Global Investment Outlook

THE GLOBAL
INVESTMENT
OUTLOOK
RBC Investment Strategy Committee
FALL 2015
THE RBC INVESTMENT
STRATEGY COMMITTEE
The RBC Investment Strategy Committee consists From this global forecast, the RBC Investment
of senior investment professionals drawn from Strategy Committee develops specific guidelines
across RBC Global Asset Management. The that can be used to manage portfolios.
Committee regularly receives economic and
These include:
capital markets related input from internal and
external sources. Important guidance is provided the recommended mix of cash, fixed income
by the Committee’s regional advisors (North instruments, and equities
America, Europe, Far East), from the Global the recommended global exposure of fixed
Fixed Income & Currencies Subcommittee and income and equity portfolios
from the global equity sector heads (financials the optimal term structure for fixed income
and healthcare, consumer discretionary and investments
consumer staples, industrials and utilities,
the suggested sector and geographic make-up
energy and materials, telecommunications and
within equity portfolios
technology). From this it builds a detailed global
investment forecast looking one year forward. the preferred exposure to major currencies
The Committee’s view includes an assessment Results of the Committee’s deliberations are
of global fiscal and monetary conditions, published quarterly in The Global Investment
projected economic growth and inflation, as well Outlook.
as the expected course of interest rates, major
currencies, corporate profits and stock prices.
CONTENTS
EXECUTIVE SUMMARY 2 CURRENCY MARKETS 49

The Global Investment Outlook Dagmara Fijalkowski, MBA, CFA – Head, Global Fixed Income
Sarah Riopelle, CFA – V.P. & Senior Portfolio Manager, and Currencies (Toronto and London),
RBC Global Asset Management Inc. Daniel Mitchell, CFA – Portfolio Manager,
Daniel E. Chornous, CFA – Chief Investment Officer, RBC Global Asset Management Inc.
RBC Global Asset Management Inc.
CHINA AND THE SDR 60

ECONOMIC & CAPITAL MARKETS FORECASTS 4 Taylor Self, MBA – Analyst,
RBC Investment Strategy Committee Global Fixed Income and Currencies,
RECOMMENDED ASSET MIX 5

REGIONAL EQUITY MARKET OUTLOOK
RBC Investment Strategy Committee
United States 66
Raymond Mawhinney – Senior V.P. & Senior Portfolio Manager,
CAPITAL MARKETS PERFORMANCE 10 RBC Global Asset Management Inc.
Milos Vukovic, MBA, CFA – Vice President &
Head of Investment Policy, Brad Willock, CFA – V.P. & Senior Portfolio Manager,
RBC Global Asset Management Inc. RBC Global Asset Management Inc.
Canada 68
Stuart Kedwell, CFA – Senior V.P. & Senior Portfolio Manager,
GLOBAL INVESTMENT OUTLOOK 13 RBC Global Asset Management Inc.
Chinese concerns crystallize Europe 70
Eric Lascelles – Chief Economist, Dominic Wallington – Chief Investment Officer,
RBC Global Asset Management Inc. RBC Global Asset Management (UK) Limited
John Richards, CFA – Analyst, Global Equities,
RBC Global Asset Management Inc. Asia 72
Daniel E. Chornous, CFA – Chief Investment Officer, Mayur Nallamala – Head & Senior Portfolio Manager,
RBC Global Asset Management Inc. RBC Investment Management (Asia) Limited
Emerging Markets 74
Christoffer Enemaerke – Analyst,
GLOBAL FIXED INCOME MARKETS 44 RBC Global Asset Management (UK) Limited
Soo Boo Cheah, CFA – Senior Portfolio Manager,
RBC Global Asset Management (UK) Limited
Suzanne Gaynor – V.P. & Senior Portfolio Manager, RBC INVESTMENT STRATEGY COMMITTEE 76
THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 1

EXECUTIVE SUMMARY
Headwinds remain, with China settled back to a simmer. Other

Sarah Riopelle, CFA and oil topping the list European political risks are notable
Vice President & Senior Portfolio Manager but less intense. Financial-market
RBC Global Asset Management Inc. Concern regarding China’s financial
weakness and volatility are naturally
markets and slowing economy
Daniel E. Chornous, CFA concerns at present, though we
contributed to the sudden spike in
Chief Investment Officer expect the first of the two will fade.
market volatility. These concerns are
RBC Global Asset Management Inc. Commodity-oriented risks – revolving
certainly legitimate given that China’s
mostly around resource-exporting
economy generates a startling 33% of
countries and companies – may linger
global economic growth even though
The combination of still- it makes up only 13% of aggregate
given a fundamental supply-demand
mismatch. Lastly, there are a number
sluggish growth and global GDP. However, it is important
of interest-rate and debt-related risks
significant downside risks to keep in mind that the Chinese
that could be triggered.
economy continues to grow at a rate
creates a challenging that would be considered enviable Modest revisions to our
environment for investors. almost anywhere else in the world.
economic forecasts
While the recent stock-market We have long maintained a below-
consensus growth forecast for China, We have nudged our global growth
volatility has attracted the forecasts lower this quarter, with
but do not expect a hard landing.
bulk of the public’s attention, changes to both the developed
Oil prices are also grabbing and emerging-market outlook. This
a wide range of markets
headlines. After a brief revival in nevertheless leaves developed
have actually been involved the early summer, oil prices have economies on track for improved
in the correction. Bond again slumped. This is wonderful growth in 2015 while emerging-
news for some countries, and horrific market growth should be materially
yields declined materially,
for others. The main story remains slower this year. Gazing into 2016,
commodity prices dropped the supply side where production most regions should manage faster
and currency markets have is near an all-time high, forcing growth though we have more
been in flux. These types of market participants to rethink when conviction about this view for the
the global oil market will return to developed world than emerging
corrections tend to be difficult balance. Whereas the consensus was nations. In the developed world,
to anticipate, and it is no easy previously that equilibrium would North American growth prospects
task to distinguish between be restored by early 2016, this now have been reduced, while the
looks to be a 2017 proposition. We European and Japanese outlooks
garden-variety reactions and believe that West Texas oil prices are little changed. All appear on
the onset of a bear market. In can rise moderately from here, but track for growth next year that is no
our view, this episode looks probably not all the way back to worse than 2015, consistent with the
US$60 per barrel in the near term. economic-recovery narrative.
more like a correction than
the beginning of a new bear In addition to China and oil prices, More to go for the dollar rally,
a number of other significant but proceed with caution
market.
headwinds remain, much as they
The U.S. dollar continued to perform
have in various combinations since
very well last quarter, but the
the global financial crisis. Greek
greenback has been in a bull market
sovereign risks spiked higher during
for four years now and we feel
the past quarter, but have since
confident declaring that the “easy
2 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

Executive Summary | Sarah Riopelle, CFA | Daniel E. Chornous, CFA
money” has been made. To be clear, Reserve embarked on a tightening equilibrium, potentially providing an
we’re still bullish on the U.S. dollar cycle, and there has been much focus attractive entry point for investors.
but are more tentative, recognizing on the negative impact that such a With stable earnings and the
that the pace of the gains has been shift could have on the economy and potential for rebounding valuations,
significant and that the currency is the stock market. The prospect of a total-return prospects for equities
no longer undervalued. While the rate hike this month has arguably remain compelling.
U.S. dollar will probably become fallen, but we still expect the Fed to
significantly overvalued before this move sometime this year. When the Taking a longer-term view of equity
cycle ends, the latter stages of a bull Fed does begin the tightening cycle, markets, the rally over the past few
market are more difficult to predict sluggish growth, low inflation and years has pushed stocks above the
and, therefore, to profit from. Of the the remaining slack in the global broad trading range, or secular bear
four major currencies, we think the economy should allow the Fed to market, that existed from the late
pound will continue to hold its own be gradual and transparent in its 1990s through the early years of
against the U.S. dollar, while the program of rate hikes. the current decade, indicating that
Canadian dollar, the euro and the yen we may have shifted into a secular
will continue to suffer. Our views are Continue to look for modest bull market. While secular bear
also informed by Chinese currency- increase in bond yields markets are characterized by weak
market reforms, which are happening rallies and deep corrections, secular
Bond yields have moved in a fairly
much faster than many investors had bull markets typically feature short,
wide range over the past year
expected and carry important short- shallow declines and powerful,
based on highly variable inflation,
and long-term implications. sustained rallies.
economic and central-bank outlooks.
We continue to look for a modest Continue to prefer stocks
Low inflation to persist increase in bond yields over the
over bonds
Global inflation remains very low and coming year given that developed-
is likely to fall even more in the near world economic growth continues The valuation mismatch between
term as the latest wave of oil-price to improve, inflation should begin a stocks and bonds is sufficiently
weakness washes over the economy. gradual rise this fall as commodity large to continue to warrant an
Nevertheless, inflation should prices stabilize, and the Fed still overweight equity position, despite
rebound somewhat over the next year appears likely to raise rates before the risks described above. In fact,
as commodity prices stage a partial the end of the year. Even a modest our analysis shows that returns for
recovery and economic slack shrinks. increase in yields poses a significant stocks could exceed those for fixed-
We have accordingly edged down our risk to bondholders. We expect that income markets across most relevant
2015 inflation forecasts. returns to sovereign bondholders time frames, with bonds producing
will be low, or potentially negative, low or even negative total returns
Policymakers in focus through the quarters ahead. for many quarters ahead. Over the
Global monetary-policy uncertainty past quarter, we increased the equity
has certainly increased as some Equities remain compelling exposure in our recommended
central banks debate raising rates, Stock markets have sold off heavily asset mix by two percentage points,
while the combination of Chinese over the past few weeks, reflecting sourcing the funds from bonds.
complications, greater financial- renewed concerns over global For a balanced, global investor, we
market uncertainty and lower growth. In our view, the long-term recommend an asset mix of 62%
commodity prices could encourage case for stocks remains intact. equities (strategic neutral position:
others to deploy another wave of Equity valuations were broadly fair 55%), and 36% fixed income
monetary stimulus. It has been before the downturn, but the decline (strategic neutral position: 40%),
11 years since the U.S. Federal has pushed equity markets below with the balance in cash.

ECONOMIC & CAPITAL MARKETS FORECASTS
ECONOMIC FORECAST (RBC INVESTMENT STRATEGY COMMITTEE)
UNITED UNITED EMERGING

STATES CANADA EUROPE KINGDOM JAPAN CHINA MARKETS1
Change Change Change Change Change Change Change
from from from from from from from
Fall Summer Fall Summer Fall Summer Fall Summer Fall Summer Fall Summer Fall Summer
2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015
REAL GDP
2014A 2.42% 2.40% 0.88% 2.56% 0.00% 7.41% 5.50%
2015E 2.25% (0.25) 1.00% (0.75) 1.50% N/C 2.50% 0.25 0.75% (0.25) 6.75% 0.25 4.75% (0.25)
2016E 2.50% (0.50) 1.75% (0.25) 2.25% N/C 2.50% N/C 1.75% N/C 6.00% N/C 5.25% N/C
CPI
2014A 1.61% 1.89% 0.43% 1.47% 2.75% 2.00% 4.15%
2015E 0.00% (0.25) 0.75% (0.25) 0.00% (0.25) 0.00% (0.25) 0.50% (0.25) 1.50% N/C 4.00% N/C
2065E 1.75% N/C 2.00% N/C 1.00% N/C 1.75% N/C 1.50% N/C 2.25% (0.25) 3.75% N/C
A = Actual E = Estimate *
GDP Weighted average of China, India, South Korea, Brazil, Mexico and Russia
TARGETS (RBC INVESTMENT STRATEGY COMMITTEE)

FORECAST CHANGE FROM 1-YEAR TOTAL RETURN
AUGUST 2015 AUGUST 2016 SUMMER 2015 ESTIMATE (%)
CURRENCY MARKETS AGAINST USD
CAD (USD–CAD) 1.31 1.40 0.07 (5.3)
EUR (EUR–USD) 1.12 1.00 N/C (11.3)
JPY (USD–JPY) 121.24 133.00 N/C (9.4)
GBP (GBP–USD) 1.53 1.51 0.06 (1.4)
FIXED INCOME MARKETS
U.S. Fed Funds Rate 0.25 1.00 0.13 N/A
U.S. 10-Year Bond 2.20 2.75 0.25 (2.5)
Canada Overnight Rate 0.50 0.50 (0.50) N/A
Canada 10-Year Bond 1.49 1.75 (0.25) (0.8)
Eurozone Policy Rate 0.05 0.05 N/C N/A
Germany 10-Year Bund 0.80 1.00 0.30 (1.1)
U.K. Base Rate 0.50 1.25 0.25 N/A
U.K. 10-Year Gilt 1.96 2.75 0.25 (4.9)
Japan Overnight Call Rate 0.10 0.05 N/C N/A
Japan 10-Year Bond 0.38 0.60 0.10 (1.8)
EQUITY MARKETS
S&P 500 1972 2225 25 15.0
S&P/TSX Composite 13859 15500 (750) 15.0
MSCI Europe 1564 1900 N/C 25.0
FTSE 100 6248 6800 (450) 13.1
Nikkei 18890 22000 500 18.2
MSCI Emerging Markets 819 900 (250) 13.0
Source: RBC GAM

RECOMMENDED ASSET MIX
Asset mix – the allocation within portfolios to stocks, A tactical range of +/- 15% around the benchmark
bonds and cash – should include both strategic and position allows us to raise or lower exposure to specific
tactical elements. Strategic asset mix addresses the blend asset classes with a goal of tilting portfolios toward
of the major asset classes offering the risk/return tradeoff those markets that offer comparatively attractive near-
best suited to an investor’s profile. It can be considered term prospects.
to be the benchmark investment plan that anchors a
portfolio through many business and investment cycles, This tactical recommendation for the Balanced profile can
independent of a near-term view of the prospects for the serve as a guide for movement within the ranges allowed
economy and related expectations for capital markets. for all other profiles. If, for example, the recommended
Tactical asset allocation refers to fine tuning around current equity exposure for the Balanced profile is set at
the strategic setting in an effort to add value by taking 62.5% (i.e.: 7.5% above its benchmark of 55% and part
advantage of shorter term fluctuations in markets. way toward its upper limit of 70% for equities), that would
imply a tactical shift of + 5.02% to 25.02% for the Very
Every individual has differing return expectations and Conservative profile (i.e.: a proportionate adjustment
tolerances for volatility, so there is no “one size fits all” above the benchmark equity setting of 20% within the
strategic asset mix. Based on a 35-year study of historical allowed range of +/- 15%).
returns and the volatility of returns (the range around
the average return within which shorter-term results The value-added of tactical strategies is, of course,
tend to fall), we have developed five broad profiles and dependent on the degree to which the expected
assigned a benchmark strategic asset mix for each. These scenario unfolds.
profiles range from very conservative through balanced to Regular reviews of portfolio weights are essential to the
aggressive growth. It goes without saying that as investors ultimate success of an investment plan as they ensure
accept increasing levels of volatility, and therefore greater current exposures are aligned with levels of long-term
risk that the actual experience will depart from the longer- returns and risk tolerances best suited to individual
term norm, the potential for returns rises. The five profiles investors.
presented below may assist investors in selecting a
strategic asset mix best aligned to their investment goals. Anchoring portfolios with a suitable strategic asset mix,
and placing boundaries defining the allowed range for
Each quarter, the RBC Investment Strategy Committee tactical positioning, imposes discipline that can limit
publishes a recommended asset mix based on our current damage caused by swings in emotion that inevitably
view of the economy and return expectations for the accompany both bull and bear markets.
major asset classes. These weights are further divided
into recommended exposures to the variety of global
fixed income and equity markets. Our recommendation
is targeted at the Balanced profile where the benchmark
setting is 55% equities, 40% fixed income, 5% cash.
1. Average return: The average total return produced by the asset class over the period 1979 – 2014, based on monthly results.
2. Volatility: The standard deviation of returns. Standard deviation is a statistical measure that indicates the range around the average
return within which 2/3 of results will fall into, assuming a normal distribution around the long-term average.

Recommended Asset Mix
GLOBAL ASSET MIX
BENCHMARK PAST FALL NEW YEAR SPRING SUMMER FALL

POLICY RANGE 2014 2015 2015 2015 2015
CASH 2.0% 1% – 16% 1.0% 1.0% 1.0% 2.0% 2.0%
BONDS 43.0% 25% – 54% 40.0% 38.0% 38.0% 38.0% 36.0%
STOCKS 55.0% 36% – 65% 59.0% 61.0% 61.0% 60.0% 62.0%

Note: Effective September 1, 2014, we revised our strategic neutral positions within fixed income, lowering the ‘neutral’ commitment to cash from 5% to
2%, and moving the difference to bonds. This takes advantage of the positive slope of the yield curve which prevails over most time periods, and allows
our fixed income managers to shorten duration and build cash reserves whenever a correction in the bond market, or especially an inverted yield curve,
is anticipated.
REGIONAL ALLOCATION
CWGBI* PAST FALL NEW YEAR SPRING SUMMER FALL

GLOBAL BONDS AUG. 2015 RANGE 2014 2015 2015 2015 2015
North America 37.5% 18%– 40% 32.9% 39.6% 36.4% 36.9% 37.5%
Europe 40.7% 32% – 56% 41.9% 39.0% 40.5% 40.7% 40.7%
Asia 21.8% 20% – 35% 25.2% 21.4% 23.1% 22.4% 21.8%
Note: Based on anticipated 12-month returns in $US hedged basis
MSCI** PAST FALL NEW YEAR SPRING SUMMER FALL

GLOBAL EQUITIES AUG. 2015 RANGE 2014 2015 2015 2015 2015
North America 59.0% 51%– 61% 59.1% 60.5% 59.2% 58.6% 58.2%
Europe 22.3% 21% – 35% 22.3% 20.8% 22.8% 22.4% 22.9%
Asia 11.4% 9% – 18% 11.3% 11.3% 10.5% 11.5% 11.4%
Emerging Markets 7.3% 0% – 8.5% 7.3% 7.5% 7.5% 7.5% 7.5%
Our asset mix is reported as at the end of each quarter. The mix is fluid and may be adjusted within each quarter, although we do not always report
on shifts as they occur. The weights in the table should be considered a snapshot of our asset mix at the date of release of the Global Investment
Outlook.
GLOBAL EQUITY SECTOR ALLOCATION
MSCI** RBC ISC RBC ISC CHANGE FROM WEIGHT VS.

AUG. 2015 SUMMER 2015 FALL 2015 SUMMER 2015 BENCHMARK
Energy 6.67% 7.40% 5.87% (1.53) 88.0%

Materials 4.77% 4.73% 3.77% (0.96) 79.0%
Industrials 10.66% 11.65% 9.66% (1.99) 90.6%
Consumer Discretionary 13.10% 14.80% 15.10% 0.30 115.2%
Consumer Staples 10.08% 7.82% 10.08% 2.26 100.0%
Health Care 13.79% 13.94% 14.80% 0.86 107.3%
Financials 21.15% 20.68% 21.15% 0.47 100.0%
Information Technology 13.25% 15.39% 15.05% (0.34) 113.6%
Telecom. Services 3.42% 2.47% 3.42% 0.95 100.1%
Utilities 3.10% 1.13% 1.10% (0.03) 35.4%
*Citigroup World Global Bond Index **MSCI World Index Source: RBC Investment Strategy Committee

“ At RBC GAM, we have a team dedicated to setting and

reviewing the strategic asset mix for all of our multi-asset solutions. With
an emphasis on consistency of returns, risk management and capital
preservation, we have developed a strategic asset allocation framework for
five client risk profiles that correspond to broad investor objectives and risk
preferences. These five profiles range from Very Conservative through
”
Balanced to Aggressive Growth.
VERY CONSERVATIVE
BENCH- LAST CURRENT
Very Conservative investors will
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION seek income with maximum capital
Cash & Cash Equivalents 2% 0-15% 1.7% 2.0% preservation and the potential for modest
Fixed Income 78% 55-95% 73.8% 72.3% capital growth, and be comfortable with
Total Cash & Fixed Income 80% 65-95% 75.5% 74.3% small fluctuations in the value of their
Canadian Equities 10% 5-20% 11.1% 11.6% investments. This portfolio will invest
U.S. Equities 5% 0-10% 6.1% 6.6% primarily in fixed-income securities, and
International Equities 5% 0-10% 7.3% 7.5% a small amount of equities, to generate
Emerging Markets 0% 0% 0.0% 0.0% income while providing some protection
Total Equities 20% 5-35% 24.5% 25.7%
against inflation. Investors who fit
this profile generally plan to hold their
RETURN VOLATILITY investment for the short to medium term
35-Year Average 9.1% 5.9% (minimum one to five years).
Last 12 Months 4.7% 6.0%

CONSERVATIVE
BENCH- LAST CURRENT
Conservative investors will pursue
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION modest income and capital growth with
2% 0-15%
Cash & Cash Equivalents 1.8% 2.0% reasonable capital preservation, and be
Fixed Income 63% 40-80% 58.4% 56.7% comfortable with moderate fluctuations
Total Cash & Fixed Income 65% 50-80% 60.2% 58.7% in the value of their investments. The
Canadian Equities 15% 5-25% 16.2% 16.8%
portfolio will invest primarily in fixed-
U.S. Equities 10% 0-15% 11.2% 11.8%
income securities, with some equities, to
International Equities 10% 0-15% 12.4% 12.7%
achieve more consistent performance and
Emerging Markets 0% 0% 0.0% 0.0%
provide a reasonable amount of safety.
Total Equities 35% 20-50% 39.8% 41.3%
The profile is suitable for investors who
RETURN VOLATILITY plan to hold their investment over the
35-Year Average 9.3% 7.1% medium to long term (minimum five to
Last 12 Months 5.2% 6.8% seven years).
BALANCED
The Balanced portfolio is appropriate
BENCH- LAST CURRENT
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION for investors seeking balance between
Cash & Cash Equivalents 2% 0-15% 2.0% 2.0% long-term capital growth and capital
Fixed Income 43% 20-60% 38.0% 36.0% preservation, with a secondary focus on
Total Cash & Fixed Income 45% 30-60% 40.0% 38.0% modest income, and who are comfortable
Canadian Equities 19% 10-30% 20.1% 20.8% with moderate fluctuations in the value
U.S. Equities 20% 10-30% 21.1% 21.8% of their investments. More than half the
International Equities 12% 5-25% 14.3% 14.7% portfolio will usually be invested in a
Emerging Markets 4% 0-10% 4.5% 4.7% diversified mix of Canadian, U.S. and
Total Equities 55% 40-70% 60.0% 62.0% global equities. This profile is suitable
RETURN VOLATILITY
for investors who plan to hold their
35-Year Average 9.3% 8.5% investment for the medium to long term
Last 12 Months 5.9% 8.0% (minimum five to seven years).

GROWTH
BENCH- LAST CURRENT
Investors who fit the Growth profile
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION will seek long-term growth over capital
2% 0-15%
Cash & Cash Equivalents 2.0% 2.0% preservation and regular income, and
Fixed Income 28% 5-40% 22.8% 20.3% be comfortable with considerable
Total Cash & Fixed Income 30% 15-45% 24.8% 22.3% fluctuations in the value of their
Canadian Equities 23% 15-35% 24.1% 25.0%
investments. This portfolio primarily
U.S. Equities 25% 15-35% 26.1% 27.0%
holds a diversified mix of Canadian, U.S.
International Equities 16% 10-30% 18.3% 18.9%
and global equities and is suitable for
Emerging Markets 6% 0-12% 6.7% 6.8%
investors who plan to invest for the long
Total Equities 70% 55-85% 75.2% 77.7%
term (minimum seven to
RETURN VOLATILITY ten years).
35-Year Average 9.2% 10.6%
AGGRESSIVE GROWTH
BENCH- LAST CURRENT
Aggressive Growth investors seek
ASSET CLASS MARK RANGE QUARTER RECOMMENDATION maximum long-term growth over capital
2% 0-15%
Cash & Cash Equivalents 1.0% 1.0% preservation and regular income, and are
Fixed Income 0% 0-10% 0.0% 0.0% comfortable with significant fluctuations
Total Cash & Fixed Income 2% 0-20% 1.0% 1.0% in the value of their investments. The
Canadian Equities 32.5% 20-45% 32.4% 32.4% portfolio is almost entirely invested in
U.S. Equities 35.0% 20-50% 34.9% 35.1%
stocks and emphasizes exposure to
International Equities 21.5% 10-35% 22.7% 22.5%
global equities. This investment profile
Emerging Markets 9.0% 0-15% 9.0% 9.0%
is suitable only for investors with a high
Total Equities 98% 80-100% 99.0% 99.0%
risk tolerance and who plan to hold their
RETURN VOLATILITY
investments for the long term (minimum
35-Year Average 9.2% 13.2% seven to ten years).

