SIM GLOBAL MARKET REVIEW JANUARY 2012

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How can a rational person justify voting for a party that aligns itself with somebody like Berlusconi? What good do you think you can do by voting in a government run by anti-everything geeks and bloggers? The Italian electorate didn’t vote for the clown and joker, they voted against European forced austerity.

“Clowns to the left of me, jokers to the right, here I am, stuck in the middle with you…” (Stealers Wheel) This was the first thought that came into my mind when I read the outcome of the Italian election this morning, except that the Italian public and the Eurozone are stuck in the middle with nothing. At the time of writing it seems that the big winner of the Italian election is the protest vote (5% rise in abstention) but, more importantly, a super strong 25% score for Beppe Grillo’s Five Star Movement, a new party founded by geeks and bloggers with an anti-everything discourse (anti-Monti, anti-Berlusconi, anti-euro, anti-establishment, anti-debt repayment, anti-markets, etc.) (Gavekal Research, 26 Feb Daily comment, Et tu, Italy?)

Ex-comedian Grillo (who is not himself a candidate) has succeeded in gathering protest votes that were usually spread between the extremists. So we have a clown being tasked with forming a government with Joker Berlusconi controlling the next block. No wonder markets tumbled. The possibility of reversal into the negative fear cycle of 2012 is real. If a new Italian government rejects austerity it will put severe pressure on relations with Germany and could jeopardise the possibility of Angela Merkel being re-elected. This election highlights how irrational voters can be in times of stress. How can a rational person justify voting for a party that aligns itself with somebody like Berlusconi? What good do you think you can do by voting in a government run by anti-everything geeks and bloggers? It highlights the frustration and distrust the electorate has with past governments.

The end of a united Europe? Some commentators feel one must look past the individuals involved, and note that “for the first time a majority of electors has decisively voted against the euro and rejected policies imposed by technocrats”. Just as the USSR dissolved, Europe is a failed technocratic attempt and will dissolve! (Gavekal Research, 26 Feb 2013, Ideas: Down with Reform) The Italian electorate didn‟t vote for the clown and joker, they voted against European forced austerity. They prefer being together in a poorly managed state rather than being in a well-run European union. This would imply that this is only the first step and that markets face a period of uncertainty until it becomes clear whether (or how) Italy and Greece stay in the Euro Zone.

SIM GLOBAL MARKET REVIEW MARCH 2013

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The Italian electorate didn’t vote for the clown and joker, they voted against European forced austerity.

What now? Sell, sell, sell? Daniel Kahneman‟s book “Thinking, Fast and Slow” (highly recommended; refer to Appendix A) shows that most investors‟ immediate reaction (System One Thinking) is to do just that: Sell. But if you invoke your “System Two Thinking” and reason a bit further you will come to realise the following: Although the Italian population has sent a strong anti-austerity

signal to the rest of Europe, Italy is one of the countries in Europe that is the least in need of further austerity measures.

Table 1: Italy

Whilst Italy‟s debt/GDP number is high, the budget deficit is very

manageable and is falling (but please note this is forecast!). France‟s big problem is that government expenditure as % of its budget is very large. A signal that South Africa should watch closely as history has shown that it is the private sector that grows an economy. The bigger a government becomes the more the private sector is crowded out and growth slows down.

Table 2: France

The Spaniards are still trying to work out what hit them. Their debt/GDP went from only 36% in 2007 to a forecast 95% in 2013. Spain‟s problem now is that the high debt levels in combination with negative growth and a high budget deficit are causing a debt trap (i.e. continuously increasing debt levels). Spain has to urgently cut its budget deficit or boost growth (the more difficult option) and/or sell state assets to bring down its ballooning debt level (refer Appendix B for more detail on Spain). Surprisingly, Italy doesn‟t look bad, but living with their debt level is like living with a raised cholesterol level, the risk of a heart attack is increased significantly. But looking at the budget deficits of Italy and Spain you can understand why Italians rejected further austerity. What the Italian voters don‟t understand is that yes, the dream of controlling your own destiny again is wonderful, but were they too leave the Euro their cost of borrowing would jump dramatically which would spiral them into a debt trap and ultimately worse austerity measures.

Having high debt levels is bad. But having to pay a high interest rate on a high debt level is terrible.

Table 3: Spain

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Gross Debt/GDP 106% 106% 103% 106% 116% 119% 121% 124% 123% 121%

Budget Deficit/GDP -4.5% -3.4% -1.6% -2.7% -5.4% -4.3% -3.8% -2.6% -1.8% -0.5%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Gross Debt/GDP 67% 64% 64% 68% 79% 82% 86% 90% 94%

Government Expe as % GDP -54% -53% -53% -53% -57% -57% -56% -57% -58%

Budget Deficit/GDP -3.0% -2.4% -2.8% -3.3% -7.6% -7.1% -5.2% -4.6% -3.4%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Gross Debt/GDP 43% 40% 36% 40% 54% 61% 69% 90% 95% 98%

Budget Deficit/GDP 1.3% 2.4% 1.9% -4.5% -11.2% -9.7% -9.4% -7.2% -5.6% -4.4%

SIM GLOBAL MARKET REVIEW MARCH 2013

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On calls to devalue the US dollar: “You have to pursue the argument of dismal monetary science ad absurdum to understand it. If a little bit of devaluation is supposed to be good for the country, then a big devaluation should be even better and, reducing the exchange rate to zero, Nirvana itself. Then a country could give away its goods and services to foreigners free of charge. That, finally, will really perk up exports.” – Prof. Antal Fekete, Memorial University of Newfoundland, Canada.

