60
Feature The great manipulation continues. The most important variable for savers, producers, and investors to allocate capital and risk continues to be manipulated in a fashion that is arguably unprecedented and dangerous. The current political regimes do not trust the markets. It is fair to say that the distrust is mutual. More and more investors want real assets. They want out. They want something outside of the whole financial system where the authorities are becoming more and more repressive. Trust has been lost. Sadly, not all investors have the flexibility to take their funds and park them outside of the financial system; they’re stuck. Bonds are expensive. If an asset class is priced cheaply and something goes wrong, the asset class gets even cheaper and potentially becomes an opportunity for value and distressed investors and bottom fishers. If an asset class is priced expensively and something goes wrong, hell breaks loose. Macro update Global economy remains at an inflection point. The average PMI are below 50 and stabilising. So the economic trend, on average, is towards slight contraction and slow deterioration of economic circumstances. This would be more or less consistent with a falling average GDP growth rate and falling average industrial production. All the monetary easing and fiscal stimuli have stabilised the whole situation. Economically it’s not great, but it’s not a global depression either. Risk update Risk is on. Risk seeking behaviour remains elevated, currently in the 4 th highest percentile since 1997. The easing of sovereign credit spreads is partially a function of Draghi and partly a function of regulatory-induced short covering. Risk management research Repressionomics 18 January 2013 Alexander Ineichen CFA, CAIA, FRM +41 41 511 2497 [email protected] www.ineichen-rm.com “My true adversary does not have a name, a face, or a party. He never puts forward his candidacy but nevertheless he governs. My true adversary is the world of finance.” —Francois Hollande, Financial Times, 22 January 2012 Ineichen Research & Management (“IR&M”) is an independent research firm focusing on investment themes related to absolute returns and risk management.

RMR Q1 2013

Embed Size (px)

DESCRIPTION

Global macro

Citation preview

Page 1: RMR Q1 2013

Feature

The great manipulation continues. The most important variable for

savers, producers, and investors to allocate capital and risk

continues to be manipulated in a fashion that is arguably

unprecedented and dangerous.

The current political regimes do not trust the markets. It is fair to

say that the distrust is mutual.

More and more investors want real assets. They want out. They

want something outside of the whole financial system where the

authorities are becoming more and more repressive. Trust has been

lost. Sadly, not all investors have the flexibility to take their funds

and park them outside of the financial system; they’re stuck.

Bonds are expensive. If an asset class is priced cheaply and

something goes wrong, the asset class gets even cheaper and

potentially becomes an opportunity for value and distressed

investors and bottom fishers. If an asset class is priced expensively

and something goes wrong, hell breaks loose.

Macro update

Global economy remains at an inflection point.

The average PMI are below 50 and stabilising. So the economic

trend, on average, is towards slight contraction and slow

deterioration of economic circumstances. This would be more or

less consistent with a falling average GDP growth rate and falling

average industrial production. All the monetary easing and fiscal

stimuli have stabilised the whole situation. Economically it’s not

great, but it’s not a global depression either.

Risk update

Risk is on. Risk seeking behaviour remains elevated, currently in the

4th highest percentile since 1997.

The easing of sovereign credit spreads is partially a function of

Draghi and partly a function of regulatory-induced short covering.

Risk management research

Repressionomics

18 January 2013 Alexander Ineichen CFA, CAIA, FRM +41 41 511 2497 [email protected] www.ineichen-rm.com “My true adversary does not have a name, a face, or a party. He never puts forward his candidacy but nevertheless he governs. My true adversary is the world of finance.” —Francois Hollande, Financial Times, 22 January 2012

Ineichen Research & Management (“IR&M”) is an independent research firm focusing on investment themes related to absolute returns and risk management.

Page 2: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 2

Repressionomics

On a personal note .............................................................................................. 3

Whatever it takes moments ............................................................................ 3

Murphy’s Law .................................................................................................. 4

We do not trust you......................................................................................... 7

Dogma in investment management .............................................................. 12

The ALM time bomb and the reality kick ...................................................... 15

Macro update .................................................................................................... 20

Summary ........................................................................................................ 20

Global economy: at inflection point .............................................................. 21

United States: improving ............................................................................... 29

Europe: at inflection point ............................................................................. 35

Germany: improving ...................................................................................... 37

France: declining ............................................................................................ 39

Italy: at inflection point ................................................................................. 41

Spain: improving ............................................................................................ 42

Netherlands: declining ................................................................................... 43

UK: declining .................................................................................................. 44

Switzerland: improving .................................................................................. 46

Japan: declining ............................................................................................. 47

China: improving ............................................................................................ 49

Risk update ........................................................................................................ 53

Summary ........................................................................................................ 53

Publications ....................................................................................................... 59

Page 3: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 3

On a personal note

“We must re-establish the primacy of

politics over the markets.”

—Angela Merkel1

“Make no mistake: We have

instruments of torture in the cellar,

and we’re going to show them, if

necessary.”

— Jean-Claude Juncker2

Whatever it takes moments

The great manipulation continues. Investment banks are being punished for

manipulating Libor by a couple of basis points; while central banks are being

lauded for manipulating the whole yield curve by a couple of percentage points.

The most important variable for savers, producers, and investors to allocate capital

and risk continues to be manipulated. Figure 1 shows some “whatever it takes”

moments in recent financial history. Where would interest rates be when left to

the market? Higher, most likely.

Figure 1: Whatever it takes moments

Source: IR&M, Bloomberg

One result of the great manipulation is that buy-and-hope strategies have worked

very well. Reflation has resulted in all boats rising. Figure 2 shows performance

since QE1 was announced in November 2008.

1 Firefighting, The Economist, 14 July 2011

2 Interview in Handelsblatt, 1 March 2010.

Page 4: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 4

Figure 2: Performance of a selection of indices/instruments (25 Nov 2008 to 11 Jan 2013)

Source: IR&M, Bloomberg

Risk management came at a cost and was a drag on performance.

Murphy’s Law

Mark Boleat, Chairman of The City of London, said in relation to the summer

Olympics in London:

Everything that could have gone wrong, didn’t.1

This quote is obviously a witty reference to Murphy’s Law:

Anything that can possibly go wrong, does.

In relation to the current financial landscape, here referred to as Repressionomics,

there is potentially a third variation:2

Anything that can possibly go wrong, will eventually but it may take a while.

In the inaugural report of this risk management research effort I made fun of

forecasting. The reason for the ridicule is due mainly to an unfortunate lack of

foresight on my part of course. Secondarily, the track record of forecasting is not

great. The latest analysis I came across was from Big Picture Barry Ritholtz. He did

a back of the envelope analysis of “Ten stocks to last the decade” from Fortune in

August 2000.3 The portfolio managed to lose 74.31% to 19 December 2012, with

two high profile bankruptcies (Nortel and Enron). Top pick was Nokia that fell

roughly 95%. Thirdly, an investment process that relies on forecasting cannot be

robust; I would argue, by definition.

How does Murphy’s Law or the modified Murphy’s Law above apply to the current

market environment of Repressionomics? It has to do with bonds. Here some

related facts:

1 AIMA’s Annual Conference, Guildhall, London, 20 September 2012

2 There are actually many more variations. See http://www.murphys-laws.com/murphy/murphy-laws.html

3 “Buy-and-Forget Portfolio: 10 Stocks To Last The Decade,” Big Picture 20 December 2012

“I've gone into hundreds of fortune-

teller's parlors, and have been told

thousands of things, but nobody

ever told me I was a policewoman

getting ready to arrest her.”

—New York City detective

Page 5: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 5

Bonds are widely perceived as less risky than equities, mainly due to academia

saying so. The argument is that bonds have, generalising a bit, lower volatility

than equities. Since volatility is the metric for risk chosen by modern portfolio

theory, bonds are less risky.

Regulators like bonds, as do national and supra-national accounting

committees. They need to go with the scholarly consensus; what else?

Retiring—and equity market crash doubly-shell-shocked—baby boomers have

been switching from equities into bonds for some time now. Japanese

investors have small allocations to their local stock market; it simply has been

going down for too long.

Last of all, and most importantly, allocations by institutional investors are high,

not low. Many bond markets in developed economies had a really really good

30-year run, hence the high allocation.

Newsletter writer Dennis Gartman from the Gartman Letter likes to refer to

something that has risen a lot as having moved “from the lower left hand corner

to the upper right”. Bonds are a good example, as Figure 3 shows. Bonds, quite

literally, have been going from the lower left hand corner to the upper right hand

corner in the graph. This is true in nominal as well as real terms. The Barclays US

Aggregate has compounded at a rate of 8.5% per year since 1980 which

compares to 3.4% for official US consumer price inflation.

Figure 3: Bonds (inception – 11th January 2013)

Source: IR&M, Bloomberg

With institutional bond allocations historically so high, the one thing that should

not happen is a strong rise in yields. The relevance to modified Murphy’s Law is

that it will eventually happen, it just might take a while. The “when” is the trillion

dollar question. Figure 4 shows yield curves of a selection of industrialised

economies compared to their own 10-year history as well as inflation. (CPI is

negative in Japan and Switzerland and therefore does not show in the graph.)

“A random market movement

causing the average investor to

mistake himself for a financial

genius.”

—Alternative definition of a bull market

Page 6: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 6

Figure 4: Yield curves

1.85

3.04

1.57

2.362.03

3.27

0.75

2.00

0.68

1.21

0

1

2

3

4

5

6

7

3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y

Yie

ld,

%

10Y Range

18/01/13

03/01/13

31/12/12

30/12/11

Inflation

USD EUR GBP JPY CHF

Source: IR&M, Bloomberg

Note: Numbers in graph stand for 10-year and 30-year yields. Short end of CHF yield curve “disappears” because yields

are negative.

Yield curves are low and have been reasonably stable over the past two years. The

US yield curve is negative up to a maturity of ten years, assuming official consumer

price inflation of 1.8% has any meaning. Shadow Government Statistics claims

inflation to be around 5% using pre-1990 methodology and around 10% using

pre-1980 methodology.1 The practical relevance is of course that the larger the

difference between inflation and nominal yields, the more extreme and quicker is

the saver expropriated. (At a real rate of -8% it takes a bit more than eight years

to half ones wealth in real terms.) The EUR and GBP yield curves are nearly fully

under water, i.e., real yields are negative for nearly all maturities. Negative real

yields are probably the most elegant, politically pragmatic way to reduce debt.

Interest rates are essentially the price for money, for risk capital. We know that

prices fluctuate. They rarely only go in one direction forever. Trees don’t grow to

the sky; even Apple shares are not excluded from gravity. It’s how these things

work. We just do not know when.

1 shadowstats.com

“There are two ways to conquer and

enslave a nation. One is by the

sword. The other is by debt.”

—John Adams (1735-1826), Founding

Father and second US President

Page 7: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 7

We do not trust you

Do we know what will be the catalyst for higher yields? Not really. Does it matter?

Yes it does. However, debating on the catalyst is speculative. One idea is that

yields will rise when trust is lost. But hasn’t that happened already? Europe is a

comedy. In Italy a comedian might become the next prime minister and France

inaugurated one last May while the infantile gyrations between the two political

squabblers in relation to the fiscal cliff was even embarrassing to me, and I’m a

non-American and an eight hour flight away from DC. So dwindling trust in our

leaders cannot help us time the eventual rise in yields. Note that we are now in a

sovereign crisis. A couple of years ago it was a banks crisis. The problems have

moved on. The pin that pricked the bubble in the banking crisis was a collapse of

trust. When banks didn’t trust each other, the game was over. Now, when

sovereigns stop trusting each other, the game is over. Asmussen’s “we do not

trust you,” therefore is quite a statement. Whether it is the clownish behaviour in

Washington and the political comedy unfolding in Paris which is the underlying

reason why the Bundesbankers in Frankfurt want their gold back, I don’t know. It

is certainly an indication that trust is not rising.

Another aspect on trust that is related to Repressionomics is the short selling bans.

Credit spreads on sovereigns in peripheral Europe have narrowed considerably. See

Figure 5. Having been as wide as 600 bps, Spanish 5-year CDS is now around 240

bps, Italy is down from 570 bps to 220 bps. Ireland now trades below 200 bps.

Now at least part of this performance can be put down to Draghi’s “it will be

enough – whatever it takes” speech in July 2012. And after the speech, Draghi

eventually followed this up in September with the announcement of the Outright

Monetary Transactions (OMT) programme in which the ECB would buy short dated

government bonds of Eurozone members where bond spreads reflected too high a

breakup premium (but with some conditionality attached in return). So is the

improvement in credit sentiment a reflection of conviction in the European

authorities to “save” peripheral bond markets? Not really.

Figure 5: Sovereign CDS spreads of PIIGSF (Jan 2006 – 11 Jan 2013)

Source: IR&M, Bloomberg

1 “Currency Union Teetering, 'Mr. Euro' Is Forced to Act,” Wall Street Journal Online, 26 September 2010

2 “Debt crisis: Mario Draghi pledges to do 'whatever it takes' to save euro,” The Telegraph, 26 July 2012

“Because we do not trust you.”

—Joerg Asmussen, the debuty

German finance minister’s response to

the question “Why don’t you let us

handle this?” to a senior commission

official trying to persuade Mr.

Asmussen to let Brussels run the

stabilization fund1

“Within our mandate, the ECB is

ready to do whatever it takes to

preserve the euro. And believe me,

it will be enough.”