CAPITAL MARKETS PERFORMANCE
because of the drop in the Canadian was essentially flat for the 12-month
Milos Vukovic, MBA, CFA dollar, while Japanese bonds, as period, while the S&P 600 Index, a
Vice President & Head of Investment Policy measured by the Citigroup gauge of small-cap performance, fell
Japanese Government Bond Index, 5.0% in the three-month period and
gained 2.9%. gained 1.8% over the 12 months.
The Russell 3000 Growth Index fell
The U.S. dollar fell against all major Major equity markets declined 4.7% during the quarter versus the
currencies except for the Canadian during the latest three-month Russell 3000 Value Index, which
dollar between June 1, 2015, and period. The MSCI Europe fell 7.2%, dropped 7.4%. Over the 12 months,
August 31, 2015. The greenback followed by a 7.0% drop in the MSCI the Russell 3000 Growth Index rose
gained 5.8% versus the Canadian Japan, while the S&P 500 Index fell 4.3% and the Russell 3000 Value
dollar, but fell 2.3% against the 5.9%. Within Europe, the MSCI U.K. Index lost 3.6%.
yen, 2.1% versus the euro and lost 9.2% and the MSCI Germany
0.4% versus the pound. Over the fell 7.5%, while the MSCI France All 10 global equity sectors declined
12-month period ended August 31, retreated 5.0%. Over the 12-month during the quarter ended August 31,
2015, the U.S. dollar rose 21.0% period, the S&P 500 increased 0.5%. 2015. The best-performing sector
against the Canadian dollar, 17.1% The MSCI U.K. lost 12.8%, followed was Telecommunication Services
versus the euro and 16.5% against by a 7.3% drop in the MSCI Germany with a loss of 2.9%, followed by
the yen. The greenback climbed and a 7.2% fall in the MSCI France. Consumer Staples with a decline
8.2% versus the British pound. The S&P/TSX Composite Index lost of 3.6%, and Health Care with a
12.1% in U.S. dollar terms during the 4.5% drop. The worst-performing
Fixed-income markets were mixed
three months, versus the 11.2% drop sectors were Materials, which lost
during the three-month period. The
for the large-cap S&P/TSX 60 Index 15.8%; Energy, which lost 15.0%;
Barclays Capital Aggregate Bond
and a 17.0% decline in the S&P/TSX and Industrials, which declined
Index, a broad measure of U.S.
Small Cap Index. The MSCI Emerging 8.1%. Over the 12-month period, the
fixed-income performance, declined
Markets Index fell 17.6% during the best-performing sectors were Health
0.6%. European bonds rose 0.9%
three-month period and dropped Care, Consumer Discretionary and
in U.S. dollar terms as measured by
23.0% over the 12-month period. Consumer Staples, and the worst-
the Citigroup WGBI – Europe Index.
performing were Energy, Materials
The FTSE TMX Canada Universe The S&P 400 Index, a measure of and Utilities.
Bond Index, Canada’s fixed-income the U.S. mid-cap market, declined
benchmark, declined 5.6%, mostly 6.7% in the latest three months and

Capital Markets Performance | Milos Vukovic, MBA, CFA
EXCHANGE RATES
Periods ending August 31, 2015
Current 3 months YTD 1 year 3 years 5 years
USD (%) (%) (%) (%) (%)
USD–CAD 1.3156 5.79 13.24 21.00 10.09 4.31
USD–EUR 0.8911 (2.13) 7.83 17.08 3.88 2.47
USD–GBP 0.6517 (0.40) 1.57 8.18 1.14 (0.01)
USD–JPY 121.2350 (2.32) 1.21 16.52 15.70 7.61
Note: all changes above are expressed in US dollar terms
CANADA
USD CAD
3 months YTD 1 year 3 years 5 years 3 months 1 year 3 years
Fixed Income Markets: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
FTSE TMX Canada Univ. Bond Index (5.61) (9.22) (13.30) (5.79) 0.32 (0.14) 4.91 3.72
U.S.
USD CAD
Citigroup U.S. Government (0.01) 0.89 2.26 0.88 2.33 5.78 23.73 11.06
Barclays Capital Agg. Bond Index (0.55) 0.45 1.56 1.53 2.98 5.21 22.88 11.77
GLOBAL
USD CAD
Citigroup WGBI 0.27 (2.68) (6.01) (1.00) 1.23 6.07 13.73 8.99
Citigroup WGBI – Europe 0.94 (6.16) (10.71) 2.15 2.66 6.79 8.04 12.46
Citigroup Japanese Government 2.86 (1.49) (12.22) (11.59) (5.24) 8.81 6.22 (2.67)
CANADA
USD CAD
Equity Markets: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
S&P/TSX Composite (12.09) (14.76) (24.53) (1.67) 1.71 (7.00) (8.68) 8.25
S&P/TSX 60 (11.24) (14.13) (22.75) (0.72) 1.93 (6.10) (6.52) 9.30
S&P/TSX Small Cap (16.95) (18.73) (37.00) (9.91) (4.34) (12.15) (23.77) (0.82)
U.S.
USD CAD
S&P 500 (5.92) (2.88) 0.48 14.31 15.87 (0.48) 21.58 25.85
S&P 400 (6.70) (1.48) 0.01 15.10 16.14 (1.30) 21.00 26.71
S&P 600 (5.01) (2.07) 1.80 15.25 17.37 0.49 23.18 26.88
Russell 3000 Value (7.44) (6.19) (3.60) 13.74 14.56 (2.08) 16.64 25.22
Russell 3000 Growth (4.72) 0.94 4.30 15.38 17.43 0.80 26.21 27.03
NASDAQ Composite Index (5.79) 0.85 4.28 15.91 17.71 (0.33) 26.18 27.61
Note: all rates of return presented for periods longer than 1 year are annualized Source: Bloomberg/MSCI

Capital Markets Performance | Milos Vukovic, MBA, CFA
GLOBAL
USD CAD
MSCI World* (7.15) (2.44) (4.13) 10.95 11.07 (1.03) 17.59 22.56
MSCI EAFE* (8.11) (0.21) (7.47) 8.53 7.05 (2.06) 13.49 19.90
MSCI Europe* (7.16) (0.56) (8.46) 8.78 7.50 (1.05) 12.28 20.17
MSCI Pacific* (10.10) 0.27 (5.86) 7.95 6.28 (4.17) 15.47 19.25
MSCI UK* (9.19) (3.95) (12.81) 5.35 7.31 (3.21) 6.94 16.38
MSCI France* (5.00) 2.48 (7.17) 9.37 6.49 1.26 13.86 20.83
MSCI Germany* (7.50) (2.90) (7.34) 9.44 8.74 (1.40) 13.65 20.90
MSCI Japan* (6.99) 7.52 4.17 12.41 7.35 (0.86) 27.77 24.18
MSCI Emerging Markets* (17.55) (12.85) (22.95) (2.41) (0.92) (12.12) (5.49) 7.81
GLOBAL EQUITY SECTORS

USD CAD
Sector: Total Return (%) (%) (%) (%) (%) (%) (%) (%)
Energy (15.01) (16.04) (33.39) (4.33) 2.88 (9.41) (18.30) 5.69
Materials (15.84) (11.12) (20.30) (0.96) 0.43 (10.30) (2.24) 9.41
Industrials (8.08) (4.50) (5.58) 11.11 10.94 (2.02) 15.81 22.75
Consumer Discretionary (5.16) 2.45 5.61 17.13 16.89 1.09 29.53 29.39
Consumer Staples (3.60) (0.03) 1.81 9.78 12.46 2.75 24.87 21.27
Health Care (4.53) 6.20 9.88 21.35 19.74 1.76 34.78 34.05
Financials (6.86) (3.45) (4.94) 12.69 8.75 (0.73) 16.60 24.49
Information Technology (7.64) (2.21) 1.05 12.68 14.83 (1.56) 23.95 24.48
Telecommunication Services (2.85) 2.80 (1.07) 8.87 9.50 3.56 21.35 20.27
Utilities (5.55) (7.94) (5.97) 6.63 4.35 0.68 15.33 17.80
* Net of Taxes Note: all rates of return presented for periods longer than 1 year are annualized Source: Bloomberg/MSCI

GLOBAL INVESTMENT OUTLOOK
Chinese concerns crystallize
Eric Lascelles Exhibit 1: Chinese economy continues to slow

Chief Economist
60
Daniel E. Chornous, CFA Expansion
Caixin China General

Manufacturing PMI
Chief Investment Officer 55
John Richards, CFA 50

Analyst, Global Equities
45
Contraction
40
Financial markets shuddered in late
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
August as concerns crystallized Note: PMI refers to Purchasing Managers Index, a measure of economic activities.
around China’s financial markets and Source: Caixin, Markit, Haver Analytics, RBC GAM
faltering economy (Exhibit 1). Risk

appetite naturally receded (Exhibit Exhibit 2: Risk appetite wavering
2), though it remains well above the
depths reached during the financial 2 Loving
crisis.
1 Seeking
Risk appetite index
Stock market gyrations have

(average = 0)
0 Neutral
attracted the bulk of the public’s Reluctant
-1
attention (Exhibit 3), but a wide
-2 Averse
range of markets have actually been
involved in the correction (Exhibit -3
4). Bond yields declined materially, -4
commodity prices dropped and 1991 1995 1999 2003 2007 2011 2015
currency markets have been in flux. Note: Measures risk appetite based on 46 normalized inputs. Source: Bloomberg, BofA ML,
Consensus Economics, Credit Suisse, Federal Reserve Bank of Philadelphia, Haver
Analytics, NedDavis, RBC GAM
It is always a worrying affair when
financial markets convulse. These
events tend to be difficult to Exhibit 3: U.S. equities rattled by China turmoil
anticipate, and it is no easy task to
2200 All-time high
distinguish between garden-variety
corrections and the onset of a bear 2000
market. A natural “recency bias” – 1800

S&P 500 Index
the inclination to assume that the 1600

latest trend will persist – prods 1400
many investors toward the latter 1200
conclusion, even though the former 1000
is usually correct.
800
Some worries about China are 600
entirely legitimate, but there are 2009 2011 2013 2015
Source: WSJ, Haver Analytics, RBC GAM
several reasons why the market’s

Global Investment Outlook | Eric Lascelles | John Richards, CFA | Daniel E. Chornous, CFA
initial response was probably

excessive. China’s economy is Exhibit 4: Market turbulence this summer
decelerating, but continues to grow
at a rate that would be considered 15 20
Yield change (basis point)

Latest Extreme
Percentage change
enviable almost anywhere else in 10
5
the world. Global leading indicators 0
are hardly inspiring, but are still -5 -10
entirely consistent with further -15 -20
economic growth (Exhibit 5). Equity -30
-25
valuations were broadly fair before -40
the downturn, making current -35 -50
levels arguably attractive. Technical Commodities TSX S&P 500 U.S. U.S. 10-year
dollar yield
indicators also point to reasonable Note: Percentage change of S&P Goldman Sachs Commodity Index, TSX, S&P 500 and
prospects of a rebound. broad trade-weighted U.S. dollar since 6/30/2015. Basis point change of U.S. 10-yr yield
since 6/30/2015. Source: Haver Analytics, RBC GAM
Through an economic lens, the

decline in stock valuations is
undesirable, but not a huge blow. Exhibit 5: Stable developed-market growth, decelerating emerging markets
Providing a substantial offset, the
pairing of lower bond yields and JP Morgan Global PMI Developed markets PMI
55
rock-bottom oil prices is clearly Emerging markets PMI
54
Manufacturing PMI
beneficial for global growth. In turn, 53 Expansion

developed countries remain poised 52
for slightly better economic growth 51
over the next year, continuing their 50
gradual post-crisis recovery. In 49
contrast, emerging-market growth 48
Contraction
remains disappointing and is not 47
Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15
obviously bottoming yet.
Note: PMI refers to Purchasing Managers Index for manufacturing sector, a measure for
economic activity. Source: Haver Analytics, RBC GAM
Inflation remains very low and is
likely to fall even more in the near
term as the latest wave of oil-price quarter, but have since settled back a fundamental supply-demand
weakness washes over the economy. to a simmer. Other European political mismatch. Lastly, there are a number
Nevertheless, inflation should risks are notable but less intense. of interest-rate and debt-oriented
rebound somewhat over the next Chinese risks have been central risks that could be triggered.
year as commodity prices stage a for quite some time, and have now
ratcheted even higher. Financial- Altogether, the combination of
partial recovery and economic
market weakness and volatility mediocre growth and substantial
slack shrinks.
are naturally concerns at present, risks remains an imperfect
Of course, significant downside risks though we expect the first of the environment for investors.
persist, much as they have in various two will fade. Commodity-oriented Nevertheless, the valuation
combinations since the global risks – revolving mostly around mismatch between stocks and
financial crisis. Greek sovereign resource-exporting countries and bonds is sufficiently large to
risks spiked higher during the past companies – may linger given continue warranting an overweight
equity position, despite the risks.

China’s many concerns

Exhibit 6: China makes up a significant portion of world growth
China now generates a startling
33% of global economic growth
even though it makes up only 13% 50
China's share of world GDP

of aggregate global GDP (Exhibit 45
40
6). This contribution is eagerly 35
growth (%)
welcomed by the global community 30
under normal conditions, but 25
20
presents something of a worry now 15
10 IMF forecast
that China finds itself grappling
5
with four complications (Exhibit 7). 0
First, China has recently adopted a 1990 1997 2004 2011 2018
Market exchange rate based PPP based
more market-oriented currency, with
Note: 5-year average real GDP growth and 5-year average weights used in calculations.
the yuan depreciating in response. Source: IMF, Haver Analytics, RBC GAM
Second, China’s stock-market
bubble has seemingly burst. Third,
the country has a problematic debt Exhibit 7: China’s four worries
overhang. Fourth and finally, the
country’s economy is slowing. New Stock
currency market
While the history books will rightly
regime bubble
look back on China’s currency-
regime change as a landmark event,
the near-term consequences are
rather small. China is still many China worries
years from vying to be one of the
world’s reserve currencies, and a
Debt Slowing
long, long way from making a case to excesses economy
be the world’s dominant currency.
Source: RBC GAM
Moreover, once the initial surprise
and volatility faded, the yuan fell
by a mere 3% versus the U.S. dollar Exhibit 8: China’s yuan in context
(Exhibit 8). This does not materially
change the world’s competitive Hard peg
to USD
balance, and is not obviously the 8.5
exchange rate (yuan/US$)
U.S. dollar-Renminbi spot
starting gun for a new round of tit- 8.0

for-tat devaluations. Shift to
7.5 floating yuan based New, more
on a basket of market-oriented
The Chinese stock market has 7.0 currencies regime
experienced a real roller-coaster Daily trading band
6.5 Flexible yuan returns
ride, more than doubling from the expands to 0.5%
6.0 Temporary peg to Trading band

middle of 2014 before crashing back USD after financial increases to 1% Policymakers shake Trading band widens
crisis carry trader loose to 2%
down to earth this summer (Exhibit 5.5
9). This decline has contributed 2005 2007 2009 2011 2013 2015
Source: Bloomberg, RBC GAM
significantly to global financial-

market distress, but should arguably

be viewed as something of a Exhibit 9: Chinese second stock bubble pops
sideshow relative to the country’s
debt challenges. The Chinese 7000 Free fall 3500
Shanghai Stock Exchange

stock market is small relative to
Shenzhen Stock Exchange

6000 3000
Composite Index
its host economy, and the great 5000 2500
Composite Index
bulk of shareholders are domestic. 4000 Bubble fueled by 2000
Furthermore, Chinese share prices reforms and
3000 stimulus 1500
were sharply overvalued before 2000 1000
correcting, and even now remain 1000 500
higher than they were a year ago – 0 0
hardly evidence of an inappropriate 2005 2007 2009 2011 2013 2015
decline. Finally, as a general rule, Shenzhen Stock Exhcnage Composite (RHS)
Shanghai Stock Exchange Composite (LHS)
stock-market swings usually have Source: CNBS, Bloomberg, Haver Analytics, RBC GAM
only a limited impact on the real
economy.
Exhibit 10: Chinese housing is weak, but prices have bottomed for now
Chinese debt is the real threat
China’s private debt load has soared 12
since the financial crisis and the
100-city average home prices
10
absolute debt level is now very high 8
(YoY % change)
by emerging-market standards. The 6

key debt risk metrics of the Bank of 4
International Settlements regarding 2
China are all blinking red. 0
-2
China’s credit excesses mostly -4
revolve around the housing sector, -6
which has been weak for some Mar-12 Jan-13 Nov-13 Sep-14 Jul-15
time, if a bit less so recently Source: China Index Academy/Soufun, Haver Analytics, RBC GAM
(Exhibit 10). This problem ricochets

into households, builders, local
governments, and shadow-finance Exhibit 11: Non-performing loans in China rising
entities (and their investors),
60 7
Non-performing loans ratio (%)
eventually settling on bank balance 50

Non-performing loans
40 6
sheets. Indeed, Chinese banks now
(YoY % change)
30
20 5
grapple with non-performing loans 10
0 4
that have expanded by a furious -10 3
57% over the past year, though the -20
-30 2
absolute level of such loans is still -40
-50 1
relatively small (Exhibit 11). -60
-70 0
Mar-08 Dec-09 Sep-11 Jun-13 Mar-15
The debt story, in turn, is a key
NPLs YoY % change (LHS) NPLs ratio (RHS)
reason why the Chinese economy Note: Non-performing loans (NPLs) of commercial banks.
Source: China Banking Regulatory Commission, Haver Analytics, RBC GAM
is slowing. So far, this is mainly

a function of slower credit growth

providing less of a tailwind. But, Exhibit 12: Leading indicators point to slowing China
as debt problems accrue, this may
eventually start to actively impede 15 4
growth. The economy is now 14
(standard deviations from

3
Economic Activity Index

13
decelerating by both official and
China GDP growth

2
(YoY % change)
12
historical norm)
unofficial metrics (Exhibit 12), and 11 1
earnings reports of multinationals 10
9 0
confirm a marked economic 8 -1
slowdown. 7
-2
6
We have long maintained a below- 5 -3
1995 1999 2003 2007 2011 2015
consensus growth forecast for GDP Growth (LHS) Economic Activity Index (RHS)
China, but do not expect a hard Note: Index constructed using sixteen proxies for real economic activity in China.
Source: Bloomberg, Haver Analytics, RBC GAM
landing. Instead, we continue to
look for further turbulence before
an eventual soft landing at around
6.0% GDP growth in 2016. The basis Exhibit 13: China growth slowdown has various theoretical implications
for this view is that the Chinese
national government still has both 0.0
Change in real GDP growth
the will and ample means to bail out -0.1

-0.2
key aggrieved debtors/creditors,
trajectory (ppt)
-0.3 -0.25 -0.25

thanks to a low public debt and -0.4
an enormous stockpile of currency -0.5 -0.4
-0.6 -0.5 -0.5
reserves. The process will probably
-0.7
be somewhat more painful than -0.8 -0.75
in past episodes given that the U.S. Eurozone EM Canada EM Japan
Asia commodity
country is less able to simply grow exporters
itself out of trouble. But it is still a Note: Impact of 1 ppt reduction in China GDP on real GDP growth over subsequent
year. Brail is used as a proxy for EM commodity exporters. India is used as a proxy for
manageable issue. EM Asian countries. Source: IMF, RBC GAM
What do China’s challenges mean for

the rest of the world? The country’s
and fellow Asian emerging markets a close eye on fiscal and monetary-
financial markets are still dominated
(Exhibit 13). This makes Chinese policy developments.
by domestic players, meaning that
developments relevant but not all-
the immediate financial contagion is Globally, fiscal policy now takes
consuming for the global economy.
theoretically limited. That said, there a back seat to monetary policy,
are unquestionably contagion risks as demonstrated by Exhibit 14.
that operate through the economic Policymakers in focus
The era of massive fiscal-stimulus
channel. An IMF model finds that Policymakers have played an programs appears over, and the
for every one-percentage-point unusually central role in determining subsequent painful experience
deceleration in Chinese growth, the course of economic activity of unwinding that exuberance
the U.S. economy slows by around and financial markets since the via fiscal austerity is also largely
0.25 percentage point. It is a similar 2008-2009 crisis. Consequently, done. In the U.S., fiscal uncertainty
effect for Europe, and around twice market participants must maintain has declined handily as the fiscal
that impact for commodity exporters

cliff, debt ceiling and government

shutdown have faded from memory Exhibit 14: Fading fiscal uncertainty, rising monetary uncertainty
and next year’s presidential
election has both parties on their
140 Debt ceiling dispute 350
Rates volatility index (bps)

best behavior. However, global 130
Fiscal
U.S. Economic Policy

cliff 300
monetary-policy uncertainty has Taper
Uncertainty Index
120
tantrum 250
undeniably increased, as some 110 More Fed
100 uncertainty 200
central banks debate raising rates 90 150
while the combination of Chinese 80
100
70
complications, greater financial- 50
60
market uncertainty and lower 50 Less fiscal uncertainty 0
commodity prices could encourage 2010 2011 2012 2013 2014 2015
Monetary uncertainty (LHS) Fiscal uncertainty (RHS)
others to deploy another wave of Note: Rate volatility index is MOVE 6-month index with weighted average of 2yr, 5yr,10yr
monetary stimulus (Exhibit 15). and 30yr. 20-day moving average of Economic Policy Uncertainty Index.
Source: www.PolicyUncertainity.com, Deutsche Bank Research, Bloomberg, RBC GAM
Chinese policymakers have been

busy supporting their markets with
a raft of measures. Over the spring Exhibit 15: Central banks cut on sluggish growth and low inflation
and early summer, the country was
focused on assisting its borrowers. Emerging
market led
Change in central bank policy
In late summer, the focus shifted to 50 Tightening

rates (% raising/cutting in
tightening
supporting the stock market. Most
recently, the People’s Bank of China 0
month)
has been defending its currency and

injecting stimulus to support growth -50
and restore confidence. Widespread Persistently
easing in reaction accomodative
to financial crisis Easing
-100 policy
The U.S. Federal Reserve (Fed)
2008 2009 2010 2011 2012 2013 2014 2015
continues to agonize over when to % of central banks tightening % of central banks easing
begin raising its benchmark interest Net % of banks easing
Note: Based on policy rate for 30 countries. Source: Haver Analytics, RBC GAM
rate, given the uncertainty of recent
volatility. The Fed still seems inclined
to tighten rates some time this year
Exhibit 16: Complexity need not be paralyzing
from current ultra-low levels given
steady economic progress and a
Stronger exchange rate
falling unemployment rate, but the Lower profit
prospect of a September rate hike Lower wages
Rate hike Lower commodity prices
has arguably fallen. Bond sell-off

Lower stocks
Many market participants have Higher borrowing cost
expressed concern about what will
Possible debt problems
happen when the Fed does tighten.
A common fear is that rate hikes
will impose a truly dizzying array of Yes, the world is complicated, but the collective effect is modest:
problems including lower corporate
profits, falling equities, a stronger
+25 bps
rate hike = -0.1 to -0.4 ppt
GDP growth
Source: RBC GAM

U.S. dollar and higher borrowing

costs. However, these concerns Exhibit 17: Fed tightening impulse ricochets around world
are exaggerated. Such linkages do
indeed exist, but they are not very -0.1 Poland
-0.1 U.K.
strong (Exhibit 16). Historically, -0.1 Japan
-0.1 Eurozone
a 25-basis-point rate hike can be Emerging -0.2 Canada
expected to subtract via all of these markets hit -0.4 South Africa
hardest -0.4 Mexico
different channels anywhere from -0.4 China
-0.5 Russia
0.1 to 0.4 percentage point from -0.6 India
-0.6 Brazil
economic growth. This is material, -0.8 Korea
but hardly a killer blow. The Fed -0.8 Indonesia
-0.8 U.S.
understands this math and plans to -1 -0.8 -0.6 -0.4 -0.2 0
proceed gingerly. As such, disaster Change in real GDP growth trajectory (ppt)
is unlikely when the Fed tightens. Note: Impact of an additional 50 bps of rate hike on real GDP growth over subsequent two years.
Source: Oxford Economics, RBC GAM
Another fear is that Fed tightening

will cascade into other countries,
causing damage there. This is a Exhibit 18: Steady global growth masks divergent trends
realistic concern. The Fed tends
not to put much weight on the 10
Real GDP (annual % change)
implications of its actions outside 8

U.S. borders because they are not 6
a part of its mandate. Some foreign 4
countries will be hit by an economic 2
drag no less substantial than that 0
felt within the U.S. (Exhibit 17). -2
The consequences are particularly -4 IMF Forecast

adverse for emerging-market -6
2004 2006 2008 2010 2012 2014 2016 2018 2020
economies given the potential Emerging markets Developed markets
interruption to their capital flows Source: IMF, Haver Analytics, RBC GAM
when U.S. rates rise, and to the cost
of servicing their external debt as
the greenback rises. unfortunate trend (Exhibit 18). than 2015, consistent with the
Gazing into 2016, both regions economic-recovery narrative (Exhibit
Downgraded forecasts should manage faster growth though 19). Our forecasts are above the
We have nudged our global growth we have more conviction about this consensus for the Eurozone and
forecasts lower this quarter, with view for the developed world than Japan, broadly on consensus for the
changes to both the developed emerging nations. U.S. and U.K., and below consensus
and emerging-market outlook. This for Canada.
In the developed world, North
nevertheless leaves developed American growth prospects have Among emerging economies, Brazil,
economies on track for improved been reduced, while the European Mexico, Russia and South Korea
growth in 2015, while emerging- and Japanese outlooks are little suffered significant downgrades. The
market growth should be materially changed. All appear on track for first three relate to weak commodity
slower this year, continuing an growth next year that is no worse prices, while the fourth is linked

to China’s economic softness and

underwhelming global trade flows. Exhibit 19: RBC GAM GDP forecast for developed markets
Our Chinese forecast has not
changed much due to pessimistic 3.0
2.50% 2.50% 2.50%
prior assumptions. Most of the
Annual GDP growth (%)