And by the way, for those who agree with Rob Davies (SA‟s minister of Trade and Industry) that a weak currency is good for the country, it only helps the exporters and those who own assets. The majority of the population battle with significantly higher food and fuel inflation. My call is that: Ireland and Portugal have gone so far down the austerity road it is

unlikely that they will change course now. Similarly, it is unlikely that David Cameron will budge. So we‟re left with Spain and France, with Spain the worst in our

opinion. Luckily the rest of the world is unlikely to be much affected. Banks have been recapitalised, liquidity levels have been restored and provisions for possible bad debts have been increased. Companies have cut stock levels and costs, have right sized and de-geared. So the risk of a 2008 type collapse is very, very small.

SIM GLOBAL MARKET REVIEW MARCH 2013

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The companies we are invested in grew their net asset value per share each year right through the US banking and housing crisis of 2007/8 and the European sovereign debt crisis of 2010/2011

Rather base investment decisions on company managements than governments.

But as Douw reminds us regularly in our meetings: Base your investment decisions on company management rather than governments. In that regard, I must remind you of the research we highlighted in our previous Review: The companies we are invested in grew their net asset value per share each year right through the US banking and housing crisis of 2007/8 and the European sovereign debt crisis of 2010/2011. Table 4 shows how our February 2013 Global Financial portfolio would have fared from 2002. (I selected the financial fund as bank shares were the

most affected by the crises)

Table 4: February 2013 portfolio

NAV/Share

Growth NAV/Share Growth

(with Divis)

2003 18.7% 23.1%

2004 20.3% 25.4%

2005 16.4% 23.9%

2006 22.2% 29.1%

2007 13.6% 20.3%

2008 6.4% 12.6%

2009 19.3% 25.1%

2010 16.6% 23.1%

2011 11.3% 16.6%

2012 14.1% 19.2%

2013* 13.1% 18.4%

2014 13.4% 18.9%

2015 13.7% 19.3%

Because Table 4 is the Feb 2013 portfolio, you could observe that it is in hindsight and ambiguous. Table 5 depicts our Dec 2006 portfolio (in both cases the model takes the portfolio as it was and assumes that same portfolio of shares was held throughout the period)

Table 5: Dec 2006 portfolio

NAV/Share

Growth NAV/Share Growth

(with Divis)

2003 11.7% 14.8%

2004 15.0% 18.9%

2005 13.5% 19.0%

2006 15.5% 20.5%

2007 10.0% 14.6%

2008 14.5% 20.2%

2009 16.1% 19.1%

2010 17.5% 21.9%

2011 6.4% 9.5%

2012 7.3% 10.4%

2013* 8.4% 11.7%

2014 8.8% 12.4%

2015 9.6% 13.4% You can see that the companies selected for both portfolios collectively grew their NAV/share and paid good dividends throughout what were most arguably the worst years for global banking shares since 1930.

SIM GLOBAL MARKET REVIEW MARCH 2013

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…. and where the share price at the time of investing leaves a sufficient margin of safety to the value of the future cash flows

The answer remains the same If you select good quality shares, with sustainable business models, and you invest when valuations are not too high (preferably when they are low), you don‟t have to worry about how the crisis affects the companies. And by the way… European companies are hoarding more than 3x the cash that they held only 10 years ago, as they head for their 2nd year in recession. Cash holdings at the 265 European companies (which have reported 2012 results) that comprise the Euro Stoxx 600 Index (excluding banks and insurers) totalled $475bn at year end- that compares with $136bn in 2002, and is 14% more than as recent as 2011. The market will (temporarily) sell them down, but once the panic is over, the market pushes the share prices back up again. (Refer our December 2012 and January 2013 Market Reviews) So no surprise there, you’ll find we invest in: Businesses that generate good and sustainable returns on capital, And where the share price at the time of investing leaves a

sufficient margin of safety to the value of the future cash flows

SIM GLOBAL MARKET REVIEW MARCH 2013

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Has Warren gone senile? Warren does seem to have deviated from part two of this rule when he bought a significant stake in Heinz at what seems to be a high price. However, he looks further into the future than most clients allow their fund

managers to do; and he was prepared to pay a higher price for the predictability of those

future cash flows (based on a long history) and also for the size of the investment.

