Markets-in-2011_DB

Deutsche Bank
Corporate & Investment Bank

The Markets in 2011
Foresight with Insight

Deutsche Bank Markets in 2011—Foresight with Insight

Foreword
Challenges and opportunities in 2011

As the world economy slowly recovers from the most
far-reaching dislocation in living memory, the outlook for
markets in 2011 will continue to be uncertain.

Even so, we do expect to see three themes Having long been active in emerging markets,
continuing to drive our clients’ investment we will continue to facilitate capital flows
decisions: between developed and emerging markets for
our clients, and to support the development of
The global economic recovery is set to continue, the local EM markets.
albeit at an uneven pace. Growth in the mature
economies will be anaemic despite central banks In this guide, we have attempted to provide
flooding markets with liquidity. some clarity on the outlook for the year ahead by
bringing together insight and analysis from our
Sovereign debt markets in peripheral Europe will most experienced market experts.
remain under pressure, although we do not think
a default in 2011 is likely. As you determine where to invest and how
to mitigate risk in 2011, we aim to distinguish
The seismic move in the balance of power from ourselves through the breadth and depth of our
West to East will continue, as demographic analysis and our willingness to take a view.
trends ensure that emerging markets continue to
offer superior long-term growth potential. We hope you find this guide valuable.

Anshu Jain
Head of the Corporate & Investment Bank
Member of the Management Board


Markets in 2011—Foresight with Insight Deutsche Bank

Contents

Leaders Markets Risk Management
1.1 Global Economic Outlook 3.1 Regulatory Change 5.1 Equity Hedging
Prospects and worries for 2011 What’s coming up Look beyond the put
1.2 Corporate Multinationals 3.2 Asian Equities 5.2 Credit Risk Management
Strategies in 2011 Signs of euphoria Getting easier
1.3 Emerging Market Capital Flows 3.3 European Equities 5.3 Rate Hedging
Will the wave continue? Price rises ahead Key risks for 2011
1.4 Mergers & Acquisitions 3.4 US Equities 5.4 FX Risk Management
Outlook for the year ahead Strategic case is compelling Going super-sized
1.5 Chinese and Indian Multinationals 3.5 EM Equities 5.5 Longevity Risk
Companies to watch out for Watch out for FX Live long and prosper
1.6 Risk Management 3.6 Foreign Exchange 5.6 Inflation
10 key risks to hedge in 2011 Don’t get complacent No need for panic but
1.7 Capital Raising 3.7 Commodities take precautions
How easy will it be to raise Outlook for 2011 5.7 Commodity Risk Management
money? 3.8 Rates What risks are worth hedging?
1.8 Credit Rising in Q2
The final hoorah 3.9 US Real Estate Financing
Outlook for 2011
Economics 3.10 Asset Backed Securities 6.1 Bond Market Outlook
Investor demand returns Uncertainties need resolving
2.1 The EMU Crisis 3.11 Art 6.2 IPO Market Outlook
Will Portugal and Spain Four artists to watch in 2011 Encouraging trends
follow Ireland? 6.3 Trade Finance in Asia Pacific
2.2 China Trading Embracing the old
Japanese ghosts, and the outlook 6.4 Bank Recapitalisation
for 2011 4.1 High Yield Credit Possible responses
2.3 United States Ten high yield trades for 2011 6.5 Bail-Ins: Pros and Cons
What’s different this time? 4.2 Investment Grade Credit A fast-track option
2.4 Germany Trading ideas for the year 6.6 Infrastructure
Outlook for 2011 4.3 Foreign Exchange Privatisation rises up the agenda
2.5 Emerging Markets Ten FX trades for 2011
Another good year but not for all 4.4 Commodities Investing
2.6 ASEAN and North Asia Ten commodity trades for 2011
Still attached to the G3? 4.5 Rates 7.1 Asset Allocation
Ten rates trades for 2011 A model portfolio for 2011
4.6 Asset Backed securities 7.2 Stock Picking Strategies
Ten ABS trades for 2011 What value analysis tells us
4.7 Carry Trading 7.3 Exchange Traded Funds
Is the FX carry trade dead? On the march
7.4 Hedge Funds: EU Directive
Impact of the new rules
7.5 Managed Accounts
Good news for investors and
hedge fund managers
7.6 Asset and Liability Management
New rules for European insurers
7.7 Portfolio Theory
Binary outcomes, bimodal returns
7.8 Green Investing
Opportunities ahead


1
Leaders
Global Economy
Corporate Multinationals
Emerging Market Flows
Mergers & Acquisitions
Asia on the March
Risk Outlook
Financing
Credit


1.1 David Folkerts-Landau
Leaders Global Head of Research

Outlook for Global Economy 2011
Prospects and worries for 2011

The coming year is likely to prove challenging The world economy is looking for a
recovery in private demand to take
for the world economy and policy makers over the baton from government
spending, which is likely to be cut in
alike. After a strong bounce from the worst many countries now facing record
recession in decades during 2009 and early peace-time budget deficits and looking
to repair public finances battered by
2010, thanks to unprecedented monetary the recession. Interest rates in the
US, Europe and Japan are at record
and fiscal stimulus, 2011 is likely to be slower low levels and are likely to remain so
and more difficult for much of the world, throughout the year as central banks
try to keep economies growing in the
especially developed economies such as the face of this fiscal retrenchment.

US, Japan and the Eurozone. Many emerging We see the world economy growing
economies will continue to perform relatively by a modest 3.9% in 2011, down from
4.7% this year. We think a double-dip
strongly, however, as the shift in global is unlikely and, while we agree with
the US Federal Reserve that deflation
economic power continues apace. But they is a threat, we think this, too, will be
will not be immune to slower growth in the avoided. But much of the world will see
lacklustre growth by historic standards
developed world. next year, and slower than 2010.

We expect the US economy to
expand at a similar modest pace
to 2010 in 2011. We’re anticipating
growth of around 2.5% after the
Fed, disappointed at the lack of
strong growth in the US economy
and stubbornly high unemployment,
in early November 2010 launched a
second round of quantitative easing,
or QE2. We think this was necessary,
particularly because further fiscal
support is unlikely after the mid-term
elections, and it should modestly
boost growth and inflation next year.
But the country’s weak housing
market and continued debt reduction
by households remain major downside
risks to our forecast.

