LombardOdier 2014 Outlook : A Slow and Fragile Healing Process To Safeguard

Investment Strategy Group
A slow and fragile healing process to safeguard

Samy Chaar, PhD & Stephanie de Torquat Investment Strategy Group November 2013
Global leading economic indicator firming

Mid year economic soft patch is abating
Global economic conditions are improving, a sign that the risk of global recession is currently low.
GLOBAL LEADING ECONOMIC INDICATOR (PROXY FOR GLOBAL GROWTH)

OECD COUNTRIES PLUS 6 LARGEST NON MEMBERS, YOY%
Economy improving
Economy slowing
Source: Datastream, Lombard Odier calculation

Please see important information at the end of the document
Investment Strategy ! October 2013 !
Global manufacturing PMI improve

Developed markets firming, emerging markets less of a drag
PMIs are picking up implying little risk of contraction ahead, despite some regional divergences.
LEADING ECONOMIC INDICATORS - PMI

LEVEL (X-AXIS, CONTRACTING LINE IS 50) VS RATE OF CHANGE (Y-AXIS)
Bottoming Expansion
Contraction
Maturing
Note: DM in blue / GEMs in brown; Source: Bloomberg, Lombard Odier calculation

Global growth imbalanced

New normal equilibrium still prevails
Global growth still well below trend suggesting economies to reach escape velocity is premature. .
NOMINAL GROWTH CONSTITUENTS (INFLATION + REAL GDP GROWTH)

IN YOY % CHANGE
Note: DM in blue / GEMs in brown; Source: Datastream, Lombard Odier calculation

Recovery set to remain mediocre and imbalanced

With weak employment growth over the long run
An impressive set of stimuli - Auto Bail-Out - Cash for Clunkers - Homebuyer Tax credit - TARP - Tax cuts - Extended unemployment benefits - Massive Fed balance sheet expansion (QEs, Operation Twist) for one of the slowest US recoveries ever!
US REAL GDP ANNUALIZED GROWTH

OVER THE 5 YEARS FOLLOWING THE END OF RECESSIONS, IN %
Global imbalances adjusting

Deleveraging implies a reduction in the western deficit, and a turn to surplus, and a corresponding decline in the emerging surplus as EM growth models will evolve toward more domestic demand.
EMERGING VERSUS DEVELOPED ECONOMIES CURRENT ACCOUNTS

USD BN
Major Turning Point in 2008 Global Imbalances Global rebalancing

Re-balancing global growth

The Emerging Market Growth Miracle is, in fact, a simple reflection of the willingness of the advanced countries to run deficits to provide the demand for emerging overinvestment: the gap between advanced and emerging country GDP growth is easily explained by the growth in western private sector leverage / current account deficits.
EMERGING MINUS ADVANCED ECONOMIES REAL GDP GROWTH (%Y/Y) VS ADVANCED ECONOMIES CURRENT ACCOUNT BALANCE (USD BN, 3Y MMA)

Macro conclusions
A slow and gradual healing process, but not one without risks
! The global environment remains fragile. An escape route for the world economy lies ahead if, and only if, a number of conditions are met:
1.
Keep the cost of capital under control

Western economies are still burdened by unsustainable levels of total debts and deficits. The world is not yet ready to support higher rates - the US housing recovery also depends on contained mortgage rates
US Interest Rate Risk: the great divergence
1/2
Long-term rates close to fair-value, short term rates widely disconnected

Too rapidly rising LT yields would be unsustainable and detrimental to the economic and financial environment due to excess leverage. However, ST yields, especially when adjusted to QE3, are not consistent with low but stable inflation, and declining unemployment. .
US YIELD CURVE MATURITIES

IN %
Short-end of the yield curve is widely disconnected to fundamentals: relatively stable inflation (no deflation) and declining unemployment. No value distortion on the long-end of the yield curve. In line with sub-trend nominal growth and excess leverage.

