why Modern Growth has continued its

stable performance during 2011 is our allocation to High Yield 3%
4%
and Emerging Market debt in the fixed income sub-portfolio. 5%
Companies are continuing to improve their finances, and the 29% 5% Cash
bankruptcy risk is continuously decreasing, which is benefiting 2.5% Currencies
High Yield. Since February, we have allowed out positions in Commodities
Private equity
these segments to increase compared to other asset classes
Real estate
but have also made an active allocation to High Yield in par- 24.5%
Hedge funds
ticular, since our assessment was that it could make a positive Fixed income
contribution amid prevailing short-term market uncertainty. 27% Equities
The outlook also remains good for convertible bonds, but we
are also seeing potential in senior secured leveraged loans −
loans issued to companies with low creditworthiness but with
better underlying collateral and variable interest rates. We

Portfolio strategy
MODERN Aggressive The fixed income sub-portfolio is still focused on High Yield
In order to achieve the best possible risk-adjusted potential re- and Emerging Market Debt. The High Yield segment is contin-
turns, without sacrificing our broad diversification philosophy, uing to benefit from stronger balance sheets and an increas-
in Modern Aggressive we are currently investing in five asset ingly positive underlying economic situation, which lowers
classes: equities, commodities, hedge funds, private equity the risk of bankruptcies. In Modern Aggressive we are also
and fixed income. This strategy showed its strength, with the considering an increase in our allocation to Emerging Market
portfolio gaining more than 1 per cent during February-April, Debt − at the margin, we foresee somewhat higher potential
while world stock markets lost more than 1 per cent in euro returns, but above all this should contribute to better risk di-
terms. versification from a portfolio standpoint.
In the equities asset class, emerging markets regained lost The objective of Modern Aggressive is to generate a return
ground against the OECD countries between February and that is higher than the stock market over en economic cycle,
April, and the MSCI EM Net in euro lost a marginal 0.1 per and this should also be reflected in the hedge fund sub-port-
cent, while the MSCI World Net in euro lost 1.3 per cent. For folio. This past winter and spring, the hedge fund sub-portfolio
the equities sub-portfolio in Modern Aggressive, this meant has gradually shifted towards funds and managers with higher
a marginal downturn of 0.3 per cent, both because nearly 40 potential returns. During April we began the process of phas-
per cent of the equities sub-portfolio is invested in emerging ing down Global Micro funds, which we believe have a profile
markets and because both the EM and global equity sub- that will not achieve the targeted return of the overall portfo-
portfolios performed better than their respective benchmark lio. We also plan to re-assess our Credit Long/Short-oriented
indices. holding; this strategy as such clearly contributes to risk di-
versification in the hedge fund sub-portfolio, but it might be
Meanwhile the commodities sub-portfolio has risen more possible to boost potential returns. Hedge funds decreased
than 5 per cent. An ever-weaker US dollar caused commodity as a proportion of the Modern Aggressive portfolio during the
prices to rise generally, and uncertainty about global monetary period, but this is primarily because we prefer to invest in such
systems boosted the demand for gold. Uncertainty about the assets as High Yield bonds during the period while our search
future of nuclear power and about global oil supplies in con- for new hedge fund managers is under way.
junction with unrest in Libya paved the way to rising oil prices,
among other things. The private equity sub-portfolio rose by Despite a higher risk profile, Modern Aggressive has per-
5 per cent. The total allocation to private equity today is about formed well during a turbulent 2011. We will largely retain
9.5 per cent of Modern Aggressive, one percentage point the allocation of the portfolio between asset classes and will
lower than in February, which is actually because we chose to continue to seek the most attractive risk-adjusted returns in
invest capital inflows mainly in High Yield funds during this each asset class.
turbulent period. The outlook for private equity remains good,
however, and at present we see no reason to change this al-
location.
1%
5%
9.5%
40%
19.5% Cash
Commodities
Private equity
Hedge funds
Fixed income
25% Equities

Theme:
Identifying risks
The economic upturn is not in jeopardy

• The economic and stock market upturn may ing situation, the economic policy reaction was exceptionally
go on for another 2-3 years... powerful, characterised by heroic fiscal rescue measures and
large budget packages that propped up faltering economies.
• …unless some form of shock interrupts the Central banks also immediately implemented zero interest
upswing rate monetary policies, along with massive quantitative easing
measures.
• The risks are manageable, and not too severe
As a consequence of these fiscal emergency responses and
− in the wake of the economic crash − declining tax revenue
Rising economic cycles are mostly paired with rising stock
as well as the triggering of automatic stabilisers (such as
markets, and vice versa. As long as the economy is in an up-
higher expenditures as unemployment climbed), fiscal defi-
ward phase and is expected to remain so for another while,
cits in many DM countries rose and sovereign debts soared.
there is thus good potential for a bull market.
Seemingly overnight, there was an escalation of the public
sector debt problems that had been building up for the past
Over the past 50+ years, economic upturns in the United
three decades or so − the “debt super-cycle” − and for a
States, for example, have had an average length of five years.
number of European countries the financial situation became
This coincides with the average length of equity bull markets
acute during 2010.
during the same period. The length of these upturns has
varied greatly, however, indicating that they have sometimes
About a year ago, this forced the international community
been interrupted by various shocks. If the current upswing is
to extend an emergency bail-out loan of EUR 110 billion to
not affected by any kind of shock, according to historical ex-
Greece and to create a financial safety net totalling EUR 750
perience it should be capable of continuing for another two to
billion based on the European crisis mechanism (EFSF/EFSM)
three years (see also Theme: Navigating through risky waters).
and loans pledged by the International Monetary Fund (IMF).
It also led to stress tests of European banks; in June 2011 the
But today’s crystal ball also contains a number of conceivable
European Union (EU) will publish the results of a new round of
risks, which might interrupt the economic upturn early and
such tests. In November 2010 the safety net had to be utilised
shorten the prevailing equity bull market. Some of these have
when Ireland needed a bail-out loan amounting to EUR 85
their origins in the historically deep financial and economic
billion. In April 2011 it became clear that Portugal also needed
crisis during the latest recession − government financial
a bail-out loan which ended up at nearly EUR 80 billion. In
problems, monetary exit policies, various tension-generating
return, these countries − along with Spain, which has not yet
problem situations in developed market (DM) and emerging
needed to apply for a fiscal bail-out − launched sizeable aus-
market (EM) countries. Others are related to the consequences
terity programmes aimed at drastically reducing their budget
of more recent geopolitical events: mainly a sharp rise in com-
deficits.
modity prices. In addition, there are conditions that favour the
creation of speculative bubbles. Well managed under the circumstances
The government financial crisis − a lengthy drama So far, the difficult government financial problems in Europe
have been managed comparatively well by the EU and the
Immediately after the announcement of the Lehman Brothers
IMF, together with the European Central Bank (ECB). In recent
bankruptcy on September 15, 2008, the economic system
months, however, the situation in Greece has again deterio-
was brutally shaken to its foundations. In the DM countries,
rated dramatically. It is difficult to see how the country will be
the economy went into free fall. The risk of a global financial
able to avoid some form of public sector debt restructuring,
meltdown was real. Against the background of this menac-
but this risk is regarded as manageable.

Theme: Identifying risks
Looking a little further ahead, it cannot be ruled out that sharp economic slide. Later this year and during 2012, it will
Ireland and Portugal may also face debt renegotiations. By be followed by accelerating growth related to restoration and
then there will hopefully be larger lending resources as part of reconstruction work after the natural disaster. The cost will be
the newly created European Stability Mechanism (ESM) that substantially larger than after the Kobe earthquake of 1995.
will be sufficient to provide loans to Spain as well, if needed. This will leave a deep hole in government finances, and sover-
eign debt may increase to 230-240 per cent of GDP by the end
Fiscal austerity will hamper DM growth of next year.
One consequence of fiscal deficits and debts will be multi-
year, non-cyclically-related fiscal austerity, both in countries The Japanese natural disaster initially posed an obvious threat
whose governments have ended up in an acute financial situa- to financial markets, with falling risk appetite and risk asset
tion − Portugal, Ireland, Greece and Spain (the PIGS countries) prices. Looking ahead, however, Japan will instead offer op-
− as well as the United States and the United Kingdom. In portunities to the global economy when its reconstruction
itself, this is something that will hamper economic growth in increases world demand.
the DM sphere for many years to come.
Conclusion: Government financial problems will not halt the
The pressure on the US to start trimming its huge budget defi- upturn
cits increased further when Standard & Poor’s recently low-
ered its outlook on US sovereign debt to negative. President Granted that for many years, government financial problems
Barack Obama’s proposal to tighten the federal budget by will be an occasional source of market worries. Budget tighten-
USD 4 trillion during the period 2012-2023 thus became the ing in the wake of deficits will be a drag on economic growth
focus of political discussion in Washington. If a bipartisan in the DM countries for many years to come. There will also be
consensus can be reached − which is our basic scenario − the major fiscal challenges during the next recession, when room
US government can achieve a tightening equivalent to an for counter-cyclical policies will appear nonexistent. However,
estimated 3.5 per cent of GDP during fiscal 2012. For the DM a government financial crisis of such calibre that it would cut
countries as a whole, the contractive effect attributable to short the economic upturn is unlikely, though the risk must be
fiscal austerity next year would be about 1.5 per cent of GDP monitored very carefully.
(0.25 per cent this year).
SOARING DEFICITS NEED TO BE REINED IN Central banks in different policy phases

At the same time as many DM countries are now tightening
0.25 0.25
their fiscal policies − with Sweden and Norway among the
0.00 0.00 exceptions − in most places, central banks will continue or
initiate their exit policies from an abnormal starting position,
-0.25 -0.25
following the emergency management measures required by
-0.50 -0.50 the financial and economic crisis. The Bank of Japan will hold
USD trillion
USD trillion
off for a long time, however.

-0.75 -0.75
-1.00 -1.00 Key interest rates have been raised in parts of Europe as well
as in such commodity-producing countries as Canada and
-1.25 -1.25
Australia, and the ECB has cautiously begun its rate hiking
-1.50 -1.50 cycle. The Bank of England is in less of a hurry but is likely to
1905 1920 1935 1950 1965 1980 1995
Source: Reuters EcoWin
follow suit this autumn. The Federal Reserve (Fed) will com-
plete its quantitative easing programme (QE2) − purchasing
Mainly due to the financial and economic crisis, the US federal USD 600 billion worth of US government securities − but will
budget deficit has exploded in recent years. Austerity measures probably allow its balance sheet (the monetary base) to shrink
are imminent, however, shrinking the deficit from about USD 1.4 slightly this autumn and then carry out its first key rate hike
trillion in fiscal 2011 to USD 1.1 trillion in fiscal 2012. The chart early in 2012.
shows budget outcomes until fiscal 2010.
The phase-out of QE2 should not lead to any significant
Japan in a special situation effects on market interest rates, since the USD 600 billion
Japan’s sovereign credit rating and credit outlook have been increase in the Fed’s balance sheet since last autumn has
downgraded this year, but no budget-tightening is in the cards not been accompanied by sharply rising money supply and
− on the contrary, due to the consequences of the March 11 lending. The ratio between the money supply and the mon-
earthquake and the subsequent tsunami and nuclear power etary base − the credit multiplier − has instead fallen steeply,
plant failure. In the short term, the country has suffered a implying that the money has stayed within the walls of the
banking system. In other words, QE2 has not stimulated the