Eagle-eyed readers will have noticed that the net asset value per share growth of our Dec 2006 portfolio has consistently been lower than our Feb 2013 portfolio. Table 6 however shows that we did a “Warren-buys-Heinz”. The price in relation to the net asset value (P/NAV) of the 2006 portfolio was consistently lower than the P/NAV of the 2013 portfolio.

Table 6: Comparison of the NAV/share growth and P/NAV of the Feb 2013 and Dec 2006 portfolios

1

NAV/Share Growth

(with Divis) Feb 13

NAV/Share Growth

(with Divis) Dec 06

P/NAV Feb 13

P/NAV Dec 06

2003 23.1% 14.8%

1.5 0.9 2004 25.4% 18.9%

1.6 1.1

2005 23.9% 19.0%

1.8 1.3 2006 29.1% 20.5%

1.6 1.2

2007 20.3% 14.6%

1.5 1.2 2008 12.6% 20.2%

1.1 0.6

2009 25.1% 19.1%

1.5 1.0 2010 23.1% 21.9%

1.5 1.0

2011 16.6% 9.5%

1.3 0.8 2012 19.2% 10.4%

1.4 1.0

2013* 18.4% 11.7% 1.2 0.9 2014 18.9% 12.4%

1.0 0.8

2015 19.3% 13.4% 0.9 0.7

In other words, post the crisis we have focussed on companies with higher ROE‟s and were prepared to pay a higher P/NAV for that. In the current uncertain, volatile and slower growth global environment, we feel comfortable paying up a bit for quality – and don‟t forget, we do get a higher return on capital. A last point on this is India. Although we used the same approach in India (preferring quality private sector players like City Union Bank, Jammu and Kashmir Bank, Shiram City Union, etc.) we remain invested in a few poor quality (in terms of lending criteria and quality of lending book) public sector banks, simply because they are “too cheap”. India‟s government is undergoing a credibility crunch which has led to a severe growth slowdown and a resulting deterioration of credit quality and significantly increased bad debts. But historically this has proven to be a good time to invest.

1 The data and tables used above all depict the Global Financial fund, but we‟ve

followed the same strategy in both funds – I simply used the GF as the example because it would have been affected most by the crises. I could fill a few pages on the differences of the two portfolios and the implications thereof, but most readers won‟t be interested in that level of detail. However, feel free to send an e-mail to Nora or myself if you do have questions on this.

SIM GLOBAL MARKET REVIEW MARCH 2013

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IF you can’t trust politicians, bankers and food manufacturers, who can you trust?

“Trying to make some sense of it all, but I can see it makes no sense at all”

- “Stuck in the middle with you”, Steelers Wheel -

Banks like ING and Commerzbank appear mispriced and very undervalued, but we‟ve returned to an environment where the political outcomes are difficult to guess and do have an effect. We prefer to invest where the probability of being right about the future is higher like Microsoft, Tesco, TSKB, Tisco, etc. and where the probability of being wrong is sufficiently reflected in the valuations. (refer Appendix A for a suggestion regarding politicians) IF you can’t trust politicians, bankers and food manufacturers, who can you trust? The Financial Times did some research on this topic and on 19 September 2012 wrote an article on “Trust” and displayed a table that showed:

Public trust in: Politicians 7% Journalists 7% Bankers 11%

Estate Agents 11% Doctors 90%

It now seems you can’t even trust food manufacturers: “More than two-thirds of meat samples from South African supermarkets contained unlabeled traces of donkey, goat or water buffalo, a study by university academics at Stellenbosch found” ...Of 139 samples of meat, 68% tested positive for ingredients other than those declared on the packaging, according to an article made public yesterday by the University of Stellenbosch... Or even beer companies: “InBev has been sued for overstating Budweiser Alcohol content ...keeping prices flat while reducing the alcohol content...“ (From Ian Doyle (RMB) Market Commentary, 27 Feb 2013)

Fortunately the FT didn‟t include fund managers in their questionnaire! But it does lead us to the question we have undertaken to address in the past.

SIM GLOBAL MARKET REVIEW MARCH 2013

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The bottom-line is, do enough homework to ensure you know what you want, and then select a fund manager who has a long track record of following a process that delivers that consistently.

…..basing investment decisions (whether it be stocks or funds) solely on the performance over the past 3 or 5 years is dangerous.

How do you judge and select a fund manager? The first big problem in the investment industry is that distribution is incentivised to sell product. Ideally you want investors to buy investment products like they buy bread or milk. You go to the shop when you need it. Imagine if you had 5 types of bread and the assistants were incentivised on how many loaves, or which loaves were sold. Secondly, the industry is complex and there is an incredible amount of rubbish spouted about what a good investment is. Joe Public doesn‟t have the knowledge to decide what product or which fund is best suited for him/her. To complicate it, there is a long time gap between making the decision and being able to judge if it was the correct decision, often 5 - 10 years. The industry is populated by many slick salespeople, well paid to represent their products by speaking, presenting and dressing well. The important point is to check the track record. Look behind the façade! That will give you a clue about the suitability of the product. To do that you need to measure over periods long enough to eradicate the role of luck or randomness (e.g. anyone who happened to start a new fund on 1 January 2009 looks brilliant). For Joe Public, the simpler the product and the lower the costs (especially upfront commission) the better. In the same breath, I must add that I don‟t understand investors who don‟t want to pay performance fees. At least you know you only pay when you‟ve received good returns. The bottom-line is, do enough homework to ensure you know what you want, and then select a fund manager who has a long track record of following a process that delivers that consistently.