The Eurozone, hampered by the
ongoing sovereign debt crisis,
should only manage to expand by
around 1%, down from 1.5% this
year. Indeed, the bloc’s economy


has already begun to decelerate as very low bond yields. The inflows Figure 1: Widening gap between
the peripheral economies are cutting into emerging markets are tending to EM and G3
spending sharply and raising taxes to depress yields there at a time when Source: IMF G3
EM
try to bring their huge budget deficits many countries’ authorities are looking
10 GDP growth % yoy DB Forecast
back under control. Growth for the for higher interest rates, not lower.
8
area slowed sharply to 0.4% in the China has announced a series of policy
6
third quarter of 2010 from 1% in the tightening measures in the recent past
4
previous three months. designed to prevent inflation in some
2
parts of its economy.
0
We are likely to continue to see a two-
-2
speed Europe with core countries such International discord is a major
-4
as Germany continuing to perform concern for next year. The unity shown
-6
strongly but many of the peripheral by the G20 nations during the worst
economies remaining in recession. of the financial crisis in 2008 and 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

The recent problems surrounding 2009 has, unfortunately, dissipated.
Ireland and, to a lesser extent, Many countries, in particular Germany
Portugal, highlight the vulnerability and Brazil, have been critical of the
of the European economy should Fed’s QE2, arguing that the US is
markets continue to test various intentionally trying to drive down its Figure 2: Global growth
governments’ resolve. In response currency and thus risks igniting a Source: IMF

to the recent volatility, the European global currency war. We think that 6 % yoy DB Forecast
Central Bank has postponed its exit these fears are totally misplaced as the 5
from its emergency liquidity support principal aims of QE2 are to avoid the 4
for the continent’s banking system. very real threat of deflation as well as 3
We do not see it raising interest rates to spur economic growth. 2
from the current 1% level before Q3 1
2011 at the earliest. We also believe that China’s policy 0
on the yuan: of real appreciation via -1
Japan, recently overtaken by China as domestic inflation, while gradually 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
the world’s second largest economy, adjusting the band within which its
we see barely expanding at all in 2011, currency can fluctuate, is the right
after a reasonable showing of over 3% one. This should result in gradual
in 2010. The country remains mired yuan appreciation and allow domestic
in recession and deflation. China and demand to expand and help reduce
India we expect to grow robustly the global imbalances that were
at 8.7% and 8.1% respectively, but partly to blame for the financial
those rates are down slightly because crisis. November’s G20 summit in
neither will be able to entirely shrug off Seoul made little progress on the
the slowdown in Western economies. fundamental issue of economic
imbalances. As the year draws to a
Indeed, in many Asian countries, close, there is a real risk of further
inflation remains more of a concern tension in 2011 if emerging economies
than deflation. The situation has not continue to restrict capital inflows,
been helped by inflows of capital from the dollar continues to weaken or
the developing world as investors if US Congress backs protectionist
seek higher returns in emerging measures against China and
markets (EM) than they are able to others it considers to be ‘currency
get in the US, for example, with its manipulators’.


1.2 Jacques Brand
Leaders Co-Head of Investment Banking
Coverage & Advisory

Edward Chandler
Chariman, Global Corporate Finance

Stephan Leithner
Corporate Multinationals Co-Head of Investment Banking
Strategies in 2011 Coverage & Advisory

2010 has been an extraordinary year: record low interest rates,
massive currency swings and rising stock markets juxtaposed
with faltering western economies, banks failing stress tests,
funds seized by regulators and, of course, several countries in
actual or impending financial crisis prompting social unrest and
associated shifts in political regimes.

Yet corporate multinationals have The fiscal impasse in the United States counterparts and, above all, defending
navigated these unprecedented times is unresolved. While the flexibility their own home markets.
with apparent equanimity, by and and resilience of the US economy is
large delivering on their forecasted undoubtedly without parallel, moves All these factors will continue to have
recovery in earnings. Some have to resume sustained consumer led a profound impact on companies of
capitalised on the crisis by completing growth seem likely to impose stresses all sizes and in virtually all sectors in
mergers or acquisitions. Others have on the international financial system 2011. The key issues that multinational
opted to wait out the storm, tightening which many outside the US will find boards will need to confront are:
their belts wherever possible, investing unpalatable.
in research and development, How to weigh the near-term risks of
strengthening their balance sheets The banking sector will continue to emerging markets against their long-
and adapting their risk management absorb resources. Even as we move term rewards?
procedures to the new environment. towards industry stability, banks It is clear that Asian consumption
All, however, have been alive to the remain under-capitalised and exposed will drive global growth, and that
changing growth patterns in the global to risky assets. Balance sheets will companies which can continue to
economy and to the opportunities – need to be buttressed as institutions strengthen their market positions
and challenges – this presents for their exit the period of state ownership and in China and India, in particular, will
stakeholders. support. Adding to this uncertainty is benefit in terms of the way they are
the daunting amount of new regulation valued by the investment community.
As we look to 2011, the road ahead which is set to place additional But emerging market economic
appears uncertain. The sovereign debt restrictions on lending capacity. growth and capital inflows appear to
crisis is entering a new and potentially be on an unsustainable trajectory. The
more dangerous phase which will test Meanwhile, a new world order is risk of a bubble – coupled with socio-
the limits of international coordination continuing to develop as the fast economic and environmental fragility
as the IMF, ECB, central banks, national growing economies in the eastern and – reminds us that growth cannot be
governments and supranationals seek southern hemispheres spawn major taken for granted.
to tread the narrow line between multinationals of their own, competing
political practicalities and capital for human resources, technologies and
markets reassurance. markets head on with their western


