Global Insights Feb 2012

FEBRUARY 2012

RBC Wealth Management Global Insight
New central bank policies have calmed equity and fixed income markets. In this issue
Does this mean all is quiet on the European front? (page 3)
2 Financial Markets Commentary

4 Politics in 2012: The Stakes are High
In 2012, politics could have an even greater impact on markets than last 8 Global Equities
year. The stakes are high. (page 5)
16 Global Fixed Income

18 Commodities

19 Currencies
Stocks are relatively cheap in most markets, reflecting the challenges
facing the global economy. Risks need to be acknowledged in portfolios. 20 Key Forecasts
(page 9) 23 Market Valuation & Equilibrium

Within the fixed income sector, investment-grade corporates continue to
offer attractive opportunities. (page 16)

Priced as of January 31, 2012, unless otherwise stated.

Global Insight is a monthly publication by
the Global Portfolio Advisory Committee

1 GLOBAL INSIGHT - JULY 2011

Global Overview
RBC’s Investment Stance Global Asset Class View
The lingering Eurozone risks, combined with their potential spillover effects in the U.S. and China, are primary reasons we maintain
Asset Class View
our “Neutral” stance on global equities. To be clear, “Neutral” means including equities at a benchmark weighting in portfolios—
that is, a weighting up to but not more than the long-term target allocation. After all, Eurozone officials could surprise markets again Equities =
and announce new policies that would reduce the region’s vulnerabilities. A sufficiently constructive announcement could trigger Fixed Income –
another worthwhile rally in equities.
Cash +
Equally plausible, any of several tripwires (Greece, Portugal, politics, bank lending, etc.) could worsen the European and global
outlook, and induce more painful volatility episodes. “Invested but vigilant” sums up our stance.

Equity view: Overweight
Equity view: Neutral Nikkei: 8,802 (+4.1%)
Equity view: Neutral Equity view: Underweight Equity view: Neutral
FTSE 100: 5,681 (+2.0%) 10-yr JGB: 0.97% (-2 bps)
S&P/TSX: 12,452 (+4.2%) Stoxx Eur. 600: 254.41 (+4.0%) Shanghai Comp: 2,292 (+4.2%)
Fixed Income view: Underweight Economy: production back in
Fixed Income view: Underweight Fixed Income view: Underweight 10-yr Govt: 3.41% (-3.6 bps)
10-yr Gilts: 1.97% (+1 bps) gear, needs a reacceleration
10-yr Cdn: 1.89% (+5 bps) 10-yr Bund: 1.79% (+4 bps) Economy: within the 7%-9%
Equity view: Neutral Economy: weak and under pres-
Economy: domestic strength Economy: in recession, austerity policy growth target and likely in China
S&P 500: 1,312 (+4.4%) sure from the Eurozone
sapped by weaker trade headwind blowing hard to stay there
Fixed Income view: Underweight
10-yr Tsy: 1.80% (+8 bps)
Economy: stuck in a 2% rut
Hang Seng: 20,390 (+10.6%)
10-yr Govt: 1.32% (-19 bps)
Economy: inflation stubborn,
global trade flow dominates

Bovespa: 63,072 (+11.1%)10-
9-yr Govt: 11.50% (+17 bps)
S&P/ASX 200: 4.262 (+5.08%)
Economy: 3%+ growth positive
10-yr Govt: 3.72% (+5 bps)
but below potential
Economy: headed for 3%+ growth,
capex leading the way
Equity index returns and fixed income change in basis points (bps) are for January 2012

2 GLOBAL INSIGHT | FEBRUARY 2012

Financial Markets Commentary

> The ECB has taken great strides to protect the Financial markets breathed a sigh of relief after the concerns aside and focus primarily on market
European Central Bank forcefully intervened to fundamentals.
global financial system from bank defaults,
prevent cascading bank failures. But now is not the time to become complacent. All
and another round of stimulus is in the offing.
The new policy represents more than a massive is not quiet on the European front:
> Even so, the Eurozone must negotiate many liquidity injection or back-door quantitative
ƒ Banks have a limited ability to support
difficult hurdles in the coming months. easing. It indicates central bankers are unwilling
sovereign debt markets. There have been
Renewed global market volatility can’t be to stand idly by when weak institutions threaten
media reports Eurozone banks could use
ruled out. Now is not the time for investment to exacerbate a financial crisis à la the Lehman
February LTRO proceeds to purchase sizeable
Brothers collapse in 2008. The ECB signaled it
complacency. amounts of Italian and Spanish debt (and
stands behind the banking system and, in turn, the
earn attractive returns in the process), thus
global financial system.
further stabilizing the sovereign debt market
No wonder most debt markets stabilized and and banking system. RBC Capital Markets’
equity markets traded higher after the ECB European bank analysts caution this is an
unveiled its Long-Term Refinancing Operations unrealistic expectation and “at the bottom of
(LTRO) plan in early December. Continental banks’ to-do list,” based on recent management
European markets led the rally; the S&P 500 contacts. Sizeable purchases would make
Equity Market Scorecard recorded its best January performance since 1997. banks even more vulnerable to any renewed
sovereign debt stress or disorderly defaults. Our
LTRO Round II
Index (local currency) Level 1 mo 6 mo 12 mo analysts believe banks’ first priority will be to
Markets are now focused on the next LTRO
S&P 500 1,312.41 4.4% 1.6% 2.0% use LTRO cash to pre-fund their corporate bond
liquidity injection in late February. Eurozone banks
S&P/TSX Comp 12,452.15 4.2% -3.8% -8.1% redemptions.
will once again have the opportunity to borrow
FTSE 100 5,681.61 2.0% -2.3% -3.1% ƒ Sovereign yields could trend back up once the
funds at 1% over three years instead of the ECB’s
Hang Seng 20,390.49 10.6% -9.1% -13.0% typical one-year program. This provides more time LTRO impact fades. Italy, Spain, and others
Dow (DJIA) 12,632.91 3.4% 4.0% 6.2%
to clean up balance sheets, recapitalize, and raise are scheduled to sell significant debt during
funds in the private debt market. the next few months. Positive sentiment about
NASDAQ 2,813.84 8.0% 2.1% 4.2%
Market expectations are high, with some analysts the LTRO program and abundant liquidity may
Russell 2000 792.82 7.0% -0.5% 1.5%
forecasting banks will borrow over €1 trillion—far help keep rates at manageable levels near term,
STOXX Europe 600 254.41 4.0% -4.1% -9.2%
more than the €489 billion ($641 billion) in loans but over time supply could overwhelm the
German DAX 6,458.91 9.5% -9.8% -8.7%
issued during the first three-year LTRO tranche in market and funding costs could rise again—
Nikkei 225 8,802.51 4.1% -10.5% -14.0%
December. especially if countries miss their austerity and
Straits Times 2,906.69 9.8% -8.9% -8.6%
growth targets.
Shanghai Comp 2,292.61 4.2% -15.1% -17.8%
All Quiet on the European Front? Think Again. ƒ Greece may request additional write-downs
Brazil Bovespa 63,072.31 11.1% 7.2% -5.3%
It’s tempting to assume the ECB can solve most or could succumb to a disorderly default even
Source: Bloomberg, equity index returns do not include dividends; data is of the region’s woes with this unprecedented
through 1/31/12. if the country strikes a deal soon with private
program. This rare, positive development feeds creditors to forgive a portion of its debt. Its
into the understandable desire to cast Eurozone debt-to-GDP ratio will remain unsustainably

