Global Economics Equity Valuations 2014 Jun 25 GS

June 25, 2014
Issue No: 14/24

Global Economics Weekly

Economics Research
A global look at equity valuations
Equity returns largely driven by multiples not earnings
Year-to-date, the S&P 500 is up 6%, joining most other global equity
markets in positive territory for the year. Going back to the start of 2013,
global equity markets have made significant gains, led by DM markets.
Returns over this period have been driven, in large part and in most places,
by changes in P/E.
Relative to long-run histories, multiples look elevated
Against this backdrop of significant stock price appreciation, one source of
skepticism that we often encounter is that equity market valuations are
increasingly a constraint. Looking at trailing P/E multiples over long
histories, valuations do look elevated. But assessing macro linkages is
probably a better way to assess how reasonable current multiples are.
Macro background still favourable for elevated multiples
The macro backdrop in most major DM markets suggests that multiples are
not a constraint to further index-level price appreciation, with growth
expected to pick up, inflation moderate and yields at all-time lows in many
places. However, multiples at current levels do suggest that forward
returns may be more muted than in the recent past, as the wringing out of
equity risk premia in the wake of the GFC has progressed.
Since 2013, P/E multiple expansion has propelled global equity markets
Source: Bloomberg, Goldman Sachs Global Investment Research.

Dominic Wilson
(212) 902-5924 dominic.wilson@gs.com
Goldman, Sachs & Co.

Kamakshya Trivedi
+44(20)7051-4005 kamakshya.trivedi@gs.com
Goldman Sachs International

Noah Weisberger
(212) 357-6261 noah.weisberger@gs.com

Aleksandar Timcenko
(212) 357-7628 aleksandar.timcenko@gs.com

Jose Ursua
(212) 357-2234 jose.ursua@gs.com

George Cole
+44(20)7552-3779 george.cole@gs.com
Goldman Sachs International

Julian Richers
(212) 855-0684 julian.richers@gs.com

Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification
and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.
The Goldman Sachs Group, Inc. Global Investment Research
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June 25, 2014 Global Economics Weekly

Goldman Sachs Global Investment Research 2
A global look at equity valuations
Year-to-date, the S&P 500 is up 6%, joining most other global equity markets in positive
territory for the year. Should the index finish the year in the green, it would mark the fourth
year of positive market returns out of the five years since the Great Financial Crisis (GFC),
which, for the US at least, is about on par for most bull market runs in the past 30 years or so.
Although our US Portfolio Strategy team has an end-2014 price target of 1900 a touch
below current levels of around 1950 they see upside over the next 12 months (see Exhibit
1): they expect the S&P to climb to 2000, with further upside beyond that. Outside of the
US, our Strategy teams forecast even greater upside in Europe, Japan and elsewhere in
Asia over the course of this year and into next.
From a trading perspective, we continue to advocate a risk on stance in global equity
markets, as expressed by our slate of current recommendations: as Top Trades, long
positions in the S&P 500 funded out of AUD and long positions in G3 large cap banks, and
tactically, long positions in US consumer cyclicals vs. defensives, implemented via our
Wavefront Consumer Growth Basket.
Moreover, we have argued in several forums that in an environment with excess capacity,
below-target inflation, low real rates, and low economic and market volatility, equities
continue to look attractive relative to other asset classes. However, against the backdrop of
significant stock price appreciation since the GFC, one source of scepticism that we often
encounter is that equity market valuations are increasingly a constraint.
In this weeks Weekly, we put current global market valuations into a historical and
macroeconomic framework to assess and assuage these worries.

Exhibit 1: Our 12-month-ahead equity index price targets point to further market gains

Source: Goldman Sachs Global Investment Research.