2.5 2.25% 2.25%
emerging-market nations we forecast
2.0 1.75% 1.75%
appear set for less growth in 2015
1.50%
than in 2016, before staging a partial 1.5
rebound in 2016 (Exhibit 20). Our 1.00%
1.0 0.75%
emerging-market forecasts mostly
remain below consensus. 0.5
0.0
U.K. U.S. Eurozone Canada Japan
Debt hot spots
2015 2016
High global debt levels present an Source: RBC GAM
obvious risk to future prosperity.
The vast majority of borrowers will
Exhibit 20: RBC GAM GDP forecast for emerging markets
be perfectly fine, but an important
minority may struggle in the future.
We have identified a number of 8 7.50%8.00%
Annual GDP growth (%)
6.75%
potential “debt hot spots” (Exhibit 6.00%
6
21), as discussed in considerable
4 3.50% 3.25%
detail in a recent Economic Compass 2.50% 2.25%
entitled “Vetting Debt Hot Spots.” 2 1.00%
0.25%
0
There are four near-term debt hot
spots worthy of mention (in addition -2
-1.50%
to China’s already discussed debt -4 -3.50%
India China Mexico South Korea Brazil Russia
challenges).
2015 2016
Source: RBC GAM
First, emerging-market external
debt – money owed to foreigners –
has increased by a remarkable Exhibit 21: Debt hot spots
US$2.5 trillion since 2007 (Exhibit
22). This is very nearly a doubling Near-term Medium-term Long-term
risk risk risk Global
of the overall level. There are a (0-2 years) (3-10 years) (>10 years) significance
few particular dangers brewing for 1) Developed-world public debt Normal Elevated High High
external debt. One is that the bulk of
2) Greek public debt High High Elevated Low
emerging-market external debt is in
foreign currencies – a problem when 3) Japanese public debt Normal High High Medium
those foreign currencies (mainly 4) Emerging market external debt Elevated Normal Normal High
the U.S. dollar) are appreciating.
5) Corporate debt Elevated Elevated Normal High
Another is that foreign investors tend
to be flightier than domestic ones, 6) Chinese credit High High Elevated High
and so often flee during periods of 7) Oil-oriented debt Elevated Normal Normal Low
market distress such as the current
8) Housing exuberance High Elevated Normal Low
Source: RBC GAM

one, especially when emerging-

market economies have serially Exhibit 22: Staggering growth of EM external liabilities
disappointed expectations. Outflows
have recently picked up noticeably, 6
External credit to developing

$2.5 trillion
but are on the aggregate still smaller
countries (US$ trillions)

5 increase since
2007
than during the taper tantrum of 4 Bank loans
2013 (Exhibit 23). increased over 50%
3
As such, external debt is a very clear 2
risk. However, we identify it as an Debt outstanding
1 grew over 130%
“elevated risk” rather than a “high
0
risk” like China. As a percentage of 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
GDP, external debt actually remains Bank loans Debt securities
at a pedestrian, steady 27% (Exhibit Note: External bank loans and international debt securities issued by all sectors of
developing countries. Source: BIS, Haver Analytics, RBC GAM
24). Apparently, the economic
engines have grown just as quickly
as the debt. Perhaps the true
worry is that a handful of countries Exhibit 23: Emerging-market bond outflows have picked up again
seem at particular risk, mostly in
Eastern Europe (where external 3
Inflow
Weekly EM bond fund net flows
debt loads are especially high) and 2

Latin America (where external debt 1
levels are middling but softening 0
(US$ billions)
currencies and weak economies -1

-2
complicate matters).
-3 Taper
tantrum
A second threat is corporate leverage, -4 EM suffer
a risk that is most pronounced -5 from renewed
Outflow
-6 outflows
in the emerging-market space
2010 2011 2012 2013 2014 2015
(Exhibit 25). There are few signs of
Source: EPFR, RBC GAM
distress, but of course borrowing
costs are still very low. The concern
is that rising rates will render this
Exhibit 24: Emerging-market external debt tame relative to GDP
additional leverage unsustainable.
At the national level, countries
100
External liabilities (% of GDP)
such as China, Bulgaria, Malaysia 90

and Hungary have accumulated 80
70
particularly heady private debt loads 60
(Exhibit 26). Fortunately, there are 50
40
a number of reasons why this risk 30
is also “merely” elevated rather 20
than high. In contrast to emerging- 10
0
market companies, many emerging- 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
market governments have reduced Global Emerging markets
Note: Measured as external debt securities and loans of all reporting countries.
their public debt and accumulated Source: BIS, IMF, Haver Analytics, RBC GAM
foreign-exchange reserves, creating

greater fiscal capacity to assist

domestic businesses if needed. Exhibit 25: Corporate debt in both developed and emerging markets is high
Furthermore, it must be conceded
that interest rates could just remain 110
Corporate debt as % of GDP

stubbornly low. 100
A third debt threat lies in a sprinkling 90
of exuberant housing markets 80

around the world, Canada among 70
them. For countries lucky enough 60
to retain a functioning banking 50
system through the financial crisis,
40
households found the combination 2000 2003 2006 2009 2012 2015
of cheap and accessible credit Developed markets Emerging markets
Source: IIF, RBC GAM
irresistible. Home prices rose
substantially in Canada, Hong Kong,
Singapore, Australia, New Zealand
and a handful of northern European Exhibit 26: Corporate debt especially high in some countries
countries. Affordability levels are
not particularly bad at current
160 155
Non-financial debt securities
and loans, 2013 (% of GDP)
interest rates, but would deteriorate 140 122

113112
significantly in a higher interest-rate 120 103
93 88
100
environment. This is a high risk to 80 70
59 58
51 49 46 44 43 43
the countries affected, but ultimately 60
34 31
40 24 20
a low risk to the global economy 20
15
given limited potential for contagion. 0
Russia
Indonesia
Israel
China
Bulgaria
Malaysia
Hungary
Korea
Thailand
Turkey
Ukraine
Chile
India
Brazil
S. Africa
Poland
Philippines
Colombia
Czech Rep.
Mexico
Argentina
A fourth potential debt hot spot
relates to oil-oriented debt. The
sharp decline in oil prices creates Note: Debt securities and loans of nonfinancial corporations for 2013.
Source: Haver Analytics, RBC GAM
debt risks at both the corporate and
sovereign levels. Energy firms have
nearly tripled their debt outstanding nations in particular suffer. They probably crop up somewhere. This
since 2006, gambling that high oil are highly reliant on oil revenues, need not be disastrous, but should
prices would persist. They have and are incapable of balancing their problems metastasize, or leap-frog
not, and history shows that distress budgets at current prices. This is unexpectedly from one market to
usually becomes perceptible around not an acute risk for many given another, the consequences could
a year after an oil shock. This argues substantial currency reserves, but for become much greater. This is a risk
that the second half of 2015 and Nigeria and a handful of others, it is that merits close watching.
the first half of 2016 could be quite a pressing matter.
revealing, particularly in the shale- Underwhelming emerging
oil space. In all likelihood, many of these risks
will fail to trigger. But the sheer economies
At the sovereign level, no oil- amount of debt outstanding and this Emerging-market economic growth
exporting country relishes the current long period of ultra-low borrowing continues to underwhelm. The
regimen of low prices, but OPEC costs suggest that problems will group has been on a decelerating

trend for several years, in line

with our expectations. As with Exhibit 27: Trade should be growing faster
China, this slowdown is the result
of several factors. Headwinds Trade usually grows 2X faster than GDP
18
include decelerating globalization
12
YoY % change
(Exhibit 27), sluggish developed-
world demand, a natural maturing 6
of emerging-market economies, 0
decelerating credit growth and
-6
ebbing demographics. Most of these Trade
-12 dipped
factors were identified long ago. below GDP
-18
Lately, a handful of additional issues 1980 1985 1990 1995 2000 2005 2010 2015
have emerged. The commodity Real world trade Real world GDP
Source: OECD, Haver Analytics, RBC GAM
collapse has badly damaged Latin
American and other commodity-
exporting countries. Eastern Europe
has been squeezed by a sluggish Exhibit 28: U.S. dollar strengthened against most currencies
Europe and a troubled Russia. The
Russian ruble -48
strong dollar has been another Ukrainian hryvnia -45
Colombian peso -41
complication given the negative Brazilian real -38
Turkish lira -27
Malaysian ringgit -24
implications for capital flows, Mexican peso -23
Chilean peso -20
external debt and inflation (Exhibit Polish zloty
South African rand
-19
-19
28). China’s slowdown is a story Hungarian forint -19
Bulgarian lev -18
Czech koruna -17
unto itself, and has sucked in key Indonesian rupiah -15
Korean won -14
trading partners such as South Argentinian peso -12
Israeli new shekel -12
Indian rupee -9
Korea and Taiwan. Thai baht -9
Philippine peso -7
Chinese yuan -3
Leading economic indicators do -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0
not yet reveal an obvious economic Change in exchange rate against U.S. dollar (%)
Note: As at 8/27/2015. % change since July 1, 2014. Source: WSJ, Haver Analytics, RBC GAM
bottom for emerging economies, and
growth will probably remain sluggish
over the next few years as these reforms have better prospects Oil machinations
factors play out. than those that continue to reject
After a brief revival in the early
such measures. In practice, this
That said, strikingly cheap emerging- summer, oil prices have again
makes India look fairly good. More
market equity valuations mean slumped (Exhibit 29). This is
broadly, we will confess to some
the sector should not be shunned, wonderful news for some countries,
disappointment that the rate
and unusually divergent growth and horrific for others (Exhibit 30).
of reform delivery among most
prospects across markets make it
emerging economies over the There are a number of factors behind
important to differentiate among
past year has been so slow, oil’s double-dip decline. Chinese
countries and companies. In general,
particularly given the opportunity economic disappointments provide
commodity-importing countries are
and incentive provided by relatively a key demand-side angle. But the
set to continue faring much better
new governments and urgent main story remains on the supply
than commodity-exporting ones,
economic need. side, where a tentative deal to lift
and those delivering structural

Iranian sanctions has the country

chomping at the bit to increase Exhibit 29: Oil’s summer slump
production (Exhibit 31). Iran’s 4%
global share of oil production is well 115
below its 9% share of oil reserves. 105
Oil price (US$/bbl)

Assuming formal approval of the 95 Prices dropped further
deal, the country could be selling an 85 on oversupply and
75 growth concerns
extra 600,000 to 800,000 barrels of
oil per day in 2016 – an almost 1% 65
increase in global supply. 55

45
The other supply story is the U.S. 35
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
shale-oil sector. Despite a collapse
Brent future price WTI
in drilling activity (Exhibit 32) and
Source: Haver Analytics, Bloomberg, RBC GAM
a theoretically high “decline rate”
that should see existing production
decay rapidly, the reality is that U.S.
oil production remains near its all- Exhibit 30: Low oil prices – beneficiaries vs. losers
time high. All of this has forced a
South Korea -6.3
rethink of when the global oil market South Africa
India
-6.3
-5.2
will return to balance. Whereas Netherlands -3.6
Japan -3.4
Turkey -3.3
the consensus was previously that Indonesia -3.2
Spain -3.1
equilibrium would be restored by China
Germany
-2.4
-2.2
European Union -2.2
early 2016, this now looks to be a France -2.1
Italy Oil boost -1.8
2017 proposition. U.S.
Brazil
-1.5
-1.4
U.K. -0.8
Mexico 2.4 Oil drag
That said, some of the latest Canada
Colombia
3.9
6.5
pessimism may prove excessive. Russia 14.8
U.S. production figures have finally -9 -6 -3 0 3 6 9 12 15

Oil net balance, 2014 (% of GDP)
started to show a tentative decline
Source: BP Statistical Review of World Energy 2015, Haver Analytics, RBC GAM
(Exhibit 33). This could be the
beginning of a long-awaited turn, or
it could just be another red herring.
Exhibit 31: Current oil reserves – market share by region
Meanwhile, global oil-demand
Europe & Eurasia
forecasts have ratcheted higher Iraq 9%
9% Iran Natural upside
on several occasions so far this Africa 9% 9% stock
8% 4% flow
year, suggesting that low prices
Canada
are beginning to alter consumer Kuwait
10%
6%
behaviour. In all of this, it is
U.A.E.
important to remember that the 6%
U.S.
global supply-demand mismatch 3% Saudi Arabia
is not huge. We therefore believe Asia Pacific 16%
2% Others
that West Texas oil prices can rise 2% Central &
moderately from here, but probably S. America
20%
not all the way back to US$60 in Note: 2014 proved reserves. Source: BP, RBC GAM
the near term.

Commodity super-cycle
Exhibit 32: U.S. rig count rises tentatively after steep cuts
It may also be worth contemplating
oil prices in the context of the
broader set of commodities. 1,600
Number of U.S. oil rigs in

Commodities of almost every 1,400
description have suffered significant 1,200
operation
declines in recent years (Exhibit 1,000
34). The rationale varies slightly 800
from resource to resource – OPEC 600
has strikingly little control over 400
the world’s orange juice supply, 200
for instance – but there are a few 0
common themes. Strong emerging- 2001 2003 2005 2007 2009 2011 2013 2015
market growth in the 2000s drove Source: Baker Hughes, RBC GAM
commodity prices higher. With a lag,
this created additional commodity
supply, and that additional supply Exhibit 33: U.S. crude-oil production trending down
is now available at precisely the
moment when emerging markets, 9.6
and most importantly, China, have
U.S. crude production
9.5
slowed. In this manner, a commodity
(million bbl/day)
shortage has metamorphosed into a 9.4

commodity glut. 9.3
We are inclined to view this as a 9.2

multi-year but not multi-decade
9.1
phenomenon. Emerging-market
growth will not decelerate forever 9.0
Jan-02 Feb-13 Mar-27 May-08 Jun-19 Jul-31
and resource producers are proving 2015
reasonably nimble at cutting Source: EIA, Haver Analytics, RBC GAM
production. Commodity prices are

unlikely to return to prior highs
anytime soon, but current valuations Exhibit 34: Extreme commodity markets
may be unsustainably low.
900 Initial
800 commodity
S&P Goldman Sachs
Low inflation to persist rout

Commodity Index
700
Global inflation has been 600
extraordinarily low in recent years, 500
though it had begun to demonstrate 400
a bit of positive momentum in 300
Prior low Another
recent months (Exhibit 35). That 200 leg down
story is now likely dormant given 100
the latest decline in commodity 0
prices. We have accordingly edged 2005 2007 2009 2011 2013 2015
Note: Historical low since July 2005. Source: Haver Analytics, RBC GAM
down 2015 inflation forecasts

(Exhibit 36). Currency swings are

another important consideration for Exhibit 35: Low inflation across major economies
inflation, with the strong U.S. dollar
constricting U.S. inflation while 6
exporting higher prices to other 5 Economic
4 slack
Headline inflation
(YoY % change)
markets. Oil prices
3 plummet
U.S. inflation expectations are again 2
declining, but not in a sufficiently 1
serious way to compromise the 0
ability of inflation readings to -1
eventually revert to target (Exhibit -2
2006 2009 2012 2015
37). We continue to look for
U.S. Eurozone U.K. Canada
modestly higher inflation in 2016 Source: Bureau of Labor Statistics, Office for National Statistics, Statistics Canada,
Statistical Office of the European Communities, Haver Analytics, RBC GAM
as commodity prices bottom out
and economic slack fades. An aging
population presents a small speed
bump in pursuit of this goal. Exhibit 36: RBC GAM CPI forecast for developed markets
2.5
U.S. prospects firm 2.00%
YoY CPI change (%)
After an early-2015 scare, the U.S. 2.0 1.75% 1.75%

economy is now back in its familiar 1.50%
1.5
role as a source of economic good 1.00%
cheer. Second-quarter GDP put 1.0 0.75%
to bed economic concerns with a 0.50%
0.5
robust 3.7% gain, substantially
0.00% 0.00% 0.00%
offsetting the poor first quarter. 0.0
Canada Japan U.K. U.S. Eurozone
Consumer spending remains
resilient and business investment 2015 2016
is now showing signs of strength. Source: RBC GAM
The labour market is still robust,

though wage growth has remained
frustratingly soft even as a growing Exhibit 37: U.S. inflation expectations turned lower
chorus of indicators show that it is
3.8
picking up. 3.6
U.S. 5Y5Y inflation swap
3.4
The U.S. housing market is still well
3.2
positioned for strength thanks to
forward (%)
3.0
good affordability, improving credit 2.8
conditions and better household- 2.6
formation rates (Exhibit 38). 2.4
2.2
If recent history is any guide, U.S. 2.0
economic surprises are on track to 1.8
May-08 Oct-10 Mar-13 Aug-15
Source: Bloomberg, RBC GAM

become more positive through the

remainder of the year (Exhibit 39). Exhibit 38: U.S. household formation has revived
In turn, we forecast 2.25% GDP
growth in 2015 followed by 2.50% 2.5
in 2016. 2
Number of households
(YoY change, millions)
This new forecast is diminished 1.5
relative to our prior outlook for three
1
key reasons: U.S. dollar strength,
the Chinese flare-up and revisited 0.5 Historical
assumptions about the sustainable average
0
U.S. growth rate. We now believe
that a normal U.S. growth rate is -0.5
more like 1.50% to 2.00% per year 1981 1988 1995 2002 2009 2016
Note: Historical average since 1980.Source: Census Bureau, Haver Analytics, RBC GAM
rather than 2.00% to 2.25% (Exhibit
40). To be clear, the economy can
still temporarily outpace this clip
when there is economic slack to Exhibit 39: U.S. economic surprises on familiar upswing
capture. But, over the long run, that
may be the new benchmark 120
for success. Positive Surprises
Economic Surprise Index (1 std
80
Unfortunately, a diminished growth 40
trajectory implies that American
dev=100)
well-being will also rise less quickly. 0
However, it does not necessarily -40

imply more dovish monetary policy.
-80
The Fed cares about whether the Negative Surprises
economy is outpacing its speed -120
limit, not whether growth is fast or Oct-10 May-12 Dec-13 Jul-15
Source: Citigroup Economic Surprise Index, RBC GAM
slow on an absolute basis.
Although the U.S. economic outlook

is arguably fine, the combination Exhibit 40: U.S. growth speed limit lower than once imagined
of Chinese uncertainty, financial-
market volatility, U.S. dollar strength Prior assumption New assumption
and the low inflation that will now
linger through the fall could easily
keep the Fed from pulling the trigger
on a rate hike for a little while longer. 2.0% – 2.25% 1.5% – 2.0%
In the end, however, the Fed is likely
to raise rates multiple times over
the coming year (Exhibit 41), and
Rationale
this should contribute moderately to
■ Downward GDP revisions (-0.2 ppt)
further U.S. dollar strength.
■ Fed staff forecast (1.6%-1.8%)
Source: RBC GAM

Eurozone flares up Exhibit 41: U.S. Fed funds rate

The Eurozone flared up over the past Equilibrium range
quarter as Greek debt negotiations
24
became ever more fraught. For a 22
brief period in July, it appeared 20
18
quite likely that Greece would opt to 16
14
default on its debt and perhaps exit 12
the Eurozone. However, an unlikely
% 10
8
sequence of events – a referendum 6
that rejected the creditors’ final 4
2
offer followed by an about-face in 0
-2
which the Greek government signed 1980 1985 1990 1995 2000 2005 2010 2015 2020
on for even more onerous terms Last Plot: 0.14% Current Range: -1.30% - 0.90% (Mid: -0.20%)
just one week later – managed to Source: Federal Reserve, RBC GAM
keep the region intact. Inevitably,
some uncertainty remains: bailout
negotiations are not quite done and Exhibit 42: Eurozone holding up despite Greek crisis
some form of debt relief must still
be arranged, but the country is now
1.5 Rising economic activity 65
on a much more credible path. As a
Eurozone PMI Composite

result, European political risks have 1.0 60
EuroCoin indicator
Output Index
declined precipitously. 0.5 55
0.0 50
Of course, a few more political tests
exist for Europe over the fall. The -0.5 45
Greek government has called another -1.0 Falling economic activity 40
election to consolidate power.
-1.5 35
Meanwhile, Portugal, Spain and the 1999 2003 2007 2011 2015
somewhat disaffected Catalonia EuroCOIN (LHS) PMI Composite Index (RHS)
region of Spain all have autumn Source: Centre for Economic Policy Research, Markit, Haver Analytics, RBC GAM
elections. Greece’s costly experience

combined with improving economic
prospects argue that Europe’s Exhibit 43: Easier credit and stronger demand in Eurozone
populist sentiment may have peaked.
If true, these events should pass 40 -40
Credit demand (diffusion index)
without too much effect. Improving credit

conditions
20 -20
Credit availability
(diffusion index)
Economically, the Eurozone

0 0
continues to signal mediocre
economic growth that, while -20 20
unexciting, is a big improvement
-40 40
over prior years (Exhibit 42). We Deteriorating credit
conditions
continue to focus on the Eurozone -60 60
credit market to determine the 2003 2005 2007 2009 2011 2013 2015
Credit demand (LHS) Credit availability (RHS)
likelihood of better prospects ahead.
Source: European Central Bank, Haver Analytics, RBC GAM

The odds seem good given material

improvement to credit conditions Exhibit 44: Spain’s stellar economic growth
(Exhibit 43). Other economic support
comes from quantitative easing by 5 Fastest growth since Q1 2007: 4.0%
4 60
(QoQ % change annualized)

the European Central Bank (ECB), a 3
Spain Manufacturing PMI

55
relatively weak euro and the decline 2
Spanish real GDP

1 50
in commodity prices. It is also 0 45
promising that some of the long- -1
40
-2
beleaguered “peripheral” economies -3 35
are gaining economic traction. Spain, -4 30
-5
for instance, has been recording -6 25
relatively strong leading indicators -7 20
2005 2007 2009 2011 2013 2015
and GDP growth (Exhibit 44).
GDP growth (LHS) Manufacturing PMI (RHS)
Given all of this, we continue to Source: Markit, Statistical Office of the European Communities, Haver Analytics, RBC GAM
forecast 1.50% Eurozone-wide GDP

growth for 2015, followed by an
acceleration to above-consensus Exhibit 45: Central-bank bond-buying relay
2.25% growth in 2016. The ECB has
hinted at the possibility of more 12
Central bank
ECB
Collective monetary base
stimulus should recent market 10 bond buying of around

$1 trillion per year from begins
turmoil and low inflation rates persist 2011 to 2016 Fed
(US$ trillions)
8 QE3
(Exhibit 45). We expect the euro to SNB
6 intervention BoJ
depreciate further to facilitate the Fed Fed begins
QE1 QE2
Eurozone’s economic recovery. 4
BoE
2 QE
Forecast
U.K. resilience 0
2007 2009 2011 2013 2015
The U.K. economy continues to
Note: U.S. Fed, BoE, ECB, BoJ and SNB balance sheets combined using PPP
rhyme with the U.S., managing solid exchange rates. Source: Bank of Japan, Federal Reserve Board, European Central
economic growth and hiring (Exhibit Bank, Swiss National Bank, Haver Analytics, OECD, RBC GAM
46). Political issues have faded for

the time being, with the Scottish
referendum and national election Exhibit 46: U.K hiring slows but still fine
now firmly in the rear-view mirror
and any vote on whether the U.K. will 6 2.5
U.K. real GDP (YoY % change)
remain within the European Union 4 1.5

still fairly distant in the future.
U.K. employment
(YoY % change)
2
0.5
Arguably, the British economy is even 0
further along in its economic recovery -0.5
-2
than the U.S., sporting a smaller -1.5
-4
output gap. This helps to explain why
U.K. wage growth has revived so early -6 -2.5
2005 2007 2009 2011 2013 2015
(Exhibit 47), and supports the notion
GDP (LHS) Employment (RHS)
that the Bank of England (BOE) is Source: Office for National Statistics, Haver Analytics, RBC GAM

also nearing its first rate hike. We

look for some tightening either late Exhibit 47: U.K. wage growth lifts off
this year or over the first half of 2016
(Exhibit 48). 6
5
That said, the British economy
Total private sector pay

4
is not without headwinds. Fiscal
(YoY % change)
3
austerity remains intense, hindering
2
growth, and the country’s large
current-account deficit has still not 1
been fully resolved. A strengthening 0

Eurozone economy should help in -1
this regard. -2
2005 2007 2009 2011 2013 2015
We have slightly raised our U.K. Source: Office for National Statistics, Haver Analytics, RBC GAM
growth forecast for 2015 to 2.50%
from an earlier 2.25%, and left the
Exhibit 48: U
nited Kingdom base rate
2016 forecast at 2.50%. These are a
Equilibrium range
little ahead of the market consensus.
As with the U.S. dollar, the pound 18
should demonstrate continued 16
14
strength given similar monetary- 12
policy trajectories. 10
8
6
%
Japan’s split personality 4

Japanese second-quarter GDP 2
contracted as expected, partially 0
-2
reversing the unusual strength
1980 1985 1990 1995 2000 2005 2010 2015
demonstrated in the first quarter. Last plot: 0.50% Current range: -1.78% - 0.81% (Mid: -0.48%)
Private consumption was particularly Source: RBC GAM, RBC CM
weak, indicating that households
still refuse to spend despite labour-
market strength and still-positive Exhibit 49: Japanese inflation expectations are still unusually good
inflation expectations (Exhibit 49).
This is frustrating, and perpetuates 4.0
Japan's expected inflation (%)
our view that Japan remains among 3.5

the most difficult economies in
3.0
the world to understand given its
2.5
multiple personalities. Our 2015
2.0
growth forecast has been sliced to
1.5
0.75%, but should revive to as much
1.0
as 1.75% in 2016.
0.5
On the plus side, Japanese tourism 0.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
is on fire thanks to the weak yen and
Source: Consumer Confidence Survey, Cabinet Office of Japan, Haver Analytics, RBC GAM
ebbing tensions with China

(Exhibit 50). Bank lending also

continues to grow at a healthy rate Exhibit 50: Foreign tourists like weak yen
(Exhibit 51) and Japan’s economic
surprises have been more positive 130
400
U.S. dollar-Yen exchange rate

Tourism industry activity index
than negative. 120
300 110
However, a long string of
(2005=100)
100
positive economic surprises is 200
90
usually followed by a period of
80
disappointments as expectations 100
70
overshoot. This may now be starting
to happen. The country is also 0 60
May-11 Mar-12 Jan-13 Nov-13 Sep-14 Jul-15
arguably at risk of descending back
Tourism activity industry index (LHS) USDJPY (RHS)
into deflation given the trend in
Source: Japan Ministry of Economy, Haver Analytics, RBC GAM
commodity prices, some recent yen
strength and the tentative evidence
of real-time indicators. Deflation is
a greater danger to Japan than to Exhibit 51: Renewed Japanese bank-lending growth
other nations given the country’s
4
past experience. Japan also
Bank lending to private sector
remains vulnerable due to its poor 2

demographics and high public
(YoY % change)
0
debt load.
-2
We have nevertheless tended to
alight on the positive side of the -4
ledger with regard to the Japanese -6
outlook, recognizing that Prime
Minister Abe and the country’s -8
2003 2005 2007 2009 2011 2013 2015
central bank are both committed to Source: Bank of Japan, Haver Analytics, RBC GAM
reviving growth, and that the country
has made some important headway
on reforms in 2015 (Exhibit 52). inflation continue to disappoint. economy has now contracted for
Governance developments – the The yen may fall moderately further, two consecutive quarters, it fails to
requirement of more independent but policymakers are not keen for a meet a more precise definition of
directors on corporate boards and large move. “recession” given insufficient depth
the arrival of activist-shareholder or breadth. To illustrate, GDP is a
practices – could usher in an era Woe, Canada mere 0.3% lower in non-annualized
of much more effective and thus terms, and most sectors and regions
The Canadian economy has
profitable companies. of the country continue to expand.
struggled mightily in 2015,
Of course, the latest downward leg
contracting for five consecutive
At this juncture, we do not look for in oil prices threatens to overturn
months before managing a return
additional monetary easing, but that assessment or at least keep
to growth in June. Although the
it could well come if growth and future growth quite meagre.