Financial Markets Commentary

Central Bank Total Assets in U.S. dollars (bln) Another Wildcard Market Scorecard
The European economy is another wildcard for Bond Yields 1/31/12 12/31/11 1/31/11 12 mo chg
4000
markets and earnings in 2012, and could weigh on US 2-Yr Tsy 0.215% 0.239% 0.562% -0.35%
3500 North American and Asian growth. As Eurozone US 10-Yr Tsy 1.797% 1.876% 3.370% -1.57%
3000
banks shed assets to improve capital ratios, the Canada 2-Yr 0.955% 0.956% 1.667% -0.71%
result may be reduced lending to the region’s Canada 10-Yr 1.889% 1.941% 3.275% -1.39%
2500
businesses and households, thereby increasing the UK 2-Yr 0.357% 0.327% 1.299% -0.94%
UK 10-Yr 1.970% 1.977% 3.656% -1.69%
2000 risk of a prolonged or deeper European recession.
Germany 2-Yr 0.158% 0.144% 1.372% -1.21%
We also anticipate Eurozone banks will continue
1500 Germany 10-Yr 1.787% 1.829% 3.155% -1.37%
European Central Bank to reduce loans to emerging markets where they Commodities (USD) Price 1 mo 6 mo 12 mo
1000 Federal Reserve fund a meaningful share of private-sector debt. Gold (spot $/oz) 1,737.60 11.1% 6.7% 30.4%
500 Silv er (spot $/oz) 33.18 19.2% -16.8% 18.2%
Even though U.S. economic momentum has
2008 2009 2010 2011 2012 Copper ($/ton) 8,299.50 9.3% -15.4% -15.0%
improved recently and China seems headed for a
Oil (WTI spot/bbl) 98.48 -0.4% 2.9% 6.8%
Source: Bloomberg; data through 1/31/12 soft landing, neither region can completely side- Oil (Brent spot/bbl) 111.62 2.7% -4.7% 12.3%
Note: ECB total assets converted into U.S. dollars using spot EUR/USD
step these headwinds. Many large multinational Natural Gas ($/mlnBtu) 2.52 -15.4% -40.8% -43.1%
exchange rates
companies are already beginning to see signs of Agriculture Index 434.46 0.0% -8.5% -19.7%
sluggish European demand, and Asian export Currencies Rate 1 mo 6 mo 12 mo
high as long as the public sector (ECB, growth is relatively weak. US Dollar Index 79.29 -1.1% 7.3% 2.0%
Eurozone central banks) is unwilling to take CAD/USD 1.00 1.9% -4.7% -0.2%
RBC’s Investment Stance USD/CAD 1.00 -1.8% 5.0% 0.2%
steep losses on its debt. The country is mired
EUR/USD 1.31 1.0% -9.1% -4.5%
in a deep recession or worse. Its austerity plans The lingering Eurozone risks, combined with their GBP/USD 1.58 1.4% -4.1% -1.6%
have missed the mark on multiple occasions. potential spillover effects in the U.S. and China, AUD/USD 1.06 4.0% -3.4% 6.5%
There’s no guarantee the next government— are primary reasons we maintain our “Neutral” USD/CHF 0.92 -1.9% 17.1% -2.5%
elections are tentatively scheduled for April— stance on global equities. To be clear, “Neutral” USD/JPY 76.27 -0.8% -0.6% -7.0%
EUR/JPY 99.78 0.1% -9.7% -11.2%
will honor previous austerity agreements. means including equities at a benchmark
EUR/GBP 0.83 -0.4% -5.3% -2.9%
weighting in portfolios—that is, a weighting up to EUR/CHF 1.20 -1.1% 6.4% -6.9%
ƒ Portugal could slide deeper into a debt trap.
but not more than the long-term target allocation. USD/SGD 1.26 -3.0% 4.5% -1.7%
Its short- and long-term sovereign yields have
After all, Eurozone officials could surprise markets USD/CNY 6.31 0.2% -2.0% -4.3%
soared despite the new LTRO program. Its USD/BRL 1.75 -6.4% 12.7% 4.8%
again and announce new policies that would
credit default swaps are signaling a 70% chance
reduce the region’s vulnerabilities. A sufficiently Source: Bloomberg, RBC Wealth Management; data through 1/31/12. Bond
of default. RBC Global Asset Management’s
constructive announcement could trigger another yields in local currencies. U.S. Dollar Index measures USD vs. six major cur-
Chief Economist Eric Lascelles anticipates rencies. Currency rates reflect market convention (CAD/USD is the exception).
worthwhile rally in equities.
Portugal will ultimately need to negotiate a Currency returns quoted in terms of the first currency in each pairing.
debt writedown. We doubt global markets fully Equally plausible, any of the tripwires noted above Examples of how to interpret currency data: CAD/USD 1.00 means 1 Canadian
reflect this possibility. (Greece, Portugal, politics, bank lending, etc.) dollar will buy 1 U.S. dollar. CAD/USD -0.2% return means the Canadian dollar
could worsen the European and global outlook, has fallen 0.2% vs. the U.S. dollar in the past 12 months. USD/JPY 76.27
means 1 U.S. dollar will buy 76.27 yen. USD/JPY -7.0% return means the U.S.
and induce more painful volatility episodes. dollar has fallen 7.0% vs. the yen in the past 12 months.
“Invested but vigilant” sums up our stance.


Politics in 2012: The Stakes are High

2011 was a year of significant political change—scheduled and unscheduled—that
contributed to volatility across global markets. In 2012, politics could play an even
greater role because more is at stake. Power shifts could …
> take place in 5 of the 10 largest global economies,
> affect 4 of the 5 permanent members of the U.N. Security Council,
> involve nearly half of the world’s population, and
> directly impact countries that produce more than 40% of the world’s GDP.
Russian Presidential Election
- March 15th

French Presidential Election China - 18th National
- first round (22 Apr), second Congress of the Communist
round (6 May) Party - Oct
Greek Presidential
U.S. Presidential Election Election - Apr (TBD)
- Nov 6th Egypt Parliamentary India Presidential Election
Election - Jul 1st - July

Mexico Presidential Taiwan Presidential
Election - Jul 1st Election - Jan

Major Political Timeline
Throughout 2012, RBC Wealth Management will discuss key election issues with an emphasis on
how they could potentially affect financial markets and investment portfolios.
Other Political
Events In this article, the first in the series, we provide an overview of the French and U.S. elections and
China’s power transition.



Country Election Date In an environment fraught with contentious First, France is under market pressure to adopt
economic and fiscal policy issues, the 2012 more austere economic and social policies to
Taiwan Presidential January 14, 2012 election cycle will soon catch investors’ attention. reduce its national debt—not ideal issues to
Taiwan Legislative January 14, 2012 Election outcomes in France, the United States, discuss with voters during an election. The
and Greece, and China’s power transition imposition of austerity measures in response
Finland Presidential First Round January 22, 2012
could have a considerable effect on investment to the crisis have proved highly unpopular.
Egypt Legislative Stage One January 29, 2012 portfolios around the world. Opposition parties will push strongly for a change
Finland Presidential Second Round February 5, 2012 > Many of the Eurozone’s challenges remain in policies.
Syria Legislative (Tentative) February 2012 unresolved, particularly the way the region will Second, if the main opposition candidate,
forge a closer fiscal union. The French election François Hollande, were to be elected, it could
Russia Presidential March 4, 2012
in May should help determine whether Europe create uncertainty about the relationship between
Iran Parliamentary March 29, 2012 becomes more or less integrated and if it takes France and Germany—the two countries most
Egypt Presidential March 2012 on a German or French bent. It may also end up active in resolving the Eurozone crisis.
influencing whether the Eurozone as we know it
France Presidential First Round April 22, 2012 Even though German Chancellor Angela Merkel
today exists in the years ahead.
and Sarkozy—dubbed “Merkozy” in the press—
Greece Parliamentary (Tentative/ Snap) April 2012 > In the U.S., voters will choose between two have disagreed on many occasions, the two
South Korea Parliamentary April 2012 very different economic recovery plans and managed to hammer out important compromises
Palestine Presidential May 4, 2012
approaches to tackle the federal deficit and in an attempt to stabilize the crisis. Sarkozy’s
debt. The election will lay the groundwork for campaign is likely to lean heavily on his ability
Palestine Parliamentary May 4, 2012 the 2013 legislative agenda, which should be to influence key European leaders. Further, he
France Presidential Second Round May 6, 2012 one of the busiest in years. More importantly, it advocates using Germany as an economic model
could establish the course for the world’s largest and suggests some reforms to increase France’s
France Legislative First Round June 10, 2012
economy during the next decade. productivity.
France Legislative Second Round June 17, 2012
> A major transition in Chinese leadership will A change atop France could not only alter the
Iceland Presidential June 30, 2012 begin this year. Any significant policy shift German-French relationship, it would possibly
Mexico Presidential July 1, 2012 would take some time to surface. But one thing require previous Eurozone agreements to be
is certain—a new generation of leaders will reviewed and changed—if Hollande’s rhetoric is
Mexico Legislative July 1, 2012
eventually make its mark on the world’s second- to be believed. He has been critical of Merkel’s
Kenya Presidential First Round August 14, 2012 largest economy and the global balance of demands for changes to European Union treaties
Kenya Parliamentary August 14, 2012 power. to allow disciplinary actions against overspending
Eurozone governments and has expressed a desire
Hong Kong Legislative September 2012 France – April/May to renegotiate agreements from 2011. This would
United States Presidential November 6, 2012 President Nicolas Sarkozy will likely face Socialist
likely further delay any lasting solutions as well
Party candidate François Hollande in his bid for
United States Legislative (Congress) November 6 2012 as create market volatility. Hollande also seeks to
reelection.
raise taxes on affluent French citizens.
Romania Parliamentary November 2012
The Most Important Election in Decades
The uncertainty created by the French election
South Korea Presidential December 2012 For France, the Eurozone, and global markets, this calendar and outcome could test German
election is critically important. leadership. Merkel will be faced with a re-election

bid in 2013, which will require increased focus on up for election, they would win control of this S&P 500 Returns in Presidential Election Years
domestic issues in 2012 and provide an incentive 100-member upper chamber—a real possibility. Conditional on Political Party Changes
to stabilize the Eurozone crisis prior to her At this stage, opinion polls indicate the House of Election Outcomes
17.2%
election campaign. Representatives, the lower chamber, could remain 14.7%
13.2%