—Mario Draghi2

Page 8: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 8

The other dynamic in H2 2012 might have been just as powerful; namely the

realisation amongst hedge funds and other asset managers that the EU regulation

on short selling and sovereign credit default swaps, published in April, might well

force them to close out short positions in the troubled sovereigns. The regulation

states that uncovered (“naked”) sovereign CDS shorts on European Union (not just

Eurozone) nations will not be permitted, and must be closed out by 1st November

2012. This is of course just a further, more aggressive stage in Repressionomics.

Short selling bans are the equivalent of banning gold in earlier times. “Naked”

broadly means not hedging an underlying government bond exposure – it covers

bearish trades on government creditworthiness. The short can be closed out by

either using an opposing CDS contract, or by buying underlying government

bonds to the same value. Whilst there was an exemption for positions initiated in a

period before the regulation was published, any short positions put on since then

have to be closed out, whether this is a single name CDS or even an index which

includes an EU member (for example the iTraxx Sovx CEEMEA index, a CDS index

consisting of 15 sovereigns from Central and Eastern Europe, Middle East and

Africa, includes Poland, and so a naked short position in the index would be

banned). The regulation is global in its reach and so should forbid even, for

example, a Singaporean bank dealing with a US insurance company out of an

office in Chile.1

Liquidity in the EU sovereign CDS market has collapsed. Since sovereign debt

instruments include short-term bills with a maturity of just one month when first

issued, market-making is often unfeasible over the entire term of such

instruments. Some market participants worry that the sovereign CDS market could

die off altogether due to these constraints and a host of other regulatory

pressures. There is a risk that market participants may find other ways to hedge

their exposures or express bearish views on EU sovereign risk, including shorting

government bonds – which the regulation does not forbid – or finding single-

name proxy CDSs. It’s a bit like prohibition or prostitution; the market will find a

way to respond to the repression. Since the ban on short selling, there has been a

sharp uptick in the number of investors using exchange traded futures that are

more lightly regulated. Open interest in Eurex listed Italian BTP futures for example

have almost doubled since the announcement of the ban.

The bottom line is that the current political regime doesn’t trust the markets. It is

fair to say that the distrust is mutual.

One could of course argue that trust has evaporated a long time ago. It must be

something else that causes real yields to fall further or nominal yields to rise;

financing a war perhaps, or a balance-of-payments crisis in the emerging markets,

or anything else. Figure 6 shows the underwater perspective of UK bonds since

1700. Judging by Figure 6, war can be ruled out too. After all, Britain has been at

war for most of its recent history (and I haven’t even included all conflicts where

military force was used). That’s what super powers—as well as former super

powers—do; it’s the norm. Pax Romana was defended by force; as was Pax

Mongolica and Pax Britannica; and now Pax Americana is secured by force.2 (If

1 http://www.bondvigilantes.com

2 Otherwise the USD$700bn+ per year spent on defence could be spent on social security; granting redistributive

payments to 99% of the population instead of just 50% which is the current estimate. Personally, I am actually quite

grateful of growing up and living in the Pax Americana; the alternatives are so much less attractive. The older I get, the

Short selling bans, forbidding the

holding of gold, nationalising

private pensions, etc. are forms of

repression

The market will find a way

“The past may not repeat itself, but

it sure does rhyme.”

—Mark Twain (1835-1910), American

author and humourist

Page 9: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 9

there is ever a Pax Helvetica, then they will use force too.) The US military currently

has troops in more than 150 countries; barbarians at the gate everywhere.1 History

does indeed rhyme sometimes.

Figure 6: UK bonds under water in real terms (Jun 1700 – Dec 2012)

Source: IR&M, Global Financial Data, Bloomberg, inflation from 1750-1800 from Twigger (1999)2, war dates from wikipedia.

Note: Zero inflation was assumed for 1700-1749

As a very rough estimate, Great Britain spent 71% of its time at war since

1700. It’s the norm, peace the exception.

Bonds can spend a long time under water; in the UK and elsewhere of course.

At the moment it seems that the regulators don’t know this, while the asset

liability benchmark hugging community doesn’t care. Their incentive to care is

being repressed. More on that later.

Figure 7 shows the underwater perspective of a proxy for US Treasuries as well as

US equities.

more I seem to side with Margaret Thatcher: “During my lifetime most of the problems the world has faced have come, in

one fashion or other, from mainland Europe, and the solutions from outside it.” Thatcher, Margaret (2002) “Statecraft—

Strategies for a changing world,” New York: Harper Collins, p. 320. Thankfully, my native place, Switzerland, is not in

Europe.

1 Note that Osama Bin Laden is perceived and named a terrorist by the people who live within Pax Americana; similarly as

George Washington was to the people living within the Pax Britannica. The perspective matters greatly. (And winning, of

course.) Note that the word “terrorism”—emotionally charged with different definitions in circulation—is younger than

George Washington, another word was used for massacres inflicted by non-governmental forces.

2 Twigger, Robert (1999) “Inflation: the Value of the Pound 1750-1998,” Research Paper 99/20, House of Commons

Library, 23 February.

Page 10: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 10

Figure 7: US equities and bonds under water in real terms (Jan 1900 – Dec 2012)

Source: IR&M, Global Financial Data, Bloomberg, war dates from wikipedia

When risk for an asset class is defined as “potential years under water in real

terms”, i.e., the longevity of capital compounding negatively, bonds are more

risky than equities. The drawdowns in equities are more violent and the

recovery more swift, both contributing to a higher standard deviation of

returns, i.e., volatility. Bond/credit cycles are longer than equity/business cycles.

What is most important is that the 48-year episode in Figure 7 is outside of the

living memory of the contemporary investor or regulator.

The United States was at (hot) war in 81% of the time since 1900 when the

cold war and some minor conflicts are ignored. War is the rule, not the

exception. History is a constant struggle between freedom and repression. Pax

Americana and its allies, with differing contributions, have fought for the

former and against the latter. Perhaps it’s one of the ironies of history that

Western civilisation is now becoming repressive on its own citizens and those

who were formerly repressive are opening up. It seems that Russia and China

are done with social experiments whereas the United States have just began.

Ms Merkel—an Ossi—knows. She has seen with her own eyes and knows that

it doesn’t work. Mr Obama hasn’t and doesn’t.

The idea that wars are more likely in a fiat money system is difficult to defend

when examining the chart. When you want to go to war, you go to war.

Nevertheless, the financing of the armament is probably easier in a fiat money

system. (In a non-fiat monetary system you would need to tax the rich heavily

or use financial repression and force investors to buy government bonds and

ban short selling of those bonds or you would need an influential orator, a

demagogue, a yes-we-can-kind-of-guy in charge.)

Yields can rise for a long time. This means of course that bonds can

compound negatively (nominally as well as in real terms) for a long time.

A further aspect is related to correlation. Both equities and bonds can both

compound negatively simultaneously for a long time. Both equities and bonds

are valued on the basis of discounting future cash flows to today. When

1 Merkel hints at need to cap social spending, Financial Times, 17 December 2012

“Man seems to insist on ignoring the lessons available from history.” —Norman Borlaug (1914 - 2009), American agronomist and the father of the Green Revolution

“We witnessed in the GDR and in

the entire socialist system that an

economy which was no longer

competitive was denying people

prosperity and ultimately leading to

great instability.”

—Angela Merkel1

Page 11: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 11

nominal yields rise, the present value of those cash flows falls. The period of

disinflation and falling interest rates was good for both. The opposite,

whatever that might be, is not. It is not surprising, therefore, that more and

more investors want real assets. They want out. They want something outside

of the whole financial system where the authorities are becoming more and

more repressive. Trust has been lost. Sadly, not all investors have the flexibility

to take their funds and park them outside of the financial system; they’re

stuck.

When examining bonds in Figure 7, it is not necessarily obvious that the past 25+

years are in any way representative for the long term. It seems the past two or

three decades seem actually rather an exception than the rule. The Maestro,

pictured, was inaugurated in 1987. When thinking about bonds and correlation

between equities and bonds, it is possible that the past 25+ years were one single

regime with certain characteristics. It essentially was a credit bubble causing asset

price hyperinflation. Whatever it’s called, if this idea has any merit then, of course,

a different regime may have entirely different characteristics. For mean-variance

optimisation, or any other optimisation, to be intelligent, the regime should not

switch. Currently, diversification is perceived as a good idea.1 It is possible that a

regime awaits us, where no government bonds of sovereigns in the industrialised

economies is the course of action of the wise investor. This would be quite the

opposite of the risk parity idea in which one essentially levers up on bonds because

volatility is so much lower than equities.

Figure 8 shows what Keynes meant, what Keynesians did, and what seem the

current and unintended consequences. The third regime/graph is arguably

different from the previous/second one.

Figure 8: What Keynes meant, what Keynesians did, and the mess it caused

Source: First two graphs are from Protégé Partners, third is IR&M

Keynes idea was about counter-cyclical fiscal stimulus, i.e. boosting aggregate

demand by expanding debt to weather the trough of the business cycle and

correspondingly shrinking demand by retiring debt during the ensuing boom.2

However, this latter point was sort of ignored. As the Economist put it:

The state’s growth has been encouraged by the right as well as the left, by

favour-seeking companies as well as public-sector unions, by voters as well as

1 The idea of diversification goes back a long way and is indeed a good idea. See Diversification? What diversification? for

some additional colour on the topic.

2 From Protégé Partners 4Q 2009 quarterly letter

Mon

ey

Time

Save

Borrow

Borrowing

Business Cycle

What Keynes Meant

Mon

ey

Time

Borrow

Borrowing

Business Cycle Borrow

Borrow

What “Keynesians” Did

Mon

ey

Time

Borrowing

Business Cycle

Monetising debt

Unintended consequences

Monetising debt

Monetising debt

“None of us can have as much as

we want of all the things we want.”

—Oliver Wendell Holmes (1809-1894),

American writer

Page 12: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 12

bureaucrats. Indeed, given the pressures for ever larger government, many

reformers feel they will have to work hard just to

keep it at its present size.1

Alan Greenspan on the topic of fiat money, gold,

welfare state, and the government’s involvement;

before working for the government:

In the absence of the gold standard, there is no

way to protect savings from confiscation through

inflation. There is no safe store of value. If there

were, the government would have to make its

holding illegal, as was done in the case of gold. …

The financial policy of the welfare state requires

that there be no way for the owners of wealth to

protect themselves.

This is the shabby secret of the welfare statists'

tirades against gold. Deficit spending is simply a

scheme for the confiscation of wealth.2

I’m not a believer in the gold standard. However, I believe in Repressionomics, i.e.,

that failed authorities go after the saver’s money. (I also believe that sometimes

there is great wisdom and truth in cartoons.) And what better place to get the

money where it currently resides: institutional investors, namely pension funds and

insurers. These institutions are the safekeeper of the forced savings of the

populace. They hold large allocations of government bonds. They have to.

Interestingly, in many cases, they also want to.

Dogma in investment management

At one level, dogma, beliefs, faith, and uncertainty are related. On another level a

discussion of dogma, beliefs, faith, and uncertainty could become emotionally

charged as someone’s strongly held beliefs are complete and utter nonsense to

someone else. To some historians dogma is the number one cause for Homo

sapiens killing one another. 500 years ago it was Catholics against Protestants (in

some places they still do) and today its Shiites and Sunnis.3 George Bush went on

record saying that “God told me to invade Iraq.” This is one example of differing

perceptions. Imagine he had said: “A creature on Alpha Centauri has told me

through my hair blower to invade Iraq.” Everyone would have thought he is mad.

However, by adapting a common belief system, only parts of the world population

thought he was mad. For some people, those in the second and third row in Table

1, the two aforementioned statements are nearly identical.

1 The Economist, A special report on the future of the state, Taming Leviathan, 19 March 2011

2 Gold and Economic Freedom, The Objectivist, 1966, reprinted in Ayn Rand’s Capitalism: The Unknown Ideal, 1967.

3 These things seem to oscillate. In 500 years it might be Catholics and Protestants again. When Europeans were

chopping each other’s heads off because they couldn’t agree which old book was more important, the area we today call

the Middle East made great advances in the natural as well as social sciences as well as philosophy and medicine. For

the time being it’s the other way around.

History suggests that when

authorities fail, the 99% lose

Montaigne's axiom:

"Nothing is so firmly believed as

that which least is known."

—Michel de Montaigne (1533-1592),

French author, philosopher, and

statesman

Page 13: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 13

Table 1: Belief in a supreme being by country

Source: Harris Organization Inc.

Caveat lector: The topic of belief and dogma are tricky, especially when combined

with ridicule. However, the topic of belief and dogma is central to this publication

as will become apparent below. Ridicule1, humour2, cynicism3 are all forms of

honesty, the search for the truth; essentially the opposite of political correctness.

Political correctness is dishonest by definition. Research is defined as seeking the

truth and ought to be honest and therefore must be political incorrect by

definition. Occasional and potential offensiveness is not the purpose but an

unfortunate side effect.

I believe the following pieces of wit and wisdom have merit and, in one form or

another, apply to the topic of dogma in finance. If some of these remarks are

offensive, it’s not the messenger’s fault. Personally, I find the way in which they

apply to finance and the current political environment shocking. It goes without

saying that these quotes were taken out of context; Leonardo da Vinci wasn’t

thinking of asset-liability benchmarking when he said the below. I must assume,

therefore, that the applicability of these references lie in the eye of the beholder.

"Believe those who are seeking the truth; doubt those who find it."

—Andre Gide (1869 – 1951), French author and winner of the Nobel Prize in

literature in 1947

Well, that one was just a bit of self-promotion; bad taste, so to speak. The

following are more applicable.