Our Canadian composite leading

indicator demonstrates that the Exhibit 52: Japan reforms
economy remains in a weak position,
if not nearly as bad as during the Labour • Efforts underway to reduce two-tier nature of
financial crisis, and slightly better labour market
than in the early 2000s (Exhibit 53).
• Underutilized pools of potential workers being
Regionally, there can be no denying tapped
that the oil-exporting provinces
of Alberta, Saskatchewan and Governance • Tokyo Stock Exchange mandates independent
Newfoundland are experiencing full- directors on boards
on recession conditions. • Shareholder activism comes to Japan
The oil pain has manifested itself Trade • Trans-Pacific Partnership implementation now likely
primarily in the form of sharply
reduced capital investment (Exhibit Source: RBC GAM
54) rather than lower oil production.

Conventional models suggest that
the oil shock shouldn’t be as painful Exhibit 53: Glum outlook for Canadian economy
for the Canadian economy as it has
been, but the soft Canadian dollar 2
Canadian Economic Composite
simply hasn’t been as helpful as

(standard deviations from
1
expected. Perhaps the cavalry are
historical norm)
0
still on its way: the full economic -1
effect of Canadian currency swings
-2
are not felt for several years after the
-3
initial adjustment (Exhibit 55).
A recent month of strong export -4
data could well mark the beginning -5

2001 2003 2005 2007 2009 2011 2013 2015
of this process. Note: Composite constructed using four leading indicators from surveys on Canadian
businesses. Source: CFIB, Haver Analytics, RBC GAM
Nevertheless, the Canadian
economic outlook remains feeble.
We forecast below-consensus GDP Exhibit 54: Canadian businesses cut investments
growth of 1.00% in 2015, followed
by a sluggish 1.75% gain in 2016. 30
These are both downgrades from 20 Long swoon
Business investment
earlier expectations. The prospect of

(YoY % change)
10
a close Canadian election in the fall 0
add a jolt of uncertainty, and might -10
ultimately produce a government -20
viewed less favourably by financial -30 Oil
shock
markets. Add in a lingering -40
housing risk (Exhibit 56), and the -50
Canadian macro narrative remains a -60
2005 2007 2009 2011 2013 2015
challenging one.
Source: Haver Analytics, RBC GAM

In this environment, a third Bank

of Canada rate cut is entirely Exhibit 55: Weaker loonie boosts growth
conceivable, though not currently
our base case expectation (Exhibit 1.0
57). We look for the Canada-U.S.
Cumulative impact on level of

0.9
Canadian GDP (% change)

exchange rate to provide further 0.8 Low loonie Much later,
0.7 benefit still effect fades
support by softening to 1.40 (71 U.S. 0.6
building
cents). 0.5
0.4
0.3
Bumpy rates 0.2
Bond yields have gyrated over the 0.1
0.0
past year based on highly variable 0 1 2 3 4 5
inflation, economic and central-bank Years after a 10% depreciation of Canadian dollar
Note: % change in Canadian GDP level from original trajectory due to 10% depreciation
outlooks (Exhibit 58). The latest of Canadian dollar against U.S. dollar. Source: Oxford Economics, RBC GAM
financial-market rout has reduced
commodity prices and spooked
central banks, again sending yields Exhibit 56: Canadian housing challenges mount later
downward (Page 42).
While there are limits to how high Credit sustainability Credit sustainability
yields can rise due to still-sluggish
and vulnerable global growth, heavy Unemployment Unemployment
debt loads in some regions and Canadian Canadian

housing Income Income
substitution effects across markets, housing
(short term) (medium term)
we nevertheless continue to look for Affordability Affordability
a modest increase in bond yields
Construction Construction
over the coming year. This is for sustainability sustainability
several reasons: Would need multiple of
these going wrong at
once for serious trouble
Developed-world economic Source: RBC GAM
growth continues to improve.

Commodity prices are now at Exhibit 57: Canada overnight rate
Equilibrium range
unsustainably low levels, so
the downward pressure that 24
raw materials have exerted on
20
inflation should peak this fall and
then recede. 16
12
%
The term premium remains

unnaturally low (Exhibit 59). 8
Global currency reserves are now 4

in decline, reducing appetite for 0
sovereign debt. 1980 1985 1990 1995 2000 2005 2010 2015
Last Plot: 0.37% Current Range: 0.01% - 1.96% (Mid: 0.99%)
Source: RBC GAM, RBC CM

The Fed still appears likely

to raise rates, if on a slightly Exhibit 58: Bond yields down due to risk aversion
delayed trajectory.
The market has focused much of Peak Fed
2.6 expectations
U.S. 10-year Treasury yield (%)

its attention on the last point: what
happens to bond yields as the Fed 2.4
embarks on a tightening cycle?
2.2
Although rising short-term rates will
likely push up long-bond yields, the 2.0 China retreat
path higher need not necessarily be
destructive. Exhibit 60 shows the 1.8
Koenig-Taylor rule, which estimates Yields too low
1.6
the appropriate level for short-term Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15
interest rates based on the past Source : Federal Reserve Board, Haver Analytics, RBC GAM
relationship between inflation,
economic growth and the fed funds
rate. While the rule now suggests Exhibit 59: Term premium has climbed but still too low
rates should be higher, there is
little pressure for a significant
adjustment. The Taylor rule now 3.0
Term premium on U.S. 10-year
indicates the appropriate level for 2.5

Term
fed funds is only 0.78%, and as 2.0 premium is
Treasurys (%)
recently as spring 2014 fixed that 1.5 too low

level in negative territory. Absent 1.0
too-fast inflation or an overheating 0.5 Historical
economy, we expect the Fed will be 0.0 average
able to raise rates gradually. -0.5

-1.0
1990 1995 2000 2005 2010 2015
Bond risks return Source: Kim & Wright (2005), Federal Reserve, RBC GAM
A slow normalization of monetary
policy means that bond yields are
unlikely to spike higher, at least Exhibit 60: Koenig Taylor rule and fed funds rate
in the near term. Exhibit 61 shows
the components of our fair-value 12
10
models, combining an inflation 8
premium and a real rate of interest 6
to arrive at an estimate for nominal 4
2
yields. Yields now trade near 0
%
equilibrium (i.e. the band’s midpoint) -2

and the bulk of adjustment in the -4
-6
nominal yield over the past few -8
years has been delivered by a rise -10
in real rates. Following the financial 1990 1995 2000 2005 2010 2015
Fed Funds Rate Predicted Fed Funds Rate (Koenig Taylor Rule)
crisis, real yields dipped below zero,
Source: Federal Reserve Bank of Dallas, RBC GAM
meaning that fixed-income investors

were actually losing money on their

coupon income after adjusting Exhibit 61: Fair-value estimate composition
for the effects of inflation. As the
economic recovery gathered pace, United States United States
CPI Inflation Real 10-year T-bond yield
investors began to demand positive
16 12.0
real returns, pushing nominal yields 36-month Centred CPI
14 12-Month Forecast: 1.0% 10.0
higher. With real rates now in line 12
Last Plot: 0.9%
8.0
with our modeled level, the near- 10
8 6.0
term pressure on nominal yields 6 4.0
+1 SD
Last Plot: 1.3%
is much less acute. Nevertheless,
%
%
4
2.0
Average: 2.2%
we expect yields to gradually move 2
0.0
0 -1 SD
higher as monetary policy tightens, -2 -2.0
deflationary pressures subside and -4 -4.0
12-Month Forecast: 1.24%
1960 1970 1980 1990 2000 2010 2020 1960 1970 1980 1990 2000 2010 2020
the economy improves. 36-month Centred CPI Inflation Real T-Bond Yield
Actual Monthly CPI Inflation
Source: RBC GAM, RBC CM Source: RBC GAM, RBC CM
Even modest interest-rate rises,
however, pose a significant risk to
bondholders. At the current low U.S. 10-year T-bond yield
level of bond yields, it won’t take Equilibrium range
16
much to generate capital losses.
14
Exhibit 62 displays the break-even
12
for the 10-year Treasury yield. This
10
measure is an estimate of the degree 8
%
to which yields can increase over 6

the following 12 months before 4
capital losses completely wipe out 2
coupon income. With a 10-year bond 0
1980 1985 1990 1995 2000 2005 2010 2015 2020
yield of 2.20%, a mere 24-basis- Last Plot: 2.20% Current Range: 0.94% - 2.73% (Mid: 1.84%)
point rise would be enough to Source: RBC GAM, RBC CM
bring total returns to zero! As a
result, we expect that returns to Exhibit 62: U.S. 10-year Treasury
sovereign bondholders will be low, Required move in yields for break-even return against 30-day T-bill
or potentially negative, through the
50
quarters ahead.
45
Basis Points (bps)
40
Equities reverse gains
35
Stock markets have sold off heavily
30 Last Plot: 24
over the past few weeks, reflecting
renewed concerns over global 25
growth. The decline has pushed 20
equity markets below fair value, 15
potentially creating an attractive 10
entry point for investors (Page 43). 2009 2010 2011 2012 2013 2014 2015 2016
Source: RBC CM, RBC GAM

For the S&P 500, which has led

global markets for the past few Exhibit 63: Standardized S&P 500 fair-value bands
years, after rising slightly above
fair value (i.e. the band’s midpoint)
late last year, the summer swoon
took the Index back below S&P 500 most
equilibrium. Exhibit 63 illustrates overvalued 4
+1 SD
how this move can impact expected 3
forward returns. In it, we have FV
2
standardized our fair-value model -1 SD
so that equilibrium runs horizontally 1
S&P 500 most
through the centre of the chart, undervalued
and segmented the Index into four
1960 1967 1974 1981 1988 1995 2002 2009 2016
valuation buckets. The S&P 500 Source: Haver Analytics, RBC GAM
is most undervalued in Bucket 1,
and investments made within it
Exhibit 64: S&P500
typically provide the highest return Return prospects by valuation zone
over subsequent holding periods.
Bucket 4 is the most overvalued 1-year
1-year average 1-year
and, consistent with that, returns Data average Batting return in Max return
are on average weakest for positions Valuation set return average^ win* loss STD
established in this zone (Exhibit 64).
(S&P 500 most overvalued) 4 (0.7%) 50.0% 14.8% (27.5%) 17.0%
The S&P 500 now rests in
1 SD Above
Bucket 2 – the Bucket typically 3 3.6% 60.8% 13.3% (41.4%) 16.0%
offering the second-highest average Equilibrium
forward returns. In addition, 85% 2 12.0% 85.4% 16.2% (44.8%) 13.9%
1 SD Above
of months have featured positive (S&P 500 most undervalued)
1 14.7% 80.2% 19.9% (12.8%) 16.3%
returns when the index lies within
Bucket 2, and volatility has been, on *Win = Periods where returns are above 0%. ^Batting average = Incidence of winning in any
given period. Source: RBC GAM
average, the lowest.
While buying stocks below fair value Exhibit 65: Valuations and returns
increases return potential, we may Correlation between average composite z-score and S&P 500 forward returns
of course continue to see near-term 1.0
weakness for equities. Over longer 0.9 0.85
periods, however, market-valuation 0.8 0.72 0.72

0.7
models typically exhibit reasonably 0.6
Correlation
0.49
strong predictive power. We created 0.5 0.42
a composite of eight valuation 0.4
0.27
0.3 0.20
models to test this assumption, 0.2 0.13
comparing the cheap vs. expensive 0.1
0.0
signal of this indicator (as measured 3M 6M 1Y 3Y 5Y 10Y 15Y 20Y
by the z-score) with S&P 500 Time horizon
forward returns across a range of Note: the composite valution metric is the simple average of the following 8 valuation indicators:
market cap ÷ U.S. GDP, Tobin's Q, Shiller P/E (CAPE), 12-m forward P/E, 12-m trailing P/E, RBC
time frames. As one would expect, GAM fair value, equity risk premium, fed model. Source: Bloomberg, Haver Analytics, RBC GAM

buying stocks when the market is

Exhibit 66: S&P 500 Index
cheap (a low z-score) commonly Average of normalized valuation metrics
delivers stronger returns through
subsequent holding periods, but the 3.0
2.5
strength of that relationship nearly Market is expensive
2.0
doubles when moving from a one- 1.5
year horizon to a five-year time frame 1.0 Last plot: 0.08
(Exhibit 65). Currently, this valuation Z-score 0.5
0.0
composite is not far from our own -0.5
estimate of equilibrium for the -1.0
S&P 500, suggesting valuations are -1.5 Market is cheap
consistent with average to above- -2.0
1956 1963 1970 1977 1984 1991 1998 2005 2012 2019
average forward returns (Exhibit 66). Notes: Historical data from Jan 1956 for 12-M Trailing P/E, 12-M Forward P/E, Equity risk premium,
Importantly, the efficiency of this Shiller P/E, Tobin's Q and Fed model. Historical data from Mar 1956 for market cap ÷ U.S. GDP.
Historical data from Jan 1960 for RBC GAM fair value. Source: Haver Analytics, RBC CM, RBC GAM
indicator rises as the holding period
lengthens, and its predictive power
is simply not that impressive for Exhibit 67: S&P 500 Index
short intervals.
2500
Panic attack or bear market?
2000
A key debate for investors will be
whether the sell-off is the start 1500
of a bear market, or whether it’s
what Yardeni Research has called 1000
a “panic attack.” The evidence so

500
far suggests we are not in a bear
market. We examined pricing, 0
valuations and profit data from the 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Corrective phases
last 15 years in order to understand
Source: Yardeni Research, Bloomberg, RBC GAM
the difference between the two
types of corrections. Exhibit 67
shows the S&P 500 has had 10 Exhibit 68: S&P 500 in downturns
“panic attacks” in that time period,
reacting to a variety of triggers
Short-term Bear
including oil shocks and the panic market Average
Eurozone debt crisis. On average,
these corrections resulted in an 8% Average market decline (8.13%) (45.41%) (15.59%)
drop in the market, compared to an
average 45% decline experienced Average change in EPS estimates (0.17%) (15.74%) (3.29%)
during the period’s two bear markets
(Exhibit 68). The cause of the Average duration (days) 61 1647 378
weakness through these episodes
seems extremely important to Note: based on 10 downturns in the past 15 years.
the outcomes. Through the two Source: Yardeni Research, RBC GAM
bear markets of the past 15 years,

earnings estimates have plunged

Exhibit 69: U.S. analyst overoptimism in S&P 500 EPS estimates
nearly 16%, while revisions during Monthly pattern, averages for 1985-2014
panic attacked averaged only 0.2%.
The current turmoil has moved $125
equity-market valuations lower, $120

but forecasts for earnings have
been stable compared to the usual $115
degradation as a year progresses $110

(Exhibit 69). If profit estimates are
any indication, the current correction $105
could be short lived – the average $100

panic attack has lasted just 61 days. Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Average Forecast Error Rebased to Feb. 2015 Forecast
With still-rising earnings and more 2014 Mean Earnings Estimate 2015 Mean Earnings Estimate
Source: Chopra, ThomsonReuters, RBC GAM
attractive valuations, the total return
outlook for equities is compelling.
Exhibit 70 combines several Exhibit 70: E arnings estimates & alternative scenarios for valuations and
estimates for earnings with our outcomes for the S&P 500 Index
estimate for equilibrium valuations
to arrive at potential levels for CONSENSUS
the S&P 500. Combining the most 2015 2015 2016 2016
Top down Bottom up Top down Bottom up
conservative profit estimates and
the “equilibrium” P/E ratio (i.e. the P/E $121.3 $118.2 $131.8 $130.9
P/E ratio statistically consistent with +1 Standard Deviation 22.9 2783.0 2712.3 3022.2 3002.3
current and expected interest rates, +0.5 Standard Deviation 20.8 2522.2 2458.2 2739.1 2721.0
inflation and corporate profitability)
Equilibrium 18.6 2261.5 2204.1 2456.0 2439.7
pushes fair value for the S&P 500
to 2200 at year-end 2015, 12% -0.5 Standard Deviation 16.5 2000.8 1950.0 2172.8 2158.5
higher than the index at the time of -1 Standard Deviation 14.3 1740.1 1695.9 1889.7 1877.2
writing. Applying the current top-
Source: RBC GAM
down consensus forecast for 2016
earnings estimates provides upside
potential of nearly 24% over the Exhibit 71: S&P 500 and the fed funds rate hike
Implications for current cycle, following first rate hike
coming 16 months!
150
Level at Date of Initial Rate Hike
Rate-hike risks
Median Index Level as a % of
140
130
A possible shock to the stock market 120
110
too could come from a change in 100
monetary policy. It has been 11 90
years since the Fed has embarked 80
70
on a tightening cycle, and there has 60
been much focus on the negative 50
-12 -9 -6 -3 0 3 6 9 12 15 18 21 24
impact such a shift would have on Median of All Cycles Recession Cycles
the economy and equity prices. No Recession Cycles Worst (1973)
Months Prior to & Following Fed Fund Rate Hike
Historically, though, a round of rate Source: RBC GAM

hikes has resulted in an acceleration

Exhibit 72: AAII Sentiment Survey
of equity returns as often as it has Percent neutral
tipped stocks into a bear market.
60 2500
Exhibit 71 plots a “road map” of the
typical path of the S&P 500 leading 50 2000
into and following the start of a cycle
40
of rate hikes. In most cases, returns 1500
moderate in the period just prior to % 30
1000
a rate hike and shortly after, before 20
the rally resumes. Bear markets 500
10
have been triggered when policy
rates rise too quickly as the Fed 0 0
1995 1998 2001 2004 2007 2010 2013 2016
attempts to battle inflation, pushing
AAII neutral sentiment (LHS) S&P 500 Index (RHS)
the economy into recession. Today’s Source: American Association of Individual Investors (AAII), Bloomberg, RBC GAM
modest growth and low inflation
suggest that policymakers are ahead
of the curve, not behind, which Exhibit 73: AAII Sentiment Survey
should allow the Fed to boost rates Percent neutral and percent bearish
at a relaxed pace and avoid putting 60
too big a burden on the economy.
50
40
Sentiment shifts, styles stay
the same 30
%
One of the more interesting trends of 20

the past year had been the growing 10
number of investors with little or no 0
view on the market. The American 2011 2012 2013 2014 2015 2016
Association of Individual Investors Neutral Bearish
tracks sentiment and compiles Source: American Association of Individual Investors (AAII)
indices of the proportion of bullish,
bearish and neutral investors in the
market. We pointed out last quarter Exhibit 74: Returns for growth
that the AAII “neutral” sentiment S&P growth indices
was at a 10-year high, potentially
80% 40%
putting the market at risk of a
Cumulative excess returns to
60% 30%
consolidation/correction if investors 40% 20%
shifted into the bear camp (Exhibit 20% 10%
S&P 1500
S&P 1500
72). Since then, neutral sentiment 0% 0%

has collapsed and the proportion of -20% -10%
bears has risen materially (Exhibit -40% -20%
73). We are not yet at a point -60% -30%
where there are too many bears – a -80% -40%
2002 2004 2006 2008 2010 2012 2014 2016
contrarian signal that the market has S&P 400 Mid Cap Growth Index (LHS) S&P 600 Small Cap Growth Index (LHS)
found a bottom – but this will be an S&P 500 Large Cap Growth Index (RHS)
Source: S&P Dow Jones Indices, Bloomberg, RBC GAM
important indicator to monitor.

Even as sentiment changed rapidly

Exhibit 75: Returns for value
at the end of August with the sell- S&P value indices
off in markets, stocks that profile
closest to a “growth” style continued
60% 15%

to outperform (Exhibit 74). This
40% 10%
trend makes sense in the current
environment as a sluggish economic 20% 5%
S&P 1500
expansion pushes investors toward S&P 1500 0% 0%
companies with superior growth -20% -5%
potential. Value stocks typically
-40% -10%
outperform later in the economic
-60% -15%
cycle, when growth is no longer 2002 2004 2006 2008 2010 2012 2014 2016
scarce. Within the value style, S&P 400 Mid Cap Value Index (LHS) S&P 600 Small Cap Value Index (LHS)
S&P 500 Large Cap Value Index (RHS)
stronger relative returns for mid- and
Source: S&P Dow Jones Indices, Bloomberg, RBC GAM
small-cap stocks is an enduring
theme as large-cap value especially
continues to lag (Exhibit 75). Exhibit 76: Range-bound markets & cyclical bull phases
S&P 500 – 1870-2015
Asset mix 2187 Associated with Significant Economic Adjustment:
The re-emergence of macro- 729 1930s: Depression/Deleveraging
economic concerns and subsequent 1970s: Inflation
243
stock market decline have lowered 2000s: Tech Bust/Housing Bust/Deleveraging
equity valuations and bolstered the 81
long-term return potential for stocks. 27
Table A on the next page shows the
9
prospective returns for a list of asset
classes if they were to move to fair 3
value over a variety of time periods. 1

1870 1890 1910 1930 1950 1970 1990 2010 2030
On this basis, returns for equities
Source: RBC GAM, Robert J. Shiller
can be expected to exceed those
from fixed-income markets across all
time frames, with sovereign bonds Exhibit 77: S&P 500 Index
producing low or even negative total Long-term price momentum and departure analysis
returns. As a result, we continue to
90 YEARS 1926 - 31AUG15
overweight stocks and underweight TREND:
1860.20
fixed income in our recommended TURN:
2123.37
asset mix. We have increased our
1924 1934 1944 1954 1964 1974 1984 1994 2004 2014
equity exposure by two percentage 2000
1600
1200
points in recent months, sourced 800
600
400 CLOSE:
from bonds. 200 1972.18
S&P 500
In our view, the long-term case

for stocks remains intact. Equity
markets tend to move in long cycles,
featuring decade-long or even multi-
Source: RBC CM

Table A: Asset-class forward returns

1-year 2-year* 3-year* 5-year* 10-year* 15-year* 20-year*
Current forward forward forward forward forward forward forward
Asset class return1 return return return return return return return
U.S. Treasury Bill 0.10%

U.S. 10 Year Treasury Bond 3.34% 3.85% 0.26% 0.21% 0.80% 1.29%
U.S. 30 Year Treasury Bond 4.78% 4.48% (1.94%) (1.57%) 0.03% 1.33% 1.83% 2.12%
Canada 10 Year Government Bond (8.09%) (7.74%) (4.97%) (3.40%) (1.66%) (0.30%)
U.S. Investment Grade Bond** 4.44% 6.78% 2.78% 2.54% 2.93% 3.29%
Canada Investment Grade Bond** (5.12%) (3.19%) (1.71%) (0.61%) 0.72% 1.78%
U.S. High Yield Bond*** 6.81% 14.28% 9.31% 8.62% 8.55% 8.59%
U.S. Stocks (S&P 500) Total Return 9.31% 32.72% 20.51% 15.93% 12.84% 10.68% 9.94% 9.56%
Canadian Stocks (TSX) Total Return 26.75% 25.83% 16.16% 13.23% 11.68% 10.13% 9.58% 9.28%
1
If market moves to equilibrium. *Annualized returns **Bank of America ML Indexes, assuming long-term reversion to normal spread to T-bond, evenly through to end date
Source: RBC GAM, Bloomberg
decade secular bull markets followed

Exhibit 78: 10-year U.S. stock and bond performance
by long periods of consolidation and Stock market 10-year total return minus long bond 10-year total return
decline. Exhibit 76 shows that the
S&P 500 was locked-in a secular 600
bear market through the 1930s, the
Stock Market Outperformance
500
1970s and, most recently, following 400
+2 Std Dev
the peak in the late-1990s tech
300 +1 Std Dev
bubble. The rally over the past few
200 Mean: 120.5%
%
years pushed stocks above this last

100
trading range, indicating that we
0 -1 Std Dev
may have shifted into a secular bull
market. While secular bear markets -100 -2 Std Dev
are characterized by weak rallies -200
1935 1945 1955 1965 1975 1985 1995 2005 2015
and deep corrections, secular bull
Source: Ned Davis Research
markets typically feature short,
shallow declines and powerful,
sustained rallies. Technical work asset class dominates the other may support continued equity
from RBC Capital Markets supports for long stretches of time. After outperformance.
this thesis, as their Long Term Price underperforming significantly
following the technology-stock For a balanced, global investor, we
Momentum indicator featured in
boom and bust of the late 1990s, recommend an asset mix of 62%
Exhibit 77 (the smoothed line in the
the relative performance of equities equities (strategic neutral position:
top box) has been bottoming and
bottomed in 2009 (Exhibit 78), 55%), and 36% fixed income
could soon turn positive for the first
and at its lowest plot in over 75 (strategic neutral position: 40%),
time in over a decade.
years. Stocks have since moved with the balance in cash.
A similar pattern can be seen ahead significantly on a relative
in the relative performance of basis, but the relationship remains
stocks versus bonds, where one below the long-term average, which