US Housing
Rising rates starting to weigh on housing recovery
US NEW HOME SALES VS MORTGAGE RATES
RISING RATES TO WEIGHT ON HOUSING RECOVERY
US HOUSING STARTS VS MORTGAGE RATES

RISING RATES TO WEIGHT ON HOUSING RECOVERY

US Interest Rate Risk: the great divergence
2/2
Long-term rates close to fair-value, short term rates widely disconnected

FED FUNDS RATE VERSUS TAYLOR RULE
IN %
US Fed Funds disconnected from fundamentals especially when taking QE financed LSAP into account
US 10Y YIELDS VERSUS FAIR-VALUE

LEVEL IN % & TRAILING Z-SCORE
US 10Y close to fair-value

Monetary involvement 101

Quantitative versus qualitative/credit easing
The debt burden is still too large to be only tackled by conventional measures such as austerity and growth policies. Monetary support remains the main workable tooI in the absence of debt restructuring and banking sector recapitalizations. However, Central Banks also need to be consistent with their mandates.
EXPANSION & DETERIORATION OF CENTRAL BANKS BALANCE SHEETS

SIZE & COMPOSITION OF THE FEDS BALANCE SHEET, IN USD BN
Others MBS UST and Fed agency debt QE2 (+600 bn) QE1 (+1400 bn) QE3 (+85 bn MBS & UST per mo) Operation Twist (400 bn)
QE3 Tapering starting Jan. 2014 (-10 bn/mo)
Shaded area: projection of Fed holdings

Divergences in monetary activity to be reversed

Taper debate in the US versus low inflation in the Eurozone
The USD suffered while the EUR benefited from relative monetary policies. The gap should somewhat normalize starting early 2014 as EUR strength is undermining the Eurozone's competitiveness and pressing downward inflation figures.
EURUSD SPOT PRICE VS FED/ECB BALANCE SHEET RATIO

LEVELS

The ECB in a vicious cycle?

Contracting balance sheet leads to stronger EUR and accelerating disinflation
EUROZONE HEADLINE & CORE CONSUMER PRICE INFLATION - IN % ECB RATE VERSUS TAYLOR RULE
IN %
The ECB should be forced to reverse ongoing trends thanks to conventional (rate cut) and/or unorthodox (VLTRO) monetary policy tools EZ Inflation figures are very low when compared to official ECB target rate

Macro conclusions
1.

2.
Stabilisation of fiscal deficits, not too high, not too low

especially in the US and Japan. Growing deficits (unrestrained addition of new debt) would be as counterproductive as rapidly shrinking deficits (public austerity during private deleveraging prevents any economic recovery)
US debt ceiling and budget balance

Remarkable but worrying - politically driven - improvement on the flow side
US TOTAL PUBLIC DEBT & STATUTORY LIMIT
IN USD MN; 53 INCREASE SINCE 1972
US GOVERNMENT SURPLUS/DEFICIT
AS % GDP; 18 GOV. SHUTDOWNS SINCE 1970S
Only 3 defaults in US history (1790, 1934, 1979). Only once because of a debt-limit crisis; the US accidentally defaulted on a small number of bills in 1979.
18 shutdowns since 1970s; Average length 6.5 days; Cost 0.1% GDP per week. - Oct. 31: USD 6 bn in interest on Treasury securities - Nov. 15: USD 29 bn in interest on Treasury securities

Macro conclusions
1.