US economy via the domestic lending channel, but instead Efforts to ease overheating likely to bear fruit
because the dollar has fallen. QE2 has strengthened the belief Efforts by EM countries − especially in Asia − to reduce over-
among market players that the Fed’s monetary policy will heating problems are soon likely to start bearing fruit. Growth
remain ultra-loose far longer than that of other major central has decelerated as a result of interest rate hikes, bank lending
banks, except for the Bank of Japan. restrictions and fiscal austerity, and price pressure is trending
downward. Assuming a sizeable decline in food prices during
DM exit policies − a balancing act the second half of this year (see below), conditions will im-
Generally speaking, central banks must now perform a care- prove further. In the EM countries, food accounts for between
ful balancing act. On the one hand, they must nurture the 25 and 50 per cent of the consumer price index, compared
economic upturn, while bearing in mind that fiscal policies to an average of 15 per cent in the DM countries. Meanwhile,
are tightening significantly in many places. On the other hand, the EM sphere is less sensitive to oil price movements. The
they must take into account that total inflation − the target prospect of cheaper agricultural products later this year is thus
variable for many central banks − has increased significantly especially important to the EM countries. As a result of these
since last autumn, due to sharp increases in commodity prices. prospects, the need for tightening economic policies will fade
in some of the EM countries.
The price outlook is not alarming, however. Assuming that
the commodity price increase culminates and that later this Conclusion: No economic hard landing in the EM sphere
year, certain prices − among them energy and food − fall
somewhat, total consumer price inflation on both sides of the A very shallow economic slump in the EM countries in 2008-
Atlantic in 2012 will be well below the 2011 level. Core inflation 2009 and above-trend growth plus surging commodity prices
(excluding food and energy) will climb very modestly next year. have resulted in currency-related tensions and overheating in
many of these countries. The overheating problem now seems
Conclusion: There will be no reason for DM central banks to to have decreased, and the prospect of cheaper food will ben-
sharply tighten their monetary policies efit EM households in particular.
In recent months, central banks in the DM countries have

faced more difficult decision-making problems as inflation has More expensive food a cause of dearer oil
increased sharply, mainly due to more expensive commodities. One risk that is not based on the financial and economic crisis
But the price outlook is not alarming. The process of unwind- is the big increase in commodity prices during the past year or
ing very accommodative interest rate policies can thus occur so. This can be explained by increased demand, a significant
gently. Imminent monetary exit policies consequently pose no element of speculation in rising prices, a weakening of the US
threat to the economic upturn. dollar and − in the case of food prices − supply-side disrup-
tions due to the La Niña weather phenomenon.
OVERHEATING HAS IGNITED INFLATION
Different cyclical positions have created tensions
While the DM sphere saw deep downturns in the last reces- 17.5 17.5
sion, economic reversals for EM countries were substantially 15.0 15.0
shallower. As a consequence of this, tensions have arisen in 12.5 12.5

the global currency system. These have included what the
10.0 10.0
EM countries regard as undesirably strong upward pressure
7.5 7.5
on their currencies as well as overheating risks, also related
5.0 5.0
to above-trend growth and commodity price increases. Some
countries have responded by limiting the inflow of portfolio 2.5 2.5
investments from DM countries; some have tightened their 0.0 0.0
economic policies in order to slow economic growth. -2.5 -2.5

2005 2006 2007 2008 2009 2010 2011
The situation has cooled somewhat since China accelerated Russia, consumer prices
Brazil, consumer prices
China, consumer prices

its revaluation of the yuan against the US dollar, but by all India, wholesale prices
indications currency-related tensions will continue in the fore- Inflation in the BRIC countries has accelerated since the global
seeable future. In any event, there is little likelihood of a wide- recovery began in late 2009. Rapid growth, shortages of spare
spread currency and trade war, especially since the outlook production resources and the commodity price rally are the main
for the EM sphere now seems to be improving in important reasons, but the upturn has levelled off, especially due to tighter
respects. economic policies. Assuming lower food prices, this should mean
gradually slower inflation ahead.

More expensive food was also the spark that ignited social un- Fading commodity price upturn
rest and violence in the Middle East and North Africa (MENA), Last − but not least − a peak in the commodity price upturn is
which in turn further fuelled the oil price upturn. The risk is part of our forecast for the second half of 2011, since supply-
that oil prices may climb so much as to cause a sharp decel- side disruptions are likely to diminish by then. In the case of
eration in economic growth. So far, more expensive commodi- oil, for example, production in Libya should increase again,
ties have had a certain cooling effect on the world economy, and that naughty weather girl La Niña will turn nice again, ac-
but without jeopardising the upturn. cording to long-term meteorological forecasts: the weather
will be far more favourable for production of agricultural com-
Rather minor inflationary effects in DM countries modities.
The inflationary effects of the price upturn to date are likely
to be rather minor in the DM sphere. Oil and other com- LITTLE WEATHER GIRL WITH BIG PRICING POWER
modities account for only a small fraction of total company 1100 6000
1000 5500
expenses − an overwhelming majority of these expenses
900 5000
consists of labour costs (about 70 per cent) − and in today’s
800 4500
macroeconomic environment it is also likely that companies
700 4000
will have difficulty passing on higher expenses to consumers.
600 3500
Meanwhile households/employees will find it hard to push
Index
Index
500 3000
through demands for higher wages and salaries as compensa- 400 2500
tion for more expensive energy. 300 2000
200 1500
Household energy consumption as a share of GDP has also 100 1000
fallen substantially during the past four decades, for example 0 500
2006 2007 2008 2009 2010 2011
in the US from 17 per cent in 1970 to about 9 per cent today. It
Soya beans Wheat Index, Agricultural products
thus requires a significantly larger price increase now to have Maize (corn) Sugar Source: Reuters EcoWin
the same tightening effect on private consumption as before. The price increases for agricultural products last autumn and
winter were mainly due to the La Niña weather phenomenon,
Furthermore, the correlation between American GDP growth which caused flooding, droughts and more. Today forecasts point
and energy prices has changed signs. In the 1970s and early towards more normal weather and thus lower prices for various
1980s, the correlation was strongly negative: 80 per cent at agricultural products.
the peak. In other words, rising oil prices went hand in hand
with falling GDP. Since then it has gradually changed and has Conclusion: More expensive commodities have slowed but
become positive. In the fourth quarter of last year, this positive not interrupted the upswing
correlation was about 75 per cent. Nowadays, rising GDP thus
goes hand in hand with rising oil prices, as higher growth and So far, the increase in commodity prices has slowed but not in-
demand from households and businesses lead to a greater terrupted the prevailing cyclical upswing in the DM countries,
need for energy and other commodities. since their sensitivity to dearer oil in particular has gradually
GDP CHANGES AND OIL PRICES GO HAND IN HAND diminished since the 1970s. There is also potential for cheaper
oil and − not least − agricultural products later this year. A de-
12.5 150
cline in food prices will especially benefit EM households.
10.0 125
7.5 100
Management of bubbles has paved way for new ones
Per cent, q/q, annualised
5.0 75
Among the factors behind the sub-prime mortgage crisis that
Per cent, y/y
2.5 50
exploded in 2007-2008 − with dramatic financial and eco-
0.0 25
nomic consequences − was the Federal Reserve’s loose mon-
-2.5 0 etary policy after the IT/telecom bubble burst early in the new
-5.0 -25 millennium. The way that the consequences of a burst bubble
-7.5 -50
are managed can thus pave the way for the next bubble.
-10.0 -75
1998 2000 2002 2004 2006 2008 2010 Since 2008, DM monetary policies have been exceptionally
GDP, US
Brent crude oil
accommodative. Not until this spring has one of the major
central banks in these countries, the ECB, taken the first step
In the 1970s, GDP in the US usually grew more slowly or fell when towards a normalisation of its monetary policy. So is there rea-
oil prices rose, but in recent decades the correlation has become son to fear that new speculative bubbles are now inflating?
positive: Rising oil prices are associated with faster GDP growth
and falling oil prices often coincide with weak US expansion.

One obvious candidate since last autumn has been the com- Those who are worried point, for example, to excessive resi-
modities market, but early in May 2011 there was a noticeable dential construction in China, the fact that numerous house-
downward correction in many commodity prices. We also be- holds in need of a larger home cannot afford one due to price
lieve that the upturns in commodity prices have culminated. increases, that many people have regarded homes as invest-
ments and that interest rates are now rising while lending is
DM sovereign bonds − a possible bubble candidate being tightened. Those who are not worried instead empha-
Judging among other things from valuations, the stock market sise that decision makers at all levels want to avoid a decline
is not generally characterised by any bubble tendencies at the in construction and home prices, that residential construction
moment, but there is reason for some concern in the case of is not excessive at all, since there are whole cities with dilapi-
DM sovereign bonds. The yields on these bonds have trended dated housing stock, and that housing demand will increase in
downward since the early 1980s, with the accompanying in- the long term due to continued urbanisation in China.
creases in the market prices of these fixed income securities.
Today it is difficult to foresee prospects of even lower yields/ The question of whether the Chinese real estate market is in
higher market prices as monetary policies in the DM sphere a bubble or not is thus very complex, and a genuinely solid
gradually normalise. In some cases, gigantic budget deficits answer would require an in-depth analysis. So the final word is
must be financed. But at present it seems a long way between that “the jury is still out.”
our base scenario of gradually rising sovereign bond yields to a
bubble-bursting process − dramatic increases in such yields. Conclusion: There is no obvious bubble in sight, but
there are some candidates
In the real estate market, many bubbles have already burst in
recent years, not only in the US but also in such countries as The economic policy response to a speculative bubble may
Spain and Ireland. The risk that the Chinese real estate market prepare the way for the next one. But despite exceptionally ac-
may currently be in a bubble has been hotly debated in recent commodative monetary policies in the DM sphere in the past
years. few years, no obvious bubble tendencies are currently in sight.
DM sovereign bonds and the Chinese real estate market are
possible candidates.
17.5 17.5 TREND SHIFT LIKELY FOR GOVERNMENT

BOND YIELDS
15.0 15.0
Since the 1920s, government bond yield cycles in the
12.5 12.5
US (10-year Treasuries in the chart) have encompas-
10.0 10.0 sed periods of about 30 years. First there was a falling
Per cent
trend until the late 1940s, then a rising trend until the
7.5 7.5 early 1980s, followed by a period of gradually falling
yields. If history repeats itself, the trend during the
5.0 5.0 coming decades will be upward. Looking ahead at
least a few years, there are also various arguments for
2.5 2.5
rising government bond yields, which would adversely
affect bond prices. But it is unlikely that this market
0.0 0.0
1905 1920 1935 1950 1965 1980 1995 will now see a bursting bubble.

Theme:
Navigating through
risky waters
Capital investments in a calmer cyclical phase
• From strong growth to calmer expansion Price shocks and speculative bubbles more common
The upturns in the late 1950s and the 1960s were interrupted
• Greater stability will eventually mean greater due to traditional cyclical reasons, while the upturns during
risk appetite the 1970s were interrupted prematurely when the economy
was subjected to oil price shocks. The first upturn of the 1980s
• Focus shifting to less cyclically dependent was interrupted after only three quarters when the Federal
sectors Reserve sharply tightened its monetary policy via interest rate
hikes and money supply management in order to combat very
The economy is on its way into a part of the cycle where glo-
high inflation.
bal leading indicators, especially in Japan, have peaked. In
recent months they have shown somewhat lower values than
The three subsequent cyclical upturns that occurred in the
previously. At the overall level, this means adjusting our fore-
1990s and 2000s all ended in ways that included elements of
cast for the world economic growth rate slightly downward.
burst speculative bubbles.
Nevertheless, we see no reason to abandon our fundamentally
positive view of the economy, which today includes expecta-
The current cyclical upturn began in the US and many other
tions that annual global growth will be around 4.5 per cent in
industrialised countries (OECD = Developed Markets, DM)
2011 and 2012. Fundamentally, this provides good conditions
early in the second half of 2009 and has thus been under way
for risk-bearing assets such as equities.
for nearly two years. If the prevailing cyclical upswing is “left in
peace” and is not subjected to any kind of shock, it should be
Assuming that the economy is still in a growth phase, which is
able to continue for another two to three years. This, in turn,
the case, the questions asked in macro-oriented analyses of
would fuel equities and other risk assets. But since we are in a
the outlook should be: How long does the economic upturn
phase with various possible sources of risk that may influence
appear capable of continuing without disruptions? What
this favourable tendency, it is important to try to evaluate the
might interrupt the upturn “prematurely”? Are there signs of
various risks we have around us, and how they could poten-
speculative bubbles in financial asset markets or in real es-
tially have an adverse effect on the positive trend.
tate? (See Theme: Identifying risks)
History provides excellent guidance We must weigh in certain risks − for example, that economic
growth may be weaker than expected, or that one of the risk
History gives us excellent guidance regarding the length of a
factors develops in a way that is unlikely today, yet might hap-
“normal” cyclical upturn, what may interrupt such an upturn
pen − and make an assessment of how to invest capital in
prematurely, and how frequently speculative market bubbles
order to reduce the influence of these risks.
have occurred.
Our first observation is that we are moderating our view of
Between the late 1950s and the end of 2007, the United States
what will drive capital markets in the near future. We are mov-
had eight periods characterised by cyclical upturns, with an
ing from a period of accelerating growth to a calmer expansion
average length of 20 quarters. This entirely matches the aver-
phase. In itself, this will lead to different market behaviour.
age length of equity bull markets during the same time span.
This type of calmer phase is a natural part of an economic cy-
cle and is always accompanied by a certain slowdown in indi-
Cyclical upturns have nevertheless shown a wide range of
cators, creating a sense of concern among investors. It is thus
durations; the shortest ran for only three quarters, the longest
important to place this argument in its context and recall that
for 35 quarters. The average US recession since the mid-1950s
underlying growth is the natural state of the economic cycle.
has lasted just over ten months.