Based on our Best Ideas track record it would seem at first glance you shouldn’t invest with us.

The 8 year track record of our Best Ideas fund is good, but our 3 and 5 year numbers don’t look so good.

I would like to show why basing investment decisions (whether it be stocks or funds) solely on the performance over the past 3 or 5 years is dangerous.

Reason 1: Why?

The unit price of the Global Best Ideas was at an all-time high in January 2008 whilst January 2009 was the low point.

After being down 58% in 2008, from Jan 2009 the fund generated returns (net of fees) of 78%, 14%, -22%, 20% and the tea leaves indicate that 2013 should be positive, but let‟s assume 15% or 0%.

Table 7: Best Ideas – 5 year performance net of fees

Performance USD

5 year performance measured from 1 Jan 2008 -20%

5 year performance measured from 1 Jan 2009

Assuming fund performance of 0% in 2013 89%

Assuming fund performance of 15% for 2013 117%

You can see what a tremendous difference 2008 makes.

SIM GLOBAL MARKET REVIEW MARCH 2013

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If you are consistent in applying your processes, and keep doing the right things, you get the right results over time.

Fund managers cannot manage a fund on their own; definitely not a global fund.

Measured from Jan 2008 the fund looks bad, but measured from Jan 2009, the probability is high that Best Ideas will win a Raging Bull award for its 5 year performance (to December 2013). But it‟s the same fund manager, the same philosophy, the same (okay, improved) process and with a significantly more experienced team. Table 7 shows the effect of that one year. 2008 was exceptional and distorts the numbers; it also highlights how dangerous it is to select/reject a fund simply on the 5 year number.

Reason 2: Mandate The 6 year period ending Dec 2013 captures the “mandate effect”. Funds with an “equity only mandate” (and especially a fully invested, bottom-up, stock picking mandate) were hard hit in 2008 as markets crashed. Hence a balanced fund with a high percentage of cash will have outperformed in 2008 but will have done poorly in 2009 (when markets rebounded). So in that regard one must ensure one is comparing apples with apples. Be careful not to compare a balanced fund with an equity only fund in a period that includes a bear market.

Finally, the team Fund managers cannot manage a fund on their own; definitely not a global fund. So the larger a team or fund management business, the more important people management becomes. In that regard, managing a fund management unit is like managing a football team. To outperform and keep winning you need to have an above average team. Do you go the Manchester City route (i.e. pay top dollar and buy expensive players) or the Manchester United route (i.e. grow players via the “youth” academy combined with occasionally buying a star). Whichever route you follow, the challenge is to keep a group of highly talented people motivated and working together. In that regard I‟ve learnt a lot studying Alex Ferguson who is remarkable in continuously finding new talent, but then also weaning/selling players that don‟t have it or lose their willingness to play their heart out or cause problems in the dressing room. The biggest challenge is when your stars become individualistic. As with Sir Alex, if you are consistent in applying your processes, the results follow. The balance of both consistency and experience is vital. It is no coincidence that both Buffett and Ferguson are in their 70‟s (in fact Warren is 83)! For you it is important to know that our team has decided winning a 5 year Raging Bull in 2013 won‟t mean much due to the base and mandate effect. The Raging Bull we would want to win is for the 5 years to 2016. That will measure the current team from the normalised base of Jan 2012. Our DNA is to communicate regularly and be totally transparent. In the end it is vital that you trust us as you do your doctor.

SIM GLOBAL MARKET REVIEW MARCH 2013

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Kokkie in a high level meeting with

Prince Phillip

Attachments Appendix A: Joker Politicians and IFA‟s Appendix B: Brief update on Europe Appendix C: OBSR/Morningstar Report Just for laughs: Fiscal cliff explained & exercise programme for over 50s

Distributor Details If you would like to be added to the list to

receive this document electronically please contact:

Nora Geldenhuys

Tel: +27 21 950 2633 Fax: +27 21 950 2526

e-mail: norag@sim.sanlam.com OUR WEBSITE

http://www.simglobal.co.za

Our new Equity Income Fund The two global funds we manage have a high degree of volatility due to us seeking shares that are smaller or in a turnaround phase and hence mispriced We believe that over time these funds should generate good performance as can be seen in the track records of both the Global financial fund (14% compound return in US$ since 2000) and the Best Ideas fund.