“The greatest deception men suffer is from their own opinions.”

—Leonardo da Vinci (1452-1519), Renaissance Man

“It is not disbelief that is dangerous to our society; it is belief.”

—George Bernard Shaw (1856-1950), Irish dramatist, critic, political activist

and co-founder of the London School of Economics

1 “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being

self-evident.”—Arthur Schopenhauer

2 “Not a shred of evidence exists in favor of the idea that life is serious.”—Brendan Gill (1914-1997), American writer (The

New Yorker); “It is my belief, you cannot deal with the most serious things in the world unless you understand the most

amusing.”—Winston Churchill

3 “The power of accurate observation is commonly called cynicism by those who have not got it.”—George Bernard Shaw

4 Breakfast with Dave, Gluskin Sheff, 9 February 2012

% France Germany Great Britain Spain Italy United States

Believer in any form of God or any type

of supreme being27 41 35 48 62 73

Agnostic (one who is sceptical about

the existence of God but not an atheist)32 25 35 30 20 14

Atheist (one who denies the existence

of God)32 20 17 11 7 4

Would prefer not to say 6 10 6 8 8 6

Not sure 4 4 7 3 3 3

“The two pillars of ‘political

correctness’ are: a) wilful

ignorance, b) a steadfast refusal to

face the truth.”

—George MacDonald (1824-1905),

Scottish author

“In the arena of wealth

management, there is no room for

dogma.”

—David Rosenberg4

“Bad taste is simply saying the

truth before it should be said.”

—Mel Brooks

Page 14: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 14

“The fact that an opinion has been widely held is no evidence

whatever that it is not utterly absurd.”

—Bertrand Russell (1872-1970)

Rephrased: Just because everyone matches their assets to their liabilities doesn’t

necessarily mean it’s a good idea.

“The most common of all follies is to believe passionately in the

palpably not true. It is the chief occupation of mankind.”

—Henry Louis “H. L.” Mencken (1880 - 1956), American journalist, essayist,

magazine editor, satirist, and critic of American life and culture

“The death of dogma is the birth of reason.”

—Immanuel Kant (1724-1804)

"There can't be a practical reason for believing what isn't true. I rule it

out as impossible. Either the thing is true or it isn't. If it is true, you

should believe it, and if it isn't, you shouldn't. And if you can't find out

whether it is true or whether it isn't, you should suspend judgement."

—Bertrand Russell on the question whether there is a practical reason for

having a religious belief1

This essentially means: If you cannot be sure that a 90% bond allocation is really in

the best interest of your “liabilities”, diversify.

“At least two-thirds of our miseries spring from human stupidity,

human malice and those great motivators and justifiers of malice and

stupidity: idealism, dogmatism and proselytizing zeal on behalf of

religious or political ideas.”

—Aldous Huxley (1894 - 1963), English writer

At one level, one would have assumed everyone to be on the same page with

respect to the effects (not side effects, effects) of a 75% marginal tax rate. One

obviously would have erred.

“The difficulty lies, not in the new ideas, but in escaping the old ones,

which ramify, for those brought up as most of us have been, into every

corner of our minds.”

—John Maynard Keynes2

The idea that bonds are less risky than equities is a strongly held belief; it’s dogma.

Asset liability management (ALM), i.e., the idea that long-term bonds are a perfect

match for long-term liabilities, is widely regarded as the pinnacle of investment

wisdom. It might not. Not, if history rhymes.

1 “50 renowned academics speaking about god,” by Jonathan Pararajasingham, bigpicture.com.

2 Preface of The General Theory of Employment Interest and Money (1935), Paraphrased variant: “The difficulty lies not

so much in developing new ideas as in escaping from old ones.”

Page 15: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 15

The ALM time bomb and the reality kick

There is an element of déja vu. It seems I have seen this show before. Let me

explain. The period of disinflation of the 1980s and mainly the 1990s together

with some other factors gave rise to the cult of equities. By the late 1990s, I was in

derivatives research specialising in equity indices and the “adds and delets” trade.

Additions and deletions (“adds and delets” for short) were then a market

inefficiency. There are two bullet points related to dogma and belief systems that I

believe are worth mentioning and are relevant to today.

The rise of the equity cult among non-English-speaking institutional investors

was slow. The slowest invested last. I remember speaking at a conference in

Oslo around 2002, when the Ericsson-heavy OMX had already more than

halved. The Swedish finance minister was a fellow speaker and talked about

the pension reform that took place in the 1990s and was implemented quite

literally around the peak of equities. The reforms allowed some of the AP

funds larger allocations to equities, essentially to take more risk. The dogma

prior and at the peak was that “equities are for the long-run” and that they

outperform bonds in the long run. As long-term investor, one could therefore

have a large equity allocation because one could sit through large drawdowns.

In other words, some Swedish pension funds bought at the peak—literally.

The Swedish finance minister took it with humour. His vantage point was one

of hindsight. What else can one do other than grin? Other investors started

increasing their equity allocations too around the late 1990s. Many German

institutional investors, for example, started to move away from their traditional

bond-heavy portfolios and piled into equities. The whole nation was

infatuated with the “Neuer Markt” and business TV. It was a crazy time.

History rhymed a couple of years later with hedge funds. Pioneers invested in

the 1990s, early adopters in 2000-2002 while late comers made their first

allocation to fund of hedge funds close to the peak around 2007. So when we

hear more and more institutional investors claim that ALM is the pinnacle of

institutional investor’s wisdom; it somehow has a déja vu ring to it.

One aspect of the “adds and delete” trade which I still find fascinating is that

many long-only managers I have visited at that time just didn’t care. Hedge

funds and traders from investment banks were all over this. The reason why

they were all over it was because it was an investment opportunity, a

profitable market inefficiency. The inefficiency—just to recap—was that large

index funds and so-called active managers who were running money on a

tracking error constraint of 1-2% to their benchmarks were forced buyers of

the stocks that went into an index and forced sellers of the stocks that went

out. Their action was predictable; hence the profit potential. The reason they

were “forced” was because their risk management department overruled any

other discretionary decision-making. The fascinating thing is that the long-only

managers didn’t care. I’ve seen this with my own eyes; it’s not from a book or

paper. The funds were managing relative risk (tracking risk) and that was the

end of it. If this behaviour lost money, it didn’t matter, no one cared. It was

the peak of the tracking error or relative returns paradigm in equities:

complete indifference to losing money. The careful reader knows what is

1 Charmingly portrayed in Woody Allen’s Midnight in Paris.

“This is the lesson that history

teaches: repetition.”

—Gertrude Stein (1874-1946),

American writer1

Page 16: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 16

coming: the same applies today with ALM and the benchmarking of bond

allocations to match liability benchmarks.

The two or three cardinal rules to investing could be:

“Diversification should be the cornerstone of any investment

program.”

—Sir John Templeton

“The first rule of investment is don’t lose. And the second rule of

investment is don’t forget the first rule. And that’s all the rules there

are.”

—Warren Buffett quoting Benjamin Graham1

George Soros referred to Buffett’s first rule as “cardinal” in November 2008:

“During the current financial crisis, many hedge fund managers forgot

the cardinal rule of hedge fund investing which is to protect investor

capital during down markets.”

—George Soros2

The diversification idea is based on the premise that we don’t know the future. If

we knew that wind farms would yield the best 10-year point return, there would

be no need for caring about risk or diversification. Diversification is for those who

know what they don’t know. All other investors either don’t know what they

don’t know or caught some dogma bug from which the only cure is substantial

losses. “Learning by doing” is an important adage in risk management and

experience a cruel and expensive teacher.

My fascination with ALM and liability benchmarking and the subsequent high

bond allocations is that it is out of synch with the two “rules” mentioned above.

Diversification: There are institutional investors who are not diversified.

The belief is that they don’t need to. The belief is that

bonds, long-term bonds in particular, are the perfect

match for their liabilities.

Capital preservation: There is an indifference to potential losses. When interest

rates rise and bonds fall, the liabilities will fall too. So all is

well. So the risk management department, therefore, is

managing tracking risk, like in equities 10+ years ago.

There is a reality kick out there.

Figure 9 shows the S&P 500 Index with the peak of the relative returns and

tracking risk paradigm circled. When equities were falling, the absolute returns

revolution kicked in. History could rhyme once again.

1 It is unclear whether original quote is from Ben Graham. Buffett in “The Forbes Four Hundred Billionaires, October 27,

1986: “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.”

2 Statement of George Soros before the U.S. House of Representative Committee on Oversight and Government Reform,

13 November 2008

"There are three kinds of men. The

one that learns by reading. The few

who learn by observation. The rest

of them have to pee on the electric

fence for themselves."

—Will Rogers

Page 17: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 17

Figure 9: S&P 500 Index

Source: IR&M, Bloomberg, book publishing dates from amazon.com

At the peak perceptions are different than at the trough. Calling an institutional

equity mandate with a tracking error constraint of 1-2% “active” was perfectly

normal. Absolute returns weren’t even a thought among many long-only asset

managers and their clientele. However, this started to change as share prices

started to fall. The assumed indifference to absolute losses slowly but steadily

turned out to be ill-advised. It is this reality kick that put hedge funds on the

agenda of many institutional investors.

Related to ALM, this reality kick has not yet materialised. The reason is that the

ALM crowd has actually done rather well lately. So when they argue that they are

indifferent to absolute losses it actually makes perfect sense to them. After all,

when interest rates rise—assuming they will ever rise again—and bonds fall, so do

liabilities. Assets and liabilities are in synch. Risk is defined as tracking risk, i.e., risk

is perceived as the assets moving out of synch with their liabilities. This is of course

the same as the tracking risk dogma in equities twelve years ago. There is the

perception that there is no need for diversification or capital preservation. Being

indifferent to absolute losses is like hearing voices of world peace from Alpha

Centauri through our hair blowers: it’s insane to some, but not to everyone.

An additional aspect not yet mentioned is related to committee-based investment

decision making. Most institutional investment committees are comprised of

individuals with different backgrounds. Not all of them are familiar with finance

and economics in general and the history of stock and bond markets in particular.

Those with knowledge dominate the investment process, especially when all goes

well. Those with less knowledge have nothing much to add other than agree and

nod approvingly with the bellwether. Any criticism is easily put down by referring

to favourable past performance. However, when equities started to tank the

“You can avoid reality, but you

cannot avoid the consequences of

avoiding reality.”

—Ayn Rand (1905-1982), Russian-

American novelist and philosopher

“Men, it has been well said, think in

herds; it will be seen that they go

mad in herds while they recover

their senses slowly and one by

one.”

—Charles MacKay (1812-1888),

Scottish author

“A fool with a tool is still a fool.”

—Saying

Page 18: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 18

investment committee dynamics started to change. Suddenly the equities-

outperform-bonds-in-the-long-term mantra had a different feel to it. The equity-

defending bellwethers in the committee had their wings clipped. The laypeople in

the committee started to question the logic of having such a high allocation to

equities. Doubting equities was nearly impossible when they were rising, but was

made easier when falling. Was tracking risk really all that mattered? Real absolute

losses changed the game. Discussing the equity risk premium puzzle with the

academics in the investment committee over a glass of claret was a thing of the

past. Things turned less friendly when faced with losses. Suddenly underfunding

and fund solvency were agenda items. The investment committee dynamics were

different when share prices were free-falling than when they were rising irrational

exuberantly. It was like pre-battle theorising versus the reality of the battle field.

The practical relevance is that history rhymes. This time it is not an infatuation with

equities but with long-term bonds including government bonds. The regulator and

accounting ruling boards are partly to blame. Next to politics and central banking,

they play a role in Repressionomics. It is they who apply current dogma in finance

unquestioned and set the guidelines. The ALM phenomenon is essentially, or

partly, a function of the general legal and regulatory framework; hence the

perception of rationality on part of the asset liability benchmarker. The relative

return risk manager behaves rationally from the perspective of his vantage point

and assessment of the framework in which he operates.

Bottom line: Anything that can possibly go wrong, will eventually but it may take a

while.

One aspect beyond the scope of this report is an ethical one: Rational decision

making under uncertainty and asset allocation is one thing. Another is whether the

Prudent Person Rule supports financing political scoundrels, supports the

participation of what is clearly identifiable as a pyramid scheme, supports

unprecedented maladministration, misgovernment, and mismanagement of public

funds. I don’t have an answer, just doubt.

***

One aspect of something rising heavily is that it becomes overpriced as everyone

and his dog has already chipped in. That is what crowd psychology (and cheap and

available financing) does to pricing.3 Figure 10 shows pricing of equities, bonds

and cash for the US as a proxy for the industrialised economies. Valuation is based

on a high-low comparison. Equities valuation is based on the trailing earnings yield

(reverse of the PE ratio), bonds on the 10-year Treasury yield and cash on the Fed’s

fund rate. The first six groups of bars shows the valuation metric in January of the

decade while the bars on the right show the most recent valuation. The higher the

yield, the cheaper the asset class.

1 Nassim Nicholas Taleb (2012) “Antifragile – Things That Gain from Disorder,” New York: Random House, p. 15.

2 The Sun, 4 October 2012

3 Throughout my career I have occasionally been asked what my favourite books related to finance were, so I have been

maintaining a top ten list for many years. “The Crowd” by Gustave Le Bon was first place on that list for most of the time.

However, over the past couple of years it has been “The Lessons of History” by Ariel and Will Durant. The Crowd is

runner-up; for what it’s worth.

“People that are really very weird

can get into sensitive positions and

have a tremendous impact on

history.”