Theme: Navigating through risky waters
Genuine interruptions in the cyclical upturn are virtually al- • Government bond yields are normalising more and more,
ways driven by various kinds of tightening measures − which and credit spreads are narrowing further.
at present we are currently far from, in a total global perspec-
tive. What qualities characterise the investments we are focusing
on? These qualities are low cyclical dependence, low volatility
Our overall assessment is that inflation risks are manageable and increased risk appetite, high value added, increased finan-
and that we can return to a period driven by carefully nurtured cial stability and high growth at reasonable valuations.
growth and moderately accommodative monetary policies.
Low cyclical dependence
How do we generate returns in a phase like the current one? During the beginning of a cyclical upturn, there are rising
valuations in those stock market sectors that first experience
We have identified some key trends that we believe will be of increased demand; this category includes commodity compa-
great importance in the near future: nies. In later phases of the cycle, the focus moves to other sec-
tors that are less cyclically dependent. Pharmaceutical compa-
• Fundamentally, public authorities are still making significant nies are an example of a sector with low cyclical dependence,
efforts to nurture stable growth, since it will be necessary to often classified as late-cyclical. One interesting idea is to look
increase employment in order to repair government finances at which sectors can show good earnings forecasts during
around the world. 2011 and 2012. Also important is lower dependence on com-
modity prices.
• The recovery from the financial crisis is continuing slowly
but surely, banks are recapitalising via profits and government Low volatility and increased risk appetite
financial risks are currently more or less under control. In the more mature phase of the economic cycle, capital mar-
ket performance is often more uniform. We get lower volatility,
• Commodity prices have cooled down a bit − a reflection of and risk appetite thus often increases. We do not have the
a calmer economic trend − and the US dollar is showing some same wide market fluctuations.
tendencies towards appreciating against other major curren-
cies. Hedge fund management often thrives during phases of
relatively stable growth. In addition, hedge fund managers are
• Markets are moving from a cyclical focus to a more mixed often skilful technicians who can take efficient advantage of
view of what assets one should own, a pattern that has been small price differences. This works best when there is a certain
clear in stock markets during the past few months. degree of predictability in markets.
• Risk appetite is stabilising, and volatility is coming down

to sustainably low levels − an indication that capital markets
have an increasingly homogeneous view of the future.
EARNINGS FORECASTS BY SECTOR HEDGE FUNDS THRIVE IN A STABLE ENVIRONMENT
2.5 110
50.0%
0.0 100
earnings/share
40.0% -2.5 90
Growth,
30.0% -5.0 80
* electricity, gas and water Source: Factset 2011
2012 -7.5 70
20.0%
Per cent
-10.0 60
Index
10.0% -12.5 50
-15.0 40
0.0%
-17.5 30
discretionary
Information
Energy
Utilities*
Industrials
Telecom
Financials
Health care
services
Total
Consumer
technology
Materials
-20.0 20
Consumer
staples
-22.5 10
-25.0 0
May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May
2008 2009 2010 2011
World, HFR, Global Hedge Fund Index [increase %] US, VIX-index Source: Reuters EcoWin
Forecasts indicate somewhat lower profit expectations in sectors with There is a strong negative correlation between hedge fund perform-
low cyclical dependence − such as health care, telecom services, con- ance and stock market volatility. Hedge fund managers generally ben-
sumer staples and utilities. The consumer discretionary sector may be efit from phases of relatively stable stock market performance.
regarded as late-cyclical in nature and will show uniform, high growth
during 2011 and 2012.

Theme: Navigating through risky waters
The gradual increase in risk appetite also drives investors to ally but also financially. In stock markets, we have a number of
accept investments with lower liquidity, and they look for as- sectors with high value added, including traditional industries.
sets that complement traditional markets. This means that
private equity and more tailor-made investments come into Increased financial stability
focus. As the financial system becomes stronger, the financing of
various businesses will be a factor that drives values. Today
We can also add currency strategies to this category. Today we banks are showing relatively weak performance, but they may
have had major shifts in foreign exchange market trends and benefit if the healing process continues in the future. This
large interest rate spreads. These strategies are also relatively will provide a helping hand to consumption and investments.
independent of economic cycles and can provide returns Sectors that are dependent on financing will also benefit.
even if stock markets fall. They are attractive from a portfolio
standpoint.
High growth at reasonable valuations
At present, the growth rate is different for different assets. It is
High value added higher in parts of the manufacturing sector and in emerging
Because the markets will, to a great extent, be looking for as- market countries. In a more stable phase, we will see a clearer
sets that are not strictly dependent on the economic cycle, differentiation between asset classes, and the importance of
value added will be increasingly attractive. Here, too, private choosing properly will increase. The challenge lies in finding
equity will attract attention since its business model makes it assets that have high, uniform returns but are not overpriced.
possible to optimise companies in a powerful way, operation- This applies to sectors in the stock market as well as countries.
25.0%
20.0%
Growth, earnings/share
15.0%
10.0%
5.0% GROWTH VS. VALUATION

Source: Factset
In a more stable phase of the economic cycle, the
0.0% valuation gap both between countries and between
5.0 7.0 9.0 11.0 13.0 15.0 17.0 sectors will shrink. It will thus pay better to hold assets
P/E with high growth that, relatively speaking, are not
overpriced.
World Emerging markets US Europe Japan Brazil India China

Theme:
Tools for
stock market choices
New factors and new favourites

• Large discrepancy in returns – important to Roughly speaking, a bull market can be divided into three
choose properly different phases. In the first phase, asset prices surge on a
broad front. This occurs because the market can write off the
• China and the US score the best in our doomsday scenario often included in prices after a bubble
modified model bursts (the IT/dotcom crash, the financial crisis etc.). In the
second phase, risk willingness is clearly more variable, and the
• Falling food prices will benefit EM stock discrepancy in returns between different asset classes and
markets regions increases. By then the recovery has entered a more
mature phase and company profits have stabilised. In the
third and final phase, investors begin to disregard risks, after
The market is a moving target. Factors that were of impor- having experienced years of upward-trending asset prices and
tance one quarter ago may be completely out of date today, strong economic growth. This phase is often characterised by
while new driving forces continuously move onstage. Markets euphoric market players and exponentially rising asset prices.
are often driven by only one or a few factors at a time. As an Our assessment is that at present, the market is in phase two,
investor, it is vital to try to identify what these are, how much but that it will take some time before market players lose their
impact they will have and how long they will last. risk perspective and believe that trees grow to heaven (phase
three).
Where we are in the market cycle is of central importance in
being able to predict how global risk willingness will change. In an investment climate where risk willingness fluctuates and
Since share prices, commodity prices, returns on loans etc. the differences in returns between assets may be large, it is
bottomed out in the spring of 2009, we have experienced a especially important to identify tomorrow’s winners and los-
bull market characterised by high risk appetite and rising asset ers. For this purpose, in the last issue of Investment Outlook
prices. (dated February 2011) we launched a quantitative stock mar-
ket model for country allocation. We are now building further
on this effort.
1600 1600
1500 1500
1400 1400
S&P 500 index
1300 1300
S&P 500 index
Phase 1 Phase 2 Phase 3

1200 1200
1100 1100 BULL MARKET DURING PART OF THE 2000s

1000 1000 A bull market can generally be divided into three
900 900
phases. Our assessment is that at present, the market
is in phase 2, where investors increasingly distinguish
800 800
2003 2004 2005 2006 2007 between asset classes and stock exchanges, based on
US, S&P500, USD
Source: Reuters EcoWin their respective potential.
S&P 500
OMXS
Theme: Tools for stock market choices
Using a quantitative model has a number of advantages. GDP growth has historically had a fairly low co-variation with
It is a good tool for structuring the market and identifying share price movements. One explanation for this weak con-
the driving forces of the future. In addition, it is easy to fol- nection is that most of the components that make up GDP
low the analytical process, both for those who work with the growth are public information before the actual GDP figure
model and for those who view the results. One disadvantage, is published. The market thus has a rather clear perception
however, is that the model assigns figures to subjective as- of what has happened by the time the figure is published,
sessments about what factors will drive developments and more than a month after the end of each quarter. During this
how these should be scored for different countries. A model period, quite a lot of new macroeconomic statistics have also
is never better than the numbers that are put into it, and it had time to appear, reflecting a more current reading of the
will probably not capture all forces and scenarios. The model economic pulse. This is why there is rarely any excitement or
is consequently not an absolute truth, but is intended to de- major surprise when GDP growth is announced.
scribe how we view the market and what we believe will drive
it in the coming months. Changes in GDP forecasts, however, have historically had
a very large impact on share prices. A Goldman Sachs study,
The model is based on our selection of factors that we believe for example, shows that a 1 percentage point change in ex-
will affect the market in the future from a country standpoint. pected GDP growth looking ahead one year has resulted in a
We have changed some factors compared to the previous 10 per cent change in share prices (all else being equal). The
model. The factors we are now focusing on are growth, infla- countries in the model thus receive points especially when our
tion/monetary policy, valuations and currency. We score each growth expectations diverge from consensus forecasts.
factor based on its positive or negative contribution to the
stock market in each respective country. The scale runs from Inflation/monetary policy is a factor that can be approached
-3 to +3. The model also enables us to weight these various from various angles. In our previous model, we weighed in only
factors on the basis of how large an impact we believe they monetary policy, with an expansionary monetary policy being
will have, given the market climate we foresee. This time, how- preferable for investors. At that time the world was divided in
ever, we have chosen not to use such weighting, since there two, with policy tightening in the EM sphere and ultra-loose
are fewer factors than before and we find it difficult to rank monetary policy in the OECD. The spread in interest rates
their impact. remains wide, but interest rate hikes in the OECD countries
are now beginning to be priced into the market, while most
One important difference compared to the previous version of EM countries will have ended their rate hiking cycles this year.
the model is that to a greater extent, we are now focusing on Inflation is closely connected to monetary policy, and there
our view compared to the market consensus. One advantage is a clear difference in inflation pressure between different
of this new approach is that factors not yet priced in by the groups of countries. In this phase of the economic cycle, we
market are usually what will drive the market. One disad- predict that changes in inflation expectations are likely to have
vantage is that it is difficult to know exactly what the market a major impact on asset prices.
consensus is.
OUR ASSESSMENT MODEL FOR COUNTRIES/GROUPS OF COUNTRIES

country/ Growth Inflation/ Valuations Currency Total
GRoup monetary policy
EM 2 2 1 2 7
DM 1 1 0 0 2
China 2 2 1 1 6
United States 2 2 0 1 5
Germany 2 1 0 1 4
Eastern Europe 1 0 0 2 3
Russia 1 -1 1 2 3
Nordic countries 1 0 1 1 3
Sweden 1 -1 1 1 2
Brazil -1 0 1 0 0
PIGS countries -1 -1 0 0 -2
Japan -1 0 2 -3 -2

Stock market valuations are generally in line with their 10- in the EM sphere have been held back due to the tightening
year average. Meanwhile share prices are only about 10-15 per of key interest rates, which have been needed in order to ease
cent below their peaks before the outbreak of the financial cri- high inflation pressure, mainly driven by sharply rising food
sis. Compared to share prices, valuations are thus significantly prices (a large share of disposable income among EM consum-
lower in today’s bull market than before the financial crisis. ers). The interest rate hiking cycle has not yet ended, but its
In terms of valuations, most groups of countries are trading effect is already priced into the stock market. Our assessment
at about the historical average, but some markets may be re- is that later this year, food prices will fall faster and further
garded as somewhat better bargains. These are Japan (due to than current consensus expectations. Such a scenario would
post-disaster effects), the Nordic countries, Russia and China. increase purchasing power and reduce the need for monetary
policy tightening in the EM sphere.
Currency movements are a factor with several dimensions
from an investor standpoint. First, a weaker currency may be Although the EM sphere is not likely to surpass today’s high
positive for the stock market, since it strengthens the com- GDP growth expectations, we believe that there will be a
petitiveness of a country’s export sector. In the past year, for renewed focus on the growth gap between the DM and EM
example, there has been a very strong association between countries. Investors are likely to be attracted by the high
a weaker US dollar and rising prices on American stock ex- growth that EM countries will offer, resulting in capital inflows
changes. Second, currency movements may have a direct and rising share prices. Another effect is that EM currencies
impact on returns for an investor who buys foreign equities. will be in demand, and a large interest rate gap between EM
For a Swedish investor, for instance, it has been difficult to and DM countries will further enhance this attraction. Most EM
generate a positive return on a global equity portfolio due to countries should have a positive attitude towards seeing their
the strong performance of the Swedish krona during the past currencies appreciate, since this will reduce inflation pressure.
year (i.e. falling exchange rates for other currencies). Since in
many cases today’s listed companies are so globalised that it Finally, valuations on most EM stock exchanges look attractive.
is difficult to know where their production costs and sales are Traditionally, EM shares are traded with a discount to the world
located, we are assigning the largest weight to the direct effect index. Given the currently prevailing two-speed economic
of currency movements on returns in the model. situation in the world − with the EM sphere performing better
than the DM sphere − this discount is not equally justified.
Advantage EM
Dividing up stock markets into emerging market (EM) and de- Within the EM sphere, the outlook is varied. We foresee the
veloped market (DM) countries is a very crude approach, since best potential for Asia, followed by Eastern Europe and finally
there are wide variations in conditions within each of these Latin America. Compared to Asia, Latin America does not offer
groups of countries. But although we prefer to view stock mar- the same growth figures, inflation is less manageable and cur-
kets from a country perspective, at present there are certain rencies are not expected to appreciate to the same extent. In
factors that justify comparing EM to DM countries. addition, a relatively powerful correction in commodity prices
is under way, putting countries that are commodity consumers
EM countries receive more points for all factors in the model (Asia) in a better position than commodity producers (Latin
than DM countries, and the reason is as follows: Stock markets America).
4.0%
SEB’s GDP forec.
3.5%
Consensus
3.0% Source: SEB, Consensus Forecasts
2.5%
2.0% STRONGER GROWTH THAN CONSENSUS
1.5% The US and Germany score well in our model because

we believe that their growth will be well above the
1.0% 2012 consensus estimate. The EM sphere and China
0.5% also earn high scores for the growth factor, since the
growth gap between EM and DM countries is again
0.0% likely to attract intensive market attention.
US Germany