GLOBAL FIXED INCOME MARKETS

U.S. 10-Year T-Bond Yield Eurozone 10-Year Bond Yield
Equilibrium range Equilibrium range
16 18
14 16
12 14
10 12
10
8
8
%
%
6
6
4
4
2
2
0
0
1980 1985 1990 1995 2000 2005 2010 2015 2020
1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 2.20% Last Plot: 1.23%
Current Range: 0.94% - 2.73% (Mid: 1.84%) Current Range: 1.04% - 2.21% (Mid: 1.62%)
Japan 10-Year Bond Yield Canada 10-Year Bond Yield

Equilibrium range Equilibrium range
14 18
12 16
14
10
12
8 10
8
%
6
6
4
4
2 2
0 0
1980 1985 1990 1995 2000 2005 2010 2015 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 0.38% Last Plot: 1.49%
Current Range: 1.45% - 2.32% (Mid: 1.88%) Current Range: 1.60% - 3.22% (Mid: 2.41%)
U.K. 10-Year Gilt

Equilibrium range
18
16
14
“We expect yields to gradually
12
10
move higher as monetary policy
8
tightens, deflationary pressures
%
6
4 subside and the economy
2
0 improves.”
1980 1985 1990 1995 2000 2005 2010 2015 2020
Last Plot: 1.96%
Current Range: 0.21% - 2.23% (Mid: 1.22%)
Source: RBC GAM, RBC CM

GLOBAL EQUITY MARKETS

S&P 500 Equilibrium S&P/TSX Composite Equilibrium
Normalized earnings and valuations Normalized earnings and valuations
5120 Aug. '15 Range: 1583 - 2645 (Mid: 2114) 25600 Aug. '15 Range: 13749 - 20535 (Mid: 17142)
Aug. '16 Range: 1923 - 3213 (Mid: 2568) Aug. '16 Range: 13656 - 20396 (Mid: 17026)
2560 Current (31-August-15): 1972 12800
Current (31-August-15): 13859
1280
6400
640
3200
320
1600
160
800
80
40 400
1960 1970 1980 1990 2000 2010 2020 1960 1970 1980 1990 2000 2010 2020
Source: RBC GAM Source: RBC GAM
Japan Datastream Index Eurozone Datastream Index

5760 Aug. '15 Range: 1681 - 3541 (Mid: 2611)

1040
Aug. '16 Range: 1796 - 3783 (Mid: 2790)
2880
520
1440
260 720
360
Aug. '15 Range: 277 - 791 (Mid: 534)
130
Aug. '16 Range: 253 - 722 (Mid: 487) 180
65 90
1980 1985 1990 1995 2000 2005 2010 2015 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM Source: Datastream, Consensus Economics, RBC GAM
U.K. Datastream Index Emerging Market Datastream Index

26880 Aug. '15 Range: 239 - 426 (Mid: 333)

Aug. '15 Range: 5848 - 11024 (Mid: 8436)
Aug. '16 Range: 7079 - 13346 (Mid: 10212)
640 Aug. '16 Range: 250 - 445 (Mid: 347)
13440
Current (31-August-15): 4716 Current (31-August-15): 220
6720 320
3360 160
1680
80
840
420
40
210 20
1980 1985 1990 1995 2000 2005 2010 2015 2020 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM Source: Datastream, RBC GAM

GLOBAL FIXED INCOME MARKETS
deflation. In testimony before for these programs other than the

Soo Boo Cheah, CFA Congress in July, Yellen reiterated her highest debt ratios in the developed
Senior Portfolio Manager intention to raise the policy rate this world and years of anemic economic
RBC Global Asset Management (UK) Limited year and was adamant that the U.S. growth exacerbated by an aging
Suzanne Gaynor economy “cannot only tolerate but population. Japan’s experience
V.P. & Senior Portfolio Manager needs higher interest rates.” shows that almost 15 years of
RBC Global Asset Management Inc. sub-1% interest rates forces workers
Why are low rates a risk? We believe to save more for retirement and
that the U.S. economy has extracted spend less – further crimping
Market view most of the benefits associated with economic growth.
ultra-low policy rates following the
For months now, arguments against
financial-market collapse six years Another point in favour of an interest-
the U.S. Federal Reserve (Fed)
ago. Asset prices have surpassed rate hike is that it would solidify
raising benchmark interest rates
pre-crisis levels, while labour the value of an already strong U.S.
have been building. These range
markets and business/consumer dollar at a time when most major
from fears that rate hikes will trigger
confidence have improved. At this central banks are easing, and a
a fall in asset prices and dampen
point in the business cycle, the stronger greenback tends to boost
consumption, to concern that
persistence of low interest rates consumption. The risk here is that
relatively low jobless figures mask
results in an unnecessary transfer U.S. exports might suffer and that
the growing number of people who
of wealth to borrowers from savers. inflation could slow further. However,
have given up looking for work and
One group of savers that gets hurt the benefit of the strong dollar would
that current deflation threats are too
particularly badly is pension funds, outweigh these negatives, given
great to risk tighter monetary policy.
for which low interest rates make it that the U.S. economy is driven
Somewhat lost in this cacophony are
hard to generate the income needed by consumption and that cheaper
reasons why Fed Chair Janet Yellen
to cover payouts to retirees. The imports would likely have a positive
might actually want to raise rates
social and economic costs of a failed impact on economic growth.
sometime this year.
pension system are too great to
ignore, and a wave of failures would The political pressures of widening
First, let us say we believe that the
be too costly for the taxpayer-backed societal wealth gaps may also play
time is approaching, and perhaps
Pension Benefit Guarantee Corp. to a role in the Fed’s decision on
has already arrived, when rate
bear. The Fed is right to fear that it tightening. The Fed’s asset-buying
hikes are appropriate. For one thing,
would be called upon to engineer program and zero-cost money have
the risk of deflation caused by a
another round of bailouts in the boosted prices for stocks and other
measured tightening in policy is
event of a pension crisis. assets and may have fed undesirable
lower, in the view of the Fed, than it
speculation. As a result, ultra-
was when they embarked on QE II in
Japan offers a lesson on the adverse loose policy is widening the wealth
late 2010 and QE Twist the following
effects of a long-running policy of gap between those with financial
year. Moreover, with Europe
low interest rates. The Bank of Japan assets and those without. The Fed
stabilized and U.S. growth seemingly
(BOJ) kept interest rates low and has acknowledged the income and
on a sustained footing, the Fed is
expanded its balance sheet after an wealth gaps, and a higher policy
worried that risks associated with
asset bubble burst during the 1990s, rate is a good starting point to
prolonged low borrowing costs
while the government embarked on address this issue from a political
outweigh the potential for low
massive public spending. Twenty-five perspective.
inflation to develop into sustained
years later, Japan has little to show

Global Fixed Income Markets | Soo Boo Cheah, CFA | Suzanne Gaynor
Once rate hikes arrive, the Fed will understands that further dithering by the Bank of Japan (BOJ) and the
likely proceed more gradually than will only heighten volatility, and we speed of investors’ shift away from
it has in prior tightening cycles. expect more hikes next year. The holding JGBs. We expect Government
We expect the Fed to kick things coming tightening cycle will be a of Canada bonds with intermediate
off with one 25-basis-point hike drawn-out affair, although investors to long maturities to track Treasuries,
before the end of 2015, and then to will need to accustom themselves to while short maturities will remain
assess its impact on markets and an uptick in borrowing costs as risk largely flat on expectations that the
the economy before deciding on the premiums in fixed-income markets Bank of Canada (BOC) will keep its
timing of further moves. The Fed’s begin to reflect tighter monetary benchmark interest rate unchanged.
predicament in exiting from ultra- conditions. Given volatile financial
loose monetary policy is a fear of the markets and the deteriorating We expect developed-market
unknown. The Fed’s models are less outlook for emerging markets, the government bond yields to reverse
reliable today given multiple rounds Fed will continue to divert investor the rally that they enjoyed for
of market intervention since the attention from the timing of the much of the summer, with financial
2008 crisis. Policymakers will want first hike by emphasizing that any markets settling down after the
to be cautious so that it can easily tightening cycle will be very gradual Fed delivers the rate hike, and
reverse itself if the economy starts and highly data-dependent. They as commodity prices bottom and
to weaken. will also continue to hammer home investors accept the reality of
the view that a policy of leaving slower Chinese growth. During the
The Fed may decide, despite the rates near zero has outlived its summer, many emerging markets
arguments presented above, to usefulness. were hit by falling commodity prices
put off raising rates given recent and weaker currencies, the latter of
heightened volatility in global which fanned inflation and raised
Direction of rates
financial markets. After all, the Fed the risks of a debt crisis. This was a
has shown before that it will not We are nudging our bond-yield
big change from the aftermath of the
move if the data does not support forecast higher and continue to
2008 global financial crisis, when
such a move. In March and June of expect shorter-maturity yields to rise
investors fled the assets of debt-
this year, they held off on boosting faster than longer-term yields. We
ridden developed economies for
rates after dismal U.S. economic forecast that a global bond portfolio
emerging markets with low
growth in the first quarter and will produce a relatively small loss
debt levels.
evidence of a weakening global of 1.0% over the next year, narrower
expansion. As we write, commodity than the 3% to 5% loss typical U.S. – We expect the Fed to hike
prices are spiraling downward, in the year after the Fed begins the policy rate once by the end
emerging-market policymakers are tightening. We expect the Bank of of 2015, while assuring investors
intervening in currency markets and England (BOE) to follow the Fed in that the size of its balance sheet
risk assets are selling off – all signs delivering a rate hike, pulling global will remain unchanged. Our view is
of a weak global economic outlook. bond yields higher. Meanwhile, that the Fed will also begin laying
If the Fed is uncertain about its the European Central Bank (ECB) is the groundwork for reducing large
decision to start raising rates, it has continuing with its planned asset cash stockpiles held by banks at
the excuses it needs to delay. purchases and we do not foresee the central bank to facilitate further
a premature termination of the tightening over the next 12 months.
All in all, we take Yellen at her program. In Japan, the direction of To derive our 10-year yield forecast,
word that the Fed will deliver a rate Japanese government bonds (JGBs) we assume a 1% fed funds rate by
increase by the end of 2015 as it will depend largely on bond-buying the third quarter of 2016, a 0.75%

spread between the overnight rate

Exhibit 1: Land prices outlook
and 2-year yield, and a flatter spread Abe honeymoon is over, more people see falling land prices
between 10-year and 2-year yields.
Based on these components, we 40
Diffusion: % said "Will go up"

forecast a 10-year Treasury yield in 30
Arrival of PM Abe
minus "Will go down"
the neighborhood of 2.75%, up 20
10
from our previous forecast of
0
2.50%. We have increased our fed
-10
funds forecast by 12.5 basis points
-20
to 1.00%.
-30
Germany – Yields on bunds should -40
stay low as inflation remains -50

2006 2008 2010 2012 2014
subdued. After a rapid sell-off in
Source: Bloomberg
May and June, bund yields are back
to tracking those of other global
bonds. With the Fed tightening and Exhibit 2: Economy’s growth potential – Abenomic fails to turn around the
weak sentiment towards economic growth potential
the ECB pursuing loose monetary
0
policy, yields on 10-year Treasuries
4% said Greater
Diffusion: % said "Greater
-10
Arrival of PM Abe
potential" minus "Less"
should widen relative to bund yields. vs.

-20 44% said Less
In the event of a bond-market sell- -30
off, bunds would receive support -40
from ECB asset buying and the fiscal -50
surplus of Germany, which does not -60
have to issue net new debt. We are -70
-80
keeping our policy-rate forecast at
-90
0%, reflecting expectations that the
-100
ECB will complete its bond-buying 2006 2008 2010 2012 2014
program, and increase the 10-year Source: Bloomberg, Bank of Japan
yield forecast to 1.00%, 30 basis

points higher than previously.
land prices (Exhibit 1), while the In line with the direction of global
Japan – Nothing has changed over number of respondents who see rates, we increase our yield forecast
the past year regarding our view less potential for economic growth for the 10-year JGB to 0.6%, 10 basis
of JGBs: they remain unattractive. far exceeded those who see better points higher, and expect no change
We see that, despite all of the hype potential (Exhibit 2). In the absence to the 0% policy rate.
around Abenomics, expectations are of improving long-term growth
expectations and higher asset Canada – The BOC cut its policy
rising that longer-term disinflation
prices, the Japanese are likely to rate by 25 basis points to 0.50%
will return. By two measures,
place more emphasis on saving. The in July at the same time that it
respondents in recent BOJ surveys
deflationary mindset is alive and lowered its growth projections for
were less optimistic about the
well in Japan, and we expect more the economy. The main reason for
prospects for gains in longer-term
intervention from the BOJ. the reduced forecast was continued
asset prices. The respondents were
fallout from the decline in oil prices
less positive about the outlook for

and weaker-than-expected non- INTEREST RATE FORECAST: 12-MONTH HORIZON

energy exports. The economy’s Total Return calculation: August 27, 2015 – August 26, 2016
surprisingly weak first half of the U.S.
year has delayed expectations for a
Horizon
return to stronger domestic growth. 3-month 2-year 5-year 10-year 30-year return (local)
We are closely watching the reaction Base 1.00% 1.75% 2.40% 2.75% 3.35% (1.1%)
of international investors, whose Change to prev. quarter 0.13% 0.35% 0.40% 0.25% 0.25%
record purchases of Canadian fixed- High 1.75% 2.75% 3.20% 3.50% 4.20% (5.1%)
income securities in the first half of Low 0.13% 0.30% 1.00% 1.50% 2.25% 5.6%
this year led to the outperformance Expected Total Return US$ hedged: (0.83%)
of Canadian government bonds.
GERMANY
This flow has slowed in the past two
Horizon
months as investors began shifting 3-month 2-year 5-year 10-year 30-year return (local)
assets to the money market from Base 0.05% 0.35% 0.55% 1.00% 1.65% (1.5%)
longer-term assets on concern that Change to prev. quarter 0.00% 0.15% 0.25% 0.30% 0.40%
oil prices could continue to decline. High 0.05% 0.50% 1.00% 1.50% 1.90% (4.3%)
Low (0.25%) (0.20%) (0.10%) 0.10% 0.60% 8.4%
In this environment, Government of
Expected Total Return US$ hedged: (0.22%)
Canada bonds have outperformed
Treasuries to about the same degree JAPAN
that the Canadian economy has Horizon
underperformed the U.S. economy. 3-month 2-year 5-year 10-year 30-year return (local)
Canadian bonds should continue to Base 0.05% 0.15% 0.25% 0.60% 1.70% (1.8%)
outperform, with the Fed forecast to Change to prev. quarter 0.00% 0.10% 0.00% 0.10% 0.00%
raise rates several times in the next High 0.05% 0.30% 0.50% 1.00% 2.00% (5.1%)
year and the BOC not at all. Low -0.10% (0.10%) (0.10%) 0.10% 1.00% 5.5%
We expect the BOC policy rate
CANADA
to stay at 0.50% and we have
Horizon
reduced our forecast for the 10-year 3-month 2-year 5-year 10-year 30-year return (local)
government bond by 25 basis points Base 0.50% 0.80% 1.20% 1.75% 2.50% (1.1%)
to 1.75%. Change to prev. quarter (0.50%) (0.45%) (0.30%) (0.25%) 0.00%
High 1.00% 1.50% 2.00% 2.50% 3.00% (5.8%)
U.K. –The BOE expects the U.K.
Low 0.25% 0.20% 0.50% 1.00% 1.70% 6.0%
economy to perform solidly over
the next three years, and that
unemployment and inflation will U.K.
remain low. Strength in the British Horizon
pound and weakness in commodity 3-month 2-year 5-year 10-year 30-year return (local)
prices will reduce inflationary Base 1.25% 1.60% 2.50% 2.75% 2.90% (2.7%)
pressures. However, a tight labour Change to prev. quarter 0.25% 0.35% 0.25% 0.25% 0.00%
market is likely to boost wages, High 1.75% 2.30% 3.25% 3.50% 3.50% (9.2%)
partially offsetting the currency Low 0.50% 0.50% 1.20% 1.50% 2.00% 9.3%
Source: RBC GAM

effect. We continue to expect the push yields lower because of concern driven by the reversal of a flight to
BOE to deliver the first rate hike of that a withdrawal would lead to lower quality. We expect short-maturity
the cycle after the Fed, most likely economic growth, and gilts would be rates to rise as central banks hike
in the first quarter of 2016 and viewed as a safe haven. policy rates, more than those on
gradually thereafter. We suspect that longer maturities, resulting in a 1%
the BOE will hike even if inflation is We are increasing our 12-month loss for a global bond portfolio.
below the central bank’s target, and forecast for the 10-year gilt to The lack of variation in projected
to hold off on further action while it 2.75%, 25 basis points higher than total returns across U.S. Treasuries,
assesses GDP growth and inflation. the previous quarter. Our policy-rate German bunds and JGBs means
One development that could keep forecast increases by 25 basis points that we are not recommending any
U.K. yields from climbing is the to 1.25%. regional preference this quarter.
possibility of a referendum next year
on whether the U.K. should remain Regional preferences
in the EU. Any indication that Britons We expect global bond yields to
will vote to pull out would tend to increase from the current low levels

CURRENCY MARKETS
Dagmara Fijalkowski, MBA, CFA Exhibit 1: U.S. dollar divergence: up vs. EM, flat vs. DM
Head, Global Fixed Income & Currencies
(Toronto & London)
RBC Global Asset Management Inc. 1.30
Rebased at 1.00 on July 1, 2014
1.25
Daniel Mitchell, CFA
Portfolio Manager 1.20
RBC Global Asset Management Inc. 1.15
1.10
1.05
Update on U.S. dollar cycle 1.00
The foreign-exchange market is 0.95
never boring, even when it appears Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
to be so on the surface. For example, USD vs Majors USD vs OITP (EM)
Source: RBC GAM, U.S. Federal Reserve
we saw the U.S. dollar move higher
during the past quarter at the
index level. But the devil is in the
Exhibit 2: U.S. dollar strength compared to past bullish cycles
details, and the index, like other
averages, camouflages considerable
1.70
divergences in performance. The
1.60
U.S. dollar bull market continued and
1.50
even accelerated against emerging-
1.40
market currencies, a trend captured
1.30
by the Other Important Trading
1.20
Partners Index (OITP). But within the
1.10
G10, the U.S. dollar underperformed 1.00
not only European currencies -1,000 -500 0 500 1,000 1,500 2,000 2,500
but also the Japanese yen, while Days into USD Bull Market
1978 - 1985 1994 - 2002 2011 - Present
significantly outperforming Source: RBC GAM, Bloomberg
commodity-sensitive currencies
such as the Canadian dollar. Net
as the euro. After a few months, partners, four years long and 40%
net, the U.S. dollar measured on a
however, the divergence was strong, is over the hump now (Exhibit
trade-weighted basis versus major
closed as the U.S. dollar regained 2). Now comes the more difficult
trading partners was unchanged
its footing against the majors. We half of the cycle, as the greenback
during the quarter (Exhibit 1). It’s not
believe that the current episode is no longer deeply undervalued
the first time we have seen such a
will end in a similar way, and we’ll (Exhibit 3) and its ongoing strength
divergence in recent years. We saw
discuss this view in our article. depends on other factors. Central-
such a development in the second
bank policy divergence, relatively
half of 2013, during the so-called For almost five years, we’ve been strong U.S. economic growth, capital
taper tantrum, when the U.S. dollar providing variations of the same flows and risk appetite are just a few
rallied sharply against emerging- message – an outright positive view that come to mind. Still, the odds
market currencies while weakening on the U.S. dollar. The dollar bull are higher that the U.S. dollar will
against major currencies such market against major U.S. trading

Currency Markets | Dagmara Fijalkowski, MBA, CFA | Daniel Mitchell, CFA
continue its rise to overvalued levels

before the cycle reverses. However, Exhibit 3: U.S. dollar and its purchasing power parity valuation
the path may be more volatile,
and the risk-reward for dollar bulls 150
such as ourselves is becoming less 140
130
attractive. The times call for smaller
120
positions and more tactical trading. 110
100
90
What’s with China? 80
Devaluation and reserve- 70
60
currency ambitions 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15
While we typically discuss only PPP USTW$ 20% bands
the five major currencies in the Source: Deutsche Bank, Bloomberg
Global Investment Outlook, we

have broadened the scope of this
quarter’s article to discuss the Exhibit 4: China’s debt market compared to others
renminbi given concerns about
Chinese growth and the recent 7,000
currency weakness. For the past few 6,000
USD Billions
years, we have heard about Chinese 5,000

ambitions to “internationalize” 4,000
3,000
its currency. This term broadly
2,000
embraces a combination of 1,000
individual reforms aimed at 0
Japan
France
Canada
Italy
Germany
China
U.S.
U.K.
Australia
increasing the renminbi’s use
outside of China’s borders with the
ultimate objective being to become Restricted by Capital Controls Available to Foreigners
a reserve currency rivalling the U.S. Source: BNP Paribas
dollar and the euro. To this end,

China has been promoting the use of the Chinese onshore bond market created in 2007 with the China
the renminbi as a trade-settlement has increased fivefold in a decade Development Bank’s issuance of the
currency by entering into trade to almost US$4 trillion – making it first renminbi-denominated bond
deals, establishing bilateral swap the world’s third largest after the for trading outside the mainland
lines and renminbi trading hubs, U.S. and Japan1 – it is not accessible (denominated in a parallel currency
and setting up a free-trade zone in to foreigners, with the exception of known as CNH). This market is often
Shanghai. These steps need to be licensed international investors or referred to as the “Dim Sum” bond
complemented by the development foreign central banks involved in market. While the Dim Sum market
of attractive investment destinations currency swap deals with Beijing. has grown fast, it is still barely 2.5%
for holders of the Chinese currency, a On the other hand, international of onshore Chinese debt and smaller
massive task for a centrally planned investors can freely invest in China’s than the market for Government
economy. The problem is that while offshore bond market, which was of Canada bonds (Exhibit 4).
1
FTSE Russell, “FTSE China Offshore Bond
Index Series,” June 2015

On the equity side, restrictions are dominance of the global financial versus the U.S. dollar. The bottom
considerable as well. Foreigners can system and would like to take on a line is that the PBOC has taken a
participate in local equity markets similarly important role in it. It sees step to allow the exchange rate to
provided they apply and receive inclusion in the SDR basket as a be more market-driven. Naturally,
a Qualified Foreign Institutional step in that direction. While there is the news was also interpreted
Investor license (QFII), but the confusion as to whether the Chinese as a competitive devaluation or
entire capitalization accessible to currency meets the “freely usable” another salvo in the “currency war,”
foreigners is only US$150 billion so criterion, IMF Managing Director a development that brings us to
far, less than 3% of the total market Christine Lagarde has already stated the reason we chose to include a
value of China’s stock markets. that it’s simply a matter of time.2 discussion of the renminbi in
This access is being provided The renminbi’s inclusion in the this GIO.
through pilot programs that when basket, however, would be largely
rolled out will serve as the bridge symbolic, and there should not The renminbi devaluation in August
to the mainland market. Along the be any direct effect on flows as a unsettled markets across the board,
way, there have been numerous result. Importantly, it would also not spilling over into expectations of
initiatives like the Hong Kong – mean that the renminbi immediately further competitive devaluations,
Shanghai Connect program, all becomes a “reserve currency.” and weakness in emerging-market
leading to greater recognition and For that to happen, a deep debt and commodity currencies, and
comfort of foreign investors with market accessible to foreigners and broad concerns about global growth
the renminbi. These initiatives will preferred by them would be required. since China has accounted for 30%
have to continue in order to create Also, not all reserve currencies are to 40% of it lately. Consequently, the
deep, investable and open markets, in the SDR basket. For example, the Chinese devaluation had a lot to do
and create conditions whereby the Canadian and Australian dollars are with the divergence in performance
renminbi can become a “freely reserve currencies, but do not qualify of the U.S. dollar versus other
usable” currency as defined by for the SDR basket because they are emerging-market currencies and
international organizations such as not used for international trade. versus the majors.
the IMF. Is the renminbi still overvalued
Changes in the way the daily
The Chinese government is keen to renminbi fix is calculated, after its recent decline? It has
be recognized for its progress and announced on August 11, were a been appreciating for the past
is seeking to secure IMF inclusion step in the right direction for China eight years. Should we now expect
of the renminbi as the fifth currency to make its exchange rate more further devaluations? According to
in the basket for Special Drawing market-driven. The new fix will a Goldman Sachs analysis using
Rights (SDRs)(See “China and the no longer be set arbitrarily by the the FEER model,3 which looks at
SDR” article in this publication). People’s Bank of China (PBOC), but exchange-rate valuations relative to
To this end, China has been taking rather be based on the previous the current account, the renminbi’s
steps, recently accelerated, to make day’s closing price, supply-and- undervaluation peaked in 2007,
the renminbi a more market-driven demand conditions derived from and after eight years of being
currency. Why these ambitions? a survey of 32 dealers and the undervalued it has pretty much
China is concerned about U.S. movement of major currencies returned to fair value (Exhibit 5).
2 3
Comments in response to questions after a FX Views: Is the Renminbi overvalued?, Robin
speech at Fudan University on February 6, Brooks, GS, Aug 28, 2015
2015. For a more thorough discussion of this
topic, please see the article “China and the
SDR” in this publication.