Annual Returns
A Runoff is Likely in Republican hands, although their advantage
The French presidential election is based on could shrink.
securing a majority of the popular vote. If after -2.7%
Pocketbook Issues to Drive the Debate
the first round of voting (April 22, 2012) a single In addition to economic recovery and
candidate has received over 50% of the vote, the employment issues, many voters will consider
Democrat to Democrat to Republican to Republican to
election is over and (s)he is declared the winner. candidates’ spending and austerity proposals Democrat Republican Democrat Republican
If no one secures a majority, there is a runoff due to the high federal deficit (8.7% of GDP) and
between the top two candidates that would occur mounting federal debt (99% of GDP). Source: National Research Correspondent; election years 1926 to present
May 6, 2012. This ensures that one of the top two
Eric Lascelles, chief economist for RBC Global
candidates wins a majority in the second round, candidate who accumulates at least 1,144 of 2,286
Asset Management, estimates austerity measures
and that winner becomes the next president. total delegates will become the nominee.
already in place could reduce annual U.S. GDP
There are 15 candidates for the first round, three growth by 1.0%-2.5% in 2013 and beyond, The campaign for president will begin in earnest
of which are attracting some 70% of voter support; depending on which policies are actually when one of the Republican candidates has a
President Nicolas Sarkozy (Union for a Popular implemented or allowed to expire. New austerity plausible, mathematical pathway to winning a
Movement; centre-right), François Hollande measures could add additional economic majority of delegates. The race will shift into full
(Socialist Party; centre-left), and Marine Le Pen headwinds. gear by early September, when the Democratic
(National Front Party; extreme-right nationalist). Party holds its convention and officially re-
Tax policy almost always plays a big part in
nominates President Obama.
A poll published January 23 for the first round American elections; this election should be no
suggests Hollande (31%) leads President Sarkozy different. Both parties favor overhauling the tax The U.S. does not elect its president by popular,
(25%), while Le Pen gathers 17% of the votes. Polls code for individuals and corporations, and there national vote. Instead, an “electoral college” process
for the second round, focusing on Hollande (60%) is a predictably wide gap in the way they would allocates “electoral votes” to be cast for candidates
and Sarkozy (40%), suggest the former is leading approach it. Regardless of who wins the presidency, to all 50 states and Washington D.C., proportional
the race to become the next president. Congress will play a key role in shaping the tax to their populations. The overwhelming majority
reform debate in 2013. Budget constraints could of states award all of their electoral votes to the
U.S. – November force a revenue-neutral plan. With a lot at stake, candidate who wins the popular vote in that state.
President Barack Obama will likely face the race to control the Senate and House becomes The candidate who can amass at least 270 of the
Republican Mitt Romney or Newt Gingrich in crucial. total 538 electoral votes wins the presidential
his race for a second term. A high-profile, third- election. As a result, races in “swing states” or
It’s a Unique, State-by-State Process
party candidate could also surface and alter the “battleground states” where votes for each
Republicans are currently selecting their
electoral arithmetic. candidate could be closely divided (such as Florida,
presidential nominee through a series of state-
Virginia, Pennsylvania, Michigan, New Mexico, and
The national congressional elections should play wide primary elections and caucuses that award
others) will attract more of candidates’ time and
a pivotal role in shaping U.S. economic policies. “delegates” to the Party’s national convention in
attention compared to states where the electorate
The Senate, currently controlled by Obama’s late August. One candidate could begin to pull
tends to be highly skewed toward one party.
Democratic Party, is in play. If Republicans ahead in the primary race in February or March,
achieve a net gain of four seats among the 33 seats and most states will have voted by early June. The


China – Late 2012 and Beyond widespread dissatisfaction with the availability agreements, plans to step down. Eurozone and
and affordability of housing. IMF officials have repeatedly sought out and
Chinese politics have long been dominated by the
received written pledges from all Greek political
Politburo Standing Committee (PSC). Although the One might reasonably expect the mainland
party leaders that they will adhere to previously
National People’s Congress is formally the ultimate Chinese stock market, which is dominated by
negotiated bailout and austerity agreements.
decision-making body in China, in reality it is the state-owned enterprises with the government as
Even so, there remains great uncertainty about
PSC that holds the power. the majority shareholder, to exhibit less volatility
whether the new Greek government will honor
Due to the PSC’s informal rules on retirement age— this year. It is also unlikely investors will witness
its commitments. As a practical matter, this
leaders over 68 years should retire—2012-2013 any dramatic moves in the value of the Chinese
may be impossible considering the country’s
will likely see a generational shift in leadership. currency in 2012, in our view.
extreme debt load and severe economic
The country’s top two leaders will most likely Most importantly, after a political transition condition. The new government may ultimately
relinquish their positions. In total, seven of nine occurs, major policy initiatives are typically determine whether Greece exits the Eurozone.
PSC members may step down. introduced. That could make 2013 a particularly Antonis Samaras, head of the conservative New
Currently, Hu Jintao is president and Wen Jiabao interesting year. Chinese/U.S. policy issues will be Democracy Party, currently leads in the opinion
is prime minister. The two politicians widely in focus, with potential leadership changes in both polls but would likely need to form a coalition
expected to take over are, respectively, Xi Jinping countries. Clearly any Chinese policy changes are government to become prime minister.
(Xi is pronounced like “see”) and Li Keqiang likely to produce important domestic and global
> It seems inevitable Russian leadership will
(Keqiang is pronounced like “kur-chiang”). They outcomes.
officially shift back to Vladimir Putin in March—
will likely assume the top PSC positions in the although in practical terms his power and
fourth quarter of 2012 and take over the presidency Contribution to Global GDP Growth (%)
influence have been dominant for years. At this
and the premiership in March 2013 at the National 1.6% stage its unclear if there will be major changes
1996-2005
People’s Congress. According to the informal rule 1.4% 2006-2011 in economic or foreign policies. Russia’s
on retirement age, they would be the only two 2011 economy is too small to have much impact on
1.2%
continuing PSC members. 2012 global growth, but its energy policy can impact
1.0% Europe. Further, the anti-Kremlin protest
Major Changes Could Occur in 2013
Leadership changes to the PSC have occurred a 0.8% movement will be monitored by investors to
number of times before. What makes it different 0.6%
assess stability.
this time is the extent of change within the PSC and 0.4% > While India, the world’s largest democracy, will
the position China now holds on the global stage. also elect a president, the position is largely
0.2%
From an investment perspective, Chinese 0.0%
ceremonial. The country is governed primarily
0.0% by Prime Minister Manmohan Singh, who was
government policy typically has a conservative U.S. EU-15 China India
tendency during the transition year. It should be reelected to his second five-year term in 2009. As
Source: The Conference Board; 2011-2012 data are projections finance minister in the 1990s, he implemented
no surprise, then, that stable monetary and fiscal
policy were set forth as two key themes for 2012 at important reforms to open up the Indian
the annual Central Economic Work Conference that Other Elections economy. He remains a respected leader, but
ended last December. > Greek parliamentary elections, tentatively as prime minister he has been less effective in
scheduled for April, will choose a new prime advancing additional reforms and large-scale
Curbs on China’s private housing market will likely infrastructure projects than investors had
minister. Current Prime Minister Lucas
continue in 2012 while the government brings to hoped.
Papademos, leader of the caretaker coalition
market large volumes of low-cost units to quell
government that negotiated recent bailout > Presidential elections will take place in Mexico,
Finland, Egypt (TBD), and South Korea.

Global Equities

Global Asset Class View Attractive Valuations Overshadowed by Lingering Risks
Asset Class View A coordinated central bank move to ease banking system liquidity in Europe, together with an
unexpected reserve requirement cut for Chinese banks, accompanied by better manufacturing and
Equities = holiday spending data out of the U.S. allowed most markets to gain their footing in December and post
Fixed Income – worthwhile gains in January.
The successful inauguration of the European Central Bank’s LTRO facility giving the region’s banks access
Cash +
to low-cost funding for at least three years removed the immediate threat of a banking system meltdown
and put a welcome bid into the market for French, Italian, and Spanish bonds.
Regional Equity View That in turn allowed equity investors to switch their focus back onto market fundamentals (improving)
and valuations (cheap).
Region Weighting Because most major stock markets are still very attractively valued while bonds offer unacceptably
U.S. Neutral = low coupon returns as well as price risk, we would like to be able to recommend an “Overweight“
commitment to equities. However, we find ourselves constrained by the recognition the Eurozone crisis
Canada Neutral =
could still deteriorate in a way that could jolt North America from slow growth into recession and prolong
Continental Europe Underweight – China’s economic slowdown.
U.K. Neutral = Were that to happen, earnings would come under
Global Equities are Cheap on a Historical Basis
Asia (ex Japan) Neutral = pressure, today’s price/earnings ratios would
no longer look so attractive, and stocks would 35
Japan Overweight +
likely be vulnerable to an additional period of
30
retrenchment.
25
While that is not our forecast, we rate the
probability of it occurring at about 30%, high 20 Average: 19.0
enough that it needs to be acknowledged.
15
We recommend a “Neutral” exposure to stocks—
10
that is, portfolios should contain up to but not Last Plot: 12.9
more than their long-term target allocation to 5
1994 1997 2000 2003 2006 2009 2012
equities. We also counsel vigilance since we expect
many present uncertainties will be resolved over
Source: Datastream; World Index P/E data through 1/31/12
the next six months in a way that forces us off our
“Neutral” stance in one direction or the other.