2.
Stabilisation of fiscal deficits, not too high, not too low

especially in the US and Japan. Growing deficits (unrestrained addition of new debt) would be as counterproductive as rapidly shrinking deficits (public austerity during private deleveraging prevents any economic recovery)
3.
Support the global rebalancing of emerging surpluses and western deficits

Western economies are gaining internal (declining ULC) and external (FX devaluation) competitiveness pushing emerging economies to change their growth model towards more consumption. Productive capacity in the West responding to EM demand should allow world growth to very gradually recover
Looking to go onshore!
Fighting for a larger share of investment thanks to competitive gains
REAL EFFECTIVE EXCHANGE RATE
LOCAL CURRENCY, INDEXED TO Q111 = 100
TOTAL ECONOMY UNIT LABOR COSTS

China; 50%
UK.; 16% Ger.;11% EZ; 8% US.; 4% Port.; -3% Spain; -6% Japan; -7% Ireland; -11%

Looking to go onshore: Is the competitive story working?

TOTAL ECONOMY UNIT LABOR COSTS
FOREIGN DIRECT INVESTMENT NET INFLOWS

AS % GDP

Rebalancing Industrialization between emerging & developed markets

TOTAL FIXED INVESTMENT SHARE
AS % GDP

The Macro View

! Still a long way to normalcy for the world economy but giving the benefit of the doubt to a long and progressive journey to recovery.

Growth: Positive but below trend (adjusting from past excesses). Inflation: Low (little income growth, subdued aggregate demand and still ample supply). Interest Rate Risk: Keep cost of capital under control (Monetary support main workable tool) Fiscal Risk: Further deterioration endangers solvency whilst austerity jeopardizes growth. Competitive Risk: Support global rebalancing of emerging surpluses and western deficits.
Int. Rate Risk US Eurozone Japan Emerging (BRICs) Fiscal Risk Comp. Risk
! Following risks should be monitored to prevent a relapse:

1. 2. 3.
! Macro Risk Barometer:
Eurozone recovery: fragile but encouraging
Interest rate risk: fiscal unsustainability in the periphery

Interest rates have normalized but adverse funding gap remains
10-YEAR GOVERNMENT BOND YIELDS
IN % 18 16 14 12 10 8 6 4 2 0 12/07 05/08 10/08 03/09 08/09 01/10 06/10 11/10 04/11 09/11 02/12 07/12 12/12 05/13 Portugal Italy Spain Ireland France Germany
REAL POTENTIAL GDP GROWTH VS. REAL GVT BOND YIELDS IN %

8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Portugal, Italy, Ireland, Spain real long-term interest rates, GDP-weighted
PIIS real potential output growth, GDP-weighted
Fiscal risk: too much austerity detrimental to the recovery

The pace of fiscal adjustments should be controlled
Even after the efforts of the last few years, many governments still need substantial fiscal swings However, as households are deleveraging, they cannot offset sharp cuts in government spending, creating potentially a negative impact on growth 2012 and 2013 show less fiscal pressure in the EZ than in the US
CHANGES IN GOVERNMENT BUDGET BALANCE

% GDP, ANNUAL DATA 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 US Spain UK Ireland France Italy Germany 2012 2013 2012 & 2013
Japan
-8.9 to -10.3
From Dec. 2011 to Dec. 2013:
-13.3 to -7.5
-10.2 to -5.4
-9.4 to -6.9
-5.3 to -4.0
-7.9 to -13.3 to -7.1 -7.5
-0.8 to -0.2
-4.4 to -6.4

Portugal
Competitiveness risk: looking to go onshore !

REAL EFFECTIVE EXCHANGE RATE
LOCAL CURRENCY, INDEXED TO DEC 09= 100 125 120 115 110 105 100 95 90 85 80 75 12/09 03/10 06/10 09/10 12/10 03/11 06/11 09/11 12/11 03/12 06/12 09/12 12/12 03/13 06/13 09/13 Switzerland UK US Portugal Spain Italy France Germany Ireland Japan China
RELATIVE UNIT LABOR COSTS

LOCAL CURRENCY, INDEXED TO Q409 = 100 135 125 115 105 95 85 75 France Germany Portugal Italy US Ireland Japan Spain UK Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013
China
Fiscal risks in Spain & Italy: stock issues, flow improvements
Spanish private debt is still far too large