From a valuation perspective,

at least, there is little reason to Exhibit 5: China’s currency is close to fair value
expect further weakness, but that
doesn’t mean that there may not 100
Values above zero denote the required
be other reasons for the currency 75 rise in RMB to bring the current account
to weaken. One of them could be a 50 to equilibrium, i.e. undervaluation
pickup in capital outflows driven by 25

0
corporations that still hold renminbi.
-25
We expect neither an acceleration
-50
in capital outflows nor a deliberate -75
policy of weakening the currency -100
to stimulate exports, but instead 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
CNY FEER
a gradual decline managed by
Source: Goldman Sachs
authorities who value stability.
The euro their own. As investors in emerging- however, we need to focus again
market currencies continued losing on likely divergences in monetary
Volatility associated with the
money rapidly, positions had to policy. The Fed has been trying to
Chinese equity sell-off and the
be closed and the euro regained keep the possibility of a September
panicky reaction of policymakers
some of its strength. Furthermore, hike alive, but October or December
to the turmoil has in our view been
concerns about weak Chinese are more likely bets. On the other
one of the key reasons for the
growth spreading to developed hand, the ECB is facing the prospect
euro’s resilience. As we have been
markets and having a negative effect of failing its inflation mandate, with
noting, the launch of quantitative
on commodity prices resulted in an the average CPI forecast for 2015
easing by the European Central Bank
unwinding of euro shorts against lowered to 0.1% in early September.
(ECB) in March 2015 depressed
the U.S. dollar and commodity The forecast may have to be revised
interest rates and led to speculation
currencies. Risk aversion and down even more as ECB President
that the currency would decline,
position unwinds tend to level off in Draghi stressed downside risks
making the euro a popular funding
a relatively short time, so we expect stemming from falling oil prices.
currency. Meanwhile, investors
the euro strength to be temporary. So even though the ECB is making
favoured the U.S. dollar and most
good progress expanding its balance
emerging-market currencies with It’s true that the Eurozone economies sheet, they’re certainly not going
higher yields. When the renminbi have been doing better than in to taper the QE program as some
started weakening, these emerging- recent years. They benefit from ECB had been calling for. If anything,
market currencies joined the easing, low oil prices, a weaker we believe the risk lies toward an
trend. Some pegged currencies euro and recently revived lending extension of the program. After all,
including the Vietnamese dong and channels. The improvement in inflation is the ECB’s single mandate,
Kazakhstan’s tenge were devalued, growth was also part of the reason and rising bund yields are not
aided by governments scared of the the euro had been pretty resilient helping to achieve the ECB’s goals.
competitive pressures that a weaker even before China’s devaluation, We know from the Fed’s experience
renminbi would exert, while other when the currency should have been that it isn’t easy to wean markets off
currencies that trade more freely weighed down by fears of Grexit extraordinary liquidity programs.
didn’t need help and weakened on and continued QE. Looking forward,

Finally, despite its current-account

surplus, European capital flows Exhibit 6: Eurozone portfolio outflows dwarf the current account
are negative. Notably, the pace
at which Europeans are buying 600
12-month Sum, EURbn

foreign bonds represents an outflow
400
that’s TWICE the size of the current
200
account (Exhibit 6). Moreover, with
foreign-reserve growth reversing, 0
diversification flows into the euro -200

are now working in reverse. As -400
emerging-market countries spend
-600
foreign-exchange reserves to 1999 2001 2003 2005 2007 2009 2011 2013 2015
support their currencies, they tend Current Account Inflows Portfolio Outflows
Source: RBC GAM, Eurostat
to eventually sell euros to rebalance
their currency holdings. In addition,
U.S. investors continue to bring
money home from abroad, as shown Exhibit 7: U.S. investors are selling foreign investments
in the Treasury International Capital
Flow data (Exhibit 7). Once jittery 300
Inflows into US
USDbn, 12-month Sum
euro shorts are closed, which we 200

think has already played out, the 100
downtrend against the U.S. dollar 0
should resume. Our target of parity -100
should be easily achieved within the -200
next 12 months. -300 Outflows from US
-400
2000 2003 2006 2009 2012 2015
The yen
U.S. Repatriation Flows
In many ways, the yen’s story Source: Morgan Stanley, U.S. Treasury Department
seems similar to the euro’s given
the continued monetary easing and
capital outflows in Japan and the Exhibit 8: Japanese yen real effective exchange rate valuation
Eurozone. The difference is that the
yen is really cheap while the euro
160
trades near fair value (Exhibit 8).
Therefore, it will not be valuations 140
that make the yen cheaper still.
120
We believe that the primary driver
Long term average
of yen weakness will again be 100
monetary-policy divergence as the
yen resumes its relationship with 80
interest-rate differentials. That 60

relationship stopped working in 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: Bank of Japan

2013, as seen in Exhibit 9, perhaps

because U.S. rates stagnated, or Exhibit 9: USDJPY comovement with U.S. 2-year Treasury yields
perhaps because of renewed faith
in the success of Abenomics. U.S. 6% 135
rates are about to be tightened, 5% 125
while on the other side, the risk that
4% 115
the BOJ will have to resort to further
3% 105
easing measures is not insignificant.
After all, inflation is still the missing 2% 95
component of the Japanese growth 1% 85
story despite prior yen weakness 0% 75
and attempts by the government to 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
spur wage growth. The effect of low US 2yr Yields (LHS) USDJPY (RHS)
Source: RBC GAM, Bloomberg
oil prices seems to be lingering, and
wages are held down by an influx of
women into the workforce, often in
part-time or lower-paid service jobs. Exhibit 10: Japanese net purchases of foreign securities
With the BOJ’s inflation target out
of reach, there is a need for more 200
Outflows from Japan
central-bank action. 150
100
The Japanese economy is growing
USD Bn
near its 0.5% potential, and the 50

weak currency and low energy -
prices have been helping the current Inflows to Japan
(50)
account to improve. Also aiding the
(100)
current account is the re-opening Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15
of nuclear power stations, the Bonds & Equities Bonds Equities
Source: Haver Analytics, Japan Ministry of Finance
first of which occurred on August
11, and others should gradually
restart operations. Moreover, with employment gap in Japan could lift funds and insurance companies,
the third arrow of Abe’s economic the country’s gross domestic product and these flows have now been
plan, structural reforms, kicking by nearly 13%.4 amplified by outward foreign direct
in gradually, economic-growth investment (FDI). Examples include
potential could accelerate despite In the near term, however, Japanese large merger and acquisition deals
the declining population. Abe’s investment flows have been like Meiji Yasuda Life’s bid for
“Womenomics” reforms could negative for the currency (Exhibit Standcorp Financial (US$6.4 billion)
reverse the decline in the 10). After the Government Pension and direct overseas investments
working population temporarily. In Investment Fund rebalance, which into car manufacturing in Mexico
a report last year, Goldman Sachs drove approximately US$139 billion announced by Honda, Toyota,
estimated that closing the gender abroad, came the copycat pension Nissan and Mazda.5 The amounts
4 5
GS, Kathy Matsui, Japan: Portfolio Strategy, Mexico: http://www.
“Womenomics 4.0: Time to Walk the Talk”, mexicotradeandinvestment.com/factsheet.
May 6, 2014 html

are significant, with the 12-month

figure of US$120 billion representing Exhibit 11: Central banks’ policy divergence reflected in FX
almost 3% of GDP. These flows are
expected to remain a negative for 120
the currency, which may get even 115
cheaper. Between these flows 110
and policymakers’ intention to 105
drive the yen lower, we expect the 100
currency to cheapen further 95
over the next 12 months despite 90
attractive valuations. 85
Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15
USD GBP JPY EUR
Sterling Source: RBC GAM, Bloomberg
The pound continues to have more
in common with the U.S. dollar than
with the euro or the yen, mostly
Exhibit 12: Bank of England forecasts too pessimistic on employment
because the Bank of England (BOE),
like the Fed, is preparing for the first
9.0
hike of the next tightening cycle,
while other central banks are still 8.0
easing (Exhibit 11). The BOE has 7.0
been sending hawkish signals, as
6.0
wages are now rising and the central
bank’s estimates have consistently 5.0
lagged the improvement in the 4.0
unemployment rate (Exhibit 12). 2011 2012 2013 2014 2015 2016 2017
Realized unemployment rate Nov-13 Feb-14 May-14
To be clear, headline inflation is
Aug-14 Nov-14 Feb-15 May-15
still languishing near zero and BOE Source: Bank of England, UK Office for National Statistics
Governor Carney was again forced
to explain to the Chancellor why
inflation is so far below the central Exhibit 13: GBPUSD and its purchasing power parity valuation
bank’s 2% target. The BOE’s view
remains that headline inflation is
1.8
affected by the transitory impact of
1.6
the oil-price drop, and that the July
pick up in core inflation to 1.2% is 1.4
more relevant. The strength of the 1.2
pound, which at US$1.54 is 11%
1.0
overvalued (Exhibit 13), is probably
0.8
the reason why the BOE would rather
wait for the Fed to make the first 0.6
73 76 79 82 85 88 91 94 97 00 03 06 09 12 15
move. While Carney has recently
PPP 20% Bands USDCAD
welcomed the market focus on Source: Deutsche Bank, Bloomberg

the timing of the first hike, he also

reflected on the strong pound’s Exhibit 14: USDCAD and its purchasing power parity valuation
effect on inflation. In our forecasts,
we expect the parallel relationship 1.8
between the two central banks and 1.6
the currencies to continue, and for
1.4
the pound to run a close second in
performance behind the U.S. dollar. 1.2
1.0
Canadian dollar 0.8
The Canadian dollar, like the other 0.6
commodity-sensitive currencies, 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15
PPP 20% Bands USDCAD
was battered during the latest Source: Deutsche Bank, Bloomberg
three-month period, losing more
than 6.00% versus the U.S. dollar
and 4.75% on a real trade-weighted
Exhibit 15: Canadian dollar real effective exchange rate
basis. It went from near fair value
to somewhat cheap based on
110
purchasing power parity (Exhibit
14). While we have little doubt that 100
we will see the Canadian dollar
90
significantly undervalued before
this currency cycle is over, in the 80
short term valuations mean little and
70
we place more emphasis on other
potential drivers. There is no doubt 60
80 85 90 95 00 05 10 15
that the Bank of Canada (BOC) rate
BIS Real Effective Exchange Rate for Canada Long-Run Average
cuts and commodity weakness have Source: Bank for International Settlements
weighed on the loonie, but there
are other factors that still point to
more than two years for it to drop continue to run current-account
further weakness.
15%, and only this year has it deficits. Unfortunately, these deficits
Competitiveness is one of them. The settled at more attractive valuations. are not funded by more stable
Canadian dollar’s strength between However, businesses don’t react sources like FDI but by more flighty
2007 and 2012 added substantially overnight. It takes time for the sources of capital such as portfolio
to the country’s unit-labour costs currency effect to find its way into flows and short-term currency
and hurt competitiveness versus business decisions that will lead to deposits (Exhibit 16). Eventually, the
the U.S. and Mexico. The recent the desired pick up in non-energy currency weakness will work its way
weakening of the currency should exports. Economists estimate the through the system, and non-energy
help, but that effect comes with a delay to be about 18 months, which exports and FDI will follow.
lag. As Exhibit 15 shows, on a real would imply that we may not see
improvement until the middle of next Of course, weakness in energy
trade-weighted basis, the Canadian
year. Before the effect of currency prices and global growth are not
dollar spent most of the five-year
weakness kicks in, Canada will yet behind us. Until concerns about
period at expensive levels. It took

Chinese growth and its spillover

are alleviated, the Canadian dollar Exhibit 16: Canadian current-account deficits not well funded
will be on tenterhooks. Even if we
don’t see further weakening in 8% 8%
commodity prices, a lot of damage 6% 6%
to Canada’s commodity producers 4% 4%
has been done, as oil prices % of GDP
% of GDP
2% 2%
had been assumed to be much
0% 0%
higher in producer budgets and
-2% -2%
BOC projections. Morgan Stanley
-4% -4%
argues6 that as commodity prices
move below break-even levels, the -6% -6%
90 96 02 08 15
second round effects such as cuts in Net FDI Less Stable Financing Sources C/A balance
Source: Haver Analytics, Statistics Canada
capital expenditures will kick in. The
BOC’s July Monetary Policy Review
forecast a 40% investment decline In the near term, however, the We’re still bullish on the U.S. dollar,
in the Canadian Energy sector in Canadian dollar is extremely but more tentative now, recognizing
2015. However, the forecast was correlated to oil prices and a bottom that the pace of the gains has been
built with the assumption that the in oil could lead to a reprieve for significant and that the currency is
price of Western Canada Select oil the Canadian dollar. Our 1-year no longer undervalued. Of the four
would remain steady. Given further forecast of 1.40 is aligned with major currencies, the pound, we
downward movements in oil prices expectations for further weakness think, will continue to hold its own
since the report was produced, the and our longer-term view. In the near against the U.S. dollar, while the
average for the year is on track to be term, retracements below 1.30 are loonie, euro and yen will continue to
11% less than the Bank of Canada possible. suffer. Finally, we are keeping an eye
had expected. on market reforms in China. They are
Conclusions happening much faster than many
Considering competitive concerns investors had expected and carry
The U.S. dollar cycle continues to
and energy-price weakness, the some important short-term and long-
progress along the typical path,
U.S. dollar trend and the divergence term implications.
but it is maturing with each passing
in central-bank policies, we expect
quarter.
that the loonie will find its way into
overshoot territory on valuations.
6
Morgan Stanley Global Currency Research
Team, Aug 20, 2015, FX Pulse

THE CURRENCY OUTLOOK: KEY FACTORS
EURO
SUPPORTIVE NEGATIVE
SHORT TERM SHORT TERM
Growth supported by lower oil prices, ECB stimulus, Monetary-policy easing by the ECB during a period when the Fed is
cheap currency expected to hike
Corporate loan growth turns positive in July, first time Falling oil makes ECB’s inflation forecasts much harder to attain
since May 2012 Uncertainty associated with rising popularity of anti-austerity parties
Slower austerity eases strain on peripheral economies and upcoming elections
For now, Greece remains in the Eurozone Growth-eroding effect of Russian sanctions
The euro has been a popular funding currency, so bouts Possible U.S. tax on foreign cash balances of U.S. corporations would
of risk aversion result in buying pressure reduce incentive to retain earnings abroad
European fixed-income investors have been buying assets abroad in
LONG TERM search of higher yields
The ECB took over euro-area bank supervision. Steps Bearish trend well entrenched
toward a banking union scheduled over the next
two years LONG TERM
Current-account surplus Low GDP growth potential
Lack of population growth
Structural unemployment in peripheral countries
Slowing of Chinese growth will continue to weigh on Eurozone exports
Greece has lasting impact on confidence in the common currency
Reserve managers engaged in multi-year process of reducing
allocations to euro
12-MONTH FORECAST: weaker euro, 1.00
POUND STERLING
SUPPORTIVE NEGATIVE
Growth outlook is positive Expectations for near-term BOE action may be over-optimistic
Wages growth suggests Bank of England will begin to Growth in housing market peaked in 2014 and continues to decline
hike rates in 2016
Largest trading partner, the Eurozone, has begun to see LONG TERM
an improvement in economic activity High vulnerability to renewed stress in global financial system
Portfolio investment inflows have been positive Current-account deficit among highest in the world, and trend
Pound boosted relative to euro thanks to ECB is deteriorating
quantitative easing Referendum on EU membership is on the horizon
Pound is trading above fair value, which has been trending lower
LONG TERM
Beneficiary of any potential risk aversion in Europe
Inflation no longer eroding pound’s long-term
fair value
Stronger growth potential than Europe
Pound near cheaper end of multi-decade
trading range
12-MONTH FORECAST: weaker pound, 1.51

CANADIAN DOLLAR
SUPPORTIVE NEGATIVE
Currency weakness should help the non-energy Bank of Canada maintaining an easy monetary policy stance
manufacturing sector (with a lag) Monetary policy losing its effectiveness with rate cuts unable to help
New-company formation has turned positive on a year- the weakest segment of the economy (energy sector) and with banks
over-year basis for the first time since 2008 failing to match the entire cut
Possible delay in Fed hikes Impact from oil weakness has yet to be fully felt, will weigh on
Benefits from short-covering in oil, commodities employment and business investment in the western provinces
Consumer indebtedness becoming a concern, may hinder the Bank of
LONG TERM Canada’s ability to hike when the time comes
Endowed with an abundance of natural resources Upcoming elections create uncertainty
Proximity to the U.S. and economic linkage to growing Commodity sell-off bandwagon
economy Concerns about energy exposure of Canadian banks
Fiscally responsible, with a return to surplus expected in
the 2015-2016 fiscal year LONG TERM
Unanimous AAA rating is attractive to longer-term Current-account deficits financed via more precarious sources
investors like reserve managers Sluggish productivity growth underpins competitiveness problems
Deep, well-educated and flexible labour market Rising U.S. dollar trend
Thanks to immigration, Canada has a more stable FX reserve growth in EM economies, once positive for the loonie, has
demographics profile than the U.S., Europe or Japan turned negative
Housing valuations are a long-term risk
12-MONTH FORECAST: weaker Canadian dollar, 1.40
JAPANESE YEN
SUPPORTIVE NEGATIVE
Yen tends to strengthen during times of risk aversion Yen will be sensitive to U.S. yields in Fed hiking environment
BOJ in no hurry to increase quantitative easing Real yields deeply negative
Improvement in trade balance due to cheapening M&A activity picking up, with large overseas acquisitions by Japanese
energy prices insurers and automakers
LONG TERM LONG TERM

Valuations rank the yen as the cheapest of the G10 Pension funds still raising allocations to foreign assets, representing a
currencies substantial outflow of capital
’Third-arrow’ economic reforms should benefit growth in Worst public debt/GDP of any major economy
the longer term Worst demographic profile of any major economy over the next
40 years
Bank of Japan may be forced to ease monetary policy further with
inflation still unacceptably low
Yen is very sensitive to bullish U.S. dollar trend
12-MONTH FORECAST: weaker Japanese yen, 133

CHINA AND THE SDR
The Special Drawing Right be either an increase in the amount

Taylor Self, MBA in brief of gold globally or the U.S. had to
Analyst allow persistent financial outflows.
RBC Global Asset Management The Special Drawing Right (SDR)
In the immediate post-war period,
was designed by the IMF with the
persistent financial outflows were
intention of creating a reserve asset
not a concern, as the U.S. controlled
China’s decision to allow that would liberate global liquidity
some 60% of global gold reserves.
conditions from the abundance or
its currency to float more scarcity of U.S. dollars and gold.
However, in the 1960s, academics,
freely has been widely cited public policymakers and investors
However, the SDR represents neither
became increasingly wary of the fact
as an important element of a currency nor a claim on the IMF.
that such persistent shortfalls would
the spike in capital-market Instead, it is a form of liquidity
undermine the long-term value of the
provision that grants the holder
volatility in August. This paper, unconditional on-demand access
U.S. dollar. This flaw in the Bretton
prepared by a member of the Woods system is commonly known
to freely usable currencies with no
as the Triffin dilemma.
RBC currency team, explains fixed maturity. In other words, any
holder of an SDR may sell it and The Triffin dilemma refers to the fact
the development and function
receive the currencies underlying its that if global reserves were primarily
of the Special Drawing Right, value, currently the euro, the U.S. denominated in U.S. dollars, rising
why China wants its currency dollar, the pound and the yen. levels of world trade and finance
to be a part of it and what would require ever greater levels
China has done to qualify for History of the SDR of U.S. dollars to facilitate such
SDRs were originally conceived as a activity. However, such a rising stock
inclusion.
reserve asset that would supplement of dollars would necessitate a U.S.
a country’s foreign-exchange balance-of-payments deficit, which
reserves. Its creation was spurred by would gradually undermine the value
the increasing pressure faced by the of the U.S. dollar relative to the
Bretton Woods currency system in price of gold, to which it was fixed.
the 1960s. In a nutshell, the global As countries became increasingly
financial system was finding itself concerned about whether the U.S.
running short of adequate reserves dollar would retain its value, more
to finance the post-war boom in and more demanded conversion of
world trade and finance. their U.S. dollars (of which there
was an increasing supply) at the
Under Bretton Woods, exchange fixed rate to gold, whose supply was
rates were notionally fixed to the relatively constrained.
price of gold. In practice, countries
managed their exchange rates to At the 1967 meeting of the IMF
the U.S. dollar, and the U. S. agreed Board of Governors, the framework
to freely exchange dollars for gold for the creation of a reserve asset
at US$35 per fine ounce. What this to supplement holdings of gold
meant was that for international and foreign exchange was agreed,
reserves to increase, there had to and the first SDRs were issued in

China and the SDR | Taylor Self, MBA
1970 at a rate of 1 SDR to 1 USD, or What is an SDR? This market has functioned via what
0.888671/gram of gold. By granting While an SDR is notionally a reserve are called Voluntary Transaction
the IMF the prerogative to create asset on par with official foreign- Agreements (VTAs) since 1987.
an international reserve asset, exchange reserves and gold, it To date, it does not appear that
global liquidity became an issue cannot be considered a currency there has been an instance where
of international cooperation and on its own or a claim on the IMF’s insufficient liquidity was provided via
decision-making. assets. SDRs are not traded on these agreements in order to satisfy
global markets nor are any assets all parties who wished to buy or
In 1974, following the collapse of sell SDRs. In the event that there is
the Bretton Woods system in 1973 denominated in terms of SDRs and
countries cannot claim IMF assets insufficient liquidity to clear the SDR
and a move to a floating exchange- market, the IMF can implement what
rate regime, the value of the SDR in exchange for their SDRs either.
They are simply units of account is called the Designation Mechanism.
changed to the format we recognize Under this mechanism, the IMF can
today, that of a basket of currencies. for the IMF and select international
institutions. designate members with strong
Originally, the SDR basket was balance-of-payment and reserve
composed of the currencies of 16 Instead, SDRs are potential claims positions to buy SDRs from those
IMF member-countries selected on on the freely usable currencies of IMF wishing to sell. This arrangement
the basis that each comprised at members and their value is based serves to bolster the reserve status
least 1% of world trade. on commitments by all members to of SDRs by backstopping liquidity in
However, this basket proved both exchange SDRs for the underlying the instrument.
difficult to manage and costly basket currencies. In other words,
to replicate. As a result, the IMF holders of SDRs may sell them and SDR quinquennial reviews
reduced the number of currencies receive U.S. dollars, yen, pounds The SDR basket is subject to five-
in the basket to five: the U.S. dollar, and euros in exchange. These year reviews, at which time the
the French franc, the German funds received can be used to meet weights of the component currencies
deutsche mark, the Japanese yen balance-of-payment obligations are determined. The SDR basket
and the British pound. By doing without the need to implement is kept stable for at least the full
so, the IMF hoped to significantly special policy measures or to meet five-year period, although the
improve the ease with which the SDR repayment obligations. They are IMF’s Executive Board reserves
basket could be replicated while still unconditional liquidity claims. the right to adjust the basket at
ensuring a stable value. Moreover, any time (subject to the stipulated
There is no market whereby the
the basket currencies were to have member approvals). In between
forces of supply and demand adjust
broad and deep exchange markets to meetings, it must be noted that the
the value of the SDR. Instead, the
facilitate transactions. In 1999, the component weights can change due
value of SDRs is calculated daily
franc and deutsche mark shares of to exchange-rate fluctuations.
using prevailing noon exchange rates
the SDR basket were combined into and is the U.S. dollar sum of the four
a single euro weight. The IMF follows five broad principles
basket currencies’ values. The IMF regarding its SDR valuation decisions
brokers the flows of SDRs between that together serve the goal of
members in order to clear the market
at that price and ensure liquidity.