—Dan Quayle

“Modernity has replaced ethics with

legalese, and the law can be gamed

with a good lawyer.”

—Nassim Taleb1

The United States has 5% of the

world’s population, 25% of its

incarcerated people, and almost

50% of the world’s lawyers.

—Conrad Black2

Page 19: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 19

Figure 10: Valuation (January 1960 – 14 January 2013)

Source: IR&M, Bloomberg

Equities are neither historically cheap nor expensive. Demographics favour

bonds, not equities, as flows over the past couple of years have indicated. If

institutional investors for whatever reason need to reduce bonds, equities are

most likely to benefit.

Cash is expensive and not king. In Repressionomics it’s a wasting asset. Cash

and low duration fixed income instruments compound negatively in real terms.

However, there is a difference between an economic area that is fragile and

one that is antifragile. A system that is fragile breaks when under stress while

a system that is antifragile, benefits; at least up to a point.1 Italy is fragile

because of its debt levels, misadministration and corruption. Switzerland is

antifragile, it benefits from disorder in the Eurozone; up to a point at least. I

like to explain these things with Wriston’s Law of Capital. However, Taleb’s

new word creation is original and works well too.

Bonds are expensive. I do not know what will prick the bubble, neither does

anyone else. But something is for sure: If an asset class is priced cheaply and

something goes wrong, the asset class gets even cheaper and potentially

becomes an opportunity for value and distressed investors and bottom fishers.

If an asset class is priced expensively and something goes wrong, hell breaks

loose.

1 See Nassim Nicholas Taleb (2012) “Antifragile – Things That Gain from Disorder,” New York: Random House.

Page 20: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 20

Macro update “There is actually a much tighter relationship

now between the stock market and the

central bank balance sheet – via the P/E

multiple – than there is between the stock

market and corporate earnings. Somehow,

this chapter on the importance of central

bank money printing was missing in the

Graham % Dodd classic on Security Analysis

when it was first published in 1934.”

— David Rosenberg1

Summary

Global economy remains at an inflection point.

Both business and consumer sentiment are reasonably stable.

Monetary policy remains easy; cash remains hoarded, volatility remains low,

uncertainty remains high.

Table 2 shows a summary of what we believe are the economic trends and surprises. A brief comment as well as some technical

information on the stock market has been added. Changes since our last update are circled.

Table 2: Summary

Remarks

Surprises**

Percentile Change*** Direction* Average Above 50D 200D 50D>

18 Jan 13 (2006-) (3 Jan 13) (10-day) (100-day) average? 200D?

Global 48 1.1 Rising Falling No Positive At inflection point Rising Rising Yes

US 97 0.9 Rising Rising Yes Positive Improving. Rising Rising Yes

Europe 44 1.0 Rising Rising Yes Positive At inflection point. Rising Rising Yes

Germany 47 4.5 Rising Rising Yes Positive Improving Rising Rising Yes

France 28 -0.7 Rising Falling No Negative Declining. Rising Rising Yes

Italy 27 -1.7 Rising Falling No Positive At inflection point. Rising Rising Yes

UK 56 -6.2 Falling Falling No Positive New: Declining (from inflection point) Rising Rising Yes

Switzerland 47 0.3 Rising Rising Yes Negative Improving. Rising Rising Yes

Japan 26 -0.7 Rising Falling No Positive Declining. Rising Rising Yes

China 24 4.3 Falling Rising Yes Positive Improving. Rising Falling No

Fundamentals Technicals

IR&M Models Moving averages

Source: IR&M

Notes: * Direction: average last ten days versus previous ten-day average; ** Surprises are from Citigroup except Germany, France , and Italy (which are our own). *** Change

in percentile points relative to date shown in brackets.

The relationship between red changes and green changes is 3:3, i.e., on

average not much has changed.

1 Breakfast with Dave, Gluskin Sheff, 11 January 2013, emphasis in the original.

Page 21: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 21

Global economy: at inflection point

GDP growth rates: falling

Table 3 shows year-on-year GDP (seasonally adjusted in most cases) for a range of economies. We have colour-coded the data to

show highs (green) and lows (red), synchronisation of the data, and past and current trend. The average is equally weighted.

Table 3: Global real GDP, SAAR (seasonally adjusted annual rate)

06 12 09 12 12 12

1.7 1.3 1.4 Average

2.1 2.6 n.a. US

7.6 7.4 7.9 China

1.0 0.9 n.a. Germany

-0.5 -0.6 n.a. Eurozone

3.9 0.5 n.a. Japan

-0.3 0.1 n.a. UK

0.1 0.0 n.a. France

-2.3 -2.4 n.a. Italy

-1.4 -1.6 n.a. Spain

0.5 0.9 n.a. Brazil

2.2 1.0 1.1 Canada

n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.5.5 5.3 n.a. India

4.0 2.9 n.a. Russia

3.8 3.1 n.a. Australia

2.3 1.5 n.a. South Korea

-0.1 1.0 n.a. Taiwan

1.2 1.3 n.a. Hong Kong

2.5 0.3 1.1 Singapore

0.3 1.4 n.a. Switzerland

Mar 1999 to Mar 2012

Source: IR&M, Bloomberg. Notes: Not seasonally adjusted: Japan, South Korea, Singapore, and Switzerland. Original data: US: Bureau of Economic Analysis; China: National

Bureau of Statistics; Germany: Federal Statistical Office; Japan: Economic and Social Institute; UK: Office for National Statistics; France: INSEE; Italy: ISTAT; Spain: Eurostat;

Brazil: IBGE; Canada: STCA; India: Central Statistical Organisation; Russia: Federal Service of State Statistics; Australia: Bureau of Statistics; South Korea: Bank of Korea;

Taiwan: Directorate General of Budget Accounting & Statistics; Hong Kong: Census & Statistics Department; Switzerland: State Secretariat for Economic Affairs.

Average GDP peaked in Q2 2010 and has fallen more or less gradually ever

since. First indications including recent PMIs suggest that the growth rate

might have stopped falling, i.e., has stabilised in low but positive territory.

China Q4 2012 were reported at 2.0% where 2.2% were expected. It seems

that everything that is “not negative” is good news.

QoQ for Q4 in Singapore was higher and above expectations. However, Q3

was revised downwards.

Page 22: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 22

Industrial production: contracting but not free-falling

Table 4 shows year-on-year industrial production. The average is equally weighted. Industrial production is generally perceived as

a lagging indicator. In the case of a figure not available, the previous one is used to calculate the latest average. Chart 1 shows

Taiwan trade (exports minus imports) as a proxy for global economic activity.

Table 4: Industrial production

Oct Nov Dec

-0.9 -0.8 n.a. Average

2.0 2.9 2.3 US

9.6 10.1 10.3 China

-3.3 -3.7 n.a. Eurozone

-4.5 -5.5 n.a. Japan

-3.0 -2.9 n.a. Germany

-3.4 -3.6 n.a. France

-3.0 -2.4 n.a. UK

-1.7 0.7 n.a. Netherlands

-4.3 -4.3 n.a. Sweden

-6.1 -7.6 n.a. I taly

-3.1 -7.2 n.a. Spain

-0.8 2.9 n.a. South Korea

8.3 -0.1 n.a. India

n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.-5.1 3.1 n.a. Singapore

4.8 5.9 n.a. Taiwan

Jul 2007 to Sep 2012

Source: IR&M, Bloomberg.

Notes: Based on yoy industrial production. Industrial production is generally perceived as a lagging indicator. The average is equal weighted. In the case of a figure not

available, the previous one is used to calculate the latest average.

US December 2012 was lower but in line with expectations, China was stable

and in line.

November 2012 figures for EC, Italy, the UK, Spain, and Sweden were all

lower and below expectations. Germany was flat but disappointing. France

and the Netherlands were higher on MoM basis and better than expected.

Chart 1: Taiwan trade

35

40

45

50

55

60

65

70

-150

-100

-50

0

50

100

150

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Glo

ba

l PM

I

Ta

iwa

n tr

ad

e b

ala

nce

Negative surprises in G10 (Citi, since 2003) Taiwan trade balance (lhs) Global PMI (JPM, rhs)

Contracting

Source: IR&M, Bloomberg.

December 2012 trade balance was higher and much better than expected.

Exports were +9% while +4.5% was expected.

Page 23: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 23

PMI: below 50 but stable

Table 5 shows a selection of global Purchasing Manager Indices (PMI) for the manufacturing sector. These are diffusion indices

and therefore oscillate between 0 and 100. A reading above 50 is associated with an expanding industrial activity whereas a

reading below 50 signifies contracting activity.

Table 5: PMI

Aug Sep Oct Nov Dec

48 47 47 47.8 47.9 Average

48 49 49 49.6 50.2 Global PMI (JPM)

50 52 52 49.5 50.7 US: ISM

53 50 50 50.4 51.6 US: Chicago

49 50 50 50.6 50.6 China

48 48 47 46.5 45.0 Japan

45 46 45 46.2 46.1 Eurozone

45 47 46 46.8 46.0 Germany

50 48 47 49.2 51.4 UK

46 43 44 44.5 44.6 France

44 46 46 45.1 46.7 Italy

47 44 46 48.5 49.5 Switzerland

45 45 43 43.2 44.6 Sweden

49 50 50 52.2 51.1 Brazil

45 44 45 44.3 44.3 Australia

48 49 50 48.8 n.a. New Zealand

51 48 47 49.5 47.4 South Africa

49 49 48 48.8 48.6 Singapore

Jan 2008 to Jul 2012

Source: IR&M, Bloomberg. Original data: Global: JP Morgan; US: Institute for Supply Management; Chicago: Kingsbury International; China: China Federation of Logistics and

Purchasing (CFLP); Japan: Markit/Nomura; Eurozone, Germany, UK, France, Italy, New Zealand: Markit; Switzerland: Credit Suisse; Sweden: Swedbank Markets; Brazil: NTC

Economics; Australia: Australian Industry Group; New Zealand: Bank of New Zealand; South Africa: Kagiso Securities; Singapore Institute of Purchasing and Materials

Management.

Average PMI peaked in February 2011, had fallen to 49 in October and

November of 2011, and had risen to a lower peak in February 2012. The

average PMI has fallen below 50 in April 2012 and has remained below 50

ever since. The Average PMI is like “hanging in there,” “muddling through” to

use a John Mauldin term.

Europe, especially the Eurozone, continues to contract. The PMIs of the

Eurozone have been below 50, i.e., the economies are contracting, since

August 2011.

The UK’s rise to 51.4 was a bit of a surprise.

Page 24: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 24

PMI Services: below 50 but stable

Table 6 shows a selection of global Purchasing Manager Indices (PMI) for the services (non-manufacturing) sector. These are

diffusion indices and therefore oscillate between 0 and 100. A reading above 50 is associated with an expanding activity

whereas a reading below 50 signifies contracting activity.

Table 6: Non-manufacturing PMI

Aug Sep Oct Nov Dec

49 49 49 49.3 49.8 Average

52 54 52 54.8 54.8 Gl. Services PMI

54 55 54 54.7 56.1 US: Non-Man

56 54 56 55.6 56.1 China

47 46 46 46.7 47.8 Eurozone

48 50 48 49.7 52.0 Germany

54 52 51 50.2 48.9 UK

49 45 45 45.8 45.2 France

44 45 46 44.6 45.6 I taly

51 47 50 46.3 49.1 Sweden

42 42 43 47.1 43.2 Australia

48 53 50 52.5 53.5 Brazil

Jan 2008 to Jul 2012

Source: IR&M, Bloomberg. Original data: See previous table.

The services PMI are reasonably consistent with the manufacturing PMI, i.e.

peaking some while ago, falling and then stabilising below 50. Note that our

average is below 50 while the composite by JPM is above 50. The reason is

that we equal weight while JPM GDP-weights the PMI indicators.

In 2008/2009 the Eurozone services PMI was below 50 for 15 months.

Currently, the services PMI has been below 50 for 16 months, ignoring one

brief spike to 50.4 in January 2012.

Italy has been below 50 since June 2011 but is off the lows from April 2012.

Page 25: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 25

Business sentiment: rising

Table 7 shows a selection of business and economic sentiment and expectations indicators for the past five years. Some are more

leading than others. We show all figures in percentiles. The period high is set to 100 and is shown green. The period low is,

therefore, set to 0 and is red. The colour coding allows getting a feel for the trend on a reasonably high frequency basis. There is

an update nearly every day.

Table 7: Business sentiment

Sep Oct Nov Dec Jan

53.1 51.7 50.4 54.4 54.5 Average

40 41 45 40 40 US: Empire State

54 58 41 59 45 US: Philadelphia Fed

67 51 74 68 n.a. US: Richmond Fed

71 74 69 80 n.a. US: Dallas Fed

69 69 52 56 n.a. US: AIM

66 68 36 39 n.a. US: NFIB

23 24 28 31 42 EZ: Sentix

38 36 39 42 n.a. EZ: Economic

47 42 50 51 n.a. EZ: Business

32 32 30 n.a. n.a. China

38 43 40 58 n.a. Germany: ZEW Exp.

55 50 55 58 n.a. Germany: IFO Climate

46 46 52 60 n.a. Germany: IFO Exp.