Private deleveraging is not over
Private sector debt is slightly down (NOT banks!), but the pace of deleveraging is muted, and debt remains too high. This will keep consumption " and growth " subpar The government has more than offset private deleveraging. Total debt has kept increasing as a result
DEBT BROKEN DOWN BY ECONOMIC AGENTS

% OF GDP 250 200 150 100 66 50 0 101 109 117 93 86 Q2 2010 (HH peak) Q4 2013 (projections) 197 176
Gross government Financial Household sector liabilities corporations debt liabilities
Non-financial corporations liabilities

Source: Oxford Economics (Q4 2013 projections), DataStream, Lombard Odier calculations
Fiscal dilemma
Deficit improving, but keeping this tightening pace would kill the recovery
Fiscal risk remains significant in Spain: the primary budget deficit is large at -4.0%, but if the government tightens too much, that could hinder the nascent recovery The good news is that lots of it is cyclical. On a cyclically adjusted basis, the government runs a primary surplus
GOVERNMENT BUDGET DEFICIT AND PRIMARY BALANCE*

% OF GDP 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 2000 2001 2002 2003 2004 2005 2006 2007 -11.2 2008 2009 2010 -10.6 2012 2013
+0.2 -2.4 -4.0 -6.9
Primary balance, cyclically adjusted Budget deficit, cyclically adjusted Primary balance Budget deficit
*The government primary balance is the government net borrowing or net lending excluding interest payments on government liabilities. Source: OECD, DataStream, Lombard Odier calculations Investment Strategy ! October 2013 !
2011
Italys debt: a public issue

Italys private debt is smaller than that of Spain The issue in Italy is on the public side: with government debt topping 130% of GDP, the country is vulnerable to any rise in rates and the cost of servicing the debt is significant
DEBT BROKEN DOWN BY ECONOMIC AGENTS

% OF GDP, Q4 2013 (PROJECTIONS) 200 180 160 140 120 100 80 60 40 20 0 Gross government Financial liabilities corporations debt Household sector liabilities Non-financial corporations liabilities
Spain
Italy
176
130 117 101 107 86 57 116
Source: Oxford Economics (Q4 2013 projections), DataStream, Lombard Odier calculations
But the primary balance is in surplus

Contrarily to Spain, Italy runs a primary surplus, which helps limiting the growth in public debt But debt servicing alone adds -5.3% to the deficit !
GOVERNMENT BUDGET DEFICIT AND PRIMARY BALANCE*

% OF GDP, DASHED LINES ARE OECD PROJECTIONS 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 -2.3 2.9 Primary balance, cyclically adjusted Primary balance Budget deficit, cyclically adjusted Budget deficit
*The government primary balance is the government net borrowing or net lending excluding interest payments on government liabilities. Source: OECD, DataStream, Lombard Odier calculations
Household saving rate has collapsed

The margin of safety for the consumer is at historical lows
With incomes down, high unemployment, and balance sheets in need of repair, households have been using their savings to keep up consumption " but there is no cushion left The fact that consumption expenditures have started to decline in Q1 2012 is for the moment obsucred by recent government spending
HOUSEHOLD SECTOR NET SAVING RATE

% OF NET DISPOSABLE INCOME 14 12 10 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2011 Spain Italy France
Germany
Source: DG ECFIN AMECO, DataStream, Lombard Odier calculations.
Competitiveness risks in Spain & Italy: diverging trends
Remarkable improvements in Spain, Italy deteriorates

Spains export market share is growing
UNIT LABOR COSTS 2005 = 100
125 120 115 Germany 110 105 100 95 2005 2006 2007 2008 2009 2010 2012 2013 2011 Spain Italy France
EXPORTS AS A % OF GDP
CHANGE SINCE 2009, IN %
16 14 12 10 8 6 4 2 0
14.3 11.7 8.4 6.9 3.9 3.4
Portugal Spain Germany Italy
France
UK
Source: OECD Economic Outlook, Eurostat, DataStream, Lombard Odier calculations
Better competitiveness helps spanish foreign direct investment