Jim Allworth – Vancouver, Canada
jim.allworth@rbc.com


Global Equities: United States

Neutral (=) Market Developments Portfolio Recommendations
ƒ The S&P 500 has rallied 19.4% from its October ƒ Stick with high-quality, dividend-paying stocks;
> The S&P 500 is trading at a compelling
low due to improved economic data and the can better withstand periods of earnings
valuation, as the chart on page 23 llustrates. ECB’s LTRO policy. Employment growth picked erosion.
This lays the foundation for attractive returns up, manufacturing activity expanded, and ƒ Among cyclicals, favor Industrials (upgraded to
over the long term. some housing indicators began to stabilize “Overweight” from “Neutral”) and Technology.
> However, in the near term the market must during the period. Industrial earnings revisions should rebound
contend with lingering Eurozone risks, ƒ Because market expectations were set rather due to improved manufacturing activity.
economic headwinds, and potentially slower low last fall, it didn’t take much for data to Technology valuations are cheap; company
earnings growth. These factors argue for surprise to the upside. The U.S. Economic balance sheets sturdy.
“Neutral” or benchmark exposure to U.S. Surprise Index, which measures whether ƒ Financials are somewhat more attractive
the flow of economic data is exceeding
stocks for the time being. (upgraded to “Neutral” from “Underweight”).
or undershooting forecasts, began to rise Bank earnings indicate U.S. financial system is
> The consensus S&P 500 earnings forecast for meaningfully in October. By early January it finally beginning to heal.
2012 has pulled back to $106 per share but reached its second-highest level since 2004.
ƒ Decrease exposure to Utilities (downgraded to
remains above our $101 forecast. This also provided a catalyst for stock prices.
“Underweight”). Sector is expensive; trades at
ƒ History suggests the Surprise Index will the high-end of its 30-year range.
eventually retreat as expectations become
Sector View ƒ Limit exposure to Health Care (downgraded to
overly optimistic. It doesn’t necessarily follow
Consumer Staples + Health Care = “Neutral”). Earnings and revenue trends less
that the stock market has to come down, too.
attractive vs. 2011.
Information Technology + Consumer Discretionary – But the record says it is unlikely the market
will run away dramatically to the upside with
Industrials + Materials – U.S. Economic Surprise Index and S&P 500
expectations already so full.
Energy = Telecommunications – 100 1500
ƒ We also anticipate actual economic activity will
moderate soon. GDP growth should pull back 1400
Financials = Utilities – 50
from its 2.8% fourth-quarter pace. We forecast 1300
Source: RBC Capital Markets
2.0% growth for all of 2012. 1200
0
1100
ƒ Almost 40% of S&P 500 revenues come
from outside the U.S., so a worsening global 1000
-50
economic outlook combined with slow U.S. 900
growth calls for subdued earnings expectations. -100 800
Kelly Bogdanov – San Francisco, United States S&P 500 earnings are near a record high as a Economic Surprise Index (left axis) 700
kelly.bogdanov@rbc.com S&P 500 (right axis)
share of GDP at a time when more sectors are -150 600
Janet Engels – New York, United States experiencing profit margin contraction than 2008 2009 2010 2011
janet.engels@rbc.com
expansion. We forecast S&P earnings will grow
Source: Bloomberg; Citigroup Surprise Index data through 1/30/2012
by only 4% this year, down from 13% in 2011.

Global Equities: Canada

Neutral (=) Market Developments Portfolio Implications
> We remain “Neutral” for Canada, on a global ƒ The TSX closed up in January, following a string ƒ We believe gold stocks offer a compelling
of 9 out of 10 months of lower closes. opportunity at the present time. Shares of gold
asset allocation perspective. While we
producers continue to discount a much lower
remain concerned about the risks of a global ƒ RBC Capital Markets recently reduced its 2012
gold price than is prevailing in the market,
slowdown, we believe current monetary EPS estimate for the S&P/TSX to $885. The
while global reserve additions continue to run
policy, especially in the U.S. and Europe, sharp reduction in estimates is primarily the
at less than half of annual production.
should be supportive of the Canadian result of weakness in commodity prices and
a stagnant U.S. economy, Canada’s largest ƒ We have increased our recommended
market for some months to come, given its
trading partner. weighting on Industrials to “Overweight” from
significant resource exposure. “Underweight” to reflect a more positive overall
ƒ At current levels, the TSX is now trading at ~14x
view on the macro backdrop. We also note that
2012 estimates, which is roughly in line with its
Sector View long-term average.
Canadian industrials have significant exposure
to mining and energy where capex levels are
Consumer Staples + Health Care =
ƒ Shares of bank stocks have recovered expected to remain high.
Financials + Materials = significantly over the past few months as fears
ƒ We have reduced our recommended weighting
Industrials + Energy –
over Europe have somewhat abated. While still
in Utilities to “Underweight”. While the sector
below its 15-year average, the valuation gap
Telecommunications + Information Technology – offers attractive dividend yields, we believe
has narrowed significantly since Q411 earnings
valuations are rich and are at risk should the
Consumer Discretionary = Utilities – were reported in early December.
macro backdrop further improve.
Source: RBC Capital Markets ƒ We note that Canadian banks have limited
direct exposure to Southern Europe; however,
as with most global banks, concerns over
Europe are still likely to weigh on valuations
from time to time.
ƒ A “soft landing” for China would be longer-
term positive for Canadian stocks because of
the high commodity weighting in the S&P/TSX
Index.

Matt Barasch – Toronto , Canada
matt.barasch@rbc.com


Global Equities: Continental Europe

Underweight (–) Market Developments ƒ With an onerous sovereign funding
programme—Eurozone governments need to
> With the euro area entering recession and ƒ The recent ECB’s LTRO of €489bn served
raise some €219bn in new bonds in the first
as a lifeline to Eurozone banks. Prior to the
inflation being tamed, the European Central quarter—risk remains. The biggest near-term
intervention, they faced severe liquidity stress
Bank (ECB), headed by the pragmatic Mario danger is Greece, which is still negotiating an
and the prospect of a series of cascading
Draghi, should continue to provide support bank failures. With its intervention, the ECB
agreement on losses that private bond holders
through liquidity provisions and monetary should bear on its government bonds. Even
is effectively underwriting bank re-financing
policy. Another three-year Long-Term a 50% “haircut” on private debt would leave
requirements for at least the next two years.
the country with an uncomfortably high and
Refinancing Operation (LTRO) is taking place Unlike the Fed balance sheet expansion in
unsustainable 120% debt-to-GDP ratio by 2020.
at the end of February. 2008/09 that dealt with the cause of the crisis—
A much bigger haircut or a disorderly default
the financial system—the ECB’s LTRO does not
> The weak macroeconomic backdrop could shock investors.
address the root of the problem—namely, the
continues, though there are signs some euro sovereign debt crisis. It merely gives the banks
area countries are stabilising. Portfolio Recommendations
breathing space to recapitalize.
ƒ We continue to recommend investing in
> The Eurozone crisis is not over, and the ƒ An abrupt market rotation occurred in January resilient companies with a solid market
region still faces an arduous road ahead. We when the immediate risk of a financial system position, a high proportion of recurring sales,
remain “Underweight” the region. collapse was averted. The discrepancy between exposure to growing regions or industries,
the highly valued defensives and lowly valued and a healthy balance sheet. Such companies
cyclicals was partially restored. Cyclical and should be well equipped to weather challenges
value stocks outperformed while defensives in upcoming months.
lagged.
European Central Bank’s Total Assets (€ billion)
ƒ The “flash” Purchasing Managers’ Index
readings rose for the third-straight month 2750
in January, indicating stabilisation in euro- Assets have grown almost 40%, to
2600 €2.7 trillion, in the past year as efforts
area economic activity. The surveys suggest continue to maintain liquidity during the
that although business conditions remain 2450 region's debt crisis.
challenging, economic headwinds may no
2300
longer be quite so intense. The pick-up in
U.S. growth, the weaker euro, and the ECB 2150
policy stimulus are providing some relief for 2000
the economy. But with fiscal austerity set to
1850
intensify this year, the economy is expected to
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
remain very fragile.
Frédérique Carrier – London, United Kingdom
frederique.carrier@rbc.com Source: Bloomberg