55 65 72 65 n.a. UK (EC)

59 65 65 68 n.a. UK (Lloyds)

49 37 44 46 n.a. France

43 41 43 43 n.a. I taly

36 40 40 48 n.a. Switzerland

54 47 33 41 n.a. Sweden

50 45 46 50 n.a. Belgium

75 70 70 97 n.a. Japan (ESRI)

79 74 72 74 n.a. Japan: Small biz

52 47 44 39 44 South Korea

61 59 43 n.a. n.a. Australia

69 70 78 75 n.a. New Zealand

Feb 2008 to Aug 2012

Source: IR&M, Bloomberg. Original: US: NY Fed, Philadelphia Fed, Richmond Fed, Dallas Fed, AIM (Associated Industries of Massachusetts), NFIB (Small Business Optimism

Index), Eurozone (EZ): Sentix Behavioral Indices, EC (Economic Sentiment Indicator and Business Climate Indicator); China: National Bureau of Statistics, Germany: ZEW

(Expectation of Economic Growth), IFO (Business Climate and Business Expectations); UK: EC, Lloyds TSB; France: INSEE; Italy: ISEA; Switzerland: ZEW/Credit Suisse,

Sweden: National Institute of Economics, Japan: ESRI, Japan Finance Corp for Small Business; South Korea: BoK; Australia: National Australia Bank; New Zealand: National

Bank of New Zealand. Note: The table sows percentiles. 100 (green) marks high for period shown, 0 (red) is the low. The average is equally weighted.

Philly came in shockingly bad, massively below expectations. Analysts literally

got the sign wrong (5.6 instead of -5.8). Dec estimate revised downwards.

Empire State was unchanged but materially below expectations.

Japan (ESRI) made a huge jump, much better than expected.

Indications for the Eurozone were “less bad” than expected.

US NFIB (small companies) was slightly higher and slightly better than

expected. This despite survey being conducted when fiscal cliff not resolved

yet.

Page 26: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 26

Consumer sentiment: falling

Table 8 shows a selection of consumer sentiment indicators for the past five years. We show all figures in percentiles. The period

high is set to 100 and is shown green. The period low is set to 0 and is red.

Table 8: Consumer sentiment

Sep Oct Nov Dec Jan

39.9 42.0 42.4 37.8 38.1 Average

50 55 53 46 n.a. US: Conf Board

55 66 66 42 n.a. US: Michigen

25 26 22 24 n.a. Eurozone

23 54 49 n.a. n.a. China

59 61 61 57 54 Germany

56 54 53 52 n.a. Japan

30 24 46 27 n.a. UK: GfK

57 84 74 74 n.a. UK: Lloyds TSB

22 19 19 26 n.a. France

3 3 0 3 n.a. Italy

28 31 26 20 n.a. Spain

19 14 5 2 n.a. Netherlands

23 35 32 n.a. n.a. Switzerland

50 41 33 24 n.a. Sweden

45 35 48 37 n.a. Denmark

31 32 36 15 n.a. Ireland

13 10 16 19 n.a. Greece

80 79 74 70 n.a. Brazil

56 55 53 55 n.a. Canada

43 45 56 47 48 Australia57 54 62 64 71 New Zealand

50 47 50 50 n.a. South Korea

Feb 2008 to Aug 2012

Source: IR&M, Bloomberg. Original: US: Conference Board and University of Michigan Survey Research Center; Eurozone, France, Spain, Greece: European Commission;

China: National Bureau of Statistics of China; Germany: GfK (for the month ahead); Japan: Economic and Social Research Institute (ESRI); UK: GfK and Nationwide; Italy:

ISAE; Netherlands: Dutch Statistics Office; Switzerland: UBS; Sweden: National Institute of Economic Research; Ireland: IIB Bank; Brazil: Fundacao Getulio Vargas; Canada:

OECD; Australia: Westpac Banking Corporation; New Zealand: ANZ Bank; South Korea: Bank of Korea, since July 2008. Note: The table sows percentiles. 100 (green) marks

high for period shown, 0 (red) is the low. The average is equally weighted.

The average consumer sentiment has been falling to October 2011, has risen

to May 2012 and has been more or less stable ever since. However, consumer

sentiment in the US, arguably the most important consumer on the planet, has

been rising and hit a 5-year high in the case of the University of Michigan

consumer sentiment index last autumn. December estimates were lower and

below expectations, with November estimates revised downwards in the case

of the Conference Board Consumer Sentiment Index, as already mentioned in

the last update.

December estimates for Japan and UK were unchanged.

Consumer sentiment rose slightly in Greece but fell sharply in Ireland and

slightly in Spain, since our last update.

Consumer sentiment estimates for January in Australia and especially New

Zealand have risen.

Page 27: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 27

Summary PMI, business and consumer sentiment: stable

Chart 2 below shows a summary of the average PMI (Table 5), average business sentiment

(Table 7) and consumer sentiment (Table 8).

Chart 2: Summary

0

15

30

45

60

75

90

30

35

40

45

50

55

60

2007 2008 2009 2010 2011 2012 2013

Bu

sin

es

s s

en

tim

ent a

nd

co

nsu

me

r c

on

fid

ence

(p

erc

en

tile

s)

PM

I

PMI Business sentiment Consumer confidence

Source: IR&M, Bloomberg

The average PMI are below 50 and stabilising. So the economic trend, on

average, is towards slight contraction and slow deterioration of economic

circumstances. This would be more or less consistent with a falling average

GDP growth rate and falling average industrial production. All the monetary

easing and fiscal stimuli have stabilised the whole situation. Economically it’s

not great, but it’s not a global depression either.

Business and consumer sentiment is reasonably stable. The former ticked up a

bit while the latter ticked down a bit in December. Both these “ticks” were

less than one standard deviation moves though.

Page 28: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 28

Economic trend vs global equity market

Chart 3 shows a model that was designed to give an indication of the economic trend nearly every day. The idea behind the

model is that these indicators are not random but trend. Models such as these allow us to decide whether the global economy is

expanding or things economic are deteriorating. The moving average is the trend. We then combine the trend with expectations.

The shaded areas show periods where reality is “coming in” worse than economists and strategists are expecting, i.e., the

economic data is below consensus.

Note here that these graphs (there are more below) do not in any way predict the future. Whether these variables turn

tomorrow or keep falling for years to come, we do not know. The idea is simply to pick up the trend and its derivative, the

surprises. We believe that being hedged when the trend is down and surprises are negative prevents experiencing long periods

of negative compounding. Also, it seems to us, negative tail events do not normally happen out of the blue. They occur when

things economic are not well and the red line in the graph below is declining.

Chart 3: IR&M global economic model vs FTSE World Index

40

55

70

85

100

115

130

145

150

200

250

300

350

400

450

500

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M G

lob

al M

od

el (

1.1

.20

06

= 1

00

)

FT

SE

Wo

rld

Ind

ex

Negative Surprises in G10 (Citi) FTSE World (lhs) IR&M Global Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Note: Surprises are based on Citigroup Expectations indices. IR&M Global Model is based on 22 indicators, was designed to give a data point

nearly every day, and remains work in progress.

In our last quarter report from October 2012 the 100-day moving average

(MAV) had just turned upwards. Now it just turned downwards. So the trend

is not as clear cut as one would hope. Surprises have been positive since

September on a G-10 basis.

When we do not know what to say or the trend is unclear we tend to call this

“at inflection point,” which might or might not be very helpful.

Page 29: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 29

United States: improving

Economic trend vs US stock market

Chart 4 shows a model based on economic variables relevant to the economy in the United States.

Chart 4: IR&M US economic model vs S&P 500

10

20

30

40

50

60

70

80

90

100

110

600

700

800

900

1000

1100

1200

1300

1400

1500

1600

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M U

S M

od

el (

1.1

.20

06

= 1

00

)

S&

P 5

00

Negative surprises in US (Citi) SPX (lhs) IR&M US Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Note: Surprises are based on Citigroup Expectations indices. IR&M US Model is based on 26 indicators, was designed to give a data point nearly

every day, and remains work in progress.

The US continues to roar ahead, at least according to his model. The crony

capitalism of the previous administration, the socialism of the current, the

fiscal cliff parody, California’s bankruptcy, food stamps for everyone, deficit

ceiling, tax complexity, falling productivity, etc. is just not very important at the

moment.

Surprises have been positive since 6th September; the same day where our

model was at its intermittent low.

Page 30: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 30

Monetary policy stance

Chart 5 shows monthly non-farm payrolls and the Fed fund rate. Note that non-farm payrolls are subject to vast revisions many

months after data release.

Chart 5: Fed fund rate with non-farm payrolls

0

1

2

3

4

5

6

7

8

-1000

-800

-600

-400

-200

0

200

400

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Fe

d fu

nd

ra

te, %

No

n-f

arm

pa

yro

lls, k

Non-farm payrolls, lhs Fed fund rate, rhs

Source: IR&M, Bloomberg

Non-farm payrolls have been low (or “not high”) but reasonably stable.

Fed tightening seems a non-issue at the moment. The last time the Fed started

tightening was when non-farm payrolls were above 200,000 (red line) for

three consecutive months.

Fed said it would probably hold the federal funds rate near zero at least until

unemployment < 6.5% or inflation > 2.5% (FOMC 12 December 2012).

However, there have been voices to stop easing earlier.

Page 31: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 31

Business outlook: disappointing

The Philadelphia Fed Business Outlook (Philly) falling below -20 is perceived as a near guarantee for a recession.

Chart 6: Philadelphia Fed Business Outlook

-80

-60

-40

-20

0

20

40

60

80

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Ph

ilad

elp

hia

Fe

d B

us

ine

ss O

utl

oo

k

Source: IR&M, Bloomberg. Note: Shaded area show official US recessions.

As mentioned earlier, the Philly disappointed last Thursday where analysts

were expecting +5.6 and -5.8 was reported for January. Furthermore,

December estimates were revised downward from 8.1 to 4.6. Revisions

downwards are of course a small negative.

Page 32: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 32

Economic outlook: red flag

Coincident-lagging indicator ratio is derived by dividing the coincident index by the lagging index and is generally perceived as

being an early indicator for a recession.

Chart 7: Coincident-lagging indicator ratio

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Co

inc

ide

nt -

lag

gin

g in

dic

ato

r ra

tio

US recessions Coincident Composite Index/Lagging Composite Index (Conference Board)

Perceived recession indicator

Source: IR&M, Bloomberg

This ratio is a red flag as the ratio is below what is perceived as a recession

indicator.

Page 33: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 33

High frequency economic indicators: stable

Table 9 shows eleven economic, high-frequency variables that are related to the business cycle in one way or another. The first

line shows the average of the percentiles since 2007 of these indicators. The idea behind this table is to get a near real-time

reading of the direction in which the economy is heading. Chart 8 graphs the average percentile compared to the S&P 500.

Table 9: High frequency indicators

Sep Oct Nov Dec Jan

High Low Median W35 W36 W37 W38 W39 W40 W41 W42 W43 W44 W45 W46 W47 W48 W49 W50 W51 W1 W2 Last Economic proxy

77 9 61 57 59 57 58 59 59 59 59 59 58 57 59 62 62 62 63 63 63 63 63 Average percentile

98 -141 10 15 20 21 6 44 49 53 55 57 61 48 47 43 51 51 55 48 34 11 5 US Surprise Index

291 -15 183 142 162 149 140 148 140 147 145 143 135 134 142 137 138 147 150 145 164 162 160 US Yield curve (10-2Y)

2 -54 -43 -47 -42 -41 -40 -37 -39 -35 -35 -35 -34 -33 -34 -33 -34 -35 -32 -32 -32 -34 -36 Bloomberg Cons Comfort

1.16 0.57 0.93 1.00 1.02 1.01 1.00 1.00 0.99 1.00 1.00 1.02 1.01 1.01 1.01 1.01 1.01 1.00 1.03 1.03 1.04 1.04 1.05 Cons Discret vs. Staples

0.84 -4.02 -0.23 -0.56 -0.49 -0.45 -0.47 -0.49 -0.49 -0.38 -0.24 -0.06 0.13 0.35 0.47 0.48 0.43 0.37 0.34 0.33 0.34 0.36 0.35 Aruoba Diebold Scotti

667 282 389 367 385 385 363 369 342 392 372 363 361 451 416 395 371 344 362 363 367 372 335 US Jobless claims

5.5 -2.5 2.7 3.7 3.4 2.1 2.9 2.4 2.8 2.7 2.9 2.7 1.4 1.8 2.5 4.0 3.2 2.5 3.5 3.2 2.7 4.0 3.3 US chain store sales, YoY

638 316 484 523 527 524 531 527 518 516 502 498 505 507 507 515 519 524 530 530 530 532 534 CRB RIND

463 127 340 365 383 379 376 378 370 364 355 348 345 345 353 363 366 368 357 359 369 365 367 Copper

81 -70 11 -2.0 1.0 5.3 5.5 5.2 6.4 0.4 -0.7 -4.8 -4.9 -3.6 -1.9 -1.8 0.4 1.6 3.1 5.2 6.7 7.3 9.5 JoC-ECRI Industrial Price

1022 237 428 380 377 375 375 374 371 371 367 365 363 362 361 359 358 356 353 353 351 351 350 Container Ship Index

2007-

Source: IR&M, Bloomberg. Notes: US Surprise Index is from Citigroup. Bloomberg Consumer Comfort was previously from ABC News. Consumer Discretionary underperforms

Consumer Staples during economic slowdown. The Aruoba Diebold Scotti Business Conditions Index (ADS BCI Index) is designed to track real business conditions at high

frequency and is a daily index, published with a one week lag. CRB RIND is the Commodity Research Bureau/Reuters US Spot Raw Industrials Index consisting of raw

industrial components with pre-cyclical characteristics. The prices of index constituents are not as much distorted through aggressive trading activity.