Graph 1: Sanlam Global Best Ideas since inception Growth of R10,000 invested 30 Sep 04

However, for investors who prefer a regular cash flow from dividends we have started the Equity Income Fund last year and can report that it has been approved by the FSB. At the moment the fund is forecast to pay a dividend yield of above 4.6%. Hence the fund is giving you an opportunity unlikely to be available for long. Regards

Kokkie Kooyman 01 March 2013

DISCLAIMER Sanlam Investment Management (Pty) Ltd (“SIM”) is a licensed financial services provider and a wholly owned subsidiary of the Sanlam Life. Sanlam Investment Management Global is a division within SIM. This document is intended for information purposes only. No representation, warranty or undertaking is given and no responsibility or liability is accepted by any member of the Sanlam Group as to the accuracy of any information contained herein. No part of this documentation is to be construed as a solicitation to buy or sell any investment. The information contained herein does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act 2002. The use of or reliance on this information by you or any third party shall be entirely at your or the third party‟s own risk and discretion and any liability arising from the use thereof or reliance thereon is accordingly disclaimed by the Sanlam Group. A financial advisor must be consulted as far as the unique needs of the investor are concerned and therefore any parties relying on any view, opinion or model contained herein does so at own risk and Sanlam disclaims all responsibility and liability for positions taken based on such reliance. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments / collective investment units may go down as well as up. Commission and incentives may be paid and if so, would be included with the brokerage charges, marketable securities tax, auditor's fees, bank charges, trustee fees and RSC levies in the overall costs which will be levied against the fund. A schedule of fees and charges and maximum commissions is available from Sanlam Investment Management (SIM) Global.

Source: Morningstar® Direct, Performance quoted in ZAR as a 31 January 2013

5,000

10,000

15,000

20,000

25,000

Aug

04

Feb

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Sanlam Global Best Ideas Performance: Growth in R10,000 invested 30 Sep 04

Sanlam Global Best Ideas A

MSCI World NR USD

GIFS OE Global Flex-Cap Equity

R24,600

R21,700

R22,800

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Promises made by Indian politicians:

Joker Politicians and IFA’s Last year I had to write three exams (after 23+ years in the industry) to prove I “can still do my job”. IFA‟s have to record their advice to clients in writing, and can (and correctly so, do) get sued and fined if their advice was poor or improper. When one looks back at the 2008 US housing crisis and the European sovereign debt crisis, many of the role players have been investigated, criticised and regulated. A major role player and primary cause of both crises has never been reviewed or investigated: politicians. Politicians can sell promises to an electorate without having to show how they will deliver on those promises ever being held to account or measured afterwards. If you think what many other industries have to go through, isn‟t it time that politicians have to write exams and their promises be independently recorded and measured? I think we can prevent many future economic crisis simply by setting up an independent body that ensures politicians are fit to govern and are held to account when they make election promises and afterwards. Okay… dream on, but now that I‟ve thought of it, I cannot believe that nobody else has ever proposed something like this? Kahneman: Thinking, Fast and Slow This is a very interesting book that explains how people think, and specifically our Systems 1 and 2. System 1 is the sort-of “instant thought‟, the first reaction. Unfortunately it is driven a lot by “recency”, i.e. most recent events or other seemingly spurious relationships (students were divided in two groups; the group answering questions relating to old age took longer to walk from the hall where they wrote to the next hall than the group answering questions about fitness, etc.). Unfortunately many decisions are made “on the fly” rather than invoking System 2, as it requires effort to access our brain and think. Again here, there are many influences, some people do this easier than others that have grown lazy, but also, if you make a decision at the end of a day of having used System 2 the whole day, the quality of the end of day decision will be poorer, simply because of fatigue or lack of “sugar”. It was found that judges granted fewer paroles later in the day than early in the day! Studies have also shown how biased we are and that most people never read anything they disagree with. So this means that the readers of our Market Review most probably share the same traits; they are ethical, believe in value investing, see themselves as rational, have a thirst for knowledge and understanding, etc. Which means I‟m continuously preaching to the converted… I thought a lot about this. It means I don‟t really need to write. But I‟ll write because I enjoy it and I‟ll focus on giving you more information that confirm your beliefs!

AIADMK (Tamil Nadu state assembly elections 2011) manifesto: • Free houses of 300 sq. ft.

each, costing Rs 1.8 lakh, to 300,000 BPL families

• Free laptop for all Higher Secondary Students and Art & Science college students

• 1gm of gold for marriage of a girl

• 20kg of free rice to BPL families

• Free Mixer, Grinder and Fan for all households

Samajwadi Party (UP state assembly elections 2012) manifesto: • Free electricity to farmers and

weavers

• Waive farmer debt to the tune of R2 50,000 per farmer

• Allowance of Rs 1,000 to unemployed youth above the age group of 25 years

APPENDIX B: SIM GLOBAL MARKET REVIEW MARCH 2013

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“The balance of risks is still tilting to the downside,”