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TOPIX DJStoxx600 Asia Pac Ex-Japan S&P 500
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Target Indx. Level:
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Decomposing 2013: Returns driven my multiples not earnings
Going back to the start of 2013, global equity markets have made significant gains, led by
DM markets. Relative to our sample of 30 (MSCI) indices, Japan is the best-performing
market over the past 18 months (up more than 30%), joined by Spain, Denmark and the US.
At the other end of the spectrum, equity indices in Mexico, Thailand, China, Russia and
Brazil are all down over this period.
Returns over this period have been driven, in large part and in most places, by changes in
P/E. Indeed, the correlation between returns over this period and multiple expansion is
about 0.5 overall and even higher for EMs, at about 0.7. Decomposing index price returns
into (percentage) changes in earnings per share (EPS) and (percentage) changes in P/E
multiple further highlights the importance of multiple expansion in understanding recent
equity market performance (see Exhibit 2).
For the US, the 30% move higher in stock price is due to a 25% expansion in the P/E
multiple and about 5% earnings growth. Most DMs have seen both earnings and multiples
expand, while in many EM, joined by Germany and France for example, P/E expansion has
buffered the market from declines in EPS. Japan stands out as one of the only major
markets that saw returns driven fully by EPS expansion (together with Spain) a trend we
expect to continue, with a still above consensus view for further EPS growth in 2014 and
beyond.
Even among EM laggards, P/E moves have been important, although sometimes in the
opposite direction, with multiple contractions in China and Russia contributing to index
declines.
We dont need no valuation; we dont need no false control
This decomposition of returns leads naturally to the following question. In the wake of the
significant market appreciation that was driven in large part by P/E expansion, are
multiples currently stretched?
The simplest way to address this question is to look at current multiples relative to each
countrys own past history. This allows us to compare across countries on equal footing,
which is particularly important here given (a) how different average multiples are across
countries and (b) how volatile they can be across time.
Exhibit 2: Since 2013, P/E multiple expansion has propelled global equity markets

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Looking at trailing P/E multiples for 30 countries from 1995 to today (which is the longest
consistent sample for the largest set of counties that tend to monitor), we find that even
after the dramatic multiple expansion seen over the past 18 months, the vast majority of
countries still have multiples well within normal ranges, say between the 75th and 25th
percentile. Two caveats are in order:
First, looking at market prices relative to trailing earnings can tend to overstate
P/Es when earnings are cyclically depressed and understate them when earnings
are at cyclical peaks. Cyclically adjusted P/Es (CAPE, calculated as price relative to
a long-run average of earnings), still look middling. CAPEs are more moderate in
Europe where earnings have yet to rebound relative to pre-crisis levels as they
have elsewhere like the US.
Second, and most critically, this is a sample that includes a period of very high DM
multiples during the run-up to the 2000 equity market correction. Looking at
percentile rankings over a 20-year window is likely to be unrepresentative of more
reasonable P/E outcomes.
To address this last concern, we look at much longer histories on a country-by-country
basis. The drawbacks are that we lose most EMs and that the time horizons on which
percentile rankings are now based are not all the same across the countries that remain in
the sample. The US and UK have the longest histories, dating back to 1871 and 1927
respectively, with data back to the 1950s for a handful of other DMs. Relative to these
longer histories, multiples are more clearly high. Relative to the very long US and UK
histories, current multiples rank around the 80th percentile for both, with rankings for other
DM market a bit lower (see Exhibit 3).
But just as the shorter sample can be misleading, so can the longer sample: markets
display very low multiples for several decades at the early part of the sample, with trend
breaks in the 1990s and higher average multiples in the decades since. Just as
comparisons to bubble-era multiples may be too optimistic, comparisons to long-run
multiples when monetary policy credibility was in question, inflation and rates were
much higher and subsequent equity returns, ex post, indicate the market was undervalued
are likely to be pessimistic, with a reasonable assessment of the appropriateness of
current levels requiring a look beyond just a past history.

Exhibit 3: Long-run histories show different story, suggesting multiples are elevated

Source: Global Financial Data, Goldman Sachs Global Investment Research.
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'56 '77 '72 '81 '69 '72 '69 '83 '69 '81 '69 '56 '69 '71 '69 '27 '75 1871 '74 '69 '69 '60 '79

Exhibit 4: Lower US 10-year yields are associated with
lower equity yields (and higher P/Es)