Whilst Italy does not attract foreign inflows
Competitiveness improvement in Spain, resp. deterioration in Italy, has led to higher spanish FDI, resp. lower italian FDI Maintaining/growing the ability to attract foreign investment, and gain exports market share is crucial to the recovery, and should be closely monitored
FOREIGN DIRECT INVESTMENT

NET INFLOWS, % OF GDP 7 6 5 4 3 2 1 0 -1 -2 Portugal Spain France UK Germany Italy Q2 2012 Change since 2009
Source: World Bank, DataStream, Lombard Odier calculations
Italys low competitiveness is the countrys achilles heel

But exports hold up for now
ULC VS. CPI-BASED COMPETITIVENESS
OECD COMPETITIVENESS INDICATORS 120 115 110 105 100 95 90 85 80 75 70 Q4 1999 Q4 2001 Q4 2003 Q4 2005 Q4 2007 Q4 2009 Q4 2011 Q4 2013
EXPORTS VS IMPORTS OF GOOD & SERVICES

% OF GDP 32 31 30 29 28 27 26 25 24 23 22
Exports
Italy - ULC Italy - CPI Germany - CPI Germany - ULC
Imports
Source: DataStream, Lombard Odier calculations, OECD
Q4 2000 Q3 2001 Q2 2002 Q1 2003 Q4 2003 Q3 2004 Q2 2005 Q1 2006 Q4 2006 Q3 2007 Q2 2008 Q1 2009 Q4 2009 Q3 2010 Q2 2011 Q1 2012 Q4 2012
The French conundrum: fiscal and interest rate risks are contained but fundamentals are poor and worsening
Debt stabilizing (at high levels)

But current account still deteriorating
TOTAL ECONOMY DEBT
% OF GDP, BREAKDOWN BY SECTOR, FRANCE 600 500 Financial 400 300 200 100 0 Q4 1995 Q4 1997 Q4 1999 Q4 2001 Q4 2003 Q4 2005 Q4 2007 Q4 2009 Q4 2011 Government corporations Households Non-financial corporations 0 -2 -4 -6 -8 -10 1978 1982 1986 1990 1994 1998 2002 2006 2010
BUDGET DEFICIT AND CURRENT ACCOUNT %

OF GDP, FRANCE 4 2
Primary balance Current account Budget deficit
Source: Datastream, Lombard Odier calculation, Oxford economics, OECD (2013 projections)
French yields spread with Germany at odd with current account

Unfair but sustained mispricing
CURRENT ACCOUNT VERSUS BOND YIELDS
FRANCE, ITALY & SPAIN DIFFERENTIAL WITH GERMANY 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2012 Q1 2013 Q1 2011 German MINUS Spain & Italy current account; Q3 2013 = 5.0% Spain & Italy vs. German 10-year yield spread; Q3 2013 = 2.6% French vs.German 10-year yield spread; Q3 2013 = 0.6% German MINUS French current account; Q3 2013 = 8.9% 14%
Source: Datastream, Lombard Odier calculation, OECD
French competitiveness risks prevail
Competitiveness eroded in absolute AND versus peers

UNIT LABOUR COSTS AND PRODUCTIVITY
FRANCE & GERMANY, INDICES 150 145 140 135 130 125 120 115 110 105 100 1991 1994 1997 2000 2003 2006 2009 2012 France productivity Germany ULC Germany productivity France ULC
UNIT LABOUR COSTS IN TOTAL ECONOMY

RECENT EVOLUTION 125 Italy 120 115 110 105 100 95 Q2 2005 Q2 2006 Q2 2007 Q2 2008 Q2 2009 Q2 2010 Q2 2012 Q2 2013 Q2 2011 France OECD total Germany Spain Ireland Greece
Source: INSEE, OECD
De-industrialization AND low industrialization