China – best in test nomic growth and the stock market. In our assessment, such
From a country standpoint, China, Germany and the United market worries are exaggerated and when these effects turn
States look the most attractive, for varying reasons. China is out to be negligible, this is likely to be reflected in share prices.
the country that best coincides with the arguments we have
presented for our positive view of EM countries in general. In
Avoid Japan
the case of Germany, high growth than expected by the mar- The lowest scores in the model go to Japan and the PIGS
ket is the main factor that pushes up the country’s score in the countries. The Japanese economy and stock market have been
model. Germany’s recovery is progressing at a rapid pace, and disappointing for a number of years. It is true that reconstruc-
it will probably remain the economic engine of the euro zone tion work following the earthquake will contribute positively to
for a long time to come. Since there is one monetary policy for GDP growth. But on the other hand, growth rates will remain
the entire single currency union, our assessment is that it is low and the natural disaster may help make an already deli-
unjustifiably accommodative for Germany, since the European cate recovery even more fragile. In addition, Japan’s zero inter-
Central Bank (ECB) also takes into account the heavily in- est rate policy and overvalued currency are indications that
debted PIGS countries (Portugal, Ireland, Greece and Spain). the yen may fall sharply in value, making a negative contribu-
The value of the euro is also affected by the weaker links in tion to total return for a foreign investor.
the euro chain, and German exporters are thus able to benefit
from a comparatively weak currency. The export sector is by The outlook for the PIGS countries is anything but bright. The
far the most important engine of German industry. situation is the most acute in Greece, where sovereign debt is
approaching 160 per cent of GDP, while economic growth is
We also predict that American economic growth will surpass falling sharply and unemployment is skyrocketing. There has
expectations. The combination of a weak dollar, dynamic recently been talk of writing down Greek debts to private lend-
companies and high productivity has created a profitable ers, something that SEB believes will happen during 2012. The
manufacturing sector. For the first time in nearly four decades, risk of contagious effects on the other PIGS countries is not
the manufacturing sector has increased its share of American negligible. On the other hand, the debt situation is no secret,
GDP. Markets are also concerned that risk assets, especially so that if the situation improves there is potential for sizeable
the US stock market, will be adversely affected when the stock market gains. At present, however, we find it difficult to
Federal Reserve stops buying government bonds early in June foresee any solution to these problems, and the PIGS coun-
(see the chart below). These bond purchases have pushed tries thus receive a low score in our model.
down interest rates to artificially low levels, stimulating eco-
3.0 3.0
END OF QE2 SHOULD HAVE LITTLE IMPACT
2.5 2.5 This summer the US Federal Reserve is ending its purchases
of government bonds (quantitative easing). These purchases,
2.0 2.0
under way since autumn 2008, have greatly enlarged the
Fed’s balance sheet. The Fed’s ambition has been to increase
the money supply and lending, but since the money has
USD trillions
USD trillions
1.5 1.5
remained within the banking system there is likely to be little
impact when the second round of the programme (QE2) soon
1.0 1.0
ends. Interest rates have perhaps been somewhat lower due
to the Fed’s government bond purchases, but overall interest
0.5 0.5
rate movements will probably be small when QE2 ceases.
Once the market can leave this source of worries behind,
0.0
2002 2004 2005 2006 2007 2008 2009 2010 2011
0.0 it should have a positive effect on the US stock market in
particular.

Macro summary
World economy will continue its upturn

• Despite new challenges, this year world ter plus large capital spending needs will also be an economic
driving force. We predict that GDP will increase by just below 3
economic growth will be well above its per cent this year and nearly 4 per cent in 2012.
historical trend...
Accentuated dualism in the euro zone
• ...and next year the pace may increase, thanks
The euro zone economies are showing increasing dualism.
to accelerating OECD growth German growth remains high, and optimism is at record levels
according to the IFO business sentiment index. Germany’s
• Inflation is now a major source of concern, but GDP will climb about 3.5 per cent this year and more than 2.5
price increases will ease significantly in 2012 per cent in 2012. France and Italy are growing more slowly,
roughly on a par with their historical trend (1.5-2 per cent).
In recent months, the global economy has faced a number of One reason is sluggish growth in domestic demand, while
challenges: social unrest and violence in the Middle East and fast-growing exports are instrumental in Germany’s expansion.
North Africa, a civil war in Libya, a natural disaster in Japan Spain was on the brink of a new recession late in 2010 but has
and a new wave of European sovereign debt crisis. As a result, since stabilised. Due to dramatic fiscal austerity in Greece,
the international economic pulse has not been as strong dur- Ireland and Portugal, these countries will see a decline in GDP
ing the spring. This has created greater uncertainty about the this year as well. We foresee overall euro zone growth of about
sustainability of the recovery. 2 per cent both this year and next.
In our assessment, however, the world economy will overcome

Obstacles to British economic growth
these new challenges. Emerging market (EM) economies will The British economy will be held back this year by fiscal tight-
continue their rapid growth. The US upturn will become more ening and high inflation, which will undermine household
self-sustaining and will soon pick up more speed after a pale purchasing power. Offsetting this are the weak British pound
first quarter. Post-disaster reconstruction work will stimulate and strong international demand, which will create good con-
the Japanese economy. Global GDP growth will thus accelerate ditions for exporters. Together with prospects of rather strong
in 2012, despite some tightening of economic policies. capital spending, this will help prop up economic growth. We
predict GDP increases of 1.5 per cent in 2011 and 2.5 per cent
Rapidly rising commodity prices have pushed up world infla- in 2012.
tion, leading to concerns about persistent high inflation. A
cool-down in commodity prices, together with low underlying
Nordic countries reaping economic success
cost pressures in the OECD industrialised countries, will nev- The Nordic countries will continue to reap macroeconomic
ertheless lead to a substantial slowdown in consumer price success. These countries are characterised by strong eco-
increases next year. nomic fundamentals in the form of budget balances, public
sector debt and current account balances. Meanwhile export-
US economy poised for acceleration ers are well positioned to respond to growing global demand.
By all indications, the first-quarter slump in the US economy Currency appreciation in Sweden and Norway − due among
was temporary, with severe winter weather and surging food other things to strong fundamentals and early key interest rate
and petrol prices hampering growth. Among indications of a hikes − will not slow the expansion to any great extent. We
rebound are prospects of a return to lower inflation, a gradual predict overall Nordic GDP increases of nearly 3.5 per cent this
labour market improvement − which will benefit private con- year and more than 2.5 per cent in 2012.
sumption − and robust optimism among businesses, which
are enjoying high earnings and strong balance sheets. The lat-

Macro summary
Natural disaster will speed Japanese growth cies. Competitive exports will remain a strong driving force.
The natural disaster and its consequences are making all Meanwhile consumption and capital spending are awakening
forecasts of Japanese economic trends unusually uncertain. from their crisis-period hibernation. In the short term, rapid
In the short term, activity appears to have fallen more than commodity-driven inflation has undermined purchasing
expected. This time around, the impact will clearly be more se- power, but we predict that energy and agricultural commodity
vere than after the Kobe earthquake of 1995. The devastation prices will fall in the second half of 2011. During the past year,
is larger. In all, about 1 per cent of the country’s capital stock better growth and improved control of public finances have
− worth 3-4 per cent of GDP − seems to have been destroyed. strengthened the market’s confidence in Eastern Europe.
But developments will likely follow the pattern of earlier natu-
ral disasters. Starting in the third quarter, the stimulus effects The gradual upturn in the Baltic countries is continuing, mainly
of reconstruction efforts will gradually take the upper hand. In thanks to strong export growth, but domestic demand is
2011 as a whole, we foresee GDP growth of only 0.5 per cent. only slowly recuperating from the crisis. In 2011-2012 annual
In 2012 growth will accelerate to about 2.5 per cent. growth may reach 4-5 per cent, led by Estonia. There is little
risk of a severe upturn in inflation. Baltic economic imbalances
Tightening will mean soft landing in EM Asia have greatly diminished, but major structural problems in the
Asian emerging markets are still leading the economic cycle labour market plus budget deficits in Latvia and Lithuania
and driving global growth, but overheating risks have become pose continued challenges.
increasingly apparent in the past six months. Together with ris-
ing commodity prices, this has justified significant economic World economic growth above historical trend
policy tightening, with a focus on monetary policy. This will We expect GDP in the emerging market sphere − which ac-
help ease price pressures and prepare the way for an econom- counts for nearly 50 per cent of the world economy (adjusted
ic soft landing. We thus expect emerging Asian economies to for purchasing power parities) − to grow by 6.5 per cent in
continue expanding at a comparatively rapid pace (7.5-8 per 2011 and a bit more slowly in 2012. Meanwhile we predict
cent) in 2011 and 2012. growth in the OECD countries of about 2.5 per cent this year
and just above 3 per cent next year. Global economic growth
We predict that China’s GDP will grow by nearly 9.5 per cent may thus average nearly 4.5 per cent in 2011-2012, a pace well
this year and 8.5 per cent in 2012. A combination of somewhat above its historical trend − despite all the new challenges.
slower export expansion and a slightly less dynamic domestic
market will help slow GDP growth compared to nearly 10.5 SLIGHTLY SLOWER GROWTH IN CHINA AND INDIA
per cent in 2010, but growth will exceed the 7 per cent target 14 14
stated in the new five-year plan. Inflation has largely been 13 13
driven by food prices and will slow gradually from this sum- 12 12
11 11
mer. In India, we forecast a slowdown in GDP growth to 7 per 10 10

cent in 2012 after this year’s 8 per cent (8.5 per cent in 2010), 9 9
but exports and industrial production will continue to perform 8 8
7 7
strongly after last winter’s slump. 6 6
5 5
Tightening will slow Latin American growth 4 4
3 3
The Latin American economies − which grew by 6.5 per cent 2 2
last year − will decelerate to 4.5-5 per cent in 2011. Inflation 1 1
was around 6.5 per cent in 2010 and rose further early this 0 0
2005 2006 2007 2008 2009 2010
year, leading to widespread monetary policy tightening. For
China, GDP change India, GDP change
example, the Brazilian central bank’s benchmark SELIC rate Source: Reuters EcoWin
has been raised several times in the past year. More hikes can In both China and India, the slump during the 2008-2009 global
be expected. Due to tighter economic policies, growth in Brazil recession was noticeably shallow, after which GDP growth accel-
and the region as a whole will slow to just over 4 per cent next erated rapidly. Due to higher inflation in the wake of the upturn,
year, but Latin America can still show far better figures than monetary and other economic policies were tightened in both
the OECD for both public sector finances and current account countries. This led to some cooling off last winter. Further decel-
balances. eration is likely in the coming year and we foresee soft landings.
Accelerating economies in Eastern Europe
The Eastern European economies will speed up in 2011-
2012, even though global growth will slow a bit and many
countries − including Poland − will tighten their fiscal poli-