How and when to deploy record How to manage currency and interest
amounts of low yielding cash? rate volatility and the headwinds of
With corporate liquidity nearing regionalised inflation?
levels last seen in 2007, we expect We expect higher currency and
companies to come under increasing interest rate volatility to be a feature
pressure to spend their cash or of markets for the foreseeable future,
return it to shareholders. Emerging causing added volatility in corporate
market M&A present risks: valuations earnings and complicating capital
are expensive and execution more investment decisions. In addition,
complex. We therefore expect EM- ‘managed inflation’ will be one of the
oriented M&A to be balanced by an principal tools used by some of the
increasing number of European and more exposed economies to address
US market transactions, as companies the aftershock of the credit crisis,
seek to enhance their product and with consequences for commodity
service offerings better to tackle the and food prices and, in turn, for
opportunities in third markets. Small the management of pension fund
and medium sized companies will also liabilities. Finally, additional capital
embrace M&A as never before. constraints imposed on banks will
force up the cost of traditional hedging
Will funding be available to support techniques and favour the adoption
external growth? of alternative approaches. All of these
The answer to this question is a factors will force renewed attention on
resounding ‘yes’. At least for the time risk management and hedging policies
being, shareholders would much around the board table.
rather trust corporate management
teams to deploy cash resources than Will shareholder structures change?
making those judgements themselves. We think so, gradually. For example,
And they will express this view via a we detect a noticeable increase
tolerance for longer pay-back periods in focus by the major sovereign
on acquisitions than the traditional two wealth funds on European and US
to three years, as well as a willingness companies (as opposed to financials),
to support M&A with fresh equity if especially those that are the global
circumstances require. As for the debt leaders in their sectors, or have strong
markets, the continued compression exposure to so-called ‘secular growth’
in corporate spreads in recent months sectors such as natural resources,
points to high levels of liquidity and energy efficiency and certain sub-
the availability of extraordinary funding segments of the food and healthcare
opportunities – hybrids, long dated industries. Moreover, the lure of high
issues and low coupon convertibles valuations on IPOs in Asia and Brazil
to mention a few. The predominant will encourage many companies
theme, however, will continue to be to monetise parts of their business
‘bonds rather than banks’. portfolios in those regions.


1.3 Marc Balston
Leaders Head of EM Quantitative Research

Robert Burgess
EMEA Chief Economist, Research

Emerging Market Flows: Will the Wave Continue?
Is a bubble coming? How will central banks stop one?

Private capital flows into emerging market (EM)
economies have rebounded strongly over the past
year. Continued strong inflows will stretch the
ability of EM economies to productively absorb
them. In this environment, there is a risk that
asset price bubbles will start to form.

While foreign direct investment (FDI) 2010, with over $50 billion of flows
remained relatively stable through the over the last quarter alone (figure 2).
crisis, bank lending and investments in
bond and equity markets were much The direction of investment has
more volatile. These shorter-term also shifted, away from EMEA and
flows recovered to an estimated $450 towards Asia and Latin America.
billion in 2010, still some way off their Led by a sharp reduction in bank
extraordinary pre-crisis peak of almost credit lines, shorter-term investments
$800 billion but well up from their into Hungary, Romania, Russia,
crisis-low of less than $100 billion in and Ukraine are expected to reach
2008 (figure 1). barely 20% of their peak 2007 levels
in 2010 (figure 3). Flows into Brazil,
Bank lending accounted for much of Chile, China, Indonesia, and Thailand,
the run up in inflows during the last however, look set to rebound above or
wave of inflows into EMs, but has close to their recent peaks.
been largely absent during the past
year as major financial institutions Will capital continue to flow into
in advanced economies continue to emerging markets in 2011?
rebuild their balance sheets. Instead, The flows are motivated by a variety of
the current wave of inflows is more factors, many of which are long term
concentrated on debt and equity in nature and should continue to drive
markets. Inflows into EM equity and inflows well into 2011. Fundamentals
debt funds have been running at are supportive: EM economies are
record levels in the second half of likely to enjoy a sustained growth


premium over developed markets, sustainable inflows into new markets markets (as opposed to foreign
while also exhibiting a lower level of that ended abruptly and painfully are currency lending) will make for less
indebtedness compared to mature well known, from the Latin American painful and disruptive burden sharing.
markets. International investors debt crisis of the 1980s through to Central banks also have much larger
remain underweight exposure to the Asian crises of the late 1990s. cushions of foreign exchange reserves
EM, certainly in comparison to their Most recently, we saw credit booms on which to draw.
share of global GDP (33%) and also in central and eastern Europe turn to
relative to their share of world stock bust as the foreign bank lending that Nevertheless, there is inevitably a
market capitalisation (also 33%) and fuelled them dried up. risk that the volume of inflows will
their share of world government debt start to stretch the ability of emerging
outstanding (16%). Anecdotal evidence Will it be different this time? economies to productively absorb
indicates that many major developed Much of the emerging world is a them. In this environment, the risk
market institutional investors hold fundamentally less risky place for that inflation accelerates and asset
less than 5% in EM equities and less investors than it was 10–15 years ago. price bubbles form is substantial. Early
than 2% in EM debt. And if these Public and private sector balance warning signs are already appearing
factors were not sufficient, the sheets are less leveraged than before among countries that have received
current exceptionally easy monetary and indeed much less leveraged than the largest capital inflows. Inflation
conditions in the US, Europe, and their mature market counterparts. has started to drift upwards in Brazil,
Japan are a further motivation to move Financial sectors are more developed Turkey, and parts of Asia. And policy
capital from advanced to EMs. and better able to intermediate flows. makers in Hong Kong, China, and
And, should things go wrong, the Israel, have taken steps to curb rapid
We have, of course, been here many relatively high share of investments growth in local property markets.
times before. Episodes of seemingly into equity and local currency debt

Figure 1: Figure 2:
Private (non-FDI) capital flows to emerging markets by year ($ billion) Cumulative inflows to emerging
Source: IIF Portfolio and other
Bank credit
markets mutual funds since the
start of 2008 ($ billion)
EM Equity funds (lhs)
800 $ billion EM Debt funds (rhs)
Source: EPFR
700

600 100 $ billion 40

500
75 30
400

300 50 20

200
25 10
100

0 0 0

-100
-25 -10
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

-50 -20

Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11

Figure 3:
Private (non-FDI) capital flows to EM by country ($ billion)
Source: IIF 2007
2010F