FRANCE VALUE-ADDED BY SECTOR
% OF TOTAL 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
INDUSTRY SECTOR SHARE

IN TOTAL DOMESTIC ECONOMY VALUE ADDED, % 30 25.8 25 21.9 19.619.3 18.618.5 18.317.8 16.816.216.1 12.8
Services
20 15 10
Agriculture
Industry
5 0 Finland Sweden Spain Italy Belgium Austria Germany Portugal Netherlands
Q1 1980 Q1 1982 Q1 1984 Q1 1986 Q1 1988 Q1 1990 Q1 1992 Q1 1994 Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008 Q1 2010 Q1 2012
Eurozone 17
Source: INSEE, Eurostat (May 2013)
Denmark
France
France is one of the lowest industrialized countries in the world!

VALUE ADDED IN INDUSTRY, INCLUDING ENERGY
AS A PERCENTAGE OF TOTAL VALUE ADDED, OECD 45 40 35 30 25 20 15 10 5 0 LUX FRA GRC ESP GBR USA ISR BEL PRT DNK NLD NZL EA17 ITA AUS JPN ISL OECD CHE SWE TUR AUT FIN EST DEU SVN CAN POL SVK IRL MEX HUN ZAF RUS CZE KOR CHL NOR IDN CHN
Source: OECD
2010 or latest available year
2000
Conclusion
Eurozone recovery fragile but encouraging
! Following risks should be monitored to prevent a relapse:
1. 2. 3.
Interest Rate Risk: Keep the cost of capital under control Fiscal Risk: A subtle fine-tuning in the pace of deficits reduction Competitive Risk: To support reindustrialization, exports and foreign direct investments
! Macro Risk Barometer:

Int. Rate Risk Eurozone Spain Italy France Fiscal Risk Comp. Risk
Impact on asset classes
Pushed further along the return curve

Corporate risk (credit & equities) offers relative appeal
The early stages of QE were very successful in boosting credit & equity markets, owing to the wide implied real return differential between equities, credit, government bonds (TIPS) and cash. Within Equities favour Europe and EM over the US Within Bonds, favour the US and EM$ over EU debt
REAL IMPLIED RETURNS FOR CASH VS BONDS, CREDIT & EQUITIES

IN %
Source: DataStream, Lombard Odier calculations. See list of underlying indices by region in following slides of the document.
Asset Classes Preferences
Market drivers: Multiple expansion

MSCI WORLD : PRICE, EPS & PE RATIO
LEVELS

Europe versus the US

Current levels of PMIs are already supportive of positive EPS growth. Earnings revisions will start to be really positive when PMIs reach 55 (EMU 51.1 in Sept., UK 56.7). The forward looking PMI components (new orders) look encouraging.
MSCI EMU YOY REPORTED EPS GROWTH VERSUS EMU PMI

%YOY 12M LAG & LEVEL

Currencies
Strategically favour fundamentally strong FX (NOK, SEK, CHF); Some EM FX will benefit from the global rebalancing (MYR, CNY, KRW)
Strategically favour the fundamentally strong currencies (low debt levels, current account & public balance surpluses), such as the NOK, the SEK and the CHF. Some EM FX will benefit from the global rebalancing (i.e. the debasement of western currencies for competitive purposes); focus on quality (fiscally sound EM FX).
PROXY FOR FX QUALITY-ADJUSTED YIELDS*