Global Equities: United Kingdom

Neutral (=) Market Developments Portfolio Recommendations
> The U.K. economy continues to suffer from ƒ Following the ECB’s LTRO operation and ƒ We have been favouring companies with a
with global leading indicators improving, relatively high exposure to North American
the pressures of austerity. Tight credit
the FTSE 100 gained in January. The FTSE customers and relatively low exposure to
conditions, eroded real disposable income, Europe, in particular Energy, Health Care, and
250 outperformed as small- and medium-
and unemployment all crimp consumption. cap stocks rallied. Greater risk appetite was Utilities.
Growth in exports has been disappointing also evident in the sector performance, with
ƒ The recent outperformance of these stocks led
and unable to offset the malaise in the Financials and Basic Materials leading while
to higher valuations, and further meaningful
domestic economy. RBC Capital Markets Utilities, Health Care, Consumer Goods, and
outperformance may be harder to come by in
expects weak, but not necessarily Energy lagged.
the short term.
disappointing, growth. ƒ Encouragingly, the manufacturing, services,
> With fears concerning the Eurozone and its and construction PMIs have all surprised on
the upside, although still consistent with a U.K. Inflation Peaked in 2011
banks receding somewhat in January and
global leading indicators improving, the weak economy.
UK Retail Price Index YoY % Change
U.K. stock market gained during the month. ƒ U.K. CPI inflation declined to 4.2% y/y in 6%
Further expansion of the Bank of England’s December. The deceleration in prices reflects 5%
quantitative easing programme expected in base effects with transport and utility prices 4%
February should help support markets. rising sharply in December 2010. These are now 3%
falling out of the annual comparison, and RBC 2%
> Recession risks continue to linger for 2012. Capital Markets expects this to take inflation 1%
These could weigh on corporate earnings down to below 3% by April. 0%
and equity prices. A disorderly outcome
ƒ Unemployment increased to 8.4% in -1%
to the European sovereign and Financial November, a little higher than expected, though -2%
sector crisis remains the key risk, though the pace of the rise in unemployment seems 2006 2007 2008 2009 2010 2011 2012

we continue to expect this risk will not to have moderated. Confidence remains weak, Source: Bloomberg, data through December 2011
crystallise. and real income growth is set to stay in negative
territory throughout 1H12. However, slightly
easing credit conditions for households, less
real wages erosion as inflation becomes less
punitive, and no marked deterioration of the
unemployment picture should all help to
attenuate headwinds later in the year.

Frédérique Carrier – London, United Kingdom
frederique.carrier@rbc.com


Global Equities: Asia (ex Japan)

Neutral (=) Market Developments Fitch had already adjusted its rating in December
2011, and S&P may do the same in the next few
ƒ For January, the Hang Seng Index rose 10.6%;
> Asia ex-Japan equity performance continues the Singapore Straits Times Index 9.8%; the
months.
to be capped by a slowdown in Chinese Nikkei 4.1%, South Korea’s KOSPI 7.1%, Shanghai Portfolio Recommendations
growth, slower global growth affecting A-Share Index 4.2%, and Australia 5.1%. Equity
performance was strong in January despite the ƒ General: We prefer a “Neutral” benchmark
demand for Asian exports, and negative weighting but recognize regional economic
Chinese New Year, which is usually a quiet period
investor sentiment from the European for markets. leading indicators may be bottoming. There may
sovereign debt crisis. We maintain our be an opportunity to consider an “Overweight”
ƒ Central banks in the region are no longer position later in the first half of the year if
“Neutral” stance on regional equity markets. tightening. They are either on hold, as in the stabilization in the regional economy is
> However, we do note that leading indicators Australia, New Zealand, South Korea, and China, confirmed.
or loosening policy, such as in Indonesia and,
in the region may be in the process of more recently, Thailand. Many central bank ƒ Countries: We prefer Japan—lowest valuation in
bottoming, and equity performance at the statements have referenced the weak global Asia on book value (see next page); Indonesia—
strong domestic consumption theme; Australia—
start of 2012 has been more encouraging. growth environment as an impediment to
domestic growth. high dividend yield.
Asian equity performance was particularly
ƒ President Ma Yingjiu was elected to a second four- ƒ Sectors: We prefer defensive, non-cyclical sectors
weak in the second half of 2011. but would selectively add to cyclical stocks in
year term as Taiwan’s president, with nearly 52%
> While the Chinese economy faces numerous of the vote. Taiwan has enjoyed closer ties with portfolios as the economic data stabilizes.
challenges, the base case still calls for a China under the rule of Ma’s Kuomintang Party. ƒ Style: We prefer large-cap names, with supportive
soft landing. We forecast 2012 Chinese GDP ƒ Chinese GDP data continues to indicate the dividends.
growth of 8.4% and moderate appreciation economy is going through a soft landing. Fourth-
quarter GDP was up 8.9%, slightly more than Leading Economic Indicators for Select Asian Economies
in the Chinese currency. expected. The economy grew 9.1% in 2011. China’s (January - December 2011)
> Central banks are either staying on hold or CPI continued to moderate to 4.1% in December.
60
selectively easing, while inflation is also We expect inflation to moderate further and the
Chinese economy to grow 8.4% in 2012. 55
moderating. Equity valuations are low.
ƒ South Korea’s fourth-quarter GDP grew at the 50
Equity performance over a 12-month time slowest level in two years, rising 0.4% over the
horizon has historically been favourable at third quarter and 3.4% over a year ago. This was 45
these valuation levels once central banks slightly below expectations and was the third- 40
have started easing. consecutive quarter of slower growth. Given that
JAN MAR MAY JUL SEP NOV
exports account for approximately half of South
Korea’s GDP, the slowdown is reflective of the Taiwan HSBC Manufacturing PMI
broader global slowdown over that period. Nomura/JMMA Seasonal PMI
Jay Roberts – Hong Kong, China South Korea HSBC PMI
jay.roberts@rbc.com ƒ Indonesia, the world’s fourth most populous
China Manufacturing PMI
country, had its sovereign credit rating raised
Yang Yufei – Hong Kong, China Singapore Purchasing Manager Index Manufacturing
yufei.yang@rbc.com
by Moody’s for the first time in 10 years to
investment grade, Baa3, with a stable outlook. Source: Bloomberg


Global Equities: Japan

Overweight (+) Market Developments auto demand, improved U.S. market share
and demand, and strong sales growth in China
ƒ As we head into Japanese earnings season the
> The “Overweight” call on Japanese stocks after a weak 2011. Toyota, the largest Japanese
Nikkei 225 index has risen 4.6% since the start
is largely a function of valuations—with of 2012.
manufacturer, also raised its 2012 sales
Japan trading at the lowest price/book value forecasts, although this was on the back of a
multiple in Asia—as well as an expected ƒ Japan’s core CPI fell for the third consecutive particularly weak 2011.
year in 2011, down 0.3%. Core prices declined
economic rebound in 2012 following the by 0.1% in December. One of the reasons Portfolio Recommendations
devastating effects of the tsunami in March deflation remains in Japan has been the ƒ Japanese cyclical sectors, such as real estate and
2011. continued strength of the yen in 2011. RBC transportation equipment, that underperformed
> Japanese stocks are trading at significant Capital Markets forecasts the yen to appreciate in 2011 have been the outperformers thus far
to USD/JPY 70.0 by the middle of the 2012 in 2012. However, this may just be a short-
discounts to historical valuations. The
before falling back to 75.0 by the end of the term market reaction to the imminent threat
Nikkei 225 Index is trading at a forward year. of a European credit crunch dissipating over
price/earnings ratio of 11.7x, compared Christmas. We continue to favour large-
ƒ Japan posted a trade deficit in 2011, its first such
to the 5-year average forward valuation of cap, dividend-paying names as we wait for
deficit since 1980. However, this is likely not the
16.4x. The trailing price/book ratio is 0.9x, start of a new trend of deficits for the world’s
confirmation the regional economic data in
compared to the 5-year average valuation of Asia is stabilizing. We would selectively add to
third-largest economy because a number of
1.3x. Negativity prevails: Japanese stocks cyclical stocks in portfolios as the data improves.
unusual factors hurt exports in 2011 and helped
are priced for a 5% earnings decline in to contribute to the deficit. These include: the ƒ We also favor companies likely to benefit from
2012. March tsunami and subsequent nuclear disaster civil infrastructure projects and reconstruction
that impacted the domestic supply chain; severe work resulting from the March 2011 earthquake
flooding in Thailand that impacted the regional and tsunami.
supply chain; and the European sovereign debt
crisis that dampened demand from that region.
However, the strong yen—also a headwind—will Japanese Headline and Core CPI (Jan 2009-Dec 2011)
likely persist in 2012.
0.5
ƒ The Bank of Japan (BoJ) lowered its growth 0.0
forecasts for fiscal-year 2012, which begins in
-0.5
April, to 2% from 2.2%. For the 2011 fiscal year,
-1.0
the BoJ forecasts a contraction of 0.4%, slightly
higher than the previous forecast of 0.3%. The -1.5
BoJ cites the European sovereign debt crisis as -2.0 Headline (JNCPIYOY Index)
Jay Roberts – Hong Kong, China the biggest risk to domestic Japanese growth. -2.5 Core (JNCPIXFF Index)
jay.roberts@rbc.com
-3.0
Yang Yufei – Hong Kong, China ƒ Mr. Takanobu Ito, the President of Honda,
Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
yufei.yang@rbc.com Japan’s third-largest car manufacturer, forecast
earnings for the company will be the best in Source: Bloomberg
at least five years on a rebound in domestic