160 $ billion

140

120

100

80

60

40

20

0
Korea

India

China

Indonesia

Phillipines

Malaysia

Thailand

Russia

Polan

Turkey

Romania

Sth Africa

Ukraine

Hungary

Brazil

Mexico

Argentina

Venezuela

Peru

Chhile

Colombia

Asia EMEA Lat Am


1.3
Leaders

What are the policy options for taming In practice, countries have adopted a big rise in the value of the real
these extremes? different combinations of these and large interest rate differentials
Given this, a key question is how approaches depending on their which push up the costs of sterilised
central banks in EMs will respond particular circumstances. Central intervention, has twice raised its tax
to continued flows. Their first banks in Latin America, emerging on foreign bond inflows.
option is simply to allow currencies Europe, and Africa, for example, have
to appreciate. However, with past typically been more comfortable Where does this leave investors?
crises still fresh in their minds, EM with currency flexibility whereas The anticipated continued asset-
policymakers are acutely aware that those in Asia have intervened more allocation shift towards higher weights
the loss of competitiveness associated aggressively in the foreign exchange for EM in global portfolios is likely
with even transitory currency strength markets (figure 4). In Latin America, to underpin the performance of EM
can take time to recoup. an increase in reserves equivalent to assets for the coming year. While
about 6% of GDP between January ongoing measures to stem inflows
A second option is to limit appreciation 2006 and August 2008 coincided with will likely reduce the attractiveness of
by intervening. However, the resulting a 25% real exchange rate appreciation, some specific investments – notably
accumulation of foreign reserves can whereas in Asia, much larger reserve domestic fixed income in countries
exacerbate overheating in already accumulation of 20% of GDP helped willing to impose controls, such as
fast-growing economies, causing to limit real exchange rate appreciation Brazil and Taiwan – they are unlikely
credit growth, inflation, and possible to 7%. to change the overall attractiveness of
asset price bubbles. Sterilising the the asset class.
intervention can help to prevent More recently, we have seen central
money and credit growth. But by banks step up their foreign exchange The extent of the inflows does raise
keeping interest differentials high, it purchases in Colombia, Israel, Peru, the risk of inflation and asset bubbles
also encourages even further inflows. South Africa, and Turkey. Others have within EM which argues for a bias
implemented more direct controls on towards real assets. The extent of
Another option is to try to stem inflows, though these vary widely in the flows also presents a real risk in
inflows directly via capital controls or nature. Indonesia, for example, has that if it were to reverse it could be
other forms of prudential limits. Their introduced minimum holding periods destabilising. However, we fail to see
aim is to curb flows of so-called ‘hot for some forms of debt. Thailand has any catalyst for such a reversal and
money’ while prioritising the ‘stickier’ imposed a withholding tax on returns are confident that this is a risk which
categories of overseas capital, such as on bond holdings, a measure also is unlikely to materialise before 2012 at
foreign direct investment. being considered by South Korea. the earliest.
Meanwhile Brazil, concerned about

Figure 4: Diﬀerent approaches to dealing with capital ﬂows
Figure 4: Different approaches to dealing with capital flows
Four data points for each region shows: Latin America
Source: INF
(i) Jan 06; (ii) crisis peak in REER and reserves; Latin America
EMEA
(iii) post crisis trougheach region shows: and
Four data points for REER and reserves; EMEA
Asia
(iv)Jan 06;observation
(i) latest (ii) crisis peak in REER and reserves; Asia
Asia (ex China)
(iii) post crisis trough REER and reserves; and Asia (ex China)
(iv) latest observation
Source: Deutsche Bank

135 Reserves (% 2006-08)

130 (iv)

(ii)
125

120

115

110

105 (iii)

(i)
100

95

90

85 REER (2005=100)

0.0 10.0 20.0 30.0 40.0 50.0 60.0


1.4 Henrik Aslaksen
Leaders Global Head of Mergers and
Acquisitions

Outlook for Mergers & Acquisitions in 2011
Cheap debt and strong cash levels will turn corporates to M&A

Underneath the overhang of fiscal deficits,
currency swings and sluggish macroeconomic
growth, the ground appears fertile for merger
and acquisition (M&A) activity.

With access to cheap debt and high As we look to 2011, what remains the after tax cost of debt). The latest
levels of corporate cash levels1, as the most telling indicator during 12-month P/E of the S&P 500 is about
boardrooms are faced with a choice: the upturn is where the pools of 14.7x, which gives the index a value of
return capital to shareholders or capital are. The most robust capital 27, about the highest it has ever been.
fund growth. markets are found in highly developed By comparison, during the peak of the
countries– like the United States up cycle in 2007, the index stood at
For corporates struggling with and western Europe. These markets circa 13.
anaemic growth in their home also play host to some of the world’s
markets, the choice will be easier to largest companies with the strongest Underpinning this is an arbitrage
make. Expect deal making to continue appetites for growth. Since capital is opportunity: low interest rates have
steadily increasing in 2011 as a result. mobile, it is fair to assume the deal significantly reduced the costs of
flow will follow the money. funding a transaction using debt
Pools of capital providing an alternative source for
Previous upswings in deal activity We recently developed an ‘affordability corporates to fund growth.
focused on particular sectors or deal index’, which tracks the gap between
structures – the technology boom in the implied P/E multiple of single A Disciplined approach to deal making
the late 1990s/2000 and leverage in rated debt and the P/E multiples of In the early stage of this recovery,
2007 – but the upturn in this deal cycle broad market indices such as the S&P companies kept an inward focus
is spread quite broadly across various 500 and Euro Stoxx 50. The greater by streamlining assets and pruning
sectors and transaction types. the index value, the more ‘affordable’ it portfolios. As M&A activity
is for a company that can raise single continued, we saw the market for
At the turn of this past year, some A rated debt to fund the acquisition of leveraged buyouts trickle back,
predicted certain sectors such as a target trading at levels comparable especially in the US.
financial institutions and oil and gas to that of the broader market.
as the hotbeds for M&A activity. In With greater stabilisation in the capital
retrospect, the market hardly followed To illustrate, the composite yield on markets and corporate cash piles
this trend. The top 20 deals of the year 10-year single A rated corporate debt increasing, the boardroom mood
span almost every sector and included in the US is currently approximately appears to have shifted from reactive
corporate reorganisations, strategic 4%. For an acquirer whose marginal to proactive.
deals, asset disposals and emerging tax rate is 40%, the implied P/E of new
market activity2. debt is therefore 41.7x (the inverse of Since funding growth is cheap, boards
have a strong argument to pursue


deals as long as they are disciplined these countries in the near-term. Lack Deal volume in the near-term will
on price. This strategy is likely to drive of developed capital markets outside likely follow a similar pattern of
medium-sized transactions in the China and little knowledge of how to growth relative to their respective
range of $1–5 billon, large enough to navigate new regulatory schemes, like regions, however the majority of
provide meaningful synergies and/or Brazil’s, will continue to make deal activity will continue to come from
growth in emerging markets. making challenging, though developed economies. Regardless
not impossible. of where the deals are, the upswing
When BHP’s $43 billion offer for looks set to continue.
Potash Corporation was rebuffed by Until these channels are better
regulators, we were reminded that developed, the BRIC deals that 1. Cash/market capitalisation ratios for S&P of
11.6% as of Q3 2010, and 12.2% for Euro Stoxx
stakeholders will play a role in deal- crop up will be sporadic. For this
2010E; Source: Compustat and Deutsche Bank
making that is equal to or greater than reason, the ‘bread and butter’ deals estimates
that of shareholders. should continue to originate from 2. Source: Thomson Reuters
the developed economies, where 3. Source: Deutsche Bank Economic Research

This stakeholder influence is a factor gross domestic products are
that will continue to be a characteristic growing at stable rates and capital
of deal activity. is readily available.