Exhibit 5: although the correlation is far from stable



What is likely up ahead for P/Es
An assessment of the reasonableness of current P/E ratios ought to take into consideration,
not just past histories, but also the context of those histories. And, as we have written
about in the past, looking at P/Es, the inverse of the equity earnings yield, in the context of
yields in other asset markets is a reasonable start.
For the US, earnings yields and nominal 10-year yields have tended to co-move in the past,
although that relationship has shifted over time (see Exhibits 4 and 5). But even so, the rate
environment seems to be an important element for evaluating P/E regimes.
Looking more broadly at the links between sovereign (10-year nominal) yields and P/Es (the
inverse of earnings yield), using the longest window of rates data available for each
country, Exhibit 6 shows that nominal interest rates are quite low in most countries and at
all-time lows in many, particularly in Europe, as we have discussed in more detail
previously (Global Economics Weekly 14/19, Long-term yields: A crawl-back more than a
snap-up, May 2014).
Indeed, the current levels of yields and the current level of P/Es are moderately negatively
correlated across this set of countries, with a coefficient of 0.52 when Japan is excluded
from the sample (see Exhibit 7). Scaling for a countrys own past history and looking at the
correlation of P/E percentile rank and yield percentile rank, however, shows little
relationship (see Exhibit 8). In percentile terms, yields are at all-time lows, though P/Es are
not, suggesting that equity risk can still be wrung out. So, in this context, it is possible to
argue that P/Es suggest that equity risk premia remain too high relative to local bond
markets, and either further wringing out of equity risk or a rerating of bond risk could be
ahead.
The fact that so many countries are experiencing interest rates at new lows does suggest
that historical comparisons that do not try to account for this factor and the underlying
drivers of this current state of play may not be the best guides. But, at the same time, it
suggests that further compression in yield, and expansion in P/Es, would be quite rare by
historical standards.

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Correlation (10yr yield and P/E US)

Exhibit 6: Nominal 10-year yields are at historical lows in many countries

Low rates, improving growth and output gaps support multiples
Putting some of these relationships into a more formal statistical model helps to
underscore the importance of macro factors. We employ a panel data framework that
allows us to control for country-specific differences and we look at the relationship
between P/E quintile (so as to further control for differences in risk preference across
countries) and key elements of the macroeconomic landscape.
We find robust evidence that (1) higher real GDP growth, (2) higher real GDP growth when
output gaps are negative (i.e., there is slack in the economy), (3) lower inflation and (4)
lower interest rates all tend to push P/Es higher. When adding controls for crises, wars, etc.,
this model has a modest R-squared of around 0.17.

Exhibit 7: Currently, lower yields seem to be related to
higher P/Es.

Exhibit 8: but in percentile terms, yields are lower still,
suggesting equity risk can still be wrung out

Source: Global Financial Data, Goldman Sachs Global Investment Research

Source: Global Financial Data, Goldman Sachs Global Investment Research

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Exhibit 9: Stronger growth, more moderate inflation and lower rates all tend to be
associated with higher multiples

To illustrate the effects we estimate, we evaluate this model at the median levels of growth,
inflation and rates as a baseline, which yields a P/E percentile ranking of about 55, and then
shock each macro variable to show the marginal impact of changing the macro landscape
(see Exhibit 9). In this exercise: an incremental 100bp of real GDP growth pushes the P/E up
by 2 or so percentile points, a 100bp move lower in inflation moves percentile rankings by
about 4 percentile points and a 100bp move lower in 10-year yields moves rankings a point
or so. Using this macro framework, we find that P/Es ought to be somewhat higher than
the median in many countries, although extreme readings such as that of the US look a bit
high based on this framework.
P/E extremes matter more than the vast middle
We now turn to the implications of current P/E reading on expected future returns. Many
academics and practitioners have documented the negative linear relationship between P/E
multiples and long-run forward returns on a country-by-country basis.
Here, we examine the impact of P/Es on one- and two-year forward total equity returns for
a panel of 19 DM countries for which we have reasonably long histories. The panel
structure of this dataset allows us to estimate the impact of a change in multiple on
forward expected returns, while controlling for systematic differences across countries.
In this cross-country framework, we also find that current P/Es have a negative relationship
with forward total returns, although the impact is at best marginally statistically significant
(although it is more clearly present when looking at some individual country experiences).
Using the same panel data structure, controlling for country-specific effects, we find a
much stronger relationship when looking at P/E quintiles and forward index returns (the
same is true for decile and percentile rankings, but we focus on the smaller set of results
here). P/E rankings are calculated relative to each countrys own past history. These
rankings allow for greater comparability across countries and also help to trim the
influence of extremely high and extremely low P/E readings in this fairly noisy cross-
country dataset.
53.0
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Median exp 100bp higher
GDP pc growth
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10y yield
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Incremental impact
Estimated P/E percentile