Global Fixed Income

Global Asset Class View Pockets of Opportunity Exist within the Ultra-Low Rate Landscape
High-grade government yields moved higher for a few days in early December as investors digested the
Asset Class View
implications of the coordinated central bank move to head off a banking liquidity crisis and concluded an
Equities = important systemic risk had been neutralized—at least for the time being. However, it was not long before
those yields began to drift lower once again—in most cases getting back to or below their November lows.
Fixed Income –
This rapid yield retreat seemed to be in response to several factors:
Cash +
ƒ Recognition the sovereign debt crisis was unresolved and just as potentially dangerous as ever;
ƒ Acknowledgement the Eurozone was in recession, a development likely to complicate and worsen the
Corporate Bond Spreads (in basis points) crisis;

581 552 ƒ Confirmation inflation rates everywhere looked to have peaked and were falling, perhaps quickly,
6 months ago
allaying investor fears about just how far safe-haven yields would back up if a crisis resolution arrived
3 months ago
427 unexpectedly; and
Current (Jan 31, 2012)
ƒ The revelation that Fed-think was focused on far-away late 2014 as the likely date of the first rate hike.
At the same time, the FOMC continued to suggest QE3 was still on the table, and the Bank of England
159 151 150 156
looked increasingly likely to enlarge its own quantitative easing efforts.
99
73 Yield-hungry investors, for their part, have had little choice but to search for pockets of acceptable
coupon or dividend return while wrestling with just how much extra risk they can prudently rationalize
away.
Europe U.S. Investment U.S. High-Yield
Investment Grade Grade Corporate Corporate Spread In our view, investment-grade corporate bonds still offer the best value in what has become a well-
Corporate Spread Spread
ploughed field, acknowledging the risk/return trade-off available today is not as attractive as it was a year
ago—or even several months ago. But we continue to remind ourselves any Eurozone crisis resolution
Source: Bloomberg; month-end data of Citigroup BIG and high-yield indices
Note: European spread vs. German Bund; U.S. spreads vs. U.S. Treasury that permitted safe-haven government yields to move back above the rate of inflation would also
substantially narrow the spread advantage on offer in the corporate sector today.
The high-yield sector presents investors with much the same choice as equity markets. Yields are high
and attracting a lot of investor interest. Default rates have remained low and probably will continue to
do so if the Eurozone downturn is mild and short lived. However, if the crisis were to worsen, pushing the
U.S. into recession and exacerbating the Chinese slowdown, history suggests default rates would move
appreciably higher as would yields. There continues to be relative value in this sector with spreads still
above historical averages, but only for investors who can accept substantially higher risks.

Jim Allworth – Vancouver, Canada
jim.allworth@rbc.com


Global Fixed Income: Focus on U.S.

U.S. Treasury Yield Curve Comparison U.S. Treasuries ƒ Even with continued sluggish economic growth in
North America, default risk remains low, which is
5%
ƒ Yields have remained volatile due to ongoing
positive for the high-yield sector.
sovereign risks and economic uncertainties.
4% ƒ High yield spreads tightened significantly in
ƒ The Federal Reserve announcement that current
January, but they remain above historic averages.
policy may remain in place until the end of 2014,
3% We believe the asset class continues to provide
coupled with the central bank’s ongoing purchase
opportunities for risk-oriented accounts.
2% 4/1/2011 of longer-dated securities, is supportive of a
12/30/2011 “lower for longer” rate environment and a flatter Municipals
1% yield curve.
1/31/2012 ƒ Yields have continued to pull back as municipal
0%
ƒ In this low-rate, benign inflation environment we bonds have extended their rally that began late
Yr 1 Yr 5 Yr 9 Yr 13 Yr 17 Yr 21 Yr 25 Yr 29 continue to prefer credit-sensitive sectors over last year. Strong institutional demand coupled
Treasuries. with tight supply resulted in a “crowding out”
effect for retail investors who had already begun
Asset Class Yield Curve Comparison
Agencies to balk at the lower yields.
ƒ Yields of Agencies (GSE bonds) compared to
8% ƒ At current levels, short- to intermediate-muni
Treasuries, or spreads, remain tight by historical
7% bonds seem overvalued. A back-off in prices
standards.
6% would provide a better entry point as we remain
5%
ƒ Nevertheless, agencies provide an opportunity to positive on this sector.
pick up higher yields and have minimal risk.
4% ƒ Supply constraints will likely diminish somewhat
3% ƒ While the Federal Reserve has yet to announce because low absolute yield levels should be
2%
official plans for mortgage-backed securities supportive of refunding activity on the part of
Investment Grade High Yield purchases through QE3, it has signaled these municipalities. We expect muni bond issuance to
1%
Munis Treasuries securities would play a role in future long-term increase in 2012.
0%
securities purchases. This should continue to
Yr 1 Yr 5 Yr 9 Yr 13 Yr 17 Yr 21 Yr 25 Yr 29 ƒ Municipals continue to be subject to headline
support the mortgage-backed securities market.
risk as a result of ongoing financial stress at the
Chart Sources: Bloomberg
Corporates state and local levels, especially as Washington
continues to debate deficit reduction proposals.
ƒ Corporate bonds were the best-performing fixed Nonetheless, demand from both traditional as
income sector in January, and the difference in well as “cross-over” buyers should remain strong.
yield (the spread) between corporate credit and
Treasuries tightened significantly. High-yield ƒ The consensus among analysts is that any serious
bonds exhibited particularly strong performance. debate about tax-code changes that could impact
munis will likely occur in 2013, after the U.S.
ƒ Due to the low interest rate environment, elections.
corporations are expected to reduce their debt
loads, which could cause credit spreads to narrow ƒ Investors continue to look for ways to increase
further. yield. In the muni market, this means moving
down the credit scale, with lower investment-
Craig Bishop – Minneapolis, United States ƒ We believe corporate debt will continue to grade health care issues as the main beneficiaries.
craig.bishop@rbc.com outperform government bonds over the short Extension swaps and “kicker bonds” with 5-10
and medium term as global policy efforts remain year calls also offer value.
supportive of riskier assets.

Commodities

> Recent improvements in global Gold sanctions over Iran’s nuclear program, and
European Union countries have decided to ban
manufacturing Purchasing Managers’ ƒ The month of December saw gold bullion trade
Iranian oil imports starting July 1, 2012. Iran has
Indices have been encouraging for down 10% towards the bottom of its multi-year
responded by threatening to prevent shipping
trend channel. Fundamental supports remain
economically sensitive commodities. through the Straight of Hormuz, through which
unchanged, and the price has since rebounded.
the bulk of the region’s oil passes.
> Over the longer term, sustained growth ƒ The price remains supported by:
ƒ The supply and demand balance for natural gas
in commodity-intensive economies—like › low real interest rates, continues to deteriorate, with the commodity now
China and India—together with constrained › the Eurozone sovereign debt crisis, trading under $3.00/Mcf. Continued growth in
supplies, would suggest constructive › longer-term U.S. debt and deficit concerns, industry-wide production in the U.S. combined
market conditions. › emerging market demand driven by inflation with warm weather have led to U.S. storage levels
and growing household wealth, rising to 3.1 Bcf, which is well above the 5-year
> In the near term, the risk of a European › central bank demand, and average of 2.6 Bcf.
banking crisis or disorderly sovereign › speculative buying.
Copper and Industrial Metals
default could lead to significant declines in ƒ Gold ETF demand continues to rise, with 2011 up
ƒ Copper prices are well above their cost floor as
all risky assets. 7% following growth of 20% in 2010.
demand from emerging markets, led by China, has
ƒ Central Bank buying advanced considerably remained robust.
in 2011 with an estimated 430 tonnes of net
Commodity Forecast 2012E 2013E ƒ China is the world’s largest consumer of copper,
purchases.
and the latest economic data, including 4Q11 GDP
Oil (WTI $/Bbl) 100.00 106.00 growth of 8.9%, are consistent with a moderation
Energy
Natural Gas ($/mmbtu) 4.00 4.75 of growth into 2012, but not a hard landing.
ƒ Oil demand remains dominated by emerging
Gold ($/oz) 1,800.00 1,800.00 markets, with RBC Capital Markets forecasting ƒ The global supply/demand balance for copper
2012 global demand to increase by 0.7 million has been in deficit for two years; however, this is
Copper ($/ton) 3.75 4.00 expected to shift to a mild surplus for 2012 when
barrels per day (mbpd), of which China makes up
Corn (US$/bu) 6.51 5.98 60% (0.4 mbpd). several large mine expansions come on-stream.