BRICs Towards stable growth
Every corner of the market has focused Economic growth is undeniable in
on how to invest in the BRIC countries emerging markets. Real GDP forecast
of Brazil, Russia, India and China. for 2011, for example, is estimated to
be 7.4% for Asia (excluding Japan),
Though these markets present long- and 4.5% for both Brazil and Russia3.
term growth potential, we believe Real GDP for G7 economies is
challenges remain for deal activity in projected to grow 2.2% in 2011.


1.5 Colin Fan
Leaders Head of Global Credit Trading and
Emerging Markets

The Rise and Rise of Chinese and Indian Multinationals
What companies to watch out for

It tells you a lot about the strength of China’s domestic
economy that Industrial and Commercial Bank of
China (ICBC) is the world’s largest bank by market
capitalisation despite barely having started to venture
offshore. It’s not alone: all of China’s top lenders, despite
having done little more than build a few branches
overseas, rank among the world leaders by market
value. When companies that are so powerful at home
decide it is time to expand overseas in earnest, there are
almost no limits to how big they could become.

At multinationals across the region, purchases, like China Petrochemical current acquisition boom and
that’s exactly what is starting Corp’s $8.83 billion purchase of Addax Japan’s in the 1980s is that Chinese
to happen. Chinese and Indian Petrolum in 2009. Indian companies companies are state-owned and make
companies, having built vast customer have also been active: Bharti acquisitions for geopolitical reasons
bases and balance sheets at home, are Airtel’s $9 billion purchase of Zain’s as well as for profit.
increasingly seeking to acquire and telecommunication assets in Africa
expand overseas. Everything is in their this year showing the scale of this new There are, though, challenges for
favour. They have cash at a time when found ambition. Indian companies in going overseas.
potential targets elsewhere in the world International capital flows into India can
are cheap, they are buoyed by fast Many Indian companies deleveraged slow very quickly if market sentiment
expanding domestic economies and during the expansion in the Indian turns, and domestic liquidity, though
they now have the confidence to grow. equity markets and now have ready plentiful, comes with a caveat: debt
access to debt finance. Chinese raised onshore can’t be used for
There were more than 100 merger companies, meanwhile, are in many acquisitions, just for working capital.
and acquisition transactions with cases even more cash-rich and enjoy
Chinese acquirers each year from almost unfettered access to capital Availability of domestic capital is not a
2007 to 2009, compared to less than from banks as well as debt and equity problem in China. League tables of top
30 in each of the first four years of markets on and offshore. equity and debt bookrunners in Asia
the decade1. Meanwhile, the value are packed with home grown Chinese
of foreign acquisitions by Chinese Chinese and Indian businesses have names, but Chinese companies
companies increased more than various reasons for buying offshore, seeking to acquire overseas attract
30 times between 2003 and 2008. chiefly market access, technology a great deal of suspicion from their
Chinese companies have also begun and resources they lack at home. targets’ governments and electorates,
to make jumbo cross-border The big difference between China’s because the bidding companies are


usually state-owned. There are well to be enormously important. A series We may see greater activity from
known examples of this, such as of liberalisations over the last year have Chinese banks, who despite
CNOOC’s failed bid for Unocal, and it set up Hong Kong as a proving ground accounting for 26% of all Chinese
is unlikely to get any easier. for RMB liberalisation in a host of M&A over the last 10 years2, have so
areas from trade finance to investment far only taken tentative steps towards
Private sector Chinese companies products, foreign exchange and local international expansion, such as
face less interference. Look at Ping currency bonds. All of these will, in time, ICBC’s purchase of 20% of South
An Insurance’s acquisition of assets help to open up the onshore market Africa’s Standard Bank. The most
from Fortis or Huawei Technologies’ to foreign players, and in turn give active acquirers will be firms that
purchase of parts of IBM. domestic champions more flexibility to import and export rather than firms in
use their profits should they choose to sectors such as property and retailing
But no matter how genuinely go overseas. where domestic growth should be
commercial a company’s aspirations, sufficient for years to come.
the spectre of state ownership causes Outlook for 2011
problems in other countries (although Expect to see further expansion There are a host of companies to
not, notably, in Africa, where many by Asian multinationals in 2011. watch: Chalco, which may buy bauxite
of the energy acquisitions have taken Companies in India will focus on mines for alumina refining; Jiangxi
place). In Europe and the Americas, natural resources. Coal India, which Copper, seeking foreign mines; China
however, Chinese companies should recently completed the largest IPO Mobile, which is targeting developing
continue to expect interference with in Indian history, has $8.4 billion on market telecommunications operators;
their bids. its balance sheet and is looking for port operators China Merchants
acquisitions in Indonesia, South Africa, and Cosco Pacific, again targeting
In India, where buyers are more Australia and the US. Oil and gas emerging markets; internet-related
frequently pure private sector rather assets are also likely to be in demand groups like Tencent and Alibaba, rail
than state-owned, politics is less of a among Indian companies, although equipment companies such as CSR,
problem. Names like Tata, whose most areas of previous activity – telecoms, coal companies seeking coking coal
recent acquisitions include Jaguar financial services, pharmaceuticals, exposure and buyers from other
Land Rover and Corus, or Reliance automotive – may be quieter. sectors including healthcare, steel and
Industries, which has been buying utilities.
shale assets in North America, are For Chinese companies, resources
considered credible partners who will also be a key target, but China Whatever happens, prepare for
bring expertise to the table without the is also keen to secure infrastructure expansion both next year and for a
agenda of a state mandate. assets in order to participate in the long while to come.
real economy of foreign countries.
FX is an issue in both countries. It’s less Despite potential political opposition 1 & 2. Source: Thomson Reuters
of a problem in India, where the rupee is to such bids, China is unlikely to
relatively liberalised, but the FX regime privatise state-owned companies to
still creates challenges such as the facilitate foreign acquisitions. Instead,
ability of Indian companies to provide it will wait to see if the European crisis
corporate guarantees. It’s much more of develops to make Chinese capital
an issue in China, but here the gradual more attractive.
internationalisation of the RMB is going


1.6 Ram Nayak
Leaders Global Head of Structuring

10 Key Risks of 2011
What to hedge against and how

The range of risks faced by borrowers and
investors in 2011 is perhaps greater than at any
time since World War 2: an economic slowdown,
sovereign defaults, inflation, rate hikes it is
a formidable list.