This table worked very well during 2011 as the average percentile trended

nicely. However, the average is currently abnormally stable.

Surprises are positive but have been in decline over the past two weeks.

Chart 8: Average percentile from high frequency indicators (Table 9) vs. S&P 500

600

700

800

900

1000

1100

1200

1300

1400

1500

10

20

30

40

50

60

70

80

90

100

2009 2010 2011 2012 2013

S&

P 5

00

Av

era

ge

pe

rce

nti

le

Average percentile (lhs) S&P 500 Index (rhs)

Source: IR&M, Bloomberg.

The trend seems up-ish. The gap between the two lines is probably best

explained by intervention; it’s all a bit artificial. As we like to say: the stimuli

would even make Lance Armstrong blush.

Page 34: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 34

Economic health check: stable, sort of

Table 10 shows three-month moving averages for four central bank balance sheets and eleven economic indicators related to the

business cycle. The table was designed for two reasons. First, during a trend this table allows us to tick a box every now and then

with respect to the current trend. This should heighten conviction that the trend is the trend and nothing materially has

changed. Second, the table should allow us to observe the trend reversal early.

Table 10: Economic health check

2011

2012

2013

Year

O N D J F M A M J J A S O N D J Month

38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 1 2 Last Week

Central Bank Balance Sheets (three-months moving average)

Rising Fed

Falling ECB

Rising BOJ

Rising BOE

Selection of US economic variables (three-months moving average)

4 # Positives

Falling Surprises

Falling PPI

Rising Steel production

Falling ISM PMI

Rising Architects Billing

Falling Consumer Confidence

Rising Nonfarm Payrolls

Falling Jobless Claims

Falling Hiring intentions

Falling CEO Confidence

Falling Restaurant Performance

Positive trend Negative trend

Source: IR&M, Bloomberg

Notes: Surprises from Citigroup, Consumer Confidence and Help Wanted Ads from Conference Board, CEO Confidence from Chief Executive Magazine, US Initial Jobless

Claims and US Employees on Nonfarm Payrolls from Department of Labor Statistics,

When looking at three-month averages as in the table, surprises and consumer

confidence are now falling. The glass is either half full or half empty, a mixed

bag of indications, sort of.

Chart 9: Jobless claims by year

300

350

400

450

500

550

600

650

700

1 5 10 15 20 25 30 35 40 45 50

Init

ial c

laim

s (4

-we

ek

mo

vin

g a

ve

rag

e)

Weeks

2007

2008

2009

2010

2011

2012

2013

Source: IR&M, Bloomberg

The labour market seems to be improving, as is the real estate market. The

two are related.

The more the 2013 jobless claims

line resembles the 2008 line, the

higher is the probability of a

recession

Page 35: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 35

Europe: at inflection point

Economic trend vs stock market

Chart 10 shows a model based on economic variables relevant to the economy in Europe.

Chart 10: IR&M Europe economic model vs STOXX Europe 600

20

40

60

80

100

120

140

150

200

250

300

350

400

450

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M E

uro

pe

Mo

del

(1.

1.20

06 =

100

)

ST

OX

X E

uro

pe

600

Negative surprises in Eurozone (Citi) SXXP (lhs)

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Europe Model is based on 26 indicators, was designed to

give a data point nearly every day, and remains work in progress.

Europe is certainly contracting economically. However, there are some

positives. Draghi’s “whatever it takes” attitude is working at the moment.

There are the occasional economic “positives” from places such as Italy (Monti

reforms) and France and Spain (improved productivity). Some deep-rooted

problems are not solved though. The Euro has not all of a sudden become the

pinnacle of monetary policy wisdom. It’s still a problem. Banks, unlike in the

US, have not yet been recapitalised.

Surprises have been mainly negative since April 2012. However, surprises have

turned positive on 7th January 2013.

Page 36: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 36

Chart 11: Euro STOXX 50 and EC Composite PMI

30

35

40

45

50

55

60

65

1500

2000

2500

3000

3500

4000

4500

5000

2005 2006 2007 2008 2009 2010 2011 2012 2013

PM

I

Eu

ro S

TO

XX

50

Euro STOXX 50 (lhs) EC Composite PMI (rhs)

Source: IR&M, Bloomberg.

The composite PMI for the Eurozone has been below 50 since September

2011, part from a brief LTRO-induced holiday at 50.4 in December 2011. It

has been stable over the past couple of months though. Readers with very

good eyesight might even spot an uptick in the Composite PMI.

Chart 12 shows two widely followed economic sentiment indicators for France and Belgium.

The latter is often referred to as a proxy for Europe.

Chart 12: Business sentiment in France and Belgium

-35

-20

-5

10

60

70

80

90

100

110

120

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Be

lgiu

m B

us

ine

ss

Co

nfi

de

nc

e

Fra

nc

e B

us

ines

s S

en

tim

ent

Bank of France Business Sentiment Indicator (lhs) Belgium General Index Business Confidence (rhs)

Averages since 1990: France = 100Belgium = -5.6

Source: IR&M, Bloomberg

The trend is down, the situation cyclically un-bullish.

Page 37: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 37

Germany: improving

Economic trend vs stock market

Chart 13 shows a model based on economic variables relevant to the economy in Germany.

Chart 13: IR&M Germany economic model vs DAX

50

70

90

110

130

150

3000

4000

5000

6000

7000

8000

9000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M G

erm

an

y M

od

el (

1.1

.20

06

= 1

00

)

DA

X

Negative surprises in Germany (IR&M) DAX (lhs) IR&M Germany Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: IR&M Germany Model is based on 16 indicators, was designed to give a data point nearly every day, and remains work in progress.

Cyclical economic variables and sentiment indicators (our model) on average

point upwards. Surprises have been positive since mid-December.

German labour costs are rising at the fastest pace in a decade according to

Bloomberg, eroding most of the progress made under Gerhard Schroeder,

which ECB board member Joerg Asmussen has warned could return Germany

to the “Sick Man of Europe”, although Germany’s EUR17bn trade surplus

hardly points to a loss of competitiveness as yet. Asmussen also criticised

German education which he says leaves German workers with skill shortages

against what they will need to compete going forward; “Germany is seriously

lagging behind in science and mathematics education,” an area that they used

to dominate and that allowed them their engineering prowess.

Chart 14 shows the last and current business cycle based on IFO (Institut für Wirtschaftsforschung) climate indices. The horizontal

axis shows current business climate whereas the vertical axis shows business climate expectations for the next six months. All is

well in the upper right quadrant where current conditions as well as expectations are high. Then things economic start slowing

down and the path goes from the upper right hand quadrant to the lower left hand quadrant. Once the nadir is reached, the

path is from the lower left to the upper right again. Then the whole circle starts anew. The practical risk management relevance

is that one ought to be hedged on the way from the upper right hand corner to the lower left hand corner. It is in those periods

where the DAX experiences its losses. Chart 15 shows the DAX with PMI.

Page 38: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 38

Chart 14: IFO Pan Germany Business Conditions and Expectations

70

75

80

85

90

95

100

105

110

115

80 85 90 95 100 105 110 115 120

Ex

pe

cta

tio

ns

(IF

O)

Current Business Conditions (IFO)

Recovery

Recession

Boom

Slowdown

02-2011

12-2008

11-2009

10-2011

02-2009

06-2012

12-2012(latest)

Source: IR&M, Bloomberg

The trend was clearly negative for many months, moving from the upper right

towards the lower left. The DAX was one of the greatest performers in 2012

anyway. The latest two indications were positive, i.e., towards the upper right.

The cyclical DAX was anticipating this, accompanied by Draghi-induced risk-on

euphoria.

Chart 15: DAX and PMI

30

35

40

45

50

55

60

65

2000

3000

4000

5000

6000

7000

8000

9000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

PM

I

DA

X

DAX (lhs) PMI (rhs)

Source: IR&M, Bloomberg

German PMI has fallen below 50 in March 2012 and has bottomed at 43 in

July of that year. Unlike the DAX, the PMI has not mushroomed.

Page 39: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 39

France: declining

Economic trend vs stock market

Chart 16 shows a model based on economic variables relevant to the economy in France.

Chart 16: IR&M France economic model vs CAC 40

50

60

70

80

90

100

110

120

130

2500

3000

3500

4000

4500

5000

5500

6000

6500

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M F

ran

ce

Mo

de

l (1

.1.2

006

= 1

00

)

CA

C 4

0

Negative surprises in France (IR&M) CAC 40 (lhs) IR&M France Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: IR&M France Model is based on 15 indicators, was designed to give a data point nearly every day, and remains work in progress.

Swopping ones French passport for a Russian one is not noble. But then,

neither is punishing success. The trend remains down.

Chart 17: INSEE Manufacturing Sentiment and General Production Expectations

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

60 70 80 90 100 110 120

Ge

ne

ral P

rod

uc

tio

n E

xp

ec

tati

on

s (I

NS

EE

)

Manufacturing Sentiment (INSEE)

Recovery

Recession

Boom

Slowdown

03-2011

03-2009

12-2012(latest)

Source: IR&M, Bloomberg

This chart looks similar to the German equivalent: a long downtrend which

recently has been interrupted by two upticks for the better.

Chart 17 is analogous to Chart 14.

Page 40: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 40

Chart 18 compares the CAC 40 Index with the manufacturing PMI.

Chart 18: CAC 40 and PMI

30

35

40

45

50

55

60

1500

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

7000

7500

2006 2007 2008 2009 2010 2011 2012 2013

PM

I

CA

C 4

0

CAC 40 (lhs) PMI (rhs)

Source: IR&M, Bloomberg

If we were chartists we probably would be quite excited about the

“breakout”. But since we’re not, we’re not.

Page 41: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 41

Italy: at inflection point

Economic trend vs stock market

Chart 19 shows a model based on economic variables relevant to the economy in Italy. Chart 20 shows consumer sentiment.

Chart 19: IR&M Italy economic model vs FTSE MIB

50

60

70

80

90

100

110

120

10000

15000

20000

25000

30000

35000

40000

45000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M It

aly

Mo

de

l (1

.1.2

00

6 =

10

0)

FT

SE

MIB

Negative surprises in Italy (IR&M) MIB (lhs) IR&M Italy Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Italy Model is based on 13 indicators, was designed to give a

data point nearly every day, and remains work in progress.

Industrial production for November published on 14th January was lower and

below expectations. Industrial orders and sales published on 18th January was

negative and lower than October. Consumer sentiment remains depressed.

Chart 20: Italian consumer sentiment and FTSE MIB

85

90

95

100

105

110

115

120

125

10000

15000

20000

25000

30000

35000

40000

45000

50000

1996 1998 2000 2002 2004 2006 2008 2010 2012

Ita

lian

Co

ns

um

er

Co

nfi

den

ce

FT

SE

MIB

FTSE MIB (lhs) Italy: Consumer confidence (rhs)

Source: IR&M, Bloomberg

Page 42: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 42

Spain: improving

Economic trend vs stock market

Chart 21 shows a model based on economic variables relevant to the economy in Spain.

Chart 21: IR&M Spain economic model vs IBEX

40

45

50

55

60

65

70

75

80

85

90

95

100

105

110

115

4000

5000

6000

7000

8000

9000

10000

11000

12000

13000

14000

15000

16000

17000

18000

19000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M S

pa

in M

od

el (

1.1

.20

06

= 1

00

)

IBE

X

Negative surprises in Eurozone (Citi) IBEX (lhs) IR&M Spain Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Spain Model is based on 14 indicators, was designed to give

a data point nearly every day, and remains work in progress.

Spain has been improving cyclically. However, the main issues are structurally,

debt related.

Mariano Rajoy has called on Germany and other creditor countries in the

Eurozone to do more to stimulate growth, arguing that a switch to a more

expansionary policy would boost economic recovery across the single currency

area. “What is clear is that you cannot ask Spain to adopt expansionary

policies at this time. But those countries that can, should," he told the FT.

Page 43: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 43

Netherlands: declining

Economic trend vs stock market

Chart 22 shows a model based on economic variables relevant to the economy in Spain.

Chart 22: IR&M Netherlands economic model vs AEX

40

50

60

70

80

90

100

110

120

130

150

200

250

300

350

400

450

500

550

600

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M N

eth

erl

ad

ns

Mo

del

(1.1

.20

06

= 1

00

)

AE

X

Negative surprises in the NL (IR&M) AEX (lhs) IR&M Netherlands Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M Netherlands Model is based on 16 indicators, was designed to give a data

point nearly every day, and remains work in progress.

The trend is downwards but potentially bottoming out. Industrial production

for November reported on 11th January was positive and better than expected.

Consumer sentiment remains low though.

Chart 23: FTSE World vs Dutch consumer confidence

-50

-40

-30

-20

-10

0

10

20

100

150

200

250

300

350

400

450

500

2005 2006 2007 2008 2009 2010 2011 2012 2013

Du

tch

Co

ns

um

er C

on

fid

en

ce

FT

SE

Wo

rld

FTSE World (lhs) Netherlands: Consumer confidence (rhs)

Source: IR&M, Bloomberg.

Page 44: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 44

UK: declining

Economic trend vs stock market

Chart 24 shows a model based on economic variables relevant to the economy in the UK.

Chart 24: IR&M UK economic model vs FTSE 100

50

60

70

80

90

100

110

120

3500

4000

4500

5000

5500

6000

6500

7000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M U

K M

od

el (

1.1

.20

06

= 1

00

)

FT

SE

10

0

Negative surprises in UK (Citi) FTSE 100 (lhs) IR&M UK model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the UK. IR&M UK Model is based on 19 indicators, was designed to give a data

point nearly every day, and remains work in progress.