Equities
Attractive valuations sustain stock markets
• Numerous risk factors are already priced into have only a limited impact on global economic growth as a
markets whole. Share prices recovered to pre-disaster levels by the end
of March.
• Stock exchange indices approaching
pre-crisis levels − but with lower relative In April, the focus shifted from the situation in North Africa
and Japan to the US and the European debt crisis, and some-
valuations what later to first-quarter 2011 company reports. Standard &
• After a bad patch in March, volatility is back at Poor’s downgraded the US government’s AAA credit outlook
to negative as a consequence of continuously growing budget
more normal levels deficits, but equity markets were only marginally affected by
this announcement − perhaps because by means of economic
Since we published the last Investment Outlook (February growth, the US has greater potential to resolve its debt prob-
2011), global equity markets have been affected by unusual, lems than its European counterparts.
unexpected events as well as risks. Some of these risks will
persist for years to come (for example the European/US debt Although the crisis in parts of Europe, especially the so-called
situation), while others will weaken over time. But since today’s PIGS countries (Portugal, Ireland, Greece and Spain), could
valuations are at or near their 10-year averages, there is room potentially lead to debt restructuring that would impact the
for a further bull market despite short-term turbulence. global stock market, we should not underestimate the ability
of markets to discount such possible changes over time.
Markets taken by surprise
Markets were not prepared for the sudden unrest that hit Upward adjustments in earnings expectations
Tunisia and Egypt early in 2011. Demonstrations then spread First-quarter corporate reports provided global stock exchang-
to other countries in North Africa and the Middle East. In light es with positive surprises. A majority of US, Nordic and other
of these events, markets witnessed sharply rising oil prices. European companies reported results that were above expec-
Equity markets became noticeably more nervous as a direct tations. But while positive figures led to upward adjustments
consequence of escalating unrest. The volatility of the S&P in global earnings expectations, the same is not true of certain
500 index, measured by the VIX index, rose from 15 per cent to major sectors and companies in the Nordic markets. Strong
above 20 per cent. Nordic currencies relative to the USD have muted some of the
expected impacts of good quarterly reports on future earnings
Equity markets were thus already vulnerable when the earth- estimates. European profit expectations have fallen marginally
quake and the subsequent tsunami hit Japan on March 11 this during the past three months.
year. Fears of an imminent nuclear power plant disaster drove
equity markets to 2011 lows. The MSCI World Index fell more Most equity markets have moved sideways in the past three
than 6 per cent during four trading days, and the VIX index months. US stock exchanges have led the way with their posi-
rapidly surged by 10 percentage points to 30 per cent. tive performance, while the biggest laggards have been Japan
(understandably), Brazil and India. At this writing, the VIX
The Japanese stock market was naturally the most strongly index is at around 15 per cent, indicating that global equity
affected, plunging by 18 per cent during the same period. investors are quite comfortable with their current exposure.
Japan represents 9 per cent of the world economy but imports
account for only 10 per cent of its GDP. Japanese imports thus Sector-wise, so far this year banks and other financial sector
only total 0.9 per cent of global GDP. Equity markets quickly companies have gone from being the shining star (+15 per
concluded that a short-term reversal in Japanese growth will cent during first two months of 2011) to levelling out, while

Equities
the travel and leisure sector has continued to struggle in the Looking at equities as an asset class, we find valuations to be
light of unrest in North Africa and the Middle East as well as of vital importance. During the past 12 months, equity markets
rising fuel costs, a direct consequence of higher oil prices. In have risen in response to increased earnings, while pricing
recent months, health care − historically a defensive sector − multiples have remained flat. In a scenario where inflation
has emerged as the winner on a year-to-date basis, indicating is contained and markets are seeing only a moderate rise in
more cautious investor sentiment. long-term bond yields, we would argue that there is ample
room for expansion in the world of equities. Our models show
Increased global risk appetite that most global equity markets are priced at or around their
Looking ahead, our fundamental view of the global stock average for the past 10 years. Looking at both Price/Earnings,
market is that risk appetite will keep increasing and that the Price/Book and expected Return on Equity (ROE) for various
bull market will continue. It is true that expectations regard- markets, we find that although several equity indices are only
ing short-term global growth seem to be levelling out, and 10-15 per cent away from their pre-financial crisis levels, their
we might even see some downward revisions due to softer relative valuations are much lower this time around.
macroeconomic signals. We will also witness gradually less
supportive fiscal and monetary conditions (the end of QE2). Potential gains vs. risk
However, we believe that most of these challenges are well Valuations are always a consequence of the balance between
known and some of a temporary nature, while valuations will potential for further gains and implicit risks. Over the past 12
continue to support equities as an asset class. By way of com- months we have seen markets take on 1) the European/US
parison, between 2004 and 2006 global equity indices rose debt crisis, 2) increasing inflation fears, 3) increasing currency
despite falling purchasing managers’ indices in the US and flat volatility, 4) political unrest in North Africa and the Middle
ones in China. It is the absolute level rather than the short- East, 5) the disaster in Japan and 6) sharply rising commodity
term trend of these macroeconomic indicators that reveals prices. Yet most stock markets are up between 10-20 per cent
investor demand for equities. during this period.
45 1 800
50 3 000
40 1 600 45
35 1 400 40 2 500
US
30 1 200 35
China 2 000
25 1 000 30
25 1 500
20 800
20
15 600
15 1 000
10 400 10 500
5 200 5
0 0 0 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010
Next 12m P/E Next 12m P/B Next 12m RoE Price Next 12m P/E Next 12m P/B Next 12m RoE Price
30 500 40 20 000
450 35 18 000
25
europe 400 16 000
30 japan 14 000
350
20
300 25 12 000
15 250 20 10 000
200 15 8 000
10
150 6 000
10
100 4 000
5
50 5 2 000
0 0 0 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Next 12m P/E Next 12m P/B Next 12m RoE Price Next 12m P/E Next 12m P/B Next 12m RoE Price
Source: Factset
VALUATIONS IN DIFFERENT STOCK MARKETS
The various key ratios can be read using the Y-axis on the left, while the Y-axis
to the right is related to the underlying equity index. The Price/Book ratio is
multiplied by 10 to make it compatible with Price/Earnings (absolute figures) and
Return on Equity (figures in per cent).
26 Investment Outlook - june 2011

Equities
Since markets have already priced in high doses of risks during Room for upward valuations
the past 12 months, coupled with a healthy first-quarter 2011 Over the past 12 months, financial markets have discounted
reporting season, we believe there is room for a further bull multiple risk factors. We maintain that there is room for major
market in global equities. upward valuations from present levels as some of the risks
assume a more subdued nature. We continue to believe that
The US equity market is showing short-term strength, having the economic expansion will result in continued support for
reached new highs this spring. Stock exchanges in Europe equities as an asset class, mostly based on sound valuations.
including the Nordics are trading at or around their previous We thus expect to see further strengthening in stock markets
highs from this upturn cycle. Most emerging markets (led by during the coming 3-6 months.
the BRICs) are showing short-term weakness, trading below
both short- and long-term averages.
Below we have aggregated our valuation models into a simple

matrix. Using the colours in a traditional traffic light, positive
factors are indicated by green, neutral by yellow and nega-
tive by red. As shown in the matrix, current valuations are in
a positive to neutral range. Estimate revisions in the US have
trended upwards this spring, while European estimates are
marginally down. The Nordics have seen small changes to
running earnings estimates, while Japan has of course expe-
rienced large downward revisions due to the effects of the
March 11 disaster.
country P/E ABSOLUTe P/E compared to P/b compared roe compared to earnings esti- technical
/REGION history to history history mate revisions analysis
US
Europe
Japan
China
India
Brazil
Russia
Sweden
Denmark
Norway
Investment Outlook - june 2011 27

Fixed income
High Yield and EM Debt remain best choices

• Modestly rising OECD key interest rates and attached the greatest importance to the latter arguments and
sovereign bond yields thus began its rate hiking cycle.
• Gradually less resolute monetary tightening in In recent months, the Bank of England (BoE) has been in a
the EM sphere decision making situation similar to the ECB, but has not yet
raised its key interest rate. More and more members of the
• High Yield and EM Debt still the best fixed BoE’s Monetary Policy Committee are leaning towards a hike,
income investment choices however. The US Federal Reserve (Fed), in contrast, seems to
be in no hurry to begin key rate escalation. This applies even
more to the Bank of Japan (BoJ), which must also take into ac-
Global fixed income perspectives remain highly varied, both count the devastating economic consequences of this spring’s
geographically and with regard to different segments of the natural disaster.
fixed income market. Behind this are such factors as divergent
monetary policy directions, different macroeconomic condi- At the other end of the scale are central banks in rapidly grow-
tions and events in the corporate world. ing OECD economies such as Sweden, Norway and Australia,
as well as their colleagues in many parts of the emerging mar-
Many central banks in the OECD industrialised countries kets (EM) sphere, which began interest rate hikes in 2010 in
now find themselves in a somewhat tricky decision-making order to keep inflation in check.
situation. Increased inflation − mainly due to more expensive
commodities − is undermining household purchasing power, The availability of spare production resources in the form of
jeopardising the banks’ chances of meeting their inflation tar- labour and production facilities remains quite large, especially
gets and risking higher inflation expectations. At its monetary in the US, but also in Europe. Inflation expectations have
policy meeting in April, the European Central Bank (ECB) remained modest in spite of everything, and the commodity
DIVERGENT MONETARY POLICIES price upturn has culminated. Against this backdrop, there is no
8 8
reason for OECD central banks to quickly and ruthlessly use
their interest rate weapons.
7 7
6 6
In the EM sphere, mainly in Asia excluding Japan and in Latin
5 5
America, central banks have been ratcheting up their key rates
Per cent
4 4
for more than a year. Some − such as the People’s Bank of
3 3
China (PBOC) − have supplemented higher interest rates with
2 2 measures to curb lending by banks. The reasons for the mon-
1 1 etary policy direction they have chosen have been overheating
0
2000 2002 2004 2006 2008 2010
0 problems in the wake of high economic growth and lack of
spare production capacity, plus a commodity-driven accelera-
UK, bank rate Source: Reuters EcoWin
Euro zone, refi rate
China, one-year lending rate
tion in inflation.
US, federal funds rate
Sweden, repo rate
Lower general price pressure

Due to different cyclical phases and outlooks, the policies of ma-
jor central banks diverge greatly. In most of the EM sphere and These measures now seem to be on their way towards having
in fast-growing OECD countries, key interest rate hikes began the intended effect. The growth rate is slowing. As a conse-
in 2010. The ECB began such hikes in April, while the Bank of quence, underlying inflation − excluding food and energy
England and the Federal Reserve have held back so far. − will probably decline later this year, while falling prices for

Fixed income
agricultural products in particular will ease general price pres- High Yield continues to enjoy advantages
sures. EM central banks could thus gradually begin to slow the Another fixed interest investment alternative that remains at-
pace of their tightening measures during the next six months. tractive is corporate bonds. This applies especially to the High
Government bond yields in the OECD countries rose clearly Yield segment, which in all essential respects has resisted the
last winter and then fell a bit during the spring due to lower market instability of this spring and has thus delivered con-
risk appetite in the wake of the unrest in North Africa and sistently good returns since the beginning of 2011. This asset
the Middle East, the Japanese natural disaster and a series class will continue to benefit from the global economic upturn,
of macroeconomic signals that were weaker than expected. increasingly strong corporate finances and prospects of fine
Today there are many indications that bond yields will again risk appetite, together with investors’ search for high yields.
head upward; central banks are raising their key interest rates American High Yield bonds now offer an average effective
(though modestly), many countries must finance very large return of nearly 7 per cent, compared to about 4.5 per cent
budget deficits and risk appetite is expected to be healthy. for Investment Grade and around 3 per cent for government
Rising yields will be accompanied by negative effects on bond bonds (5-year).
prices, and OECD government bonds are thus not attractive as
fixed income investments. OECD government bond yields − both short- and long-term −
are indeed likely to rise, and the supply of corporate bonds will
Renewed interest in EM investments continue to increase during the coming year. The yield spread
Late in 2010 and early in 2011, global investors sold both EM between corporate and government bonds remains wide,
equities and bonds on a large scale, with falling prices as a however. For example, for B-rated US corporate bonds it is
consequence. The background was mainly profit-taking after about 1.75 percentage points more than in 2005-2006 (before
sharp price increases, overheating risks and monetary tighten- the financial and economic crisis). Meanwhile the percentage
ing. Since then, investor interest has returned and prices have of bankruptcies among High Yield debt-issuing companies
risen. The prospects for EM Debt also appear bright. Yields are is continuing to fall. In the US it was around 3 per cent and in
higher than in the US and Europe, for example. Budget deficits Europe around 2 per cent at the end of March (on a 12-month
and sovereign debt are well below OECD levels. The danger of basis). During the first quarter of 2011, only eight High Yield
inflation is fading, and central bank tightening measures will debt issuers went bankrupt at the global level. According to
gradually become less resolute. Moody’s crystal ball, such bankruptcies around the world will
EM DEBT BEST IN ASSET CLASS have fallen to 1.5 per cent of issuers by December 2011.
300 300
Higher ratings far more common than downgrading
Equities, mature economies
Given a lower and lower percentage of bankruptcies and an
Bonds, US
250 Bonds, EM, local currencies 250 ever-larger positive ratio between the number of US High Yield
Index 2003 = USD 100
companies that have received higher ratings (more than 140

200 200 since January 1) and the number that have been downgraded
(fewer than 80 since January 1), the risks in this portion of the
150 150
fixed income market are falling. The upgrading of companies
100 100
is partly due to a large weighting for the liquidity in corporate
balance sheets. Concurrently, recoveries are likely to be larger
50 50 for investors holding bonds issued by companies that never-
2003 2005 2007 2009 2011 theless go bankrupt.
Source: Bloomberg
Since 2003, EM Debt in local currencies has shown significantly Corporate bonds, first Investment Grade and then High Yield,
better growth in value than both equities in OECD countries and have formed the base of our fixed income portfolios and our
American government bonds. Given our forecast of a cyclical soft fixed income investment recommendations since early 2009.
landing, lower inflation and continued good economic funda- During this period, these portfolios and investments have pro-
mentals in many countries, the outlook for EM Debt appears vided outstanding risk-adjusted returns. As indicated above,
bright. the outlook for the High Yield market also remains bright. As
the cyclical upturn matures and yield spreads narrow, however,
The prospects of stronger EM currencies during the coming the expected return on this asset class will shrink. But it will be
year − partly because central banks are using currency appre- some time before any other interest-bearing alternative can
ciation to lower domestic inflation via cheaper imports − will seriously compete with High Yield.
also make this asset class attractive to many investors domi-
ciled in OECD currency areas.