The good news is that nearly all Against this difficult background, the
these risks can be hedged thanks to best approach will be to identify and
the growth and development of the prioritise the risks that really matter,
global derivatives market over the past and then to examine the different
decade. options available. A top-down view
on risk will also be helpful not only
The bad news is that it is likely to be to reduce correlation risk but to find
expensive – using plain vanilla options ways to bring hedging costs down by
at least – because of huge uncertainty linking risks together.
among dealers about where the
markets are heading. With this in mind, here are the ten
risks that I believe cannot be ignored
Some companies will take the view this year (not in order of severity or
that the cost of hedging outweighs probability) and some suggestions on
the benefit. We believe this would be which to hedge and how.
unwise given the scale of the potential
downside.

Others will prefer not to take any
risk at all until the outlook becomes
clearer. This, too, is a strategy we
would not recommend given the
seismic changes underway in the
global economy.


1. Eurozone Sovereign Default 4. Commodity Price Rises 8. Longevity
I do not believe that a major Eurozone Commodity prices are expected An absolute must for insurance
sovereign will default in 2011 but if by Deutsche Bank Research to rise companies and pension funds with
one does, the results would be so significantly during the first half of policy holders living longer than ever.
catastrophic that it does seem a risk 2011 as supply remains constrained The old approach was to buy long-
worth hedging. Buying CDS protection and investors and consumers demand dated bonds but longevity swaps offer
on a euro sovereign index may for commodity price participation greater precision and are much more
cost you 400 basis points or more. increases. Risk management liquid than they used to be.
Alternatives are to go short the euro strategies include extendible forwards,
or wideners on the EUR/$ cross options and hybrids. 9. Regulatory Change
currency basis. We may not know the details yet but
5. Rate Hikes it looks certain that within the next 18
2. Capital Markets Freeze Deutsche Bank Research expects months, many users of derivatives will
Twice in 2010, we saw the bond rates to start rising in the US in Q2 and have to clear their trades via a central
markets close down to most forms for the European Central Bank to begin exchange rather than on an OTC basis.
of new debt issuance. The issue – tightening earlier than expected. For We strongly advise all companies
Eurozone sovereign risk – is still live. investors, front end payers would be a to get their back offices up to speed
Solutions include front loading your good solution for both. ahead of time and do a full evaluation
issuance calendar, private placements on how the changes will impact
and loans secured by equity stakes. In 6. US Dollar Weakness profitability and infrastructure.
the event of an equity capital markets Deutsche Bank FX Research’s view is
shutdown, OTC structured alternatives that the US dollar may surprise on the 10. Borrowing Cost Rises
are available. Another related risk upside this year. But for companies With banks cutting back for Basel
is the emergence of a backlog in with extensive US assets, the risk may 3 and bond investors focusing on
IPOs. Remedies for this include be too great to leave unhedged. Going emerging markets or safe havens, a
pre-IPO macro hedging and pre-IPO short the dollar via a forward is the rise in funding costs cannot be ruled
convertibles. obvious choice but comes with a stiff out for many firms. Asset backed
opportunity cost price tag. Purchased finance and loans linked to proprietary
3. EM Equity Bubble options could offer better value. trading indices can bring costs down
If Asian central banks fail to control to manageable proportions.
inflation or take too aggressive 7. Inflation
action against it (thereby provoking Not an immediate risk for US and
a slowdown), we may start to see European investors but one with
the flow of funds from the US and the potential to cause havoc in the
Europe into Asia slow significantly medium-term given rising inflation in
and perhaps start to flow the other Asia and the long-term effects of QE.
way. We would look to go short Asian We recommend getting in early while
currencies. Investors can protect hedging levels remain attractive via
themselves against both using equity collars, swaps, inflation linked bonds
put options (expensive) or put options and swaps.
linked to volatility (cheaper).


1.7 Ivor Dunbar
Leaders Global Head of Capital Markets

Financing Outlook
How easy will it be to raise money in 2011?

2011 should provide among the most favourable
financing conditions for companies in years,
despite headwinds buffeting the global economy
and the volatility disrupting capital markets.

The outlook is highly attractive for opportunities for infrequent or
companies looking to lock in low debut borrowers.
rates for their bonds. There is a wall
of cash looking for exciting equity We saw large numbers of debut issues
stories, and the market has shown it in Europe in 2010 and this trend will
will be supportive of well-considered, continue as European companies learn
strategic mergers & acquisitions. to master the post-crisis environment
by reducing their reliance on bank
For companies seeking to tap bond lending as a preferred method of
markets, borrowing rates are at an financing. With banks continuing to
all-time low and should remain so as deleverage in the wake of tough new
cash-rich credit investors hunt capital requirements such as Basel 3,
for yield. this theme of disintermediation should
continue, with more companies going
2010 saw a glut of sovereign straight to the capital markets for their
issuance, but 2011 should provide an financing needs.
opportunity for corporate borrowers,
particularly those that tapped the At the same time, the crisis and the
markets in 2009 when rates were ensuing regulatory climate has sparked
high, to take advantage of the low-rate innovation in financing, with banks
environment, and push back the wall seeking to issue contingent capital – an
of debt maturing in 2012 to lock in instrument that is at once a relatively
new funding at attractive rates. cheap form of financing and also a
capital buffer. However, before they
It is not just big names that are become a mainstream funding method
attracting investor attention. Record for banks in 2011, there remains a
low interest rates of close to zero are question mark over the regulatory
forcing investors to hunt lower down status of tier one capital.
the ratings chain for yield, providing