Wheat (US$/bu) 6.83 7.20 ƒ Supply conditions are expected to remain tight Corn and Agricultural Commodities
with the return of exports from Libya providing
Source: RBC Capital Markets forecasts (oil, natural gas, gold, copper), ƒ For potash, economic uncertainty has led
Bloomberg consensus forecasts (wheat, corn) some relief. Libya is estimated to produce oil at
buyers to be cautious. Producers were piling up
approximately two-thirds of its pre-war level and
inventories in late 2011, with potash inventories
may see full production by mid-year. OPEC spare
at two major producers up 20% in December from
capacity is expected to remain a relatively tight
the prior month and 13% over the 5-year average.
3.6 mmbpd in 2012, per RBC Capital Markets.
The near-term weakness has been met with potash
ƒ In December, OPEC set a new production ceiling volume curtailment by Potash Corp. and Uralkali.
for the first time in three years, allowing the limit
ƒ Corn and soybean prices increased in January
to increase to 30 mpbd, reflecting concerns that
on heat and drought concerns in South America.
$100 oil may lead to demand destruction.
Mark Allen – Toronto, Canada Argentina, the world’s second-largest exporter of
mark.d.allen@rbc.com ƒ The wild card for supply is now Iran, which corn, has dramatically lowered its corn production
represents ~4% of global production and exports forecast. The drop represents 4.8% of the global
2.5 mbpd. The U.S. has imposed new financial corn export market.

Currencies

> The global interest rate cycle has turned down U.S. Dollar (USD) ƒ This has stabilized the European financial system,
again. Central banks are generally cutting but the surge in liquidity pushed the Euro even
ƒ The Dollar’s strengthening trend in December
lower as traders saw the ECB’s plan as a way to
policy rates or keeping them near record continued into the New Year before giving up
inflate away the debt. However, the market already
lows. With interest rate differentials between some gains near the end of January. The driver
appears to be very short on the Euro, so we believe
of this strength was generally improving U.S.
developed economies converging towards zero, a rapid decline is now unlikely. Instead, we expect
economic data and a realization the economy,
this removes one of the main tools currency while sub-par, was still looking healthier than
only a slow, grinding weakness in the currency
forecasters use, that of relative monetary policy. until a long-term fiscal solution is found.
many of its developed country peers.
> In this environment we believe currencies are ƒ However, the January 25th Fed announcement U.K. Sterling (GBP)
trading close to their longer-term fair values. that interest rates would likely remain low through ƒ The direction of the pound continues to be
the end of 2014 underscored the headwinds
Our targets reflect this backdrop, with most of facing the economy and, by association, the U.S.
driven by a trade-off between the weakness of
our long-term forecasts unchanged since the the U.K. economy and the safe-haven aspect of
dollar. The political divisions leading up to the the currency in comparison to the euro. As 2012
end of 2011, suggesting only small potential presidential election this year will likely heighten progresses, we expect the pound to be driven by
movements are likely over our forecast horizon. the policy gridlock and add risk to the dollar. the relative performance of the U.K. economy. That
is, we expect it to strengthen against the currencies
Canadian Dollar (CAD)
Currency Current as of Forecast to of countries with slower GDP growth (e.g., the
Forecast Jan 31, 2012 Dec 31, 2012 ƒ The CAD traded narrowly on the weak side of euro), but to weaken against the U.S. dollar.
parity with the US. dollar through the end of 2011
CAD/USD 1.00 1.00 as traders struggled to find a reason to push it Japanese Yen (JPY)
higher. The BoC’s interest rate policy remains on ƒ Even though Japan hasn’t fully recovered from
USD/CAD 1.00 1.00 hold, and the rapid accumulation of new debt by the global recession, we still have the somewhat
EUR/USD 1.31 1.27 households taking advantage of these low rates contrarian view the yen will continue to appreciate
makes us doubt further cuts are imminent. against major currencies. The only natural seller
GBP/USD 1.58 1.59
ƒ This is in contrast to other commodity-focused of yen is Japanese companies investing their funds
AUD/USD 1.06 1.01 countries, such as Australia, where rates continue overseas. In the current global low interest rate
to fall. With this backdrop, we expect the loonie environment, these companies are able to hedge
USD/CHF 0.92 0.99 these flows very cheaply and, therefore, reduce the
to outperform its commodity currency peers this
USD/JPY 76.27 75.00 year as the preferred proxy for a reflation trade. selling pressure on the yen.

EUR/JPY 99.78 95.25 Eurozone Euro (EUR) Chinese Yuan (CNY)
EUR/GBP 0.83 0.80 ƒ The Euro was the worst-performing major ƒ China’s move to lower its bank reserve requirement
currency at the end of 2011—and for good reason. from 21.5% to 21% in December was the first cut
EUR/CHF 1.20 1.26 The slow policy response to the peripheral in three years. We expect this rate to fall by another
USD/CNY 6.31 6.10 debt crisis, even as growth declined, made the 2.5% in the first quarter if inflation continues to
fiscal situation even worse. Just as confidence fall. However, this should not weaken the yuan
Source: Bloomberg, RBC Capital Markets
Example of how to interpret currency data: CAD/USD 1.00 means 1 Cana- in the banking sector looked to be approaching against the dollar, since political considerations
dian dollar will buy 1 U.S. dollar. a crisis point, the ECB launched its Long-Term suggest the yuan will be allowed to float higher in
Refinancing Operation (LTRO). This provided a order to avoid an escalation in trade tensions.
Alan Robinson – Seattle, United States huge liquidity injection with banks able to offer
alan.robinson@rbc.com
their sovereign bonds as collateral.

Key Forecasts

U.S. GDP ƒ Real disposable income fell year /over year Central Bank Rate ƒ FOMC committed to no rate hike
in Q4. Modest spending growth in second Today 1-year Out before late 2014. Fed continues
2.9% 1.9% 2.0% half was fueled by savings draw-down. to hint at new asset purchase
Confidence dampened by weak housing, program (QE3) targeted at
anemic jobs growth, global uncertainty. mortgage-backed securities.
-2.6% Inflation set to recede; may give consumer a
0.25% 0.25% ƒ Flight-to-safety has repeatedly
2009 2010 2011 2012E break in 2012.
driven 10yr Treasury yields below
ƒ Fiscal drag to become more pronounced, 2%. A Eurozone solution and a
even more if payroll tax cut not extended. rebound in global economies
Inflation 10-year Rate
could at some point push them
ƒ Business capital investment was a bright Today 1-year Out
back up to 3%+, but fast falling
3.0% spot all last year, but leading indicators
3.8% inflation and the likely rapid
1.8% of capex are mixed. Tax incentives were
1.6%
deployment of QE3 would limit the
extended for 2012 but cut in half.
3.00% upside.
-0.3%
ƒ Muddle through at 2% GDP growth, but 1.80%
2008 2009 2010 2011E 2012E slow growth makes economy vulnerable to
external shocks from Europe, oil, geopolitics,
etc. Recession not our forecast but can’t be
entirely ruled out.

Canada GDP ƒ After adding to employment in 20 of 24 Central Bank Rate ƒ The Bank of Canada lowered
months, Canada lost jobs in 3 of the last 5. Today 1-year Out its growth forecasts out to and
3.2% 2.3% 2.0% including 2013, citing substantial
Flagging employment growth may start to
weigh on confidence. Inflation forecast to global headwinds including
ebb; wage growth reasonable. Longer term, a longer, deeper European
-2.5% substantial build-up of household debt has 1.00% 1.00%
downturn. Expectations for a rate
2009 2010 2011E 2012E left consumer too exposed to future rate hike mid-2012 have come off the
increases. table. Possibility of a rate cut if the
inflation threat wanes and global
Inflation ƒ Weak U.S. growth and a longer-than- 10-year Rate growth falters.
expected slowdown in China should make for Today 1-year Out
a mixed export performance. ƒ An end to the flight-to-safety
2.4% 1.8% 2.0%
2.7% bid would drive Canada bond
ƒ Government stimulus all but gone; yields sharply higher with no
substantial cuts coming this year and next. 3.00% contemplated Bank of Canada QE
0.3% 1.90%
ƒ Capex heavily skewed toward energy. Cross- program to provide an offset.
2008 2009 2010 2011E 2012E
border pipeline politics and weak natural gas
prices could be a drag.

Source: RBC Investment Strategy Committee and RBC Capital Markets


Key Forecasts

Eurozone GDP ƒ Promise of deep austerity cuts to come, and Central Bank Rate ƒ The ECB surprised with two 25 bps
inability to end the crisis sent consumer Today 1-year Out rate cuts at President Draghi’s first
1.0% 1.5% and business confidence plummeting in two meetings. Inflation receded in
0.0%
the second half. Spending weak; capex December, with more expected early
intentions uncertain. Region already in in the New Year, making other cut(s)
-4.1% recession. 1.00% feasible in Q1.
0.50%
2009 2010 2011E 2012E ƒ Rate cuts welcome but won’t have traction ƒ December move to give banks
before second half and not then if banks 3-year access to ECB funding has
raise capital by shrinking loan books. removed risk of area banks slipping
inadvertently into a funding crisis. It
ƒ Weak currency should help core countries; Today 1-year Out
has bought time and substantially
3.3% peripheral outlook grim.
narrowed Spanish, Italian, and
1.6% 1.5%
2.5% 3.00% French 10-year spreads over bunds.
1.80% (Germany)
0.3% (Germany) ƒ Big loser from “closer fiscal union” or
2008 2009 2010 2011E 2012E “Eurobond” solution would be bunds.