Exhibit 10: Declining relationship between P/Es and
forward returns in continuous variable models
Estimated (annualized) forward return by P/E quintile variable
(panels; N=19, hist. samples)

Exhibit 11: And also in discrete variable models, but
mostly in the extremes
Estimated (annualized) forward return by P/E quintile dummy
(panels; N=19, hist. samples)



By imposing a consistent scaling on P/Es, we relate forward earnings to P/E quintiles and
find that forward expected returns are lower when P/E quintiles are higher (see Exhibit 10),
all relative to a countrys own average. When P/Es fall in their lowest quintile, forward
returns average 11-12% annualised, while forward returns average 6-7% when P/Es fall in
their highest quintile. Note that in this model we impose the restriction that as P/Es move
from quintile rank to quintile rank, expected returns fall by the same amount.
However, we can relax this constraint by regressing forward returns on each quintile
separately and ask what expected forward returns would be quintile by quintile. This non-
linear specification yields some interesting results. We find that expected forward returns
are highest and significantly different from the average when P/Es are lowest, in Quintile 1
(see Exhibit 11). Expected returns in Quintiles 2, 3, and 4 are sharply lower than Quintile 1,
but not significantly different from average, and not all that different from each other. In
Quintile 5, when P/Es are highest, expected returns are sharply lower again, and
statistically below average. Hence, the decline in expected earnings is not linear as P/Es
rise; the strongest signal for forward returns comes from extremes of the distribution, and
not the vast middle.
Macro backdrop still a favourable one for elevated multiples
To summarise, we find that:
2013 market returns were largely driven by multiple expansions in DMs and by
contraction is some EMs.
Relative to the last 20 years most multiples are moderate, China is the exception at
one end of the spectrum, with a very low P/E, and peripheral Europe lies at the
other end of the spectrum, with quite elevated P/E multiples.
Where longer histories are available, mostly for DM markets, multiples look more
elevated. But, just as the shorter sample contains high multiples in the lead-up to
the tech bubble and may be unrepresentative, the longer sample contains periods
of high rates, high inflation and perhaps unrepresentatively low multiples.
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Linking P/Es to key elements of the macro landscape in a quantitative way is one
way to provide further context for current P/E levels. With yields in other asset
markets low, volatility low, expected inflation low and economic constraints
absent, the current macro backdrop seems to support elevated multiples. Indeed,
in their most recent report, our European Strategy Team assesses equity market
valuations in Europe, concluding that while valuations have expanded to around
historical average, there is room for PEs to expand further, particularly given
where bond markets are currently (see Strategy Matters: The multiple maze:
Valuations no headwind to returns, 25 June 2014).
As others have found (see GOAL - Global Strategy Paper No. 3: AsiaPac Valuation:
What works, and when, March 12, 2012 and GOAL Global Strategy Paper No. 8:
Testing European equity valuations, March 22, 2014), we show that multiples do
tend to be negatively related to future returns. The negative relation between
multiples and future returns is driven to some extent by extremes. Higher
multiples suggest below-average future returns and low multiples suggest above-
average future returns.
Taken together, this implies that in most major DM markets, multiples, in and of
themselves, are not a constraint to further index-level price appreciation. Moreover,
obstacles to prevent further multiple expansions do not seem clear or present, particularly
for many DMs: GDP growth is expected to improve, inflation remains well contained,
output gaps are open, and rates are at record lows. However, multiples at current levels do
suggest that forward returns may be more muted than in the recent past, as the wringing
out of equity risk premia in the wake of the GFC has continued to progress. And, from here,
our equity targets, particularly in the US, lean increasingly on earnings growth to propel
markets higher. Some EMs have an even more favourable outlook on this basis, with
depressed multiples pointing to scope for above-average returns in the near term, although
the EM macroeconomic landscape remains challenging in many quarters.