There seems to be a divergence between economic variables (trending

downwards when measured by an average) and the stock market. Surprises

have been positive since early September.

Bank of England Governor Mervyn King said “The economy is operating well

below full capacity, the banking system is in a stretched position and we are

clearly struggling to find instruments to ensure an economic recovery.” He

warned that “A weak recovery and people searching for yield in ways that

suggest that risk isn’t fully priced in, is a disturbing position.” As to Europe he

said “The actions of the ECB have been successful in calming markets and in

buying time. What it can’t do, because no central bank can do this, is to

resolve the underlying real challenges. And in that sense, banking union is

certainly not a magic answer.” He was also negative about the British banks

saying that “We do think there is a shortfall of capital in the system. It’s a big

number.”1

1 Andy Lees, AML Macro, 16 January 2013

Page 45: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 45

Chart 25: FTSE 100 vs PMI

30

35

40

45

50

55

60

65

70

3000

3500

4000

4500

5000

5500

6000

6500

7000

2006 2007 2008 2009 2010 2011 2012 2013

PM

I

FT

SE

10

0

PMI<50 and falling FTSE 100 (lhs) PMI (rhs)

Source: IR&M, Bloomberg.

The manufacturing PMI jumped above 50 for December. However, services

and construction PMI (not shown here) remain below 50, both disappointing

relative to expectations for December.

Chart 26: UK GDP vs Lloyds TSB Business Barometer

-80

-60

-40

-20

0

20

40

60

-8

-6

-4

-2

0

2

4

6

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Llo

yd

s T

SB

Bu

sin

es

s B

aro

me

ter

UK

GD

P

UK GDP (lhs) Lloyds TSB Business Barometer (rhs)

Source: IR&M, Bloomberg.

One (erratic) business barometer has been trending upwards though.

Page 46: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 46

Switzerland: improving

Economic trend vs stock market

Chart 27 shows a model based on economic variables relevant to the economy in Switzerland.

Chart 27: IR&M Switzerland economic model vs SMI

20

40

60

80

100

120

140

160

3000

4000

5000

6000

7000

8000

9000

10000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M S

wit

zerl

an

d M

od

el (

1.1

.20

06

= 1

00

)

SM

I

Negative surprises in Switzerland (Citi) SMI (lhs) IR&M Switzerland Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for Switzerland. IR&M Switzerland Model is based on 16 indicators, was designed to

give a data point nearly every day, and remains work in progress.

The trend is favourable, the currency not strengthening. However, surprises

have been negative since 24th September with only very brief interruptions.

At the time of writing it seems as if the Swiss central bank is teaching some

investors a lesson, namely those who thought that the EUR1.2 peg cannot

hold. It can. A central bank with its own currency can always weaken its

currency. The CHF weakened from EUR1.21 to EUR1.25 which is given the low

volatility since the peg was announced a rather substantial 7-day fall. The

adage “don’t fight the Fed” is very old. Since July 2012 everyone knows that it

also applies to the ECB. Now everyone knows that it also applies to the SNB.

Learning by doing.

Page 47: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 47

Japan: declining

Economic trend vs stock market

Chart 28 shows a model based on economic variables relevant to the economy in Japan. Chart 29 compares the Nikkei 225 with

the interestingly named Japan New Composite Index of Business Cycle Indicators Leading Index.

Chart 28: IR&M Japan economic model vs Nikkei 225

0

15

30

45

60

75

90

105

6000

8000

10000

12000

14000

16000

18000

20000

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M J

ap

an

Mo

de

l (1

.1.2

006

= 1

00

)

Nik

ke

i 22

5

Negative surprises in Japan (Citi) Nikkei 225 (lhs) IR&M Japan Model (rhs) 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M Japan Model is based on 23 indicators, was designed to give a data point

every day, and remains work in progress.

The trend is down. Surprises have been negative for a long while with only

brief interruptions. However, the game has changed in December with Abe

being elected. The new administration is pro more stimuli, pro defence

spending, pro inflation, and, most importantly, pro a weaker JPY. The Nikkei

has risen on the basis of all of these “pros”. It will of course be interesting to

see if the incoming administration can deliver.

Page 48: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 48

Chart 29: Nikkei 225 vs Leading indicator

70

75

80

85

90

95

100

105

110

0

5000

10000

15000

20000

25000

30000

35000

40000

1980 1985 1990 1995 2000 2005 2010

Le

ad

ing

Ind

icat

or

Nik

ke

i 22

5

Two consecutive quarters with negative growth Nikkei 225 (lhs) Leading Indicator (rhs)

Source: IR&M, Bloomberg

Note: LEI (Leading Economic Indicator): Japan New Composite Index of Business Cycle Indicators Leading Index, issued

by Economic and Social Research Institute Japan (ESRI).

The leading indicator is off its high from March this year. The trend is arguably

not up.

Chart 30: Economic current conditions vs expectations

10

15

20

25

30

35

40

45

50

55

60

10 15 20 25 30 35 40 45 50 55 60

Ec

on

om

ic E

xp

ec

tati

on

s (E

SR

I)

Economic Current Conditions (ESRI)

Recovery

Recession

"Boom"

Slowdown

12-2008

03-2011(Tohoku)

12-2012 (latest)03-2006

Average since 2000

Ave

rage

sin

ce 2

000

Source: IR&M, Bloomberg

Note: the chart shows all combinations since 2000 with the most recent movement highlighted.

One survey published on 11th January showed a large uptick for the better.

Page 49: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 49

China: improving

Economic trend vs stock market

Chart 31 shows a model based on economic variables relevant to the economy in China.

Chart 31: IR&M China economic model vs Shanghai Composite

60

70

80

90

100

110

120

600

1600

2600

3600

4600

5600

6600

2006 2007 2008 2009 2010 2011 2012 2013

IR&

M C

hin

a M

od

el (

1.1

.20

06

=1

00

)

Sh

an

gh

ai C

om

po

site

Negative surprises in China (Citi) Shanghai Composite (lhs) Model 100-day MAV

Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M China Model is based on 19 indicators, includes a daily read of relative

performance between property stocks and a market index, was designed to give a data point every day, and remains work in progress. Note that we had issues with data on

China in the past.

The economic trend is up. Unlike with our German model, the economic and

sentiment variables were leading the stock market, not lagging. Surprises have

been positive since early November with only a brief interruption earlier this

month due to CPI and PPI rising unexpectedly.

Page 50: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 50

Economic health check: no current red flags from electricity and freight traffic

Thanks to WikiLeaks we know what politburo member Li Keqiang thinks are important and incorruptible measures for China’s

economic speed. Given China’s high level of perceived corruption, it makes sense to look for incorruptible proxies. Li Keqiang is

the First-ranking Vice-Premier and deputy Party secretary of the State Council of the People's Republic of China, the seventh

ranked member of the Politburo Standing Committee, the People's Republic of China's de facto highest decision-making body.

Most official statistics are “for reference only” he once confide—smiling, apparently—to the US ambassador. The three variables

he looks at are electricity consumption, rail cargo volume, and bank lending. We look at electricity and rail cargo volume as a

form of economic health check. Note that some researchers suggest that electricity data is corrupted too.

Chart 32: Electricity

0

50

100

150

200

250

300

350

400

450

1 2 3 4 5 6 7 8 9 10 11 12

Ele

ctr

icit

y, b

n k

wh

Month

2005

2006

2007

2008

2009

2010

2011

2012Falling electricity is the warning

sign to look out for.

Source: IR&M, Bloomberg

Electricity has been picking up and was higher than 2011 throughout most of

2012.

Chart 33: Freight traffic volume

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

260,000

280,000

1 2 3 4 5 6 7 8 9 10 11 12

Ch

ina

Fre

igh

t Tra

ffic

Vo

lum

es

Ra

ilwa

ys

Month

2005

2006

2007

2008

2009

2010

2011

2012Falling freight traffic is the

warning sign to look out for.

Source: IR&M, Bloomberg

Freight traffic volume triggered a red flat in summer last year. The November

figure was the same as in the year before.

Page 51: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 51

Inflation: rising

The spectre of inflation is not only an issue for China. One could argue inflation in China, or any negative surprises out of China,

economic or geopolitical, are akin to a sword of Damocles bumbling over the global economy. The following graph shows CPI

with agricultural wholesale prices. The reason inflation is important from a risk assessment standpoint is that food inflation

spiralling out of control would not only bear the risk of economic weakness but also heighten the risk of intra-national tensions.

Chart 34: China CPI

-10

-5

0

5

10

15

20

25

-4

-2

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Ag

ric

ult

ura

l wh

ole

sa

le p

ric

es

CP

I

China CPI YoY (lhs) China agricultural wholesale prices YoY (rhs)

Source: IR&M, Bloomberg

It was a question of time until rising food prices would filter through to higher

CPI prints. This occurred on 11th January and sent the stock market down by

1.8%.

On one hand higher inflation is good news. Mainly because the alternative,

deflation, is worse. Generally it is perceived as bad news though as it increases

the probability of the People’s Bank of China to start tightening via the RRR

(required reserve ratio). The central bank is still in easing mode despite not

having lowered the RRR for a while.

Chart 35: PBoC 1Y lending rate and RRR

5

10

15

20

25

4

5

6

7

8

2005 2006 2007 2008 2009 2010 2011 2012 2013

RR

R (

%)

1Y

Le

nd

ing

ra

te (%

)

China 1Y lending rate (lhs) Required Reserve Ratio (RRR) for Major Banks (rhs)

Source: IR&M, Bloomberg

Page 52: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 52

Chart 36: China Real Estate Climate

94

96

98

100

102

104

106

108

0

1000

2000

3000

4000

5000

6000

7000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Ch

ina

Re

al E

sta

te C

lima

te

Sh

an

gh

ei C

om

po

site

Shanghai Composite (lhs) China Real Estate Climate (rhs)

Source: IR&M, Bloomberg

Real estate sentiment could have bottomed.

Page 53: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 53

Risk update

“The simplistic view says that because the

world is uncertain today, we shouldn't

venture forth. But I think it's much wiser to

say that despite the uncertainty, we

shouldn't automatically settle for assets

believed to be entirely safe - especially since

(a) flight of capital to their seeming safety

has rendered their promised returns low and

(b) that safety can prove to be illusory.

Instead we should attempt to take control of

our fate and strive for reasonable returns

with the risks handled responsibly.”

—Howard Marks1

Summary

Risk is on. Risk seeking behaviour remains elevated, currently in the 4th highest

percentile since 1997.

The easing of sovereign credit spreads is partially a function of Draghi and

partly a function of regulatory-induced short covering.

Yield curves: reasonably stable

Chart 37: Yield curves

1.85

3.04

1.57

2.362.03

3.27

0.75

2.00

0.68

1.21

0

1

2

3

4

5

6

7

3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y

Yie

ld,

%

10Y Range

18/01/13

03/01/13

31/12/12

30/12/11

Inflation

USD EUR GBP JPY CHF

Source: IR&M, Bloomberg

Note: Numbers in graph stand for 10-year and 30-year yields. Short end of CHF yield curve “disappears” because yields

are negative.

Yield curves remain low and positively sloped. The EUR has risen a bit but is

entirely below inflation.

1 “On Uncertain Ground,” Memo to Oaktree Clients, 11 September 2012.

Chart 37 shows five nominal yield

curves compared to history and

inflation.

Page 54: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 54

Central bank balance sheets: contracting a bit

Chart 38 shows the sum of four central bank balance sheets.

Chart 38: Total assets central banks

3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

7,500

8,000

8,500

9,000

9,500

2007 2008 2009 2010 2011 2012 2013

US

Db

n

Total assets central banks (Fed, ECB, BoJ, BoE)

Source: IR&M, Bloomberg

The trend is unmistakably from the lower left to the upper right. This is a

“helping hand” rather than an invisible one. The cost to society from this

“help” is yet unknown.

Since our last update from 3rd January the total balance sheets have

contracted a bit from $8.70tr to $8.65tr.

Chart 39: Target rates

0

1

2

3

4

5

6

7

8

9

10

1990 1995 2000 2005 2010

Ta

rge

t ra

te (<

10

%)

US, EU, and UK easing US EU UK Japan China

Source: IR&M, Bloomberg

Central banks, including China, are easing. Money was, is, and remains cheap.

And is hoarded; velocity remains low.

Page 55: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 55

Financial risk monitor: risk is on

Table 11 is a risk monitor. The idea is to show heightened risk or stress very early on. We update this frequently in our on-screen

updates.