Equity investors are proving they to credit research and assessment. However, they should not prevent
are ready to support initial public Recent events indicate that large cap company boards from executing
offerings. In 2010, there was a companies have generally done better strategic plans for which funding is
scramble for growth stories such in IPOs than smaller, lesser known available. The ability with which BHP
as the $20.5 billion flotation of AIA, companies. The difference between a Billiton was able to raise $45 billion
the Asian operation of AIG, which successful equity or bond issue and a for its ultimately unsuccessful bid for
was the third biggest IPO in history failure will lie in whether the company Potash proved there was life in the
by volume and which was multiple has a strong story to tell and can syndicated loans market, and well-
times over-subscribed. In the US, communicate it to investors. run companies with strong balance
investors showed a similar hunger sheets should find that markets
for GM, whose $18.1 billion IPO was The challenges of 2010 should will be supportive of M&A deals of
also heavily oversubscribed. Since continue into 2011 and beyond. strategic importance. With growth in
September, the majority of IPOs in the The shape of the global economic emerging markets outstripping that
US have priced above or within the recovery remains uncertain, while in developed western economies, we
filing range and outperformed in we expect volatility to continue to expect companies to look increasingly
the aftermarket. be a feature of the capital markets towards financing M&A deals to gain
as investors maintain a hawkish an edge.
However, the apparent ‘perfect stance on sovereign and credit risk.
storm’ of pent-up investor demand Crises such as those experienced The losers in 2011 will likely be those
and borrowers’ increasing use of the by Greece and Ireland in 2010 are unable to come firing out of the blocks
capital markets for their financing disruptive influences on markets that because their balance sheets are still
needs is tempered by a more can temporarily prevent companies being repaired. But for the winners,
discerning investor base taking a more accessing the capital markets. 2011 should be a year when they can
diligent and sophisticated approach put rivals to the sword.


1.8 Jim Reid
Leaders Chief Credit Strategist, Research

Is 2011 the Last Year of the Credit Cycle?
The final hoorah

One of our main secular views is that post the
financial crisis, the world will return to the shorter
length of business/credit cycles that prevailed
through history before the 25-year ‘golden
age’ that came to an end with the 2007 great
recession. If we are correct, then 2011 could see
us entering the last full year of expansion, albeit
a year of expansion where there are plenty of
potential flash points given the legacy of the debt
super-cycle that the developed world has endured
since the early 1980s.

The more optimistic analyst might complacency as investors and policy
conclude that while the developed makers extrapolated out the extremely
world has problems, globalisation benign pre-crisis economic conditions
and once in a generation levels of as far as the eye could see. The lack
emerging market (EM) growth could of inflation also allowed policy makers
allow smoother and longer business to ‘fix’ every problem during this
cycles to prevail over the next few period, thus preventing the creative
years. However we feel there is an destruction process that arguably
argument that globalisation has allows a reasonably efficient allocation
destabilised the economic system of resources. This also allowed a
for the developed world. The secular tolerance of debt from investors,
30-year reduction in inflation and consumers and policymakers alike,
the ‘great moderation’ that have had that would have been unthinkable a
their roots in globalisation, reduced decade or two earlier.
the number and severity of business
cycles in the developed world during The debt-burdened developed world
the ‘golden age’. This arguably led to will now likely have periodic funding


issues for the foreseeable future as in December 2007, then statistically
it looks to fund a colossal amount of – if we are correct – the start of the
private and public debt. With interest next US recession could be between
rates now constrained by the zero August 2011 (median) and August
bound and high historical levels of 2012 (average).
public debt, the hands of governments
are collectively tied, leaving policy This means that, again if we are
makers with much less flexibility than correct, we could be entering the last
they have had for at least 30 years. few quarters of the credit/business
This means that recessions are likely cycle. We can’t know what will cause
to happen more naturally over the next it to end but we suspect that policy
few years and given the complete lack makers will be more powerless to
of policy flexibility they may occur prevent it than they have been for
with a higher frequency than the long- several decades. The dilemma for
term average. investors is that while the business
cycle is ongoing, then all risk assets
Figure 1 shows that the last three (including credit) will likely perform
complete US economic expansions fairly well. However be warned that
were three of the five longest in the we are nearer to the end of the cycle
33 we’ve experienced since 1854, than the beginning and 2011 may be
likely due to the complete flexibility the final hoorah.
the authorities had to manage the
business cycle.

The average length of the completed
cycle (expansion and recession) over
the entire period is 4.7 years, with
the median length being 3.7 years.
Given that the last recession started

Figure 1: US economic expansion lengths (months) since 1854
Source: Deutsche Bank, NBER

120

100
Average Median

80
months

60

40

20

0
Dec 1854

Jun 1861

Dec 1870

May 1885

May 1891

Jun 1897

Aug 1904

Jan 1912

Mar 1919

Jul 1924

Mar 1933

Oct 1945

May 1954

Feb 1961

Mar 1975

Nov 1982

Nov 2001


2
Economics
EMU Crisis
China
United States
Germany
Emerging Markets
ASEAN


2.1 Gilles Moec
Economics Co-Head European
Economics Research

Mark Wall
Co-Head European
Economics Research

The EMU Crisis
Will Portugal and Spain follow Ireland?

A key question for the Eurozone as the new ‘permanent crisis mechanism’ to August peak, is still at around EUR40
end of a turbulent year approaches replace the EFSF when it expires in billion – or 7.1% of total bank assets, a
is whether Portugal, and even Spain, 2013, spooked investors, especially similar level to Ireland’s 7.6%.
will be forced to follow Greece and when German Chancellor Angela
Ireland into seeking a rescue package Merkel said bond holders would have Meanwhile, Portugal’s government
from the European Union and IMF. to share any losses in a sovereign has failed to make sufficient progress
And a longer-term question for all default. That, unsurprisingly, led to on spending cuts. In 2010, its budget
four countries is whether they will be a sell-off in the bonds of peripheral deficit actually increased. It also has
able to reduce their budget deficits economies and pushed government a persistently high current account
sufficiently to return their public borrowing costs up to record highs – deficit of around 10% of GDP,
finances to a sustainable position, with in turn, threatening the ability of those indicative of a deeply entrenched lack
or without external help, or will they countries to service their enormous of competitiveness.
end up with no choice other than a debts.
debt default? The government has to refinance
Will Portugal follow? EUR10 billion of debt in the first three
Why did the Irish crisis happen? At the time of writing, these two months of 2011, while banks will
In asking what may happen to external factors are still valid, so it is have EUR5 billion to roll over, so it is
Portugal and Spain, it is instructive not surprising that Portugal is coming probably rational for the Portuguese
to consider the fate that befell under marked pressure. Is Portugal government to call for rescue sooner
Ireland. During 2010, Ireland’s budget Ireland? Well, the liquidity position rather than later. This is especially the
deficit continued to widen despite of Portuguese banks is very fragile. case as the negotiation process with
unprecedented austerity measures. ECB lending to the country’s banking the IMF/EU could be long because,
At the same time, over-indebted system, although down from its
banks were unable to shake off the
impact of the ongoing property slump,
forcing the government, which had
agreed to underwrite the country’s
entire banking system, to dramatically
increase its support to the point of
jeopardising its own finances.