CURRENT ACCOUNT DEFICIT (AS % GDP) & 12M REAL DEPOSIT RATES (IN %)
* Current account balance as a proxy for external assets / liabilities, Real rates as a proxy for the average return on capital. Source: DataStream, Lombard Odier calculations.
Gold
Gold is a hedge against systemic risk; but systemic risk is abating
Gold has a strong correlation with CDS spreads on European peripherals. The narrowing in PIIS (ex-Greece) CDS spreads a sign of lower systemic risk successfully contained by central banks has been followed by much lower gold prices and reducing investment demand for hedging purposes
GOLD PRICES VERSUS GDP WEIGHTED AVERAGE OF 5 YEAR CDS SPREADS FOR PORTUGAL, SPAIN, IRELAND AND ITALY
2100 1900 1700 1500 1300 1100 900 700 01.08 03.08 06.08 09.08 12.08 03.09 06.09 09.09 12.09 03.10 06.10 09.10 12.10 03.12 05.12 08.12 02.13 05.13 08.13 02.14 05.14 08.14 03.11 06.11 09.11 12.11 11.12 11.13 11.14 GDP weighted average of 5y CDS for Portugal, Spain, Ireland and Italy (in bps)-> <- Gold price (in USD oz) July 26, 2012 Draghi speech believe me, it will be enough 500 450 400 350 300 250 200 150 100 50 0

Cross Asset Review

A balanced risk exposure with strong regional preferences
! Balanced positioning in terms of risk exposure with a medium term preference for equity risk over interest rate risk.
Looking to benefit from the important long term implied real return differential between equities, government bonds and cash.
! Within Equities favour Europe over the US, while Emerging markets are stabilising:
European markets could outperform thanks to a pick up in earnings growth following Eurozones exit from recession, especially against US equities which remain expensive and where equity investor sentiment is stretched. Emerging markets could benefit from a valuation discount as world growth is recovering.
! Within Bonds favor US and Emerging debt over core Europe (Germany):

US yields are now relatively attractive compared to its European pears. EM debt cheapest versus High Yield since 2005; price dynamics and flows have stabilised.

LombardOdier 2014 Outlook : A Slow and Fragile Healing Process To Safeguard

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Investment Strategy Group

A slow and fragile healing process to safeguard

Global leading economic indicator firming

GLOBAL LEADING ECONOMIC INDICATOR (PROXY FOR GLOBAL GROWTH)

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Global manufacturing PMI improve

LEADING ECONOMIC INDICATORS - PMI

Note: DM in blue / GEMs in brown; Source: Bloomberg, Lombard Odier calculation

Investment Strategy ! October 2013 !

Global growth imbalanced

NOMINAL GROWTH CONSTITUENTS (INFLATION + REAL GDP GROWTH)

Note: DM in blue / GEMs in brown; Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Recovery set to remain mediocre and imbalanced

US REAL GDP ANNUALIZED GROWTH

Investment Strategy ! October 2013 !

Global imbalances adjusting

EMERGING VERSUS DEVELOPED ECONOMIES CURRENT ACCOUNTS

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Re-balancing global growth

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Keep the cost of capital under control

Please see important information at the end of the document

Investment Strategy ! October 2013 !

US Interest Rate Risk: the great divergence

Long-term rates close to fair-value, short term rates widely disconnected

US YIELD CURVE MATURITIES

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

US HOUSING STARTS VS MORTGAGE RATES

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

US Interest Rate Risk: the great divergence

Long-term rates close to fair-value, short term rates widely disconnected

US 10Y YIELDS VERSUS FAIR-VALUE

US 10Y close to fair-value

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Monetary involvement 101

EXPANSION & DETERIORATION OF CENTRAL BANKS BALANCE SHEETS

QE3 Tapering starting Jan. 2014 (-10 bn/mo)

Shaded area: projection of Fed holdings

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Divergences in monetary activity to be reversed

EURUSD SPOT PRICE VS FED/ECB BALANCE SHEET RATIO

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

The ECB in a vicious cycle?

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Keep the cost of capital under control

Stabilisation of fiscal deficits, not too high, not too low

Please see important information at the end of the document

Investment Strategy ! October 2013 !

US debt ceiling and budget balance

Source: Datastream, Lombard Odier calculation

Investment Strategy ! October 2013 !

Keep the cost of capital under control

Stabilisation of fiscal deficits, not too high, not too low