Table 11: Financial risk monitor

2011 2012 2013

Market Risk proxy High Low Median 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 03-01 Last

Composite St. Louis Fed Stress 5.8 -1.3 -0.1 -0.1 -0.1 0.7 0.9 0.6 0.8 0.6 0.3 0.1 0.0 0.0 0.2 0.2 0.1 -0.1 -0.3 -0.3 -0.3 -0.3 -0.3 -0.5

BB Financial Conditions 1.3 -12.7 0.1 0.5 0.0 -0.9 -1.8 -1.0 -1.0 -1.0 -0.5 -0.1 0.1 0.0 -0.7 -0.1 0.0 0.1 0.5 0.6 0.7 0.6 0.9 1.0

Citi Macro Risk 0.99 0.0 0.39 0.40 0.68 0.90 0.97 0.82 0.85 0.79 0.59 0.47 0.36 0.35 0.72 0.36 0.32 0.24 0.12 0.15 0.18 0.24 0.07 0.11

Liquidity LIBOR 1M OIS Spread 338 1 9 8 8 13 15 16 18 22 17 13 12 10 8 8 11 10 7 5 6 6 7 7

Euro Libor-OIS Spread 196 -2 28 20 35 64 81 81 98 97 77 63 42 39 39 42 33 21 13 11 13 12 12 11

Euro Basis Swap Spread -3 -300 -36 -28 -46 -80 -105 -92 -131 -114 -72 -67 -51 -45 -50 -54 -42 -32 -26 -25 -25 -21 -19 -17

Credit TED Spread 464 9 32 24 16 32 35 44 53 57 49 41 40 37 40 38 35 35 27 20 23 27 24 23

EmMa Spread 1037 111 273 239 256 336 462 376 418 425 398 338 314 330 413 378 346 319 295 269 267 252 231 240

CDX.NA.IG 279 29 98 91 96 115 144 121 128 120 101 94 91 95 123 112 107 102 99 101 99 94 86 88

iTraxx 5Y Europe 217 20 98 106 117 153 202 162 185 173 143 129 125 140 180 166 160 149 136 129 123 117 103 103

iTraxx 5Y E. Crossover 1150 150 428 395 438 646 839 660 757 755 620 568 613 650 719 662 633 592 568 524 497 482 418 419

Sovereign iTraxx 5Y E. Sovereign 386 47 178 217 270 293 339 304 327 357 338 343 269 275 326 282 256 230 148 107 105 111 102 99

(5Y CDS) Greece 5047 5 56 1952 1722 2261 3536 >4000 essentially default

Ireland 1192 5 223 769 790 769 700 694 711 726 621 603 572 566 726 553 512 441 319 173 179 220 209 180

Portugal 1527 4 41 745 924 918 1110 970 1060 1093 1484 1175 1076 961 1185 805 834 662 515 503 498 449 401 382

Spain 641 3 40 270 363 358 382 340 408 394 376 368 437 476 599 531 534 518 387 305 284 295 273 253

Italy 592 6 43 171 310 361 470 445 487 503 416 381 397 445 563 488 485 466 356 274 244 278 257 226

Belgium 406 2 22 143 199 230 260 269 304 316 245 238 233 252 282 240 177 160 128 75 76 83 81 75

France 250 2 23 80 122 154 187 176 200 222 181 176 169 193 219 189 161 140 114 68 80 91 89 85

Rates BBOX (swaption volat.) 138 68 90 98 98 93 94 96 97 94 86 91 89 86 82 80 80 81 78 78 77 77 77 76

Bonds MOVE (bond volat.) 265 51 92 89 88 98 101 107 100 91 72 76 79 63 74 73 70 69 61 71 52 59 64 57

Equities VIX (equity volat.) 81 10 18 17 25 32 43 30 28 23 19 18 16 17 24 17 19 17 16 18 16 18 15 14

Skew Index (CBOE) 142 106 119 122 121 120 115 121 117 116 122 125 125 120 119 119 114 121 126 119 117 121 118 121

FX VXY (G7 FX volat.) 24 6 10 11 12 12 14 12 13 12 11 10 10 9 11 10 9 9 8 8 8 8 8 9

10-year*

Source: IR&M, Bloomberg

Note: *10-year period or since data is available.

Risk is on and this table is turning greener and greener.

One of the few upticks in risk worth mentioning is in emerging markets.

Emerging markets could be the pin that pricks the yield bubble in the

developed economies. However, the rise was modest.

As mentioned elsewhere, the easing of sovereign credit spreads is partially a

function of Draghi and partly a function of regulatory-induced short covering.

Page 56: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 56

Macro and geopolitical uncertainty

Chart 40 combines the Citigroup Macro risk index with the Citigroup G10 Economic Surprise

Index. All is well when these indices are rising, surprises rising above the zero line.

Chart 40: Macro risk and financial conditions

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0-120

-100

-80

-60

-40

-20

0

20

40

60

80

2007 2008 2009 2010 2011 2012 2013

Cit

i M

ac

ro R

isk

Ind

ex

Cit

igro

up

Ec

on

om

ic S

urp

ris

e In

dex

-G

10

Citi Economic Surprise Index (G10, lhs) Citi Macro Risk Index (reversed scale, rhs)

Positive surprises

Negative surprises Risk aversion

Risk seeking

Source: IR&M, Bloomberg

Risk seeking behaviour remains elevated, currently in the 4th highest percentile

since 1997. Economic surprises continue to fall.

Table 12 shows the IR&M conflict monitor that we update quarterly. It’s a yellow-to-red flag

approach to a selection of geopolitical as well as currency (war) conflict zones.

Table 12: IR&M conflict monitor

Source: IR&M

We made no changes to this table.

The Middle East and the Eurozone remain in turmoil. Draghi’s magic is most

likely temporary as the underlying structural problems have not been solved.

Some shooting between India and Pakistan, two nuclear nations, was

disturbing but not yet alarming. The political rumblings in the South China Sea

continue.

Geopolitical Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Currency/trade trouble Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

North Korea vs RoW China vs US

Iran vs US/RoW Brazil vs West

India vs China South Korea vs West

India vs Pakistan Euro

Russia vs Japan

Middle East

South China Sea

Alert levels:

2011 20112012 2012

Page 57: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 57

Fear gauge: low and falling

Chart 41 shows the most prominent risk/fear gauge, the legendary VIX.

Chart 41: VIX

0

20

40

60

80

100

120

140

160

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

VIX

VIX

1987 crash

Gulf war Asian crisis

Russian default

9/11

Enron/Worldcom

Iraq war

Subprime crisis

Lehman

EUR debtcrisis

Tohoku

EUR debt crisis

Source: IR&M, Bloomberg

VIX ticked up a bit at the end of the year but remains very low.

Chart 42: VIX by calendar year

0

10

20

30

40

50

60

70

80

90

1 25 50 75 100 125 150 175 200 225 250

VIX

Trading days

2008

2009

2010

2011

2012

2013

All-time low of 9.31% on 22 Dec 1993

Lowest percentile (10.7% ) since Jan 1986

Source: IR&M, Bloomberg

The VIX started 2013 on a low note, falling from 18% to 13.5%. The average

for 2012 was 17.8% which compares to 24.1%, 22.5%, and 31.5% for

2011, 2010, and 2009.

Page 58: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 58

Gold as a hedge against fiat money fear

Gold, rightly or wrongly, is perceived as a hedge against funny money, sometimes also referred to as fiat money.

Chart 43: Gold in real USD terms

0

500

1000

1500

2000

2500

3000

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Go

ld, a

dju

ste

d b

y U

S C

PI

Nixon takes USD off

the gold standard

US devalues USD

to 38 $/oz

Most major countries

adopt floating exchange rate system

US devalues USD

to 42.22 $/oz

Gold hits 850 $/oz

due to high inflation, high oil prices,Soviet intervention in

Afghanistan, impact of Iranian Revolution, etc.

Black

Wednesday

Brown's Bottom: HM

Treasury (Goldfinger Brown) decides to sell and eventually

sells 60% of UK gold reserves between July 1999 and March

2002 averaging 275 $/oz

Greenspan on Brown's

Bottom: “Gold still represents the ultimate form of payment in the

world . . . Germany in 1944 could buy materials during the war only with gold. Fiat

money paper in extremis is accepted by nobody. Gold is always accepted.”

"Washington Agreement" to limit gold

sales by 15 European central banks

Spike in run-up

of Irak invasion

2 Jan 08: Gold

breaks 850

China announces it

has raised gold reserves by three-quarters since 2003

Unrest in Middle

East starts

18 Aug 11:

Gold breaks1800

5 Sep 11: Gold

breaks 1900

26 Jul 12: Draghi put

Source: IR&M, Bloomberg

Gold responded to further announced money printing by rising. However, the

gains were modest.

The first column of Chart 44 shows the percentage of time where real 10-year Treasury

yields were below 1%. The second column shows the nominal return for the whole period

whereas the third column shows the nominal return adjusted for inflation.

Chart 44: Gold vs 10-year real USD yields

Decade

Percentage

of months where

real 10Y USD

Yield below 1%

Period

nominal return

of Gold

Period

real return

of Gold

1970s 50% 1356% 627%

1980s 11% -22% -53%

1990s 0% -28% -46%

2000s 25% 281% 196%

2010s 62% 55% 45%

Source: IR&M, Bloomberg

The first column will go higher and higher. It is not entirely unreasonably to

think that the second and third columns will go higher and higher too; even if

the theory behind the relationship is a bit shaky.

Page 59: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 59

Publications

Risk management research (subscription based)

Far from over 3 January 2013

Wriston’s Law of Capital still at work 19 December 2012

A very long process 5 December 2012

In search of a real fix – obviously 22 November 2012

Socialising losses 7 November 2012

No risk (Q4 2012 report) 26 October 2012

No panacea 12 October 2012

No knowledge, no experience 1 October 2012

QE infinity 18 September 2012

Draghi put kicks in 7 September 2012

Enormously ineffective 27 August 2012

They want your money 16 August 2012

Whatever it takes 6 August 2012

No money 20 July 2012

Wriston’s Law of Capital (Q3 2012 report) 10 July 2012

Pompous meddling continues 2 July 2012

Empty monetary bag of tricks 22 June 2012

Helping hand rather than an invisible one 15 June 2012

Fed recommends to hedge too 8 June 2012

Waiting for the next fix 1 June 2012

Hopium running low 25 May 2012

Euro area tearing itself apart 18 May 2012

PMIs make for horrid reading 7 May 2012

Just in the middle of the river 2 May 2012

Risky fragility 19 April 2012

What makes bears blush (Q2 2012 report) 11 April 2012

Conditionally well but subject to revision 4 April 2012

Not yet out of the woods 22 March 2012

Eerily unchanged 15 March 2012

Ltroveneous double liquidity whammy 2 March 2012

Bullish middle-game: an intermezzo? 17 February 2012

Shooting the economic lights out 3 February 2012

Confidence rally 27 January 2012

Relatively difficult (Q1 2012 report) 16 January 2012

Global economy stabilises a bit 22 December 2011

Santa put 8 December 2011

Europe in the tails 28 November 2011

Gap between US and Europe opening 16 November 2011

October looks like a short sigh of relief 3 November 2011

On can kicking and bouncing dead cats 25 October 2011

Kicked can cause dead cat to bounce 16 October 2011

Beware of lights at the end of tunnel 7 October 2011

Europe doubling down (inaugural report, available on www.ineichen-rm.com) 3 October 2011

Europe is levering up, ie, doubling down 30 September 2011

Summer of 2008 revisited 23 September 2011

Depression rather than recession 16 September 2011

Déjà vu 9 September 2011

Global economy arguably in recession 2 September 2011

Risk levels in Europe have risen strongly 26 August 2011

US recession a sure thing 19 August 2011

PIIGSF? 12 August 2011

Early indications continue to deteriorate 5 August 2011

Free three months trials available. (No gmail, hotmail, yahoo, etc. accounts)

Page 60: RMR Q1 2013

R

Repressionomics January 2013

Ineichen Research and Management Page 60

Copyright © 2013 by Ineichen Research and Management AG, Switzerland

All rights reserved. Reproduction or retransmission in whole or in part is prohibited except by permission. The information set forth in this document has been obtained from publicly available sources,

unless stated otherwise. All information contained in this report is based on information obtained from sources which Ineichen Research and Management (“IR&M”) believes to be reliable. IR&M

provides this report without guarantee of any kind regarding its contents.

This document is for information purposes only and should not be construed as investment advice or an offer to sell (nor the solicitation of an offer to buy) any of the securities it refers to. The

information has not been independently verified by IR&M or any of its affiliates. Neither IR&M nor any of its affiliates makes any representations or warranties regarding, or assumes any responsibility

for the accuracy, reliability, completeness or applicability of, any information, calculations contained herein, or of any assumptions underlying any information, calculations, estimates or projections

contained or reflected herein. Neither this document nor the securities referred to herein have been registered or approved by any regulatory authority of any country or jurisdiction.

This material is confidential and intended solely for the information of the person to whom it has been delivered and may not be distributed in any jurisdiction where such distribution would

constitute a violation of applicable law or regulation.

While this document represents the author’s understanding at the time it was prepared, no representation or warranty, either expressed or implied, is provided in relation to the accuracy,

completeness or reliability of the information contained herein, nor it is intended to be a complete statement or summary of the securities markets or developments referred to in the document. It

should not be regarded by recipients as a substitute for the exercise of their own judgment.

Investing in securities and other financial products entails certain risks, including the possible loss of the entire amount invested. Certain investments in particular, including those involving structured

products, futures, options and other derivatives, are complex, may entail substantial risk and are not suitable for all investors. The price and value of, and income produced by, securities and other

financial products may fluctuate and may be adversely impacted by exchange rates, interest rates or other factors. Information available on such securities may be limited. The securities described

herein may not be eligible for sale in all jurisdictions or to certain categories of investors. You should obtain advice from your own tax, financial, legal and accounting advisers to the extent that you

deem necessary and only make investment decisions on the basis of your objectives, experience and resources.

Past performance is not necessarily indicative of future results.

Unless specifically stated otherwise, all price information is indicative only.

No liability whatsoever is accepted for any loss (whether direct, indirect or consequential) that may arise from any use of the information contained in or derived from this document. IR&M does not

provide tax advice and nothing contained herein is intended to be, or should be construed as a, tax advice. Recipients of this report should seek tax advice based on the recipient’s own particular

circumstances from an independent tax adviser.