increasing the attractiveness of the that freely usable does not mean goods and services were transacted
SDR as a reserve asset:1 full capital-account convertibility. in that currency. It also took into
While the first criterion is objectively account the volume of capital
1. The value should be stable in measurable, it is the second criterion transactions conducted in the
terms of the major currencies that involves the use of judgment, currency. Due to data limitations,
2. Currencies included should be and the quantitative measures by this could be approximated
representative of those used in which the IMF proposes to assess it by the currency breakdown of
international transactions are relatively amorphous. Instead, official reserve holdings, which
freely usable is used to refer to are presupposed to have some
3. The relative weights of the
currencies that are (a) widely used relation to the volume of trade and
currencies should reflect their
to make payments in international international payments conducted
relative importance in the trading
transactions and (b) those that are in each currency. In terms of being
and financial system
widely traded in principal exchange widely traded, an assessment
4. The composition of the SDR markets. A definition of the concept of foreign exchange spot-market
currency basket should be stable of freely usable is set out under turnover in the currency could
and change only as a result of Article XXX(f) of the IMF’s Articles be assessed.
significant developments from of Agreement.
one review to the next Ultimately, the IMF Executive Board
5. There should be continuity in the Formally, this requirement that a is charged with designating member
method of SDR valuation such currency be freely usable has only currencies it deems to be freely
that revisions in the method of been enforceable for SDR inclusion usable. The overriding concern in
valuation occur only as a result criteria since the 2000 review. The including the freely usable criterion
of major changes in the roles of addition of the freely usable criterion in its assessment of the SDR basket
currencies in the world economy recognized that a country’s share is the consideration that the SDR
of global trade was not a reliable serve as a reserve asset. As such,
In terms of specifics, there are
indicator of the use of that currency should SDRs be sold to meet some
two criteria by which component
in international transactions. Even pressing balance-of-payments need,
members of the SDR currency
though the freely usable criterion the receiving country should find
basket are assessed and weights
was only added recently, this action itself able to use the currencies it
determined. The first criterion
simply codified key operational receives directly, or easily substitute
requires that the country be among
considerations that had been in them for another SDR currency
the largest exporters in the world, as
place for some time. A case in point through the foreign-exchange
measured by the value of goods and
for this would be Saudi Arabia, which market. In practice, SDR sellers have
services exported in the preceding
claims a large proportion of global preferred to receive only U.S. dollars
five years ending 12 months before
trade via oil exports, but whose trade and euros in exchange for their SDRs.
the effective date of the revision.
is mostly conducted in U.S. dollars
Secondly, any SDR basket currency
must meet the “freely usable”
rather than riyal. The Australian Changing the criteria for
dollar, Canadian dollar and Swiss SDR inclusion
criteria. This second criterion for
franc are also considered to be
the SDR arose informally during the While respecting the freely usable
widely traded, but not widely used.
difficult years of the 16-currency concern, the IMF is also acutely
SDR basket. It is important to note For an assessment of whether a sensitive to the idea that, as
currency is widely used, the IMF an organization, it is becoming
1
IMF Financial Operations: Chapter 4 – considered the degree to which increasingly marginalized in the
Special Drawing Rights, Box 4.2

global financial system and needs is required, the U.S. by itself would The renminbi and the SDR
to adjust both its architecture and be unable to block the renminbi’s For the period 2004-2009, China
policies to reflect new international inclusion in the SDR basket. became one of the four largest
imperatives such as the rise of exporters in the world, thus
emerging markets and regional IMF- In terms of considering other IMF
members’ voting intentions, it triggering its consideration for
type institutions. In this light, the inclusion in the SDR basket along
IMF has taken an open approach to can reasonably be expected that
European members would tentatively the export criteria. However, at the
possibly modifying SDR inclusion 2010 review, the IMF considered the
criteria. Formally, as discussed in vote for renminbi inclusion, or at
least the approval for a defined path renminbi to not meet the criteria of
previous sections, reviews of the a freely usable currency. The IMF
SDR currency basket are conducted towards such a step. Europeans
have historically longed for a more did recognize in that same review
on the basis of the criteria adopted that inclusion of the renminbi in
by the Executive Board. However, multipolar global financial system,
and the establishment of the the SDR was something that would
should the Executive Board see fit to have to be considered in the future.
do so, it may modify the criteria for renminbi as a global or regional
Asian anchor currency would further Moreover, since that review, material
inclusion into the SDR. Any changes in the use of the renminbi
such changes are governed by this goal. The U.S. could expect
support from Japan, but even this and the state of China’s external
Article XV, Section 2 of the Articles accounts have occurred, and all
of Agreement. would not get it to the requisite level
of support in the event of a 70% have bolstered the case for the
What this article states is that threshold vote. currency’s inclusion.
while only a 70% vote is required Most importantly, in terms of a
to adopt a change in the method It is also likely that the Europeans
would resist U.S. diplomatic efforts significant change since 2010, is
of valuation, this requirement is that China herself has considerably
superseded by the fact that any to stall debate on the renminbi. The
U.S. is widely considered to have warmed to the idea of capital-
changes in the broader principles of account liberalization and more
valuation requires an 85% vote. It is committed a foreign-policy blunder
in opposing the establishment of the two-way volatility in renminbi. The
not clear one way or the other what experience of the Japanese yen,
vote threshold would be required. China-backed Asian Infrastructure
Investment Bank (AIIB). The State euro, and U.S. dollar has shown over
The IMF has never officially created the past several years that central
a list of changes that would require Department strongly lobbied
European governments to refrain banks are able to engineer large
the higher threshold. To date, all depreciations in their exchange rates
changes to the SDR basket have from expressing support for it, a
move that roundly failed and greatly while still maintaining independent
been achieved via a 70% vote. This domestic monetary policy.
is important as the higher threshold annoyed some of the closest U.S.
can be unilaterally vetoed by the allies. With that in mind, it is unlikely Indeed, the People’s Bank of China
U.S., with its 16.7% voting share. It the U.S. would squander further (PBOC) released a report in 2012
is an open secret that the U.S. would political capital by pressing hard on positing that the restrictions of
oppose the renminbi’s inclusion yet another China issue. The Chinese the impossible trinity might be
in the SDR basket, and Treasury are also very sensitive to U.S. foreign circumvented, conditional on the
Secretary Jack Lew has stated policy strategies that they feel are currency being internationally
recently that he does not consider aimed at restricting or constraining important. Normally, a country
China to be ready. However, should the country’s influence. cannot achieve an impossible
it be deemed that only a 70% vote

trinity of an open capital account, China, moreover, is greatly temper believes strongly that the renminbi
independent monetary policy, as accusations that the country is a should play a much larger role in
well as a controlled exchange rate. currency manipulator. Indeed, the the international monetary system
Instead, they must choose two of the IMF itself declared the currency given the country’s enhanced global
three. This has served to assuage “fairly valued” in its most recent stature.
Chinese fears that they would lose assessment in the spring of this year.
control of several historical policy Where China really fails to meet the
levers should they liberalize their The leadership of the PBOC and the standards for SDR inclusion is the
capital accounts. wider Chinese political structure use of the renminbi in international
have also been pushing strongly for transactions other than trade.
The ability of quantitative easing SDR inclusion. PBOC Governor Zhao Indeed, the share of Chinese trade
to force the U.S. dollar lower also Xiaochuan said in a Beijing speech settled in its currency has risen
highlighted to the Chinese once in March at the China Development significantly to around 25% in the
again the “exorbitant privilege” that Forum that China’s goal was first five months of 2015, up from
the U.S. enjoys as the issuer of the to achieve full capital-account just 5% in 2012, an impressive
currency that anchors the global convertibility in 2015. Moreover, at climb.2 The establishment of foreign-
financial system. At the same time, a meeting of the IMF-World Bank exchange swap lines with central
China harbours concern about U.S. in April, he claimed that, according banks around the globe has also
dominance of the global financial to the IMF’s own classification started to cement the renminbi
architecture, which has never been system, 35 of 40 categories are as a globally important currency.
more apparent than in the reaction fully or partially convertible already, However, financial-market breadth
to successive waves of quantitative bolstering the claim that China and depth for renminbi assets
easing by the Fed. is not particularly far away from remains very shallow.
celebrating full convertibility.
Another major change since the That being said, categories that China does have a very large
last SDR review has been the remain to be liberalized are domestic debt market. While this
large decline in China’s current- particularly important ones for SDR market remains largely closed to
account surplus to much more consideration, as they are related to foreigners, we note that access
sustainable levels. This has largely capital-market instruments. for official investors is increasing.
been achieved by a substantial The opening of the onshore
appreciation of the renminbi since The recent move by Chinese market should improve prospects
the beginning of 2005 in both authorities to adopt IMF standards for fulfilling another important
real-effective (+50%) and nominal for reporting reserve and external- consideration for an SDR currency –
terms versus the U.S. dollar debt data has further cemented an appropriate short-term interest-
(+26%). This is in addition to the the intention of the country to seek rate instrument.
much more popularly recognized SDR inclusion in the near future.
macroeconomic policy efforts aimed The prospect of inclusion in the SDR According to the 2013 BIS survey of
at reorienting the domestic economy has also backstopped domestic the foreign-exchange market, the
toward personal consumption and Chinese support for continued renminbi was the ninth most traded
away from large-scale investment financial-market reforms. There is a currency after the Mexican peso
projects and the export sector. significant prestige factor involved and just ahead of the New Zealand
What this adjustment has done for for the Chinese leadership, which
2
For comparison purposes, a recent study
calculated that roughly 35-40% of Japanese
exports and 22% of imports were settled
in yen.

dollar. Yet conversion of renminbi is is how the IMF classifies China’s Overall, even if the renminbi does
problematic considering the PBOC’s exchange-rate regime. With this enter into the SDR basket it is worth
heavy hand in the foreign-exchange in mind, any move to include the bearing in mind that the basket of
market. Another aspect to consider renminbi in the SDR basket, as currencies would continue to act
is that the method by which the long as the peg is in place, would solely as a unit of account for the
PBOC has historically determined effectively be an increase in the IMF and a few other international
the official exchange rate is not U.S. dollar weight. Presumably, the organizations and would remain,
particularly transparent, even PBOC’s grip on the currency will in the words of the IMF, basically
when compared to the country’s continue to be relaxed. insignificant in terms of the global
emerging-market peers in Asia, and financial system. The path towards
the final published rate has been Clearly, the addition of the renminbi a time when the renminbi might
known to differ materially from to the SDR basket is not a foregone challenge the U.S. dollar for pre-
actual transacted rates. The move conclusion. The IMF Executive Board eminence in international finance,
by the central bank in late August is expected to make a decision let alone one in which it forms one
to amend this process is a response on the SDR basket’s composition of several pillars in a multipolar
to IMF demands for a more market- before the end of the year, as part world (alongside even the euro),
orientated process, though it still of its regular quinquennial review. remains at least several years
suffers from opaqueness relative to Encouragingly for the Chinese, into the future. The currency is
international benchmarks. the implementation period for simply not in wide enough use.
the new basket weights has been Nevertheless, the ascension to SDR
Considering the IMF’s goal that extended to September 2016 from status should still be considered an
the currencies composing the SDR the usual date of January 1. This important milestone for China, both
should be substitutable for one longer implementation period would domestically as well as globally, and
another, it is hardly encouraging provide the time for the needed provide tacit recognition of just how
to see such a heavily controlled operational changes should the much the architecture of the global
foreign-exchange market. While the currency ultimately be included. financial system has changed over
PBOC officially conducts a managed All of this highlights that the IMF is the past 15 years.
float of the value of the renminbi loath to shut the door on China for
versus a basket of currencies, in a further five years and wants to
reality the renminbi trades much recognize the large reform push by
more like a crawling-peg currency Beijing, but also that significant work
against the U.S. dollar. Indeed, this remains to be done.

REGIONAL OUTLOOK – U.S.
Ray Mawhinney UNITED STATES RECOMMENDED SECTOR WEIGHTS

Senior V.P. & Senior Portfolio Manager
RBC Global Asset Management Inc. RBC INVESTMENT BENCHMARK
STRATEGY COMMITTEE S&P 500
August 2015 August 2015
Brad Willock, CFA
V.P. & Senior Portfolio Manager Energy 6.0% 7.0%
Materials 2.3% 2.9%
Industrials 8.8% 10.0%
The U.S stock market has struggled Consumer Discretionary 14.8% 12.9%
lately, falling roughly 6% in the past Consumer Staples 9.7% 9.7%
three months and lowering the total Health Care 16.5% 15.5%
return for the S&P 500 Index over Financials 17.5% 16.7%
the past year to less than 1%. The Information Technology 21.3% 19.9%
bull market is in its seventh year and Telecommunication Services 2.0% 2.4%
many are wondering if the recent Utilities 1.3% 3.0%
correction in stock prices signals Source: RBC GAM
the end. In our experience, however,
the conditions that typically bring
S&P 500 EQUILIBRIUM
about the end of bull markets are Normalized earnings and valuations
not in place. Were the cycle near
its end, growth would be raging, 5120 Aug. '15 Range: 1583 - 2645 (Mid: 2114)
Aug. '16 Range: 1923 - 3213 (Mid: 2568)
core inflation would be well above 2560 Current (31-August-15): 1972
2% instead of struggling to stay 1280
above 1%, the use of leverage
640
would be high and management
teams would be adding capacity 320
to fulfill expectations of strong 160

demand. These excesses would 80
force the U.S. Federal Reserve
40
(Fed) to raise short-term interest 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
rates aggressively to slow growth Source: RBC GAM
and reduce inflation. Changes in
interest rates, in turn, would reduce incomes since the financial crisis While the market’s gyrations have
incentives for banks to lend, the have been subpar; spending on made many investors nervous, it
economy would slow, corporate new residential structures and other is important to put recent moves
earnings growth would decelerate durable goods remains well below in perspective. Since 1950, the
and stocks would likely go down, normal levels; and consumers have S&P 500 has experienced a drop
especially if the economy fell into dramatically cut their leverage since of at least 10% every 820 days on
a recession. At the moment, the the housing bubble burst, while average. However, it has happened
backdrop does not support this type companies have record cash levels only 13 times in 65 years when
of outcome. Growth in the economy, and corporate net-debt-to-equity the economy is growing and the
corporate revenues and personal ratios remain near all-time lows. unemployment rate is falling. The
recent correction, which took the

Regional Outlook – U.S. | Ray Mawhinney | Brad Willock, CFA
market down roughly 12% from the disappointing earnings. Up to this under construction at a seven-year
May high, was the first drawdown point, operating leverage has been high, and prices of existing homes
of more than 10% in almost 1,500 impressive and has supported up roughly 5% in the past year. In
days. In the 13 times a correction profits. In the past six quarters, addition, a recent survey of home
of this magnitude occurred under revenue growth for the core of the builders reached a 10-year high
similar conditions, it was associated market has come in at 2% to 4%, thanks in part to long-term mortgage
with an unanticipated event or but earnings growth has been rates below 4% and improved access
economic shock. Perhaps the running at 8% to 10%, excluding to credit. With U.S. gasoline prices
surprise devaluation of the Chinese the Energy sector. In the second down over 30% in the past year and
renminbi on August 11 was such quarter, each new dollar of sales continued improvement in housing
an event. While emerging-market generated over 25 cents of profit and employment, we should see a
currencies have been weakening in sectors excluding those that are continuation of moderate growth
for some time in response to energy-related or heavily regulated in the U.S. economy as we move
slower global growth, China in (Financials, Utilities and Energy). through the rest of the year.
particular, the devaluation caused These are impressive figures at
investors to fear a repeat of the any point in a business cycle, but The biggest risks to the stock
1998 Asian currency crisis. While quite remarkable considering how market are likely to come from
this scenario is not our base long the recovery has been in China and other emerging markets.
case, it is worth considering. place. Earnings could meaningfully China’s economy continues to
disappoint should top lines fall. slow, Brazil remains in recession
Another subject that continues as it battles too-high inflation and
to weigh on investor sentiment For the U.S. economy, fundamentals stagnant growth, and Russia is
concerns the Fed and when it will appear to be on track. Employment in deep recession. Currencies of
begin increasing short-term interest is improving as the number of many of the emerging economies
rates, how fast it will raise them and people applying for unemployment are under significant pressure as
at what level it will stop. The Fed insurance recently dropped to a China slows, commodity prices
has communicated its intention to 15-year low and the number of jobs weaken and the Fed prepares to
hike rates when the economic data available reached a 14-year high. hike short-term interest rates. Shifts
is strong enough and to do so over a The unemployment rate is half like these can be destabilizing
long period. The perplexing thing for what it was in the aftermath of the for markets but have less of an
markets is that this will be the first financial crisis as 11 million new impact on corporate earnings,
time that the Fed raises rates with jobs have been created. In particular, revenues and dividends. The recent
the goal of returning them to normal, the unemployment rate among market weakness has reduced the
versus the typical motivation of people aged 18 to 34 has started to market’s valuation to about 15.5
cooling an overheated economy. drop rapidly and this has led to an times forward earnings estimates,
Recent data points suggest the increase in household formations. suggesting investors should expect
U.S. economy is expanding at 2% In the 12 months ended this past long-term returns to average 7%
to 3%, but weaker growth from June, 1.5 million new households to 9%. Given current valuations
much of the rest of the world could were formed, more than double the and the significant investor anxiety
keep the Fed from raising rates amount in the previous 12-month expressed in surveys and displayed
until later this year or early 2016. period. As one would expect, this in various market signals, there is
has led to a solid recovery in the a good chance that market returns
Another concern that has persisted housing market with low inventories will be positive in the next year.
for several years is that slow of homes for sale, new homes
economic growth could lead to

REGIONAL OUTLOOK – CANADA
Stuart Kedwell, CFA CANADA RECOMMENDED SECTOR WEIGHTS

Senior V.P. & Senior Portfolio Manager
RBC Global Asset Management Inc. RBC INVESTMENT BENCHMARK
STRATEGY COMMITTEE S&P/TSX COMPOSITE
Energy 18.0% 18.8%
Like many global markets, the most Materials 8.5% 9.5%
recent quarter was tough on the Industrials 7.5% 8.0%
S&P/TSX Composite Index, as it
Consumer Discretionary 8.0% 6.9%
dropped 7% on a total-return basis.
Consumer Staples 6.0% 4.3%
This compared with a decline of
Health Care 4.0% 6.1%
almost 6% for the S&P 500 Total
Financials 37.0% 36.1%
Return Index and 7.2% fall in the
MSCI World Index in U.S. dollars. Information Technology 3.5% 2.8%
The Energy and Materials sectors Telecommunication Services 5.0% 5.3%
experienced double-digit percentage Utilities 2.0% 2.3%
declines and were heavily influenced Source: RBC GAM
by global growth concerns and the
resulting impact on commodity S&P/TSX COMPOSITE EQUILIBRIUM
prices: copper dropped 14.3% Normalized earnings and valuations
while West Texas Oil dropped by
25600 Aug. '15 Range: 13749 - 20535 (Mid: 17142)
18.4%. Concerns about a domestic
Aug. '16 Range: 13656 - 20396 (Mid: 17026)
slowdown also spread to the 12800
equity market, impacting both the
6400
banking and real estate industries.
The performance of the S&P/TSX 3200
Composite continued to narrow, 1600

with relatively strong performance
800
from a handful of non-financial,
non-resource companies. During 400
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
the quarter, both Restaurant Brands
Source: RBC GAM
International, which runs Tim Hortons
and Burger King, and Valeant were
positive performers. On a year-to- rate movements are indicative of the has continued to drift down and
date basis, the Canadian benchmark pressures on the exchange rate. For is now around $980, versus the
index is down 773 points, which Canada, we are forecasting 1.00% prior quarter when it was just
would have been much worse had it economic growth versus 2.25% in under $1,000. This estimate has
not been for the 347 points added by the U. S. – highlighting a persistent dropped 8% so far this year, but still
Valeant’s 83% advance. gap. After another Bank of Canada represents decent growth versus
rate cut this quarter, we expect stable 2015 and will require substantial
The Canadian dollar was weak again short-term rates in Canada versus year-over-year growth from the Energy
this past quarter and we have again rising rates in U.S. sector. Headline valuations for the
marked down our forecast for the S&P/TSX Composite are now below
currency to $1.40. Our forecasts for The aggregate 2016 earnings those of the S&P 500 by more than
economic growth and central-bank estimate for the S&P/TSX Composite a multiple point. This discount could

Regional Outlook – Canada | Stuart Kedwell, CFA
provide a shorter-term opportunity, risk appetite, they would have a traffic given lower energy prices.
although it is difficult to make negative impact on earnings. Current Nevertheless, as valuation improves
the case for a sustained period of valuations are attractive given the and lower earnings estimates are
outperformance from the Canadian potential intermediate-term returns digested, the intermediate-term
stock market. For Canadian markets on equity, yet history suggests a peak outlook for the railways is looking
to outperform over the intermediate in gross impaired loans, which have more interesting.
term, financial-services and energy only begun to rise, is a key ingredient
in sustained bank outperformance. Daily oil-price moves of at least
stocks will need to do the heavy
2% are becoming the norm. While
lifting, and both sectors in our view
The volatility of insurance stocks to prices are difficult to forecast in
will require higher energy prices for
changes in capital markets remains the short run, we believe they will
that to happen.
high but has fallen significantly be higher over the intermediate
Energy and housing continue to relative to recent history. While term. Importantly, the industry is
dominate the conversation about market volatility could delay the restructuring itself for a more volatile
the Canadian economy and, as a emergence of near-term earnings, and lower-price environment, which
result, Canadian banks. Valuations the intermediate-term prospects should augment cash flow regardless
are below average on current remain interesting. Both Sun Life and of when commodity prices recover.
estimates but about in-line if we Manulife recently outlined earnings- The election of an NDP government in
normalize credit losses and hold growth targets in the high single Alberta has also created uncertainty
all else equal. Dividend yields are digits to low double digits. These for future investment as royalty
attractive and well-protected in targets, combined with rising returns rates could change, although we
stressed credit scenarios. Housing on equity, increasing dividends and believe the likely scenario is for
concerns remain following Home a focus on wealth management and a delay in any major move until
Capital’s announcement of issues markets outside Canada, should lead commodity prices recover. A lower
with its mortgage originations. to share gains. Canadian dollar helps the industry,
While house prices in Toronto and but widening differentials between
Elsewhere in the non-financial, Western Canadian crude prices and
Vancouver had another strong
non-resource areas of the market, West Texas due to a variety of refinery
summer, underlying concern about
valuations in many cases are equal issues do not. With the equity market
the size of housing-related activity
to or greater than those of similar less open to oil companies than
relative to its historical average
companies in the U. S. as Canadian earlier this year, a round of mergers
remains a big issue. An important
capital has funneled into these and acquisitions may begin this
near-term consideration will be low
stocks at the expense of benchmark- fall. We continue to believe that the
energy prices and the potential for
heavyweight areas such as banking majority of energy exposure should
consumer loan losses in energy-
and energy. That said, the Canadian remain in well capitalized long-
related provinces. Not surprisingly,
grocery industry has attractive free- reserve-life companies with moderate
gross impaired loans in the Energy
cash-flow generation and the surge in annual production declines. For
sector moved upward in the most
square footage growth over the years smaller and intermediate-size
recent quarter and will likely rise
is ebbing, providing a more stable companies, key considerations are
further as the fall loan-renewal
industry environment. Earnings the size of the companies’ resources
process takes place. Each bank has
estimates for the railway industry and the attractiveness of the returns
discussed potential credit losses in
have been pressured by a weaker of their future projects relative to
a prolonged downturn. While loan
commodity-shipment business and those that can be found inside larger,
losses projected in this scenario are
the increasing competitiveness of more stable companies.
manageable and within each bank’s
trucking relative to rail for intermodal

REGIONAL OUTLOOK – EUROPE
Dominic Wallington EUROPE RECOMMENDED SECTOR WEIGHTS

Chief Investment Officer
RBC Global Asset Management (UK) Limited RBC INVESTMENT BENCHMARK
STRATEGY COMMITTEE MSCI EUROPE
Energy 6.0% 6.6%
From a purely economic perspective
Materials 6.0% 7.0%
there have been a large number of
Industrials 10.7% 11.2%
positive developments in the region
during the course of the last quarter. Consumer Discretionary 12.6% 11.6%
The latest Eurozone composite PMI Consumer Staples 13.8% 13.8%
moved to the highest level since Health Care 15.1% 14.2%
2011, and EPS revisions have been Financials 23.3% 23.3%
positive and should remain so for Information Technology 4.3% 3.4%
the next six months or so. Money Telecommunication Services 5.5% 5.1%
supply tends to lead the PMI, and the Utilities 2.8% 3.9%
current reading suggests that the PMI Source: RBC GAM
will continue to strengthen from here.
The Iranian nuclear accord provides EUROZONE DATASTREAM INDEX EQUILIBRIUM
further good news because it implies Normalized earnings and valuations
that the oil price may continue
5760 Aug. '15 Range: 1681 - 3541 (Mid: 2611)
to remain at lower levels, and
Aug. '16 Range: 1796 - 3783 (Mid: 2790)
commentators often fail to mention 2880
the fact that this reduces costs for
1440
consumers and businesses alike.
Also, the euro has fallen 14% over 720
the past year, which should help the 360
area’s international competitiveness
and take the pressure off periphery 180
countries that are undergoing 90

austerity to one degree or another. 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM
Another outcome of earnings
progression and markets that are the past few weeks in managing Also as an offset, Greece’s debt
more or less range-bound is that its relationship with other treaty is predominantly owned by public
valuations now look more attractive. members, and the country exhibits institutions rather than the private
The trend P/E for European equities many of the characteristics of sector and the direct exposure for
had risen to slightly above the corruption, clientelism and special Eurozone banks is equivalent to
longer-term median, but has now interest groups that have heavily 0.2% of their collective balance
returned to the median level. undermined Argentina in the past sheet. The risk, if any, is that Greece
In terms of negatives, we think that two decades. Greece is classified as cannot deliver on its reform package
political risks in the Eurozone have an emerging market for investment and that renewed problems lead to
grown as a consequence of recent purposes, so these problems and growing political tensions between
events. The Greek government has concerns are not immediately countries in the region. We think that
been remarkably reckless during relevant for our investable universe. the impact on the companies we

Regional Outlook – Europe | Dominic Wallington
invest in is likely to be limited, but with focused, high-return franchises. We view software companies as
we will watch developments. The sector’s strong balance sheets, beneficiaries of increasing corporate
robust cash flows, low earnings spending in the coming years. Over
Our areas of specific focus in the
volatility and focus on capital returns the last year, the Telecommunication
Consumer Discretionary sector have
have proved an attractive home Services sector has been one of the
been media and gaming. We remain
for the increased investment flows best-performing in Europe, driven by
committed to the structural dynamics
recently seen into equity markets. an improvement in the incumbent
of media, especially to those
telecom operators and the better
companies that have reduced their The performance of the banks,
regulatory backdrop.
capital intensity and broadened their Eurozone banks in particular, has
exposure through the Internet. We ebbed and flowed of late in line We do not have a positive view of
have also been adding to holdings with macroeconomic data, and the Materials sector at the moment.
of luxury-goods shares. Consumer the stocks have begun to run with Mining companies have dramatically
Staples remains a natural home for the implementation of QE. While underperformed, and industry
us given the high-quality companies loan-demand growth is improving, shares have fallen to levels more in
that exist in the sector, but it remains low enough given the line with value companies as they
valuations have in some instances additional burden of the tighter now offer a small dividend-yield
become somewhat challenging. We regulatory backdrop that the sector premium relative to the market. This
remain focused on beverages, food is unlikely to return to the levels of valuation shift follows a decade-long
ingredients and household goods profitability seen pre-crisis. As a run during which high commodity
because these sub-sectors offer the result, many banks will struggle to prices meant they often traded as
best mix of growth and valuation. generate returns above their cost growth companies. Our preference
We are less optimistic about food of equity. Insurers have taken a is for specialty chemicals and niche
manufacturing. hit over the past month following areas of enzymes and flavours
a very robust year. There are some and fragrances, where we see high
In the Energy sector, our concerns
attractive areas in the industry that barriers to entry and good growth
about rising capital expenditures and
show robust product pricing and and return profiles.
weak production-growth expectations
high returns, but these tend to be
have diminished somewhat, We are also less than positive about
restricted to the Nordic countries.
but have not been completely the Utilities sector. The sector trades
We see greater appeal in diversified
alleviated. Valuations are at almost at a valuation discount to the overall
financials, asset managers in
unprecedentedly low levels, both in market and has the highest dividend
particular, given their high returns
absolute and relative terms, but are yield. However, any valuation support
and limited need for capital.
not low enough to completely offset is undermined by weak underlying
the fundamental backdrop. The oil- Our preference within the Industrials fundamentals. Excess capacity exists
price collapse makes us think that sector has been for secure growth in many markets which, alongside a
some balance sheets of oil-services and returns that are high and weak demand backdrop, continues
companies may come under stress. stable or companies seeing good to put downward pressure on power
operational momentum, especially prices. The regulatory environment
We continue to have a positive
where the positive momentum has been a problem for some time but
view of the Health Care sector, as
is internally driven. Due to the might well begin to stabilize in some
valuations remain attractive and
constituents of this sector, our areas of Europe. We will carefully
recent mergers and asset swaps
exposure is more mid-cap-biased. watch developments here because
represent a substantial form of
Information Technology is still one they will be key to future returns.
progress towards creating an industry
of the preferred sectors in Europe.