Brief Update on Europe In January we highlighted that the news flow has been improving and markets were too negative. However, this turned late January and the negative trend especially regarding Europe has continued in February. At the moment both Best Ideas and Global Financial funds have less than 7% invested in Europe (and virtually nothing in Japan) and below you‟ll see why. To balance it out I‟ve added some positive news flow out of the US and China. The French industry minister is not amused. The CEO of US tire-maker Titan International has explained to the French unions why his company is not interested in any deal - noting "you can keep your so-called workers," adding that he would have to be stupid to take over a factory whose staff only put in three hours’ work a day. Maurice 'Grizz' Taylor went 'postal' at the suggestion his company invest in France: "Titan is going to buy a Chinese tire company or an Indian one, pay less than €1 per hour wage and ship all the tires France needs" His truth-filled reality letter concluded: How stupid do you think we are? Titan is the one with the money and the talent to produce tires. What does the crazy union have? It has the French government By Ian Doyle (RMB), 21 Feb 2013

Jan. 30 (Bloomberg) - Spain‟s recession deepened more than economists forecast in the fourth quarter as the government‟s struggle to rein in the euro region‟s second-largest budget deficit weighed on domestic demand. The European Commission this week signaled it may recommend easing Spain‟s budget goals for the fourth time in a year as unemployment in the euro region‟s fourth-largest economy rose to a record 26 percent at the end of Prime Minister Mariano Rajoy‟s first year in power. “The balance of risks is still tilting to the downside,” said Raj Badiani, an economist at IHS Global Insight in London. “The government‟s commitment to a very painful multi-year fiscal-austerity plan has deflated consumer spending and will continue to do so amid high unemployment, shrinking house equity and still-excessive debt levels.” The Bank of Spain said last week that domestic demand may have dropped 3.9 percent from a year earlier in 2012, nearly twice as sharply as in 2011, as output suffered from five austerity rounds in less than a year.

Sales Slip Data show retail sales fell 10.7 percent in December from a year ago, more than economists expected, while home mortgage loans slid 32 percent in November, twice the previous monthly drop. Missed payments as a proportion of total loans at Spanish banks rose to a record 11.4 percent in November. Materis Paints, Europe‟s third-biggest maker of decorative paint, last month predicted sales in Spain will drop 18 percent this year.

APPENDIX B: SIM GLOBAL MARKET REVIEW MARCH 2013

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The system is unsustainable and ignoring the problem will not make it go away

More Jobless Public-job cuts are boosting unemployment as the nation‟s 17 semi-autonomous regions race to divide their combined budget deficit by five in the two years through 2013. A third of all jobless people in the euro area are in Spain. From Bloomberg, Angeline Benoit in Madrid at abenoit4@bloomberg.net

The problem with debt/GDP and forecasting Marc Beckenstrater regularly likes to remind me that trying to forecast government debt statistics is a waste of time (don‟t worry, we don‟t spend any time trying to do that, I‟m just trying to understand the sensitivities). The reason (as Marc says) is the unfunded off-the-balance sheet stuff that is impossible to forecast. Below are a few examples: From Ian Doyle (RMB) “What is Making the news 14 Jan 2013

The US Social Security System has an unfunded liability of $18tn ...means politicians have promised $18tn more than they can possibly pay out ... the Social Security system had a negative cashflow of $47.8bn last year, after running a $48bn deficit the year before... and are likely to have to borrow $50bn this year ...77% of this deficit was created by the SSDI program, where the depressed masses gather after their 99 weeks of unemployment run out .....In 1945 there were 42 workers per retiree...In 1965 there were 5 workers per retiree...Today there are less than 2.5 workers per retiree...There are only 1.6 full time private workers for every one retiree

... The system is unsustainable and ignoring the problem will not make it go away The WSJ says that 90% of Spain’s national pension fund has now been utilized in buying Spanish debt of various sorts and class...means that $77bn has now been spent on propping up Spanish debt while another $7th has been withdrawn in cash. This reminds me of Enron who used the company pension fund to buy Enron shares, leaving its employees without a pension when the company fell over. ...The pension fund is effectively out of money now and how they will fund their social security system is anyone’s guess ...Spain plans to issue $270bn of new debt in 2013 which is up from $242bn in 2012 (+10%) - All of the new Spanish debt will carry Collective Action Clauses which gives Spain the right to force bondholders to their knees...is reminiscent of Greece Why Financial repression is inevitable Considering all assets and liabilities, ... Sovereigns are Highly indebted … if not insolvent

APPENDIX B: SIM GLOBAL MARKET REVIEW MARCH 2013

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Graph 1: Illustrative Estimates of Government Net Worth

Source: EU Commission, Eurostat, CBO, IMF, Morgan Stanley Research Note: Discount rate used in net worth calculations assume a rate that is 100bps above the nominal GDP growth rate across all countries, initial

debt level is the projected gross debt/GDP at end 2010; Initial fiscal position is the 2011 cyclically adjusted primary defic it; long term cost of ageing is based on long term projections of age-related expenditures from the EU and IMF, pre-fiscal retrenchment. Please see Sovereign Subjects, August 25, 2010 by Amaud Mares.