Noah Weisberger and Jos Ursa


Global economic forecasts
Real GDP, %ch yoy

Consumer Prices, %ch yoy

Source: Goldman Sachs Global Investment Research
For India we use WPI not CPI. For a list of the members within groups, please refer to ERWIN.
For our latest Bond, Currency and GSDEER forecasts, please refer to the Goldman Sachs 360 website: (https://360.gs.com/gs/portal/research/econ/econmarkets/).
2014 2015 2016 2017
G3
USA 2.2 3.1 3.0 3.0
Euro area 1.0 1.5 1.7 1.6
Japan 1.5 1.2 1.6 1.5
Advanced Economies
Australia 2.7 2.6 3.7 4.0
Canada 2.5 2.4 2.1 2.0
France 0.7 1.1 1.4 1.8
Germany 2.3 2.1 2.2 1.6
Italy 0.3 1.1 1.2 1.3
New Zealand 3.5 2.4 2.4 2.3
Norway 1.6 2.1 1.7 1.7
Spain 0.9 1.2 1.7 1.7
Sweden 2.5 3.4 2.8 2.7
Switzerland 2.0 2.2 1.9 1.7
UK 3.0 2.7 3.0 3.0
Asia
China 7.3 7.6 7.6 7.4
Hong Kong 3.9 4.4 3.7 4.0
India 5.1 6.3 6.6 6.9
Indonesia 5.3 5.3 6.0 6.0
Malaysia 5.1 5.2 5.0 5.0
Philippines 6.3 6.5 6.3 6.3
Singapore 3.7 4.2 4.0 4.0
South Korea 3.7 3.8 4.0 3.8
Taiwan 3.5 3.9 3.8 3.8
Thailand -0.5 3.8 4.9 5.0
CEEMEA
Czech Republic 2.6 2.4 2.6 2.4
Hungary 2.2 2.0 2.2 1.9
Poland 3.4 3.3 3.5 3.2
Russia 1.0 3.0 4.4 4.4
South Africa 1.8 3.0 3.6 3.5
Turkey 3.5 1.9 5.8 5.0
Latin America
Argentina -0.8 -1.2 2.7 5.1
Brazil 1.1 1.5 2.6 3.7
Chile 3.0 3.5 4.0 4.0
Mexico 3.1 3.8 3.6 3.6
Venezuela -1.3 0.5 1.8 2.7
Regional Aggregates
BRICS 5.5 6.3 6.6 6.7
G7 2.0 2.5 2.5 2.4
EU27 1.5 1.8 2.1 2.0
G20 3.3 3.8 4.1 4.2
Asia ex Japan 6.0 6.6 6.7 6.7
Central and Eastern Europe 3.1 2.9 3.1 2.9
Latin America 1.6 2.3 3.2 3.9
Emerging Markets 4.7 5.4 6.0 6.1
Advanced Economies 2.0 2.5 2.5 2.5
World 3.2 3.8 4.1 4.2
2014 2015 2016 2017
G3
USA 1.8 1.9 2.1 2.2
Euro area 0.6 1.1 1.5 1.8
Japan 2.7 1.6 2.0 1.0
Advanced Economies
Australia 2.4 2.2 2.8 2.4
Canada 1.5 1.8 2.0 2.0
France 0.6 0.9 1.2 1.3
Germany 0.9 1.7 2.5 2.8
Italy 0.4 0.7 1.2 1.4
New Zealand 1.5 1.9 2.2 2.2
Norway 1.9 1.8 1.9 2.0
Spain 0.1 0.8 0.9 1.0
Sweden 0.0 1.4 2.3 2.3
Switzerland 0.3 1.3 1.6 1.9
UK 1.7 1.7 1.8 1.8
Asia
China 2.6 3.0 3.0 3.0
Hong Kong 4.3 3.8 3.2 3.2
India 6.1 6.1 5.8 5.2
Indonesia 6.4 6.7 5.5 5.5
Malaysia 3.1 2.6 2.5 2.5
Philippines 3.8 3.5 3.5 3.5
Singapore 2.4 3.5 3.2 2.8
South Korea 1.8 2.6 2.7 2.3
Taiwan 1.4 1.8 1.8 1.7
Thailand 2.2 2.7 3.0 3.0
CEEMEA
Czech Republic 0.6 1.6 1.9 1.9
Hungary 0.1 2.8 3.1 3.1
Poland 0.4 1.8 2.4 2.2
Russia 6.5 4.6 3.9 3.7
South Africa 6.3 6.1 6.0 5.4
Turkey 8.8 7.6 7.4 6.2
Latin America
Argentina 23.8 28.9 20.8 15.2
Brazil 6.5 6.2 6.1 5.4
Chile 4.2 2.9 3.0 3.0
Mexico 4.0 3.5 3.2 3.0
Venezuela 61.0 51.3 28.3 20.8
Regional Aggregates
BRICS 4.2 4.2 4.0 3.8
G7 1.6 1.7 2.0 2.0
EU27 0.7 1.3 1.7 1.9
G20 3.1 3.2 3.1 2.9
Asia ex Japan 3.5 3.8 3.6 3.5
Central and Eastern Europe 0.4 1.9 2.4 2.3
Latin America 13.2 11.5 8.1 6.4
Emerging Markets 6.2 5.8 4.9 4.4
Advanced Economies 1.5 1.7 2.0 2.0
World 3.6 3.5 3.3 3.1