U.K. GDP ƒ U.K. economy continues to slowly weaken. Central Bank Rate ƒ The BoE, unconcerned by inflation
GDP contracted in Q4. Consumer badly Today 1-year Out data distorted by one-time factors.
1.3% 1.0% 1.0% squeezed by inflation awaiting some Will continue balancing ultra-tight,
reprieve as 2012 unfolds. austerity-driven fiscal policy with
a very accommodative monetary
ƒ Exports more than 30% of GDP and half are
-5.0% stance. No rate change before
bound for the Eurozone. At risk as Europe 0.50% 0.50%
2009 2010 2011E 2012E 2013. New round of QE approved in
slips into recession. Heavily exposed
October has since been increased.
to Ireland in both trade and finance.
We expect another enlargement
Recession hard to avoid if Europe downturn
Inflation 10-year Rate approved in the spring.
worsens.
Today 1-year Out
ƒ Gilts benefitting from flight-to-safety
4.3% ƒ Inflation fell sharply to 4.2% in December
3.8% 3.3% bid and the Bank of England’s
(from 5.2% in September). More to come
extended and enlarged QE program.
2.5% as VAT increase and utility rate increases
2.1% 2.75% An end to both would herald a steep
eventually fall out of the calculation. Bank 1.95%
back-up in yields.
2008 2009 2010 2011E 2012E of England forecasts a below 2% reading by
year end.



Key Forecasts

China GDP ƒ Economy slowing, mostly because of weaker Central Bank Rate ƒ Reserve requirements at 21.5%
exports, especially into Europe. Export growth Today 1-year Out and base lending rate at 6.56%
9.3% 10.5% 9.3% down from 25% to 13%. produced a credit crunch and
8.3% 6.56%* 6.56%*
brought money supply growth
ƒ Credit crunch and tough home purchase
down to just 13%. Bank lending
regulations taking a toll on small-to-medium
growth continues to slow. Inflation
manufacturers and property developers. Real
2009 2010 2011E 2012E
has fallen for 4 months running.
estate markets cooling off nationwide.
ƒ Reserve requirements were
ƒ Gov’t housing construction picking up the
lowered by 50 bps in December
Inflation slack. Consumer spending up by double-digit 10-year Rate
and another 200+ basis points
rates. Infrastructure investment a priority. Today 1-year Out
was widely expected to arrive in
5.7%
5.9%
3.3% ƒ Inflation now down to 4.1% led by food price Q1. However, the government has
4.5% moderation. recently given plenty of indications
3.45% n/a
ƒ Policy tightening over. Easing on the way. easing will be more deliberate in
-0.7% pace. Interest rate cuts unlikely
However, policymakers may allow GDP
2008 2009 2010 2011E 2012E
growth to moderate further rather than risk until inflation rate falls below one-
rekindling price pressures by reversing course year deposit rate (3.50%).
too quickly.
ƒ Our forecast is a “soft landing,” but any
reacceleration is some ways off.

Japan GDP ƒ Reconstruction and restart of the auto sector Central Bank Rate ƒ Bank of Japan provided plenty
produced the promised V-shaped recovery Today 1-year Out of liquidity during the Tsunami
2.6% 2.2% from the earthquake-induced downturn, but crisis and has now embarked on
industrial production has faded following expanded QE program (55 trillion
-0.5% the summer spurt. Currency strength a drag yen) buying JGBs. It cited European
-5.3% on trade. concerns and the strength of the
0.10% 0.10% yen. It also lowered its growth and
2009 2010 2011E 2012E ƒ Growth in first half likely to be respectable
inflation forecasts for 2012 and
against easy comps, although supply
2013.
disruptions from Thai flooding a wildcard.
Second half will need stronger demand from
Today 1-year Out
China.
1.4%
0.2%
-0.2% ƒ Retail trade and machinery orders both
ticked higher in Q4. However, moribund
-0.7%
-1.4% domestic demand together with a more 1.50%
0.95%
2008 2009 2010 2011E 2012E
challenging export environment in 2012
suggest growth will quickly subside into the
2% +/- .5% range. Inflation not a factor.
*1-yr base lending rate for working capital, People’s Bank of China; Source: Consensus Economics


Market Valuation & Equilibrium Levels

> The RBC Global Asset Management Fair Value Equity Charts
calculation looks at the returns on equity S&P 500 Equilibrium S&P/ TSX Composite Equilibrium
earned by the companies comprising the
relevant market index back more than 50 years 3311 22387
and relates them to the interest rates and 2026
Jan. '12 Range: 1155 - 1938 (Mid: 1547)
14307
Jan. '12 Range: 10490 - 15664 (Mid: 13077)
Jan. '13 Range: 1259 - 2113 (Mid: 1686) Jan. '13 Range: 10198 - 15229 (Mid: 12713)
inflation expectations prevailing at the time to 1240 Current (31-January-12): 1312 9143
Current (31-January-12): 12452

get a “normalized ROE” for a given combination 759 5843
of rates and inflation. Using today’s interest 464 3734
rates and inflation, it calculates how the 284 2387
market has typically valued the corresponding 174 1525

“normalized earnings” to get “fair value,” 106 975

which would lie at the mid-point of the band on 65 623

the adjacent charts. The edges of the band lie 40 398
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
one standard deviation either side of fair value.

> The RBC Global Asset Management equilibrium Fixed Income Charts
valuation for bonds looks at how much of an U.S. 10-year Treasury Bond Yield Canada 10-year Bond Yield
interest-rate premium investors have typically
demanded over and above the expected rate of 16 18
inflation. Using today’s inflation expectations, 14
Last Plot: 2.28%
16
it calculates which bond yield would provide 12
Current Range: 3.34% - 5.02% (Mid: 4.18%)
14
that premium (the mid-point of the band). The 10 12
band resides one standard deviation on either
8
%

%
10
side of the mid-point.
6 8
4 6
Last Plot: 2.14%
2 4
Current Range: 2.77% - 4.66% (Mid: 3.72%)
0 2
1980 1985 1990 1995 2000 2005 2010 2015 1980 1985 1990 1995 2000 2005 2010 2015

Chart Sources: RBC Global Asset Management


Research Resources and Important Information
Research Resources
This document is produced by the Global Portfolio Advisory Committee within RBC Wealth Management’s Portfolio Advisory Group. The RBC WM Portfolio Advisory Group provides support related
to asset allocation and portfolio construction for the firm’s Investment Advisors / Financial Advisors who are engaged in assembling portfolios incorporating individual marketable securities.
The Committee leverages the broad market outlook as developed by the RBC Investment Strategy Committee, providing additional tactical and thematic support utilizing research from the RBC
Investment Strategy Committee, RBC Capital Markets, and third party resources.
Global Portfolio Advisory Committee members:
Janet Engels – Co-chair; Head of U.S. Equities, RBC WM Portfolio Advisory Group Jim Allworth – Co-chair; Portfolio Strategist, RBC Dominion Securities
Maarten Jansen – Head of RBC WM Portfolio Advisory Group Mark Allen – Portfolio Advisor, RBC WM Portfolio Advisory Group
Rajan Bansi – Head of Canadian Fixed Income Strategies, RBC WM Portfolio Advisory Group Matt Barasch – Head of Canadian Equities, RBC WM Portfolio Advisory Group
Craig Bishop – Head of U.S. Fixed Income Strategies, RBC WM Portfolio Advisory Group Kelly Bogdanov – Portfolio Analyst, RBC WM Portfolio Advisory Group
Frédérique Carrier – Director, European Equities, RBC Investment Management (UK) Ltd George King – Head of Portfolio Strategy, RBC Investment Management (UK) Ltd.
Tracy Maeter – Head of Investments, British Isles, RBC Investment Management (UK) Ltd. René Morgenthaler – Head of Investments (Suisse), RBC WM International
Jay Roberts – Head of Asian Equities, RBC WM Portfolio Advisory Group Alan Robinson – Portfolio Advisor, RBC WM Portfolio Advisory Group
The RBC Investment Strategy Committee (RISC), consists of senior investment professionals drawn from individual, client-focused business units within RBC, including the Portfolio Advisory Group.
The RBC Investment Strategy Committee builds a broad global investment outlook and develops specific guidelines that can be used to manage portfolios. RISC is chaired by Daniel Chornous, CFA,
Chief Investment Officer of RBC Global Asset Management.
Disclaimer
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness.
All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of
an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world
have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some
jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities
broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or
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Copyright © RBC Capital Markets, LLC 2012 - Member NYSE/FINRA/SIPC
Copyright © RBC Dominion Securities Inc. 2012 - Member CIPF
Copyright © RBC Europe Limited 2012
Copyright © Royal Bank of Canada 2012
All rights reserved


Global Insights Feb 2012

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