November’s crisis, however, was due
to external developments. First, the
European Central Bank made it clear
it wished to begin withdrawing the
extraordinary support to banks that it
had given at the height of the financial
crisis, since the European Financial
Stability Fund – the support system
set up in the wake of the Greek crisis
in May – was now in place. Ireland’s
broken banks were heavily dependent
on ECB funding and so the entire
banking system came under strain.

Second, the initiatives by Germany
and France in October to create a


unlike Ireland, Portugal’s economy Portugal, the ECB knows that Spain is What about Portugal?
requires extensive structural reform so much bigger that it would represent As regards a future debt restructuring
to boost its competitiveness. The a systemic risk for the euro. mechanism, nothing is yet certain
government is also a minority one, although reports indicate that a
meaning the opposition will have to Will debt restructuring be necessary? permanent crisis mechanism would
be involved in negotiations to change Many investors argue that debt include changes in sovereign bonds
things such as the country’s pension restructuring (e.g. via maturity issued after 2013 to include ‘collective
or welfare systems. lengthening or ‘haircuts’) is action clauses’, extensions in the
unavoidable for some euro member duration of debt and ‘haircuts’ as
Is Spain at risk? countries, especially Greece. The a last resort. This could, of course,
Market concern that Spain will need argument goes that even the three raise risk premiums on the bonds
to be bailed out has been a consistent years the rescue package buys the and so raise the cost of finance
feature of the markets for nearly country to reform its finances and to governments, but that would
a year. Fortunately, the country’s enable it to get in a position to service depend on the existence of other
fiscal and economic developments its debts on the open market will support arrangements too, such as
have gone in the right direction, simply not be enough. the continuation of an EFSF-type
making the country fundamentally mechanism.
different from Ireland and Portugal. Greece’s public debt-to-GDP ratio
The budget deficit is falling, as is the could reach 170% by 2013 if growth
current account deficit, and banks is only slightly weaker than the IMF
are enjoying easy access to money currently expects. This would make it
markets for funding, making them very difficult, although not impossible,
less dependent on ECB lending (which to service that debt on the open
only accounted for 1.9% of total bank markets from 2013. We continue to
assets in October 2010). believe, however, that given enough
time and external support, a unilateral
We think that the cuts made thus far restructuring of sovereign Greek debt
and the budget for 2011 are enough to can be avoided.
get Spanish public finances back on a
sounder footing. This being the case, We think Ireland should be able to
we don’t think Spain should engage in return to market financing of its
further austerity for fear of damaging deficit by 2013, even including the
growth and thus worry markets about enormous cost of bailing out its banks.
the speed of the country’s private Spain and Portugal may yet have
sector debt adjustment. But we believe to recapitalise their banks if market
the country does need to speed up the pressure persists. In this regard, Spain
restructuring and recapitalisation of looks safer than Portugal. Public debt
its banking sector to address market there should reach only 73% of GDP
concerns on this point. by 2013, thanks to a very low initial
level (53%). This gives it a margin to
Even if markets do continue to pay for recapitalisation, especially as
push Spanish interest rates up, we its recapitalisation vehicle (the ‘FROB’)
think the ECB could provide a crucial can issue up to EUR90 billion, or 9%
circuit-breaker by providing lots of of GDP.
liquidity to Spain’s banks. Although
it has proved unwilling to provide
meaningful support to Ireland or


2.2 Brad Jones
Economics Asia Investment Strategist, Research

Jun Ma
Chief Economist Greater China, Research

China and the Ghosts of Japan’s Heisei Bubble
Will China repeat Japan’s boom and bust?

As international pressure intensifies now also set to decline. Both countries
on China to step away from renminbi have employed a socio-political
(RMB) intervention, the ghosts model in ‘state-based capitalism’
of Japan’s battle with currency with the principle aim of minimising
appreciation are resurfacing. unemployment rather than maximising
shareholder returns.
Some economists and analysts who
believe Japan’s Heisei boom of the However, upon closer investigation,
1980s, and subsequent bust, was we find the hypothesis that sustained
caused by the relentless appreciation yen strength was the root cause of
of the yen, fear that a similar fate Japan’s problems to be unconvincing
might befall China in the years ahead. – as we do the idea that China will
likely lapse into Japan syndrome as
During the 1980s, US public opinion the RMB inevitably strengthens. For
perceived US hegemony to be under a start, Germany’s revaluation of the
threat from Japan. A book by Harvard mark was not followed by a Japan-
Professor Ezra Vogel entitled Japan style bust. Furthermore, Japan has
as Number 1: Lessons for America continued to run a sizeable trade
became a bestseller, and Japanese surplus. Rather, we believe ill-directed
salarymen were reported to sprinkle financial sector deregulation and
gold-flakes on their noodles. monetary policy error were the major
contributors to Japan’s undoing.
By 1989, Tokyo accounted for more
than half of the world’s stock market The squeeze on lending margins in
capitalisation, with the Nikkei trading Japan in the early stages of financial
at 70x earnings. By 1991, property in sector deregulation prompted a sharp The lines of demarcation
Tokyo’s Ginza district was said to be deterioration in lending standards The following factors suggest to us a
selling for $93,000 per square foot and an increase in loans to suspect more benign adjustment for China.
with Tokyo land values worth more SMEs. The proceeds of capital raisings First, at just 47% currently, China’s
than all the land in Britain, Germany by corporates were also frequently urbanisation rate is well below Japan’s
and France, and the grounds of the used for speculative land and stock at the peak of the bubble (63%), with
Imperial Palace being more valuable purchases (a process known as the UN projecting a further 270 million
than the state of California. ‘zaitech’). But the eventual collapse people will become urbanised in China
in asset prices resulted in a self- over the next two decades. Second,
At first glance, the parallels between reinforcing cycle of loan defaults and the consumption share of GDP in
1980s Japan and China today might negative earnings, compounded by China is just 35%, and so has
appear striking. Both countries have extensive bank cross-shareholdings significant scope to take over the
successfully employed a mercantilist (banks counted unrealised capital baton of growth as fixed asset
export model to help fast-track gains on equities as capital). As for investment decelerates, while Japan’s
economic development. Partial monetary policy error, the Bank of consumption/GDP ratio was already
deregulation of the banking sector Japan initially eased too vigorously in around 54% in the 1980s. Third,
in Japan was followed by a sharp the short-lived 1985 recession, and Japan’s stock market looked
expansion in credit and a boom in then refrained from withdrawing the manifestly overvalued, peaking at 5.5x
property prices as it has in China. A monetary punch bowl for too long in book and a