Global macro and markets charts
PMI-implied global growth

GLI momentum vs. global industrial production*

See Global Economics Weekly 12/18 for methodology
Source: OECD, Goldman Sachs Global Investment Research

* Includes OECD countries plus BRICs, Indonesia and South Africa
See Global Economics Paper 199 for methodology
GLI Swirlogram

China, Europe and US risk factors

See Global Economics Paper 214 for methodology

-8
-6
-4
-2
0
2
4
6
8
03 04 05 06 07 08 09 10 11 12 13 14 15
% qoq
annl
Global PMI Model-
Implied Growth
Global Actual
Sequential Growth
GS Forecast
-4
-3
-2
-1
0
1
2
00 01 02 03 04 05 06 07 08 09 10 11 13 14
%mom
GLI Momentum
Global Industrial Production*, 3mma
-0.08%
-0.06%
-0.04%
-0.02%
0.00%
0.02%
0.04%
0.06%
0.08%
-0.1% 0.0% 0.1% 0.2% 0.3% 0.4% 0.5%
GLI Growth
G
L
I

A
c
c
e
l
e
r
a
t
i
o
n
Expansion Recovery
Contraction Slowdown
May-14
Jun-14
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
75
80
85
90
95
100
105
110
Jan-13 May-13 Sep-13 Jan-14 May-14
Index
Europe Risk
China Risk
US Risks

US equity risk premium

US equity credit premium


1.7
2.1
2.5
2.9
3.3
3.7
4.1
4.5
4.9
5.3
5.7
6.1
6.5
04 05 06 07 08 09 10 11 12 13 14
%
US ERP, calculated daily
US ERP, 200 Day Moving Average
-3
-2
-1
0
1
2
3
4
5
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
%
1985-1998
average
2 standard deviations
band
Credit
relatively
expensive