... To get out from under their debt burden, countries can either grow their way out, restructure or default on the debt, or inflate the debt problem away. ... Growth is very unlikely to reach the necessary levels, while default is politically unattractive ... hence inflation is the remaining option. Few understand the impact of “financial repression”. It means that governments steal from their citizens by forcing them to invest in government bonds or by simply keeping interest rates below inflation. This means that in real terms the government position gets better, but savers (pensioners, pension funds etc.) lose via the low returns they receive. The answer normally is to invest in real assets (equities proved to be a winner in real terms even in Zimbabwe)

Graph 2: AAA assets as a % of Global Fixed markets

Source: BAML, Bloomberg, Morgan Stanley Research

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But the investing public remain invested in bonds rather than equities…

Graph 3: The private sector is deleveraging, with little scope to add leverage, while public sector debt is close to WWII highs

Due to QE3 ... the Fed Balance sheet will grow even larger ... for an uncertain time

Federal government expenditure (% of GDP)

FY 2010 2030 2050

Medicare and Medicaid 5.5 9.2 13.0

Social Security 4.8 6.0 5.9

Other noninterest outlays 12.5 8.7 8.1

Total Excl Interest 22.9 23.9 27.0

Interest 1.4 7.2 15.8

Total 24.3 31.1 42.8 Source: CBO Long Term Budget Outlook, June 2011

(using the „alternative fiscal scenario‟)

But the investing public remain invested in bonds rather than equities…

Graph 4: US Mutual Fund Asset Allocation %

Source: ICI, Morgan Stanley Research

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“We expect the economy to perform better in the second half of the year and firms are gearing up for that,” said Michael Carey, chief economist at Credit Agricole CIB in New York

Graph 5: European Mutual Fund Asset Allocation %

Source: Various National Sources, Morgan Stanley Research

Positive newsflow from the US however continues: US Case-Shiller national house price index rose +7.3% YoY in 4Q, from 3.6%, Better than expected +7%; also, CS 20-city index rose +6.9% & FHFA +5.8% in Dec New home sales jumped +29% YoY! Cheap credit is fuelling housing recovery Feb. 27 (Bloomberg) -- Orders for U.S. durable goods excluding transportation equipment climbed in January by the most in a year, showing companies are planning to expand capacity as they look beyond the budget impasse in Washington. Bookings for items meant to last at least three years minus things such as aircraft climbed 1.9 percent, exceeding all forecasts of economists surveyed by Bloomberg and the biggest gain since December 2011, according to data from the Commerce Department issued today in Washington. Another report showed pending sales of existing homes jumped more than forecast. Demand for machinery such as construction equipment and generators jumped by the most in more than two years last month, indicating companies were relieved the U.S. avoided the brunt of the so-called fiscal cliff of tax increases and budget cuts slated to take effect at the start of the year. Growing demand from abroad will probably supplement gains in investment to ensure manufacturing keeps contributing to economic growth. “We expect the economy to perform better in the second half of the year and firms are gearing up for that,” said Michael Carey, chief economist at Credit Agricole CIB in New York. “Plus, it‟s a good time to make capital expenditures since interest rates are so low.” Carey is the best forecaster of durable goods excluding transportation for the past two years, according to data compiled by Bloomberg. Jan. 27 (Bloomberg) -- The job market in the U.S. probably kept making headway in January even in the face of Washington‟s budget battles, economists said before reports this week. Employers added 160,000 workers to payrolls last month after a 155,000 December increase, according to the median of 67 forecast in a Bloomberg survey before a Feb. 1 Labor Department report. The average monthly gain over the past two years was 153,000. Other data this week may show manufacturing is stabilizing, housing is improving and consumers are spending.

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“Rising home prices are providing an important cushion,” said Millan Mulraine, a New York-based economist at TD Securities LLC