Hedge funds
Divergent world views good for hedge funds

• Favourable scenario for hedge funds as an will mean to the price of loans, regardless of whether they are
asset class corporate loans or government loans. Fixed Income Relative
Value and Credit Long/Short can benefit from such divergent
• Increased number of mergers and acquisitions views. These strategies can also take advantage of a projected
will benefit several strategies further normalisation of credit markets, meaning that some
loans are perceived as having become expensive. Risk pre-
• Chances for good returns at reasonable risk miums have decreased, new loans may be of poorer quality
again and many observers will shift part of their attention to
With their different strategies, hedge fund managers have the inflation. There will thus probably be an increase in the differ-
potential to generate good returns in virtually all market situ- ences between loans perceived as safer compared to those
ations, but generally speaking they thrive the very most when perceived as carrying higher risk. This is good news for Credit
market assessments of future world developments diverge. Long/Short, for example, which can thus make even greater
They also benefit from the fact that the world is not so static, use of both its long book and short book.
for example when key interest rates vary greatly around the
world. Spreads in other interest rates and yields, as well as One sign of normalisation is that the market is opening up for
in estimates of which way these variables will move, also more corporate mergers and acquisitions. Companies that
provide an excellent breeding ground for many hedge fund have weathered the financial crisis better than others and
strategies. Falling or lower correlations, which we are also have gained strength from a favourable cyclical trend are more
seeing at present, contribute positively to the good hedge aggressive than they have been for years and are beginning to
fund climate. look around for ways of improving their market position. This
may be a matter of merging with another aggressive company,
In an environment where large portions of the emerging mar- buying up a fledgling company that can contribute some good
ket (EM) sphere are fighting inflationary tendencies by hiking qualities, or simply buying up a competitor in order to have
key interest rates, and the developed world is largely retaining the market more to themselves. This may also involve pure
low interest rates, hedge funds have good potential to gener- restructurings or other types of special situations. Overall, this
ate returns. When certain developed market (DM) economies indicates that a Merger Arbitrage or other Event Driven strat-
have performed so well that they have started their interest egy should generate good future returns.
rate hiking phase (for example Australia and Sweden, as well
as the European Central Bank, which has also begun raising its Mergers and acquisitions increasing
refi rate), such potential increases further. This should mean Mergers and acquisitions are likely to continue increasing,
that strategies like Fixed Income Relative Value will be able to which benefits these strategies. It is also relatively easy and
deliver good returns at reasonable risk. These strategies are cheap to borrow capital for investments in the current market
relatively liquid, and it is thus possible to gain access to good climate, thereby enabling hedge funds to take positions and
hedge funds that are traded daily if an investor wants short generate value. The really big opportunities have probably
trading cycles. It is not necessary to move further out on the already passed for hedge funds that focus on problem loans
liquidity curve than monthly trading to invest in good Global and companies, but there are still large enough opportunities
Macro or Fixed Income Relative Value funds. to generate good returns, also at reasonable risk.
At present, Relative Value managers are quite naturally fo- Over the past few years, the rally in the High Yield segment
cusing on the Fed’s expected termination of its quantitative has led to this asset class being valued on the basis of gen-
easing programme (QE2). This is expected to occur shortly, eralisations. Assuming a normalising market and bankruptcy
and there are divergent views in the markets as to what this levels close to zero, the next movement will include the differ-

Hedge funds
ences between better and worse High Yield instruments. This These movements thus have the potential to wipe out a third
will also further improve the potential for Event Driven strate- or more of a year’s returns in as short a period as a week or so.
gies, which will be able to take more constructive positions, This shows the importance of trying to keep track of such rap-
further improving the quality of investment opportunities. id shifts, if not otherwise as an indication of the performance
of other asset classes. We nevertheless currently have a very
Equity Long/Short strategies are usually the easiest to under- positive view of hedge funds as an asset class. Momentum is
stand and identify with. Buy shares you like and short those on the side of hedge funds, and we expect the overall invest-
you don’t like. Rather simple, actually, but this of course re- ment climate to improve even further. As always, quality plays
quires that both the analysis and positioning are correct and an extra large role for hedge funds, but by way of summary,
disciplined. The prevailing market climate should permit ac- the investment climate is good.
ceptable opportunities for this strategy as well, but we advo-
cate some caution with Long Biased hedge funds, since most KEY QUALITATIVE ASPECTS IN CHOOSING HEDGE FUNDS
of the time these are invested in markets up to a high percent- Dow Jones Credit Suisse Hedge Fund Index
150
age of capital. There will be some ups and downs in this type Dow Jones Credit Suisse Managed Futures Index
140
of funds, but less than for ordinary equity funds in general. HFRX Global Hedge Fund Index
130
Momentum is on the side of hedge funds 120

Index
Although we are painting a very favourable scenario for hedge 110
funds, the markets are of course not without some bumps in 100
the road. A normalisation process takes time, and the pattern 90

of movements tends to form plateaus, with large and small 80
Source: Bloomberg
corrections along the way. Throughout the economic recovery, 70
Jan/07
May/07
Sep/07
Jan/08
May/08
Sep/08
Jan/09
May/09
Sep/09
Jan/10
May/10
Sep/10
Jan/11
we have seen hedge funds as a group performing very well in
some months, then losing a lot of value in other months. This
has been repeated, with a correction about every four months.
We believe that we can expect this pattern in the future as
The returns of recent years in the hedge fund field have shown
well. We saw this most recently in the first week of May, when
divergent natures, depending on what strategy investors have
we again experienced a genuine correction, which adversely
chosen, and also depending on whether the index includes a
affected many hedge funds. During the year, many hedge
very large number of hedge funds across a broad spectrum
funds have built up positions based on a weaker USD and ris-
(HFRX) or whether the index has a more qualitative focus
ing oil prices. The market situation changed dramatically when
(DJCS Index). The chart shows the importance of trying to se-
the dollar quickly began to appreciate and oil prices dropped
lect hedge funds based on qualitative aspects. The table below
by around 15 per cent in a short period. Such sharp, rapid
shows what good characteristics CTA/Managed Futures had
movements obviously affect hedge funds, especially those
in the last crisis, but that this strategy has had a more difficult
that build up positions that follow market trends. Such hedge
time since then.
fund strategies as CTA (systematic multi-asset management),
Global Macro and Long Biased Equity L/S took a real beating,
with downturns of around 2.5-4 per cent on index levels for a
week.
Source: Dow Jones Credit Suisse
Index/strategies YTD 2010 2009

(April 2011)
Dow Jones Credit Suisse Core Hedge Fund Index 2.62% 8.10% 13.12%
Convertible Arbitrage 2.56% 11.16% 46.23%
Emerging Markets 3.50% 9.89% 26.86%
SOME HEDGE FUND SUB-STRATEGIES
Event Driven 2.33% 7.15% 20.84%
Fixed Income Arbitrage 2.20% 4.46% 3.25% The table shows the performance of various common
hedge fund strategies after the big 2008 downturn.
Global Macro 1.61% 8.29% 5.81% Figures for 2011 are until the end of April and show
Long/Short Equity 3.47% 6.84% 19.08% good upturns, among other things due to fine figures
CTA/Managed Futures 2.97% 13.80% -12.59% during April itself.

Real estate
Continued normalisation, but with problems

• Rent levels are rising ever faster and vacancies This view coincides with that of a majority of global real estate
are falling analysts.
• Better borrowing opportunities will lead to Clear signs of this improvement are that rent levels are climb-
higher transaction volume ing and vacancies are falling. The chart below shows the
change in rent levels in selected cities during 2010.
• Main risks in China and the United States
Rent increases are also showing signs of accelerating, as the
world economy improves. This trend is very clear in primary
The global economy is continuing to recover from its major
areas, whereas secondary and tertiary areas have not really
crisis, and the real estate market is generally in better health
taken off yet, but they are stable and will improve. Vacancies
today than before. In earlier issues of Investment Outlook, we
are falling as an effect of the better market climate. Combined
have maintained that this normalisation process would occur
with low levels of new construction in the Western world, this
in two phases − first an investor-led phase and then a broader,
will fuel new rent increases and lower vacancy levels in sec-
more economically prosperous phase. This is because econo-
ondary and tertiary areas as well. If the current trend persists,
mies would be gaining momentum, with higher production
this should be evident within a few quarters.
and lower unemployment as contributing positive factors.
The picture is different in emerging market countries. In some
Except for certain portions of the global real estate market,
places, especially China, authorities are choking off access
we believe that the market is now firmly in phase two. Large
to capital in order to keep real estate prices and inflation in
portions of the market may even be normalised, in any case
check. During a recent trip to China, we saw that this has had
properties with good geographic locations. In its Global
an impact. It was evident that many large skyscraper projects
Market Perspectives for the first quarter of 2011, Jones Lang
had been halted in mid-construction. A relatively large num-
Lasalle writes that for the first time since the global financial
bers of skyscrapers were only concrete skeletons, but no work
crisis, downside risks are less than upside risks. They add that
was going on at the moment. The situation is consequently
the global real estate market is the strongest in two years.
different from the Western world, although this was only a
Change in rents
Hong Kong
Singapore
Moscow
Sao Paulo
Shanghai
London
Brussels
San Francisco
Washington DC
Paris
Toronto
Sydney
Mumbai
Chicago
New York
Amsterdam
RENT LEVELS ARE MOVING UPWARD
Tokyo
Frankfurt On the whole, rent levels rose sharply during
Los Angeles Source: Jones Lang Lasalle
Madrid
2010 and are continuing to rise in a growing
Change, per cent
Dubai
number of cities.
-40 -30 -20 -10 0 10 20 30 40

Real estate
small glimpse of reality. Underlying growth in emerging market the system. What is positive is that Chinese authorities have
countries is nevertheless strong, and many real estate projects shown a skilful hand in economic management and have
will undoubtedly be completed. The chart below shows trans- influenced markets in the right direction where there were
action volume, according to Jones Lang Lasalle. previously bubble tendencies. The most probable scenario is
that they will succeed this time around too, but it is a rather
Increased supply of capital delicate balancing act.
This increase in transaction volume has been made possible
partly because banks are healthier and there is a larger supply The next problem remains the American housing market. The
of capital for real estate investors. Better borrowing oppor- commercial real estate market looks better, and the problems
tunities, along with a stronger global economic situation and are mainly in the residential market. The supply of capital is
large numbers of investors who are more optimistic about the crucial, but the healing of the credit market is occurring slowly.
future, have together resulted in higher transaction volume, We have seen positive indications in the labour market over
rising rents and falling vacancies, but also rising property the past few months, with minor reversals here and there, but
prices (or falling return on capital). During the past year, many mainly a decent pace of improvements. This will obviously
real estate investors have seen double-digit increases in value. benefit the housing market. Now we are also waiting for the
One example is the rising value of real estate shares − meas- banks to successfully get rid of a large proportion of their bad
ured as the FTSE EPRA/NAREIT Global Net, which has gained loans. If they can manage thus within the foreseeable future,
about 20 per cent in USD terms this past year. Pure real estate it should be possible to improve the momentum of lending
investments that are not stock exchange listed have risen by activity, at least to some extent. In that case the housing mar-
around 8 per cent. The past year has generally been good for ket − both in terms of prices and rents − should rather quickly
the real estate market. bounce back from today’s low levels.
The problem for us as financial investors is that it is not always Good market climate for real estate
so easy to invest in real estate that combines good returns and Another positive development globally is that a number of
low risk. Either there is an equity risk if properties are traded prestige properties have changed owners during the past
via listed companies or it is often necessary to be invested for year. This strengthens the perception among investors that
many years. Those who want their capital to be liquid have the real estate market is improving. We believe that the posi-
had fewer choices. Large German real estate funds have been tive factors in the real estate market will continue and even
one investment alternative, with German authorities currently improve further. Property investors will increase the intensity
reviewing how they will operate in the future. We will see what of their activity when the credit supply gets better and as the
comes out of this examination. world economy improves. The market climate, especially in the
Western world, is increasingly advantageous to landlords due
What, then, are the risks in the real estate market? China to shrinking vacancies, rising rents and the small number of
again. Market players are once again beginning to talk about new construction projects. Generally speaking, this is a good
bubble tendencies in some parts of China − a problem situation for the real estate market and long-term property
that could have rather severe consequences. Construction investments, but there are some troublesome problems that
projects halted in mid-course (especially apparent in the city need to be avoided.
of Chongqing) could potentially lead to the collapse of con-
struction companies, which would cause further tensions in
100
90
80
70
60
USD billions
50
40 Source: Jones Lang Lasalle
30 GOOD MOMENTUM IN THE REAL ESTATE
20 MARKET
10
0 Better borrowing opportunities together with
stronger global economic conditions have
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
led to higher transaction volume, rising rents

and falling vacancies, but also rising property
Americas EMEA Asia Pacific prices.

Private equity
Economic growth will drive values

• Favourable economic situation for PE Cyclical sensitivity, and thus exposure to corporate profits,
appears to be an advantage in today’s situation. As indicated
• Prospects of rising company values and attractive elsewhere in Investment Outlook, we have a positive fun-
valuations will benefit this asset class damental view of global economic growth during the next
several years and are anticipating growth clearly above the
• Risks consist of weaker economic growth than long-term trend. As explained in earlier issues, this particular
expected and new financial worries phase of the economic cycle is normally the best for PE com-
panies. After the recession, the efforts of these companies
to streamline their portfolio businesses have led to efficient
We are sticking to our generally positive view of the prospects
operations with the potential for high margins. Right now,
for private equity (PE). So far this year, such a bright picture
after the economic upturn has been under way for a while,
has not materialised in the form of significantly rising share
demand is finally gathering steam, providing good chances of
prices, and this might be seen as a disappointment. For ex-
higher sales. The combination of high margins and increased
ample, the SEB Listed Private Equity Fund has gained two
sales means significant potential when it comes to corporate
per cent. Yet we believe this should be viewed as a sign of
profits. This, in turn, will logically lead to rising net asset value
strength. The reason, of course, is that private equity has also
(NAV) in PE companies. We are now also seeing the cyclical
been affected by all the major events this year that have con-
upturn spreading to more sectors. This benefits PE companies,
tributed to a bumpy road for risky assets in general.
which are often active across the entire economy.
In recent months the tragedies in Japan, unrest in the Middle
Good supply of credit
East, the debt crisis in Europe and inflation worries have creat-
As for leveraging, internationally a growing number of PE
ed uncertainty about the general economic trend and have di-
companies are indicating that the supply of credit is good.
minished risk appetite. Meanwhile we have seen many signs of
The corporate bond market has been working smoothly for
health from the corporate world and some from the financial
these companies for some time. What is new is that banks are
markets. Among these signs of health, globally strong quar-
now easing the terms of the covenants related to their lending
terly reports from listed companies are especially noteworthy,
and that they are willing to allow a larger element of leverag-
along with the fact that mergers and acquisitions appear likely
ing in acquisitions of companies. Before the credit crisis, PE
to start up again on a broad front. Meanwhile the funding situ-
companies could borrow around 70 per cent of the purchase
ation is easing more and more for PE companies, and banks
price, which meant providing 30 per cent equity. After a period
are becoming more willing to provide financing.
when a significant higher equity percentage was required,
the percentage is now on the way down, this time towards 40
When analysing an asset class, it is easy to get stuck in techni-
per cent. A lower equity percentage means higher leveraging;
cal factors and to assign great significance to the latest events,
return on equity will be higher if the transaction is successful −
at the expense of key fundamental factors. It is thus important
but risk also increases.
to remember what drives long-term value in private equity:
The world financial situation does not really seem as stable.
• PE is a cyclically sensitive asset class…
The European credit crisis and large US deficits, which will
• …that provides an exposure to corporate profits − with
sooner or later lead to the withdrawal of quantitative easing,
leveraging
are causing justifiable concern. But although public sector
• To perform well, PE needs a stable financial situation
finances are weak in many places, the banking system is
• Given risk, PE needs markets with good risk
becoming more and more stable and well-capitalised. This is
appetite
perhaps the hardest parameter to assess, with the potential

Private equity
to send tremors through the financial system when worries Discount to NAV back at normal levels
mount. It would probably result in greater risk aversion, which It is worth noting that the discount to NAV in the secondaries
is likely to hurt the share prices of PE companies. market − transactions that involve existing PE commitments
− is back at normal levels, around 10 per cent. It means that
Financial uncertainty aside, there are still good reasons to some listed PE companies that have traded at relatively large
believe that risk appetite will be decent in the future. The discounts have been bought out by other PE investors, who
growth-driven phase of the economic and stock market cycle thereby “earn” the larger discount. This trend may continue
is traditionally characterised by good financial stability, with as long as listed companies are traded with larger discounts,
growth driving profits and capital supply. This time around, something that in itself helps support share prices.
uncertainty is admittedly perhaps greater, but this is offset by
low interest rates. On the whole, good risk appetite should be Assuming that our economic scenario holds up, PE invest-
possible, assuming that our economic scenario holds up. ments should be able to provide good returns during the next
couple of years. Growth will drive up the values of portfolio
Strong economic performance and earnings, and probably companies, boosting NAV. However, there will probably be no
good risk appetite, should be more than enough to offset fi- easy profit-taking. The market players that generate the best
nancial uncertainty. We continue to have an optimistic view of returns are those that are successful in creating operational
the external conditions for private equity. added value in portfolio companies.
Merger and acquisition activity is up The profits of listed PE companies are expected to rise by 10
More PE-specific factors also provide a fairly bright picture per cent or a bit more in the next couple of years. PE portfolio
of the situation. Merger and acquisition activity is again fairly companies should be able to deliver at least as much. Add
high, after essentially having been non-existent during the higher financial leverage, and return on assets should prove
credit crisis. During the pre-crisis years 2006-2008, well over very good. Since today’s valuations appear reasonable, or
2,000 transactions took place annually in the global PE uni- even attractive, it seems reasonable to imagine that the share
verse. During 2009, volume fell to around 900 transactions. prices of listed PE companies should be able to rise at least as
Last year it rebounded to 1,500. Company valuations have much as the return figures. We forecast share price potential
approached a normal situation, both as regards PE companies of around 15 per cent annually in the next 1-2 years, an as-
and the businesses they invest in: their portfolio companies. sumption that does not appear aggressive if fundamental
As for the latter, we can note that during the same periods as conditions live up to our forecasts.
above, the earning multiple measured as enterprise value/
earnings before interest, taxes, depreciation, and amortisation PAUSING FOR BREATH AFTER THE RECOVERY
(EV/EBITDA, which works in roughly the same way as a price/ 240
equity ratio) moved from 8.7 down to 7.2 and then up to 8.1 220
(Source: 2010 Preqin Global Private Equity Report). Current 200
valuation levels still look relatively attractive, but it is no longer 180
Index
160
possible to say that the companies are cheap. Valuations are
140
more attractive for small and medium-sized companies, while 120
those in the large cap segment are beginning to look more 100
strained. This is because many “mega cap” funds that started 80 Source: Bloomberg
just before the financial crisis must now invest the remaining 60
2011-04
2010-12
2011-02
2010-08
2010-10
2010-04
2010-06
2009-12
2010-02
2009-04
2009-06
2009-08
2009-10
2008-12
2009-02
portions of the capital they raised.
If portfolio companies appear relatively attractive, the same

is true of listed PE companies as such. During the spring, the LPX50 Listed Private Equity TR
discount to net asset value (NAV) has been comparatively sta-
ble at an average of 20-25 per cent of NAV. This is somewhat After the crash, share prices of listed PE companies rose
more than the historical average level of 10-15 per cent. It may sharply. In recent months, market uncertainty has slowed their
be regarded as justified, given the uncertain financial situa- upturn. It should be viewed as a sign of underlying strength
tion and lower leverage. Over time, there should nevertheless that prices of these companies have held up so well. We expect
be room for some narrowing of these discounts. All else be- the positive trend to resume once economic growth is again
ing equal, this will benefit share prices, but it is not a strong driving market performance, but the upturns will be of a more
enough factor to drive them by itself. normal nature.

Commodities
The commodity boom has hit a wall

• The silver rally has collapsed...
There are a number of factors behind the sharp commodity
• ...and gold may be next in line price increases of the past year. The strong global economic
recovery and expansive growth in Asia have created high
• Oil prices will remain at high levels demand pressure. The US dollar has trended downward in the
past year. Since commodities are traded in dollars, there is a
Since the summer of 2010, we have seen a powerful rally in strong association between the dollar and commodity prices.
commodity prices, but this upturn suffered a major tumble When the dollar weakens, producers demand higher prices for
early in May. Before the correction began, commodities as a their commodities in dollar terms, resulting in rising commod-
whole had climbed by about 40 per cent. All sub-segments ity prices, and vice versa. In addition, supply disruptions such
contributed to the upturn. In less than one year, Brent crude oil as the La Niña weather phenomenon and escalating unrest in
rose from USD 70 per barrel to more than USD 125. The prices North Africa and the Middle East have left their mark on food
of agricultural products also climbed quickly, because the El and oil prices. In addition, there was a large portion of specu-
Niño and La Niña weather phenomena adversely affected lative positions in commodities generally and precious metals
harvests. During the same period, food prices climbed a full in particular.
55 per cent. Despite a slight recent decline, food prices are still
above their previous highs from 2008. Industrial and precious The recent downward correction was mainly due to the un-
metals also experienced sharp price increases, approaching winding of these speculative positions. The decline was largest
40 per cent. for those commodities that had climbed the most in a short
time. During a one-week period, the price of silver fell no less
A CORRECTION IN COMMODITY PRICES than 27 per cent, but oil and other industrial metals also lost
160
substantial value. Increased worries about the world economy
Industrial metals
Precious metals and the reversal of the dollar’s long weakening trend were the
150
Energy factors that triggered the price decline.
140 Food
130 The silver bubble that burst

Index
120 The trend of silver prices more closely resembled the burst-
110 ing of a financial bubble than a healthy correction. During the
100 months before the price slump, silver prices climbed almost
90 Source: Bloomberg, vertically, indicating that investors had lost touch with the real
SEB Commodity Research value of this asset. In addition, silver exposure was a favourite
80
of small investors − reflected, for example, in enormous posi-
Feb/10
Jan/10
Jun/10
Jul/10
Feb/11
Jan/11
May/10
May/11
Okt/10
Aug/10
Apr/10
Nov/10
Apr/11
Dec/10
Sep/10
Mar/10
Mar/11
tions in exchange-traded funds (ETFs). In the end, few inves-

tors had not already taken a position assuming continued
price upturns. Exposure to silver normally occurs in the form of
After a year of rapidly rising prices, commodities lost ground
futures trading. Investors thus do not have to cover the entire
early in May. A stronger US dollar and increased worries about
position with their own capital; instead, about 5-10 per cent
the global economic recovery led investors to choose profit-
is enough. The death blow for the silver rally came when the
taking in their commodity exposures.
leading metals exchange boosted its margin requirement on
silver exposures.

Commodities
Since a larger proportion of the silver price upturn was driven as a chart of silver prices, but gold may also be regarded as
by speculation, it is difficult to know how much value silver having risen too far during too short a period. There is thus a
may lose. However, one rule of thumb in the financial market risk that the “bubble” will burst.
is that investors should avoid trying to catch “falling knives”,
which is a good description of silver prices at present. Cheaper food
According to recent weather forecasts, the La Niña phenom-
THE RISE AND FALL OF SILVER
enon is about to fade, and more normal weather conditions
50 50 can be expected by mid-year. If this proves correct, agricultural
45 45 prices should continue to fall, due to lower weather-related
40 40 risk premiums and prospects of higher agricultural produc-
35 35 tion. Historically, farmers worldwide also usually increase their
USD/Ounce (troy)
30 30 production substantially in response to market price increases.

25 25 The sharp price increases of the past year are also likely to
20 20 lead to profit-taking by investors. Overall, this indicates that
15 15 the price decline may be significant.
10 10
5 5
Somewhat lower oil prices
0 0 Despite the recent price decline, oil is still being traded at
1970 1975 1980 1985 1990 1995 2000 2005 2010
historically high levels. At this writing, Brent crude costs more
than USD 110 per barrel, while West Texas Intermediate is
Early in 2011 there was something of a silver hysteria among
trading at around USD 100 per barrel. The situation in North
small investors, but soaring silver prices abruptly peaked in May
Africa and the Middle East is still tense, and it will probably be
and then fell 27 per cent in one week. Late in the 1970s, silver
some time before calm is restored in this region. Oil prices are
prices underwent a similar exponential rise. If the subsequent
thus likely to remain at high levels for another while. During
correction is as big this time around as it was then, silver still has
the second half of 2011, however, we expect oil prices to fall
some distance to fall.
due to more favourable supply conditions. Today the OPEC
countries also have significantly higher reserve capacity than
Gold has done well, so far in 2008, when such capacity was very small and it was difficult
Despite the sharp decline for silver, gold has more or less re- to meet high demand.
sisted the latest price corrections in the commodity segment.
In earlier issues of Investment Outlook, we have argued that LARGE RISK PREMIUM IN AGRICULTURAL PRICES
gold is also showing bubble tendencies and that there is a risk 170
that the “gold bubble” may burst. Gold prices have climbed 160
more or less without interruption throughout the 21st century. 150

- Grain hoarding
As with all bubbles, there are good arguments that explain the - Floods
140
price upturn. In recent years, gold has been in demand regard- - Political unrest
130
less of the prevailing market climate. Investors have been at-
Index
tracted by gold in periods of worries about deflation, inflation, 120
the survival of the euro, quantitative easing and so on. Since 110
the financial crisis, however, the ongoing currency war that has 100
been the main reason for the increased attractiveness of gold. 90

Source:
Bloomberg, SEB Commodity Research
This precious metal is often viewed as an alternative currency. 80
When countries compete to weaken their respective curren- Jan 2010 Apr 2010 Jun 2010 Oct 2010 Jan 2011 Apr 2011
cies − in an effort to improve their competitiveness − demand
for gold increases. Due to exceptional weather conditions in the wake of El Niño
and La Niña, agricultural prices have skyrocketed. In recent
The disadvantage of gold is that it offers no cash flow to the months, however, they have fallen a bit, and larger price de-
owner, unlike such assets as equities or bonds. This reality has clines can be expected if/when weather conditions normalise.
been a minor worry in recent years, with the G7 countries es-
sentially embracing a zero interest rate policy. As the recovery
progresses, however, key interest rates are now being hiked in
many parts of the world. This risks reducing the attractiveness
of gold. Given our view of the market − including strong global
growth, comparatively high risk appetite and gradually rising
interest rates − there is a risk that gold prices will fall from
today’s peaks. A chart of gold prices does not look as alarming

Currencies
Imbalances and interest rate spreads crucial

• Yuan revaluation will continue “carry trade”, since the investor has a positive net financing
cost, or “carry” on such transactions. The result is downward
• Dollar will strengthen against other G7 pressure on the currencies of countries with low interest rates,
currencies in second half of 2011 whereas currencies in countries with high interest rates appre-
ciate. During periods when the carry trade has been a market
• Krona will keep gaining ground against euro theme, the volatility of the FX market has been low, which is
often synonymous with high risk appetite.
In the past three months, there have been large movements Imbalances leave their mark
in the foreign exchange (FX) market. After a year of constant
In addition to interest rate spreads, global imbalances are
weakening, the US dollar gained a lot of ground during a few
likely to leave their mark on the FX market. Historically, the US
days in early May. Its renewed strength also triggered a sharp
in particular has played the role of the world’s consumer, while
decline in most commodity prices. The euro fell from USD
emerging market (EM) countries − led by China − have been
1.48 to 1.41 and the Swedish krona weakened from SEK 6.00
in charge of production. Over time, this relationship has led to
to 6.38 per USD. This movement was, above all, an effect of
the build-up of enormous imbalances, including Chinese trade
signals from the European Central Bank (ECB) that its mon-
surpluses and US trade deficits.
etary policy would be less contractive than the market had
expected. Interest rate policy is having a major impact, an indi-
Rebalancing the world foreign exchange situation will, above
cation that the FX market is focusing on interest rate spreads
all, require increasingly strong Asian currencies. Here the re-
− a driving force that the last issue of Investment Outlook
lationship between the US dollar and the Chinese yuan (CNY)
predicted would be increasingly influential.
plays a key role. Since the summer of 2010, Chinese authori-
ties have allowed a gradual appreciation of the yuan, which
We believe that taking advantage of interest rate spreads
has gained 5 per cent so far against the dollar. Not only would
will continue to determine much of what happens in the FX
the world economy benefit from an adjustment in global
market. Investors do so by borrowing where interest rates
trade, but continued yuan appreciation is also advantageous
are low and investing where they are high. This is called the
0.50 8.25
0.25 8.00
0.00 7.75
Percentage points
-0.25 7.50
USD/SEK
-0.50 7.25 INTEREST RATE SPREADS DRIVING

-0.75 7.00
EXCHANGE RATES
-1.00 6.75
The krona’s appreciation against the dollar has
-1.25 6.50 kept pace with the widening of the key interest
rate gap between Sweden and the US. Interest
-1.50 6.25
rate spreads and expectations of future tightening
-1.75 6.00
Jan Mar Maj Jul Sep Nov Jan Mar Maj
measures are likely to continue having a major
10 11 impact on exchange rate movements.
Sweden, Spot Rates, USD/SEK, Close Key interest rate spread US/Sweden Source: Reuters EcoWin

Currencies
for China. The country’s ambition is to shift from export-led to sing programme ends in June 2011 and approaching key rate
domestic consumption-led economic growth. In addition, in- hikes start to be priced into the market, we expect the dollar
flation is at uncomfortably high levels. A stronger currency will to regain strength. The debt problems of southern Europe are
cause inflation pressure to ease, since foreign goods will be- among the reasons why we foresee a decline in the EUR/USD
come cheaper for Chinese consumers. We expect the revalua- exchange rate towards 1.35 by late 2012. Since the Bank of
tion of the yuan to continue, with the USD/CNY exchange rate Japan is likely to keep its key interest rate close to zero during
reaching 6.20 at the end of 2011 and 5.85 at the end of 2012. the foreseeable future, we also expect the dollar to appreciate
This implies an overall revaluation of nearly 17 per cent from against the Japanese yen, with the USD/JPY rate moving
the summer of 2010. towards 88 at the end of 2011 and 94 at the end of 2012.
CHINA RATCHETS UP THE VALUE OF THE YUAN During 2011, Sweden continues to stand out as the economy
in Europe that has been running the most smoothly. In order
8.5
to prevent rising inflation, the Riksbank will continue to tigh-
8
ten its monetary policy at a rapid pace. It will raise its key inte-
rest rate at each 2011 monetary policy meeting, reaching 2.75
7.5 per cent at year-end. Next year, too, it will ratchet up the repo
rate, which we expect to stand at 3.75 per cent by the end of
7 2012. Stronger economic growth than in the euro zone and a
wider interest rate spread against the ECB will probably enable
6.5
the krona to continue appreciating against the euro. Our fore-
Source: Bloomberg cast is that it will strengthen to SEK 8.70 per euro at the end of
6
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
2011 and continue appreciating to 8.50 per euro by late 2012.
We foresee a strengthening of the krona towards SEK 6.20
per dollar by late 2011, then a slight weakening as the dollar
USD-CNY X-RATE
regains ground during 2012.
Since the summer of 2008, Chinese authorities have again al-
lowed a gradual appreciation of the yuan. We expect this process Currencies – an important portfolio component
to continue, with the USD/CNY exchange rate reaching 5.85 by Currency movements account for a large proportion of returns
the end of 2012. A stronger CNY is in the interest of both China on foreign equities. For example, the sharp SEK appreciation
and other countries. over the past year has made it difficult for a Swedish inves-
tor to earn a good return on a global share portfolio, while
Like China, most other Asian countries control the value of an American investor has had a significantly easier time.
their currencies to ensure that their exports remain competi- Although US stock exchanges have gained 7 per cent this year,
tive. This occurs by means of interventions in the FX market by measured in SEK their return is close to zero. Given our cur-
the respective central bank. The revaluation of the CNY also rency forecasts, equity and bond investments in Asia are likely
increases upward pressure on these other Asian currencies, to provide a positive contribution to total returns over the next
since it is unlikely that other central banks can resist a market year.
positioned for Asian currency appreciation. Furthermore, there
CONTINUED KRONA APPRECIATION AGAINST THE EURO
is less incentive to keep currencies weak when purchasing
power in China − the most important export market for these 12.0
countries − increases via a stronger CNY. Leading EM countries 11.5
have recently discussed a coordinated revaluation against the 11.0
USD and other OECD currencies. This would accelerate the 10.5
process of addressing global imbalances and would ease infla- 10.0

tion pressures in the EM sphere.
EUR/SEK
9.5
A stronger dollar, but not yet 9.0
The US Federal Reserve (Fed) is the only central bank aside 8.5
from the Bank of Japan that has still not begun to tighten its 8.0
monetary policy. Our assessment is that the Fed will not be- 7.5
gin to raise its key interest rate until 2012. Since the focus of 7.0
02 03 04 05 06 07 08 09 10 11 12
the FX market today is on interest rate spreads, a continued Source: Reuters EcoWin
expansionary monetary policy is likely to keep weighing down Because of continued key interest rate hikes by the Riksbank and
the dollar, which is also pulled down by large US budget and strong Swedish economic growth, the krona will approach SEK
current account deficits. We expect the EUR/USD exchange 8.50 per EUR by late 2012.
rate to climb to 1.48 by mid-2011. As the Fed’s quantitative ea-

ASSET CLASSES SINCE 2000
PERFORMANCE OF DIFFERENT
60
40
20
0
-20
-40
-60
-80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Equities Fixed income Hedge Real estate

Private equity Commodities Currencies
- Return in 2011 is until April 30.

- Historical values are based on the following indices: Equities = MSCI AC World. Fixed income = JP Morgan Global GBI Hedge. Hedge funds = HFRX Global Hedge Fund.
Real estate = SEB PB Real Estate. Private equity = LPX50. Commodities = DJ UBS Commodities TR. Currencies = BarclayHedge Currency Trader.
SEB is a North European financial group serving 400,000 corporate customers and institutions and
more than five million private individuals. One area with strong traditions in the SEB Group is private
banking. From its founding in 1856, SEB offered financial services to wealthy private individuals.
Today the Group has a leading position in Sweden and a strong presence in the other Nordic
countries and elsewhere in Europe.
SEB Private Banking has a broad client base that includes corporate executives, business owners and
private individuals of varying means, each with different levels of interest in economic issues. To SEB,
private banking is all about offering a broad range of high-quality services in the financial field −
tailored to the unique personal needs of each client and backed by the Group’s collective knowledge.
SEB Private Banking has some 350 employees working in Sweden, Denmark, Finland and Norway.
Outside of Sweden, we take care of our clients via offices in Estonia, Geneva, Latvia, Lithuania,
Luxembourg and Singapore as well as a branch in London. On March 31, 2011, our managed
assets totalled SEK 277 billion.
www.sebgroup.com/privatebanking

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Investment

Investment Outlook - JUNE 2011 3

This report was published on May 31, 2011.

Hans Peterson Carl Barnekow

Lars Gunnar Aspman Reine Kase

Rickard Lundquist Daniel Gecer

Victor de Oliveira Cecilia Kohonen

Johan Hagbarth Liza Braaw

4 Investment Outlook - junE 2011

A humble attitude in a moderate growth market

Investment Outlook - junE 2011 5

Expected, 1-2 years

EXPECTED RISK AND RETURN (1-2 YEAR HORIZON,

Hedge funds Commodities

0% Equities Fixed income* Hedge funds Real estate

HISTORICAL RISK AND RETURN HISTORICAL CORRELATION

6 Investment Outlook - junE 2011

WEIGHTS IN MODERN PROTECTION WEIGHTS IN MODERN AGGRESSIVE

Currencies 4.5% Currencies

Previous Current Previous Current

WEIGHTS IN MODERN GROWTH ROLLING 36-MONTH CORRELATIONS VS. MSCI WORLD

THEME: IDENTIFYING RISKS THEME: TOOLS FOR STOCK MARKET CHOICES

17.5 17.5 1600 1600

15.0 15.0 1500 1500

12.5 12.5 1400 1400

7.5 7.5 Phase 1 Phase 2 Phase 3

-2.5 -2.5 900 900

Investment Outlook - junE 2011 7

Steady portfolios in a tumultuous market

8 Investment Outlook - junE 2011

During February, we increased our allocation to private equity

One major reason why Modern Growth has continued its

Investment Outlook - junE 2011 9

10 Investment Outlook - junE 2011

The economic upturn is not in jeopardy

Investment Outlook - junE 2011 11

SOARING DEFICITS NEED TO BE REINED IN Central banks in different policy phases

off for a long time, however.

12 Investment Outlook - junE 2011

In recent months, central banks in the DM countries have

shallower. As a consequence of this, tensions have arisen in 12.5 12.5

investments from DM countries; some have tightened their 0.0 0.0

economic policies in order to slow economic growth. -2.5 -2.5

China, consumer prices

Investment Outlook - junE 2011 13

14 Investment Outlook - junE 2011

17.5 17.5 TREND SHIFT LIKELY FOR GOVERNMENT

Investment Outlook - junE 2011 15

Capital investments in a calmer cyclical phase

16 Investment Outlook - junE 2011

• Risk appetite is stabilising, and volatility is coming down

EARNINGS FORECASTS BY SECTOR HEDGE FUNDS THRIVE IN A STABLE ENVIRONMENT

Investment Outlook - junE 2011 17

5.0% GROWTH VS. VALUATION

18 Investment Outlook - junE 2011

New factors and new favourites

Phase 1 Phase 2 Phase 3

1100 1100 BULL MARKET DURING PART OF THE 2000s

Investment Outlook - junE 2011 19

OUR ASSESSMENT MODEL FOR COUNTRIES/GROUPS OF COUNTRIES

20 Investment Outlook - junE 2011

2.0% STRONGER GROWTH THAN CONSENSUS

1.5% The US and Germany score well in our model because