The world in a nutshell
THE GLOBAL ECONOMY
OUTLOOK KEY ISSUES
UNITED STATES We expect annual growth to accelerate to 2.2% in 2014
after 1.9% in 2013. Growth should then remain above
trend in 2015 and 2016, at 3.1% and 3.0% respectively. On
an annualised sequential basis, we expect growth to
accelerate towards 3.4% in Q2 and 3.3% for the rest of the
year after that.
We expect the US to lead the reacceleration in global
growth in 2014. The rationale is a sharp reduction in fiscal
drag, which should allow the continued recovery in
underlying private-sector spending to translate into a
stronger growth picture. In particular, we expect positive
impulses from personal consumption and business fixed
investment to add significantly to growth in 2014.
JAPAN We expect real GDP growth of 1.5% in 2014 and 1.2% in
2015. On a sequential basis, we expect volatile growth
over the coming quarters as forthcoming consumption tax
hikes in 2014 and 2015 will affect personal consumption
expenditures. We expect positive private demand
dynamics to continue but worry about increased fiscal
drag.
Structurally, Japan is poised to reach above-trend growth
rates in step with an improvement in the global economy.
The new leadership at the BoJ has led to a regime shift in
Japanese monetary policy, with much more aggressive,
Fed-style easing capabilities. While this potentially offers
a way out of more than a decade of deflation, reaching
the 2% inflation target remains a tall order.
EUROPE For the Euro area as a whole, we expect a return to
positive growth of 1.0% in 2014, followed by 1.5% in 2015.
The growth outlook at the country level looks friendlier
than in 2013 but it still shows a divergent trajectory, with
growth in Italy, Spain and France around or less than 1%
and in Germany at 2.3%. At the same time, private-sector
headwinds remain as banking lending standards have
continued to tighten.
We expect the Euro area to continue pulling out of
recession, driven by modest improvements across all
major components of domestic demand. Still, the list of
necessary adjustments in the periphery remains long,
ranging from cleaning up the banking system and labour
market reform to increasing competitiveness.
NON-JAPAN ASIA For Asia ex-Japan, we expect growth of 6.0% and 6.6% in
2014 and 2015, respectively. We expect the economies in
the region to benefit from the stronger DM recovery in
2014, but with significant differentiation across countries.
In China, we expect real GDP growth of 7.3% in 2014, and
7.6% in 2015. Although growth is slightly below trend, the
recent tightening in financial conditions sends the signal
that policymakers are willing to tolerate somewhat lower
growth in order to tackle structural problems and foster
more sustainable medium-term growth.
LATIN AMERICA We forecast that real GDP growth in Latin America will be
1.6% in 2014 and 2.3% in 2015. Against a more favourable
global backdrop, the divergence between those economies
with more challenging (Brazil) and more stable (Mexico)
policy outlooks is likely to increase.
In Brazil, we expect real GDP growth of 1.1% in 2014 and
1.5% in 2015. Despite two consecutive years of sub-par
growth, inflation has been sticky above the inflation target
of 4.5%. BRL weakness will likely force the Copom to
continue to hike policy rates.
CENTRAL &
EASTERN EUROPE,
MIDDLE EAST AND
AFRICA
With growth across the region forecast at 2.6% in 2014 and
3.0% in 2015, we expect CEEMEA to continue to recover.
Helped by improvements in external demand conditions,
large output gaps provide fertile ground for recovery from
the 2012 soft patch, although current account deficit
countries in particular will continue to face stiff challenges.
The EM differentiation theme is again visible across the
region. While we forecast strong and steady growth in
Israel and Russia, we see a similar recovery in Turkey as
less sustainable. Growth in South Africa and Ukraine will
likely be dragged down by idiosyncratic political and
economic risks.

CENTRAL BANK WATCH
CURRENT SITUATION
NEXT
MEETINGS
EXPECTATION
UNITED STATES:
FOMC
The Fed funds rate is at 0%-0.25%. The Fed
initiated a new round of asset purchases and
extended its rate guidance on September 13, 2012.
July 30
Sept. 17
We expect the Fed to keep the funds rate near 0%
through 2015, and to continue asset purchases until
3Q2014, albeit at a reduced pace.
JAPAN: BoJ
Monetary Policy
Board
The overnight call rate is at 0%-0.1%. The BoJ
significantly extended asset purchases, as well as
the related maturity horizon, on April 4, 2013.
July 15
August 8
We expect the BoJ to expand its monetary easing
efforts through ongoing asset purchases and to enact
another round of QQE in the second half of 2014.
EURO AREA: ECB
Governing Council
The refi/depo rates are at 0.15%/-0.10%. The ECB
announced the OMT programme for conditional
purchases of Euro area bonds in Sept. 2012 and cut
the refi/depo rates by 10bp on June 5, 2014.
July 3
August 7
We expect the ECB to keep the main policy rates at
current levels until the beginning of 2016.
UK: BoE Monetary
Policy Committee
The BoE policy rate is currently at 0.5%. The BoE
announced threshold-based forward guidance for
the path of the policy rate on August 7, 2013.
July 10
August 7
We expect the BoE to keep the policy rate unchanged
until mid-2015.


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Disclosure Appendix
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