Sustained gains in hiring are giving incomes a lift, cushioning workers from the sting of higher payroll taxes. Nonetheless, bigger employment increases are needed to drive down a jobless rate that Federal Reserve officials, who meet this week for the first time this year, say is too high. “The labor market is pretty resilient, but it‟s also unspectacular,” said Guy Berger, an economist at RBS Securities Inc. in Stamford, Connecticut. “It looks like employers didn‟t really blink during the fiscal debates. If we keep adding jobs at this pace, the unemployment rate will gradually come down.” The jobless rate, derived from a separate survey of households, was probably 7.8 percent, matching December and November as the lowest since the beginning of 2009, according to the median forecast. Jan. 29 (Bloomberg) - Home prices in 20 U.S. cities rose in the 12 months to November by the most in more than six years, showing the housing market will play a more central role in the U.S. economic expansion this year. The S&P/Case-Shiller index of property values increased 5.5 percent from November 2011, the biggest year-over-year gain since August 2006, according to data released in New York today. Confidence sank more than forecast in January as consumers were stung by a drop in take-home pay, another report showed. Mortgage rates near a record low will probably spur a third consecutive advance in home sales this year, which will keep property values rising. The resulting gains in home equity may help support consumer sentiment and spending, the biggest part of the economy, softening the hit from the two percentage-point increase in the payroll tax that took effect this month. “Rising home prices are providing an important cushion,” said Millan Mulraine, a New York-based economist at TD Securities LLC, who correctly forecast the gain in values. Lower confidence and smaller paychecks “will slow consumer spending this quarter, but the effect will abate in coming months.” Jan. 27 (Bloomberg) -- Chinese industrial companies’ profits rose for a fourth month in December, adding to signs the country‟s economic rebound is gaining momentum. Net income increased 17.3 percent from a year earlier to 895 billion yuan ($144 billion), the National Bureau of Statistics said today in Beijing, after a 22.8 percent jump in November. Earnings for the full year gained 5.3 percent.

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Industrial profits may rise by an average 30 percent this year as the world‟s second-biggest economy recovers from a seven-quarter slowdown, businesses start restocking and export demand improves, Standard Chartered Plc forecasts. Expansion in gross domestic product may accelerate to 8.1 percent this year from 7.8 percent in 2012, according to the median of 44 analyst estimates in a Bloomberg News survey this month. “This broadly confirms the picture we‟re getting from other data that industrial and economic growth is picking up again and the pressure on output prices is diminishing,” said Louis Kuijs, chief China economist at Royal Bank of Scotland Plc in Hong Kong. “Because of quite weak numbers in the first half of 2012, the profit numbers are likely to show strong year-on- year Finally, an extract from a Gavekal article that I found very insightful: Gavekal Research; The Game of Chicken is ending (21 January 2012) The sudden breakthrough on the US debt ceiling battle is the most bullish political event since 2008. The Republicans’ peace-offering came much sooner than we anticipated in Friday’s piece (see The US Recovery (Or Not)), when we repeated some reasons for our longstanding confidence that Washington’s game of fiscal chicken would end without too much damage. It could very well set the stage for a surprisingly quick and orderly resolution of all the most serious US fiscal problems—and an even more unexpected return to bipartisan political cooperation not seen in Washington since the early 1990s. The House Republicans’ decision on Friday to extend the debt ceiling for three more months, allowing time for the passage of a 2013 budget, was followed by a positive response from President Obama and Senate Democratic leaders; the proposal should be consecrated in a House vote on Wednesday. The Democratic-controlled Senate responded by promising to pass a full budget for the first time since 2008, under rules eliminating filibusters and requiring only simple majority votes. Most surprisingly and importantly, the Republicans effectively withdrew their demand that increases in the debt ceiling should be matched with equal spending cuts, and the White House admitted that cuts in entitlement programs would be inevitable, provided they happened in the long-term. The US will probably resolve its long-term fiscal problems fairly painlessly through long-term tax and entitlement reforms that will take no risks with economic growth by imposing immediate fiscal tightening. This will become possible once both parties start explaining to voters that US fiscal challenges mainly concern plans for future decades, not deficits this year or next (see Deficit Deniers Of The World Unite).

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APPENDIX C: SIM GLOBAL MARKET REVIEW MARCH 2013

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JUST FOR LAUGHS: SIM GLOBAL MARKET REVIEW MARCH 2013

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JUST FOR LAUGHS

“Fiscal Cliff” put in a much better perspective.

Lesson #1: U.S. Tax revenue: $2,170,000,000,000 Fed budget: $3,820,000,000,000 New debt: $1,650,000,000,000 National debt: $14,271,000,000,000 Recent budget cuts: $38,500,000,000 Let‟s now remove 8 zeros and pretend it‟s a household budget: Annual family income: $21,700 Money the family spent: $38,200 New debt on the credit card: $16,500 Outstanding balance on the credit card: $142,710 Total budget cuts so far: $38,50 Got it ?? … OK, now, Lesson #2: Here‟s another way to look at the Debt Ceiling: Let‟s say, You come home from work and find there has been a sewer backup in your neighbourhood… and your home has sewage all the way up to your ceilings. What do you think you should do … Raise the ceilings, or remove the shit?

------------------------- For those like me who lost fitness for whatever reason, the attached exercise program might just do the trick:

Fitness program for Men over 50 years of age Begin by standing on a comfortable surface, where you have

plenty of room at each side. With a 5kg potato bag in each hand, extend your arms straight out

from your sides and hold them there as long as you can. Try to reach a full minute, and then relax. Each day you'll find that you can hold this position for just a bit

longer. After a couple of weeks, move up to 10kg potato bags. Then try 50kg potato bags and then eventually try to get to where

you can lift a 100kg potato bag in each hand and hold your arms straight for more than a full minute. (I'm at this level.)

Once you feel confident at that level, put one potato in each bag.