APRIL 2014

Investment Strategy Insights

Overview
ABOUT THIS REPORT
Once a month investment leaders from our Asset Allocation, Equities and Fixed Income Teams meet to share information, opinions and viewpoints and are joined once a quarter by our Alternative Investments Teams. This cross asset class discussion allows us to learn from differences of opinion.

MICHAEL J. KELLY, CFA Managing Director, Global Head of Asset Allocation

Are we witnessing an inection point in animal spirits, and will this pull forward the peaking of the credit cycle and the onset of Fed tightening?
Animal spirits are awakening in the US, but are heading in the other direction in China. A rise in US animal spirits is expected by the market and, thus, necessary. US corporate balance sheets remain ush with cash, while the capital stock is old, but much of the cash is on the balance sheets of technology companies or remains trapped overseas for tax purposes. Capital intensity has largely been outsourced to China. While these are long secular trends, cycles exist within. Corporate condence is reasonably high and rising, though still not at breakout levels, with the removal of quantitative easing (QE) a lingering uncertainty without precedent. In this sense, just like the passing of 2013s scal cliff, the end of QE might be necessary to release condence in the sustainability of fundamentals without policy support. While the credit up-cycle is close to as good as it gets in the US, China has just begun to experience its rst true credit down-cycle, with several defaults (previously unheard of) occurring in the past few months and many more ahead. This is a necessary step toward opening up the banking system and allowing the market to play a more decisive role. These are the initial steps toward ending Chinas nancial repression, where savers were undercompensated to subsidize the channeling of funds into capital-intensive industries. While policy action is coming to a close in the US, it is on the rise in Europe, Japan and China. With more valuation support overseas, and policy help on its way, we see overseas markets outperforming in 2014.

DIFFERENCES OF OPINION
PineBridge believes that not only do differences of opinion make markets, but they also foreshadow substantial moves ahead as these differences are resolved. As a multi-asset rm with investment professionals in nearly two dozen countries, we have a special platform to elevate and nurture debate across investment teams and regions. Such debate hones in on our internal differences of opinion in an attempt to develop wellrounded views within PineBridge, seeking an edge on other market participants. The objective of our Investment Strategy Insights meeting is that all our teams will contribute to, and benet from, the rms investment strategy ecosystem. The whole shall be greater than the sum of its parts.

Is deation a real risk in Europe and will it nally spur the European Central Bank (ECB) into action in 2014?
ECB President Mario Draghi has already gone as far as one can go with words alone. From astronomical sovereign rates when whatever it takes entered the lexicon, Spains ve-year government bond is now trading a bit less in yield than ve-year US Treasuries. Not only did the Feds QE spill over into emerging markets (EM), surely Europe beneted as well. While Europes improved nancial conditions spurred a modest inection in fundamentals, disination has continued, and bank balance sheets continue to shrink (both the ECBs and European banks). The recent ination point of 0.5% is the result of outright deation in smaller peripheral countries, combined with on-target ination in Germany. With the end of QE creating a void, and Draghis words ratcheting up to the occasion once again, either action lies ahead or the ECBs credibility will be at stake. Odds narrowly favor action.

Investment Views & Risk Dial Score (RDS)

Economy Markus Schomer, Chief Economist RDS = 2.5 RISK DIAL SCORE (RDS)
Investment team views on how portfolios should be positioned for the next six to nine months, with one being bullish and ve being bearish. We raised the RDS to reect the direction of risk in the next six months and increased the probability, in our view, of either our bull or bear case scenario taking over to reect an increase in global macro volatility. An increase in geopolitical risk and the slowdown in China have edged up the downside risks. Meanwhile, the end of the US icy patch and recovery in the eurozone and some fragile ve countries are boosting the bull case.

Rates Amit Agrawal, Senior Portfolio Manager, Government and Ination-Linked Credit

RDS = 3.5

The Treasury market remains in a show me growth, show me ination mindset. With winter distortions now behind us, risk has increased for a Treasury market shakeout similar to what we saw in the May to June 2013 period. The belly of the curve (three to seven years) remains most vulnerable to increased volatility. We see only modest downside to longer-dated bonds. We maintain a 2.75% to 3.25% range for the 10-year Treasury and a 3.25% year-end target. Geopolitical risks and EM volatility continue to support demand for safe assets.

Credit Steven Oh, Head of Global Credit and Fixed Income

RDS = 3.5

In the near term, heightened geopolitical risk has resulted in increase in both bull and bear case tail risks. The Feds internal forecasts appear to predict a potentially higher and earlier rate increase scenario. Credit spreads have generally ignored the potential for Russia-Ukraine tensions spreading into a broader crisis.

Currency (USD Perspective) Anders Faergemann, Senior Portfolio Manager, Emerging Markets Fixed Income

RDS = 2.5

The Feds approach of slowing asset purchases lends medium-term support to the US dollar within the G3, but outright US dollar strength will likely materialize only when the Fed becomes more vocal about rate hikes. Confusion rests over the ECBs direction amid the continued battle between Draghi and Jens Weidmann, president of the Deutsche Bundesbank, but Draghi still sets the overall tone. EM foreign exchange momentum is now more positive following rst quarter challenges and demonstrated impressive resilience in the midst of the Russia/Ukraine standoff.

EM Fixed Income Steve Cook, Senior Portfolio Manager, Emerging Markets Fixed Income

RDS = 3.0

A cautious EM outlook is still warranted due to weaker economic growth in the major EM economies China, Russia and Brazil. Geopolitical tensions appear to be diminishing, yet they may still keep investors on tenterhooks in the second quarter. The markets reaction to Marchs volatility was materially different than in January. Recently, volatility resulted in shifts within EM, whereas previously volatility resulted in overall outows. Tempered issuance further supports the improved technical picture.

Asset Allocation Hani Redha, Portfolio Manager, Asset Allocation

RDS = 2.0

We see desynchronized global expansion over the next nine to 18 months, with developed markets (DM) accelerating while EM decelerates. In equity, we favor a recent underweight in US equity as fundamental improvement is likely to be offset by the end of QE. We continue to favor policy-driven stories, such as Japan and Mexico, and now see an increasing likelihood that Europe will join this list. In xed income we continue to favor bank loans and EM debt while shying away from duration.

Global Equity Graeme Bencke, Portfolio Manager, Global Equities

RDS = 2.5

DMs outlook remains benign low ination, supportive monetary stance and bank de-leveraging coming to an end. US loans are growing again in auto, commercial real estate and commercial and indisutrial (C&I) loans. We also see robust non residential construction in the US and positive trucking surveys. Improved credit creation is likely post the ECBs comprehensive assessment. M&A and buybacks are important themes for 2014. European yields continue to converge.

Global Emerging Markets Equity Catrin Haden, Portfolio Manager, Emerging Markets Europe Equities

RDS = 3.0

Industrial production, exports and consumer condence in EM are not yet in strength territory if generalized. Chinese economic data is not supportive. Earnings revisions for aggregate EM are still negative. However, valuations are historically inexpensive, and outows are not getting worse, with only US $12 million withdrawn from EM equity funds in the week ending 26 March.

Quantitative Research Jonathan DePeri, Quantitative Equities Analyst

RDS = 2.5

Valuation spreads have normalized somewhat in DM and EM, but, globally, beta is still priced cheaply relative to history. Leverage looks cheap for Asia, Europe and Latin America, but expensive for Eastern Europe. Quality, as dened by protability, looks fairly expensive globally, with some exceptions such as the US.

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