REGIONAL OUTLOOK – ASIA
Mayur Nallamala ASIA RECOMMENDED SECTOR WEIGHTS

Head & Senior Portfolio Manager
RBC Investment Management (Asia) RBC INVESTMENT BENCHMARK
Limited STRATEGY COMMITTEE MSCI PACIFIC
Energy 2.1% 2.9%
A collapse in China’s A-share equity Materials 5.8% 6.3%
markets, driven by a sharply rising Industrials 12.9% 13.1%
U.S. dollar against emerging-market Consumer Discretionary 14.3% 13.2%
currencies, has caused Asian market Consumer Staples 6.7% 6.7%
sentiment to weaken substantially Health Care 6.0% 5.3%
over the past few months. Asian Financials 28.5% 29.7%
equity markets excluding Japan
Information Technology 14.3% 13.6%
retreated in the latest three-month
Telecommunication Services 7.0% 5.9%
period, with China, Hong Kong and
Utilities 2.5% 3.4%
South Korea leading the way. The
Source: RBC GAM
prospects for higher U.S. interest
rates have pressured equities across
the region, and the effect reached JAPAN DATASTREAM INDEX EQUILIBRIUM
a crescendo last month with the Normalized earnings and valuations
unexpected devaluation of the
renminbi by China. 1040
Australian equities underperformed 520

with a continued decline in the
commodities complex amid weaker 260
iron-ore prices and falling investor
sentiment in the region’s Materials 130 Aug. '15 Range: 277 - 791 (Mid: 534)
Aug. '16 Range: 253 - 722 (Mid: 487)
sector. Both the strong U.S. dollar
and concern about weaker demand 65
from China have been to blame for 1980 1985 1990 1995 2000 2005 2010 2015 2020
Source: Datastream, Consensus Economics, RBC GAM
falling sector valuations.
Meanwhile, Japanese equities posted

positive outlook for corporate On the economic front, sluggishness
relatively strong performance during
earnings is supported by the Bank in Japan’s exports and production
the period as investors turned more
of Japan’s (BOJ) unprecedented and weaker consumer spending have
positive on corporate-governance
monetary easing and a continued increased the challenge in reflating
reforms and the weaker yen, despite
shift to equities by domestic pension the region’s economy. Meanwhile,
what appears to be a mixed bag of
funds. Looking forward, upward the BOJ has shrugged off indicators
economic data indicators.
revisions in earnings estimates and that the economy is weakening and
Japan: Japanese equities continued the increasing number of companies emphasized improvement in wages
to rally as a result of Abenomics, raising dividends and announcing and the labor market as signs of
decent earnings growth and share buybacks should continue to improvement. The Japanese market
shareholder-friendly policies. The drive positive momentum in Japan. does face potential headwinds,

Regional Outlook – Asia | Mayur Nallamala
including high public debt and an has likely solidified his power bank will slash rates by another 25
aging and shrinking population. base in recent years, but hardened basis points in September, although
Additionally, the trajectory for potential opposition from previously that dovish stance will be tested by
private-sector growth hinges on powerful factions in the ruling continued weakness in the rupee,
economic conditions in China and Communist Party. which has fallen as much as 12%
other Asian markets. against the U.S. dollar since April.
Malaysia: Serious allegations by local
China: Equity markets in China and and international press against Prime South Korea: South Korea was
Hong Kong were highly volatile in Minister Najib regarding a corruption one of the worst performers in the
the period, as gains from the sharp scandal have left the Malaysian period as the country was negatively
rally leading up to May were wiped equity market and the country’s affected by an outbreak of Middle
out by the end of June. Ultimately, currency, the ringgit, in turmoil. East Respiratory Syndrome and a
the sell-off was the pricking of There are doubts about Najib’s slowdown in exports. Industrial
a speculative bubble long in the survival, with calls from both sides production was particularly weak,
making and the correction may of the political divide for thorough largely because of falling demand
have further to run given the recent investigations and accountability. The from Chinese rail companies and
volatility. China’s increasingly Malaysian currency’s tumble to its for South Korean ships. On the flip
desperate and ill-conceived attempts weakest level in a decade prompted side, a resilient domestic property
to shore up flagging confidence the central bank to pour foreign- market continued to disconnect from
in domestic equity markets, exchange reserves into currency weakened economic fundamentals,
including government-directed stock markets, but the bank’s resources as South Korean property developers
buybacks, look likely to fail. Margin may be dwindling. Growth prospects were some of the best performers in
positions have been reduced, but are deteriorating as the region’s the region.
are still at a relatively elevated level, weaker-than-expected private
and it seems likely that any state- consumption and fixed investments Australia: Australian equities
sponsored repurchase programs in the first half of 2015 are expected declined as the Australian economy
will be met with continued retail to persist for the remainder of the continues to decelerate due to
deleveraging and equity-market year. The good news is that exports the decline in commodities prices
outflows. The one-way bet on the are expected to pick up in the second for trade, weak wage growth,
renminbi has also ended, with the half of 2015 due to the weaker fiscal consolidation and declining
more “flexible” exchange rate likely Malaysian currency. business investment. Moreover, the
to extend to further downward weakening currency has, as yet, had
pressure on the currency after a India: India was the lone non- little impact on the manufacturing
relatively small initial devaluation. Japanese market in Asia to rise in side of the economy. As a result,
the period, buoyed mainly by market the Reserve Bank of Australia cut
Growth stabilization now becomes expectations that an accommodative interest rates for the second time
the prime policy consideration over stance will be maintained by the this year in May, as it attempts to
structural reform, an additional Reserve Bank of India, given a stimulate private and corporate
negative for the longer term. combination of weak industrial spending amid decelerating demand
Moreover, there remain hints of output and much lower-than- from China. Given the risks to the
dissatisfaction and dissent building expected inflation. Inflation is likely region’s economic outlook, another
beyond the economy and stock to fall further in the coming months, interest-rate cut is likely before the
market, especially after the Tianjin owing to the slump in global crude- end of the year.
hazardous-waste explosion. Chinese oil prices. Against this backdrop, the
President Xi’s anti-corruption drive market is anticipating that the central

REGIONAL OUTLOOK – EMERGING MARKETS
Christoffer Enemaerke EMERGING MARKET DATASTREAM INDEX EQUILIBRIUM

Investment Analyst
Normalized earnings and valuations
RBC Global Asset Management (UK)
Limited Aug. '15 Range: 239 - 426 (Mid: 333)
640
Aug. '16 Range: 250 - 445 (Mid: 347)
320 Current (31-August-15): 220
Emerging-market equities have been
weak this quarter on concern about 160
the growth slowdown in China, the
80
collapse in commodity prices and
the potential for interest-rate hikes 40
in the U.S. This combination led to
20
an about 17% decrease in emerging- 1995 2000 2005 2010 2015 2020
market stocks during the period. The Source: Datastream, RBC GAM
MSCI Emerging Markets Index now
trades below the 900-1100 range it
had occupied since 2010, and the
third by 75%. So far this year, the equities. Only the 1994 cycle was
price-to-book ratio has dropped
outperformance has been 6%. accompanied by a decline, which
below 1.5 to the lowest level since
was 22%. However, emerging-market
the global financial crisis. While The fundamental support for this equities had performed well heading
valuations have been attractive for performance difference starts with into that cycle and were trading
some time and do not necessarily the fact that returns on equity in the at a price-to-earnings ratio of 36,
give a precise indication of when top segment are increasing faster triple today’s level. By contrast,
a turning point will come, they than those of companies in the emerging-market equities rose
should be supportive of emerging- bottom third. Moreover, returns on following rate increases in the other
market equities. There has been equity for the top one-third are rising two cycles. Given the large declines
indiscriminate selling of emerging- at a pace that is sufficient to justify over the past three months and low
market shares recently, which could rising valuations as measured by valuations, it appears that a lot of
indicate that we are close to a price-to-book ratios. the negatives associated with a rate
market bottom.
Looking ahead, emerging-market hike have been priced in.
A key characteristic of performance equities face four key challenges: Emerging-market currencies typically
in emerging markets this year has U.S. monetary tightening; U.S. dollar underperform when the U.S. dollar
been that stocks of companies strength; low commodity prices; is strong, and this usually translates
with high returns on equity have and slowing Chinese growth. One into weaker emerging-market equity
outperformed those with low concern for emerging markets has returns. We have been in a strong-
returns on equity. This trend has been the potential negative impact dollar environment since mid-2011,
been in place for some time, and of the onset of a Fed tightening and this has been predictably
has intensified since 2010. Since cycle. An examination of the last negative for emerging-market stocks.
2010 a basket of the top third of three tightening cycles, in 1994, Emerging-market currencies are now
companies in the emerging-market 1999 and 2004, offers no clear at attractive levels following this
index, ranked by return on equity, evidence that Fed rate hikes are year’s weakness, which has been
outperformed a basket of the bottom always bad for emerging-market amplified by the recent depreciation

Regional Outlook – Emerging Markets | Christoffer Enemaerke
of the Chinese renminbi. All Structural growth in China is set to declined since 2010, which appears
emerging-market currencies now slow over the longer term, as the to be the main factor in emerging-
trade at discounts to purchasing country rebalances its economy. market underperformance since then.
power parity, and almost all trade at Investment-led growth is falling, According to World Bank forecasts,
discounts to their 10-year averages. and growth is now more dependent the relative growth differential is
It is therefore likely that most future on consumption. Investment now expected to bottom in 2015 and
U.S. dollar strength would be against accounts for 20% of GDP growth, expand from 2016 onwards. This is
developed-market currencies rather compared with 80% at the 2009 driven by mean-reversion in growth
than emerging-market ones. peak. At the same time, consumption in many Latin American countries,
has increased in importance and as well as in Russia. Asian countries
Historically, the performance of now accounts for more than 60% of are also expected to show growth
emerging-market equities has been GDP growth, up from 50% earlier. overall, even as China slows. The
highly correlated with commodity This reversal is positive for the historical importance of this growth
prices, so it is worth noting that the economy and companies because differential is likely a positive for
benchmark weighting of the Energy it reduces investments that are emerging-market equity performance.
and Materials sectors has decreased unneeded and that offer little or
significantly over the past 10 years, Earnings of emerging-market
no return.
with Energy declining to 7.8% from companies have been declining
14.6% and Materials decreasing to Another positive development is since 2011 amid slower economic
6.7% from 13.1%. Going forward, that credit growth has been slowing growth, falling world trade, a
the impact of commodity prices consistently since 2013. Assuming stronger U.S. dollar, rising labour
on emerging-market stock indexes this trend continues, it is likely credit costs and over-investment. Looking
should be less than in the past. growth could approach nominal GDP ahead, it appears that emerging-
growth over the next couple of years, market companies are developing
The extreme gains and subsequent allowing China to start to deleverage. better cost discipline. Growth in
sell-off in the Chinese equity market This would also be positive for the capital expenditures is expected
have been key events in emerging quality of growth in China. to decrease, and oil-importing
markets this year. Equities represent countries could benefit from
11% of household wealth in China, Emerging-market equity lower oil prices. A combination of
compared with 19% in South Korea outperformance over the past these trends, along with stronger
and 30% in the U.S. In our view, this 40 years has been driven primarily emerging-marketing currencies,
relative exposure to equities among by faster GDP growth in emerging would likely lead to an improvement
Chinese households is too small to markets relative to developed in emerging-market earnings.
create systemic risks as stocks fall. markets. The growth differential has

RBC INVESTMENT STRATEGY COMMITTEE
Members
Daniel E. Chornous, CFA

Chief Investment Officer
RBC Global Asset Management
Chair, RBC Investment Strategy Committee
Dan Chornous is Chief Investment Officer of RBC Global Asset Management Inc., which has total assets under management of $380 billion. Mr. Chornous is
responsible for the overall direction of investment policy and fund management. In addition, he chairs the RBC Investment Strategy Committee, the group responsible
for global asset-mix recommendations and global-fixed income and equity portfolio construction for use in RBC Wealth Management’s key client groups including
retail mutual funds, International Wealth Management, RBC Dominion Securities Inc. and RBC Phillips, Hager & North Investment Counsel Inc. He also serves on the
Board of Directors of the Canadian Coalition for Good Governance and is Chair of its Public Policy Committee. Prior to joining RBC Asset Management in November
2002, Mr. Chornous was Managing Director, Capital Markets Research and Chief Investment Strategist at RBC Capital Markets. In that role, he was responsible for
developing the firm’s outlook for global and domestic economies and capital markets as well as managing the firm’s global economics, technical and quantitative
research teams.
Dagmara Fijalkowski, MBA, CFA

Stephen Burke, PhD, CFA Head, Global Fixed Income & Currencies
Vice President and Portfolio Manager (Toronto and London)
RBC Global Asset Management RBC Global Asset Management
Stephen is a fixed-income portfolio manager and Head of the Quantitative As Head of Global Fixed Income & Currencies at RBC Global Asset
Research Group, the internal team that develops quantitative research Management, Dagmara oversees 15 investment professionals in Toronto
solutions for investment decision-making throughout the firm. He is also and London, with more than $40 billion in assets under management. In
a member of the PH&N IM Asset Mix Committee. Stephen joined Phillips, her duties as a portfolio manager, Dagmara looks after foreign-exchange
Hager & North Investment Management in 2002. The first six years of his hedging and active currency-management programs for fixed-income and
career were spent at an investment-counselling firm where he quickly rose to equity funds, and co-manages several of the firm's bond portfolios. Dagmara
become a partner and fixed-income portfolio manager. He then took two years chairs the RBC Fixed Income & Currencies Committee. She is also a member
away from the industry to begin his Ph.D. in Finance and completed it over of the RBC Investment Policy Committee, which determines the asset mix for
another three years while serving as a fixed-income portfolio manager for a RBC balanced products, and the RBC Investment Strategy Committee, which
mutual-fund company. Stephen became a CFA charterholder in 1994. establishes global strategy for the firm.
Stuart Kedwell, CFA

Senior Vice President and Eric Lascelles
Senior Portfolio Manager Chief Economist
Stu began his career with RBC Dominion Securities in the firm’s Generalist Eric is the Chief Economist for RBC Global Asset Management Inc. (RBC GAM)
program and completed rotations in the Fixed Income, Equity Research, and is responsible for maintaining the firm’s global economic forecast and
Corporate Finance and Private Client divisions. Following this program, he generating macroeconomic research. He is also a member of the Investment
joined the RBC Investments Portfolio Advisory Group and was a member of the Strategy Committee, the group responsible for the firm’s global asset-mix
RBC DS Strategy and Stock Selection committees. He later joined RBC Global recommendations. Eric is a frequent media commentator and makes regular
Asset Management as a senior portfolio manager and now manages the RBC presentations both within and outside RBC GAM. Prior to joining RBC GAM in
Canadian Dividend Fund, RBC North American Value Fund and a number of early 2011, Eric spent six years at a large Canadian securities firm, the last
other mandates. He is co-head of RBC Global Asset Management’s Canadian four as the Chief Economics and Rates Strategist. His previous experience
Equity Team. includes positions as economist at a large Canadian bank and research
economist for a federal government agency.

Ray Mawhinney
Hanif Mamdani Senior Vice President and
Head of Alternative Investments Senior Portfolio Manager
Hanif Mamdani is Head of both Corporate Bond Investments and Alternative As Chairman of the U.S. Equity Committee, Ray and his team are responsible
Investments. He is responsible for the portfolio strategy and trading execution for managing U.S. stock investments. Ray brings a wealth of expertise to his
of all investment-grade and high-yield corporate bonds. Hanif is Lead Manager role, having specialized in U.S. equities since 1984, and has been involved
of the PH&N High Yield Bond Fund and the PH&N Absolute Return Fund (a in managing almost all of the firm's U.S. equity funds. He joined the firm in
multi-strategy hedge fund). He is also a member of the Asset Mix Committee. 1992. Ray is also a member of the RBC Investment Policy Committee, which
Prior to joining the firm in 1998, he spent 10 years in New York with two global determines asset mix for balanced products, and the RBC Investment Strategy
investment banks working in a variety of roles in Corporate Finance, Capital Committee, which establishes a global asset mix covering mutual funds,
Markets and Proprietary Trading. Hanif holds a master's degree from Harvard as well as portfolios for institutions and high-net-worth private clients. Ray
University and a bachelor's degree from the California Institute of Technology graduated from the University of Manitoba with a bachelor's of commerce
(Caltech). degree in finance, with honours.
Martin Paleczny, CFA Sarah Riopelle, CFA

Vice President and Vice President and
Senior Portfolio Manager Senior Portfolio Manager
Martin Paleczny, who has been in the investment industry since 1994, began Since 2009, Sarah has managed the entire suite of RBC Portfolio Solutions,
his career at Royal Bank Investment Management, where he developed an including the RBC Select Portfolios, RBC Select Choices Portfolios, RBC Target
expertise in derivatives management and created a policy and process for the Education Funds and RBC Managed Payout Solutions. Sarah is a member of
products. He also specializes in technical analysis and uses this background the RBC Investment Strategy Committee, which sets global strategy for the
to implement derivatives and hedging strategies for equity, fixed-income, firm, and the RBC Investment Policy Committee, which is responsible for the
currency and commodity-related funds. Since becoming a portfolio manager, investment strategy and tactical asset allocation for RBC Funds’ balanced
Martin has focused on global allocation strategies for the full range of assets, products and portfolio solutions. In addition to her fund management role,
with an emphasis on using futures, forwards and options. He serves as advisor she works closely with the firm’s Chief Investment Officer on a variety of
for technical analysis to the RBC Investment Strategy Committee. projects, as well as co-manages the Global Equity Analyst team.
William E. (Bill) Tilford

Head, Quantitative Investments
Bill is Head, Quantitative Investments, at RBC Global Asset Management and
is responsible for expanding the firm’s quantitative-investment capabilities.
Prior to joining RBC GAM in 2011, Bill was Vice President and Head of
Global Corporate Securities at a federal Crown corporation and a member of
its investment committee. His responsibilities included security-selection
programs in global equities and corporate debt that integrated fundamental
and quantitative disciplines, as well as management of one of the world’s
largest market neutral/overlay portfolios. Previously, Bill spent 12 years with
a large Canadian asset manager, where he was the partner who helped build
a quantitative-investment team that ran core, style-tilted and alternative
Canadian / U.S. funds. Bill has been in the investment industry since 1986.

GLOBAL EQUITY HEADS

>> Paul Johnson >> Ray Mawhinney >> Dominic Wallington
V.P. & Senior Portfolio Manager, Senior V.P. & Senior Portfolio Manager, Chief Investment Officer,
Global Equities U.S. & Global Equities RBC Global Asset Management (UK)
RBC Global Asset Management Inc. RBC Global Asset Management Inc. Limited
>> Philippe Langham >> Mayur Nallamala

Senior Portfolio Manager, Head & Senior V.P., Asian Equities
Emerging Markets RBC Investment Management (Asia)
RBC Global Asset Management (UK) Limited
Limited
GLOBAL EQUITY ADVISORY COMMITTEE

>> Stuart Morrow, CFA >> Kent Crosland, CFA >> John Richards, CFA
Portfolio Manager, U.S. Equities & Analyst, Global Equities (Semis/Tech Analyst, Global Equities (Banks)
Vice President Global Equity Research Hardware, Commercial Services) RBC Global Asset Management Inc.
RBC Global Asset Management Inc. RBC Global Asset Management Inc.
>> Joe Turnbull, CFA
>> Martin Paleczny, CFA >> Sean Davey, CFA Analyst, Global Equities
V.P. & Senior Portfolio Manager, Analyst, Global Equities (Industrials ex Commercial Services,
Asset Allocation & Derivatives (Consumer Staples) Building Products)
RBC Global Asset Management Inc RBC Global Asset Management Inc. RBC Global Asset Management Inc.
>> Hakim Ben Aissa, CFA >> Matt Gowing, CFA >> Angelica Uruena
Senior Analyst, Global Equities (Energy) Analyst, Global Equities Analyst, Global Equities
RBC Global Asset Management Inc. (Telecommunications, Software, (Consumer Discretionary)
Utilities) RBC Global Asset Management Inc.
>> Rob Cavallo, CFA RBC Global Asset Management Inc.
Senior Analyst, Global Equities
(Health Care)
GLOBAL FIXED INCOME & CURRENCIES ADVISORY COMMITTEE

>> Dagmara Fijalkowski, MBA, CFA >> Soo Boo Cheah, MBA, CFA >> Suzanne Gaynor
Head, Global Fixed Income & Currencies Senior Portfolio Manager, V.P. & Senior Portfolio Manager, Global
(Toronto and London) Global Fixed Income & Currencies Fixed Income & Currencies
RBC Global Asset Management Inc. RBC Global Asset Management (UK) RBC Global Asset Management Inc.
Limited

DISCLOSURE
This report has been provided by RBC Global Asset Management Inc. (RBC GAM Inc.) for informational purposes only and may
not be reproduced, distributed or published without the written consent of RBC GAM Inc. In the United States, this report is
provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser founded in 1983. In Europe
and the Middle East, this report is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated
by the Financial Conduct Authority. RBC Global Asset Management (RBC GAM) is the asset management division of Royal Bank
of Canada (RBC) which includes RBC Global Asset Management Inc., RBC Global Asset Management (U.S.) Inc., RBC Global
Asset Management (UK) Limited, RBC Alternative Asset Management Inc., and BlueBay Asset Management LLP, which are
separate, but affiliated corporate entities.
This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should
not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable
information, and believes the information to be so when printed. Due to the possibility of human and mechanical error as well
as other factors, including but not limited to technical or other inaccuracies or typographical errors or omissions, RBC GAM is
not responsible for any errors or omissions contained herein. RBC GAM reserves the right at any time and without notice to
change, amend or cease publication of the information.
Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various
sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or
implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and
its affiliates assume no responsibility for any errors or omissions.
All opinions and estimates contained in this report constitute our judgment as of the indicated date of the information, are
subject to change without notice and are provided in good faith but without legal responsibility. To the full extent permitted
by law, neither RBC GAM nor any of its affiliates nor any other person accepts any liability whatsoever for any direct or
consequential loss arising from any use of the outlook information contained herein. Interest rates and market conditions are
subject to change.
A note on forward-looking statements
This report may contain forward-looking statements about future performance, strategies or prospects, and possible future
action. The words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “plan,” “anticipate,” “estimate,”
“expect,” “intend,” “forecast,” “objective” and similar expressions are intended to identify forward-looking statements.
Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and
uncertainties about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking
statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important
factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking
statement made. These factors include, but are not limited to, general economic, political and market factors in Canada, the
United States and internationally, interest and foreign exchange rates, global equity and capital markets, business competition,
technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic
events. The above list of important factors that may affect future results is not exhaustive. Before making any investment
decisions, we encourage you to consider these and other factors carefully. All opinions contained in forward-looking statements
are subject to change without notice and are provided in good faith but without legal responsibility.
®/TM Trademark(s) of Royal Bank of Canada. Used under licence.

© RBC Global Asset Management Inc. 2015.
100537 (09/2015)
®/TM Trademark(s) of Royal Bank of Canada. Used under licence.
© RBC Global Asset Management Inc. 2015.

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THE GLOBAL

EXECUTIVE SUMMARY 2 CURRENCY MARKETS 49

CHINA AND THE SDR 60

RECOMMENDED ASSET MIX 5

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 1

Headwinds remain, with China settled back to a simmer. Other

2 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 3

ECONOMIC FORECAST (RBC INVESTMENT STRATEGY COMMITTEE)

UNITED UNITED EMERGING

TARGETS (RBC INVESTMENT STRATEGY COMMITTEE)

4 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 5

GLOBAL ASSET MIX

BENCHMARK PAST FALL NEW YEAR SPRING SUMMER FALL

CASH 2.0% 1% – 16% 1.0% 1.0% 1.0% 2.0% 2.0%

BONDS 43.0% 25% – 54% 40.0% 38.0% 38.0% 38.0% 36.0%

STOCKS 55.0% 36% – 65% 59.0% 61.0% 61.0% 60.0% 62.0%

CWGBI* PAST FALL NEW YEAR SPRING SUMMER FALL

MSCI** PAST FALL NEW YEAR SPRING SUMMER FALL

GLOBAL EQUITY SECTOR ALLOCATION

MSCI** RBC ISC RBC ISC CHANGE FROM WEIGHT VS.

Energy 6.67% 7.40% 5.87% (1.53) 88.0%

6 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

“ At RBC GAM, we have a team dedicated to setting and

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 7

8 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 9

10 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 11

GLOBAL EQUITY SECTORS

12 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

Eric Lascelles Exhibit 1: Chinese economy continues to slow

Caixin China General

John Richards, CFA 50

faltering economy (Exhibit 1). Risk

Stock market gyrations have

market. A natural “recency bias” – 1800

the inclination to assume that the 1600

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 13

initial response was probably

Yield change (basis point)

Through an economic lens, the

beneficial for global growth. In turn, 53 Expansion

14 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

China’s many concerns

China's share of world GDP

starting gun for a new round of tit- 8.0

6.0 Temporary peg to Trading band

THE GLOBAL INVESTMENT OUTLOOK Fall 2015 I 15

market distress, but should arguably

Shanghai Stock Exchange

Shenzhen Stock Exchange

by emerging-market standards. The 6

(Exhibit 10). This problem ricochets

eventually settling on bank balance 50

16 I THE GLOBAL INVESTMENT OUTLOOK Fall 2015

a function of slower credit growth

(standard deviations from

Economic Activity Index

China GDP growth

the will and ample means to bail out -0.1

-0.3 -0.25 -0.25

What do China’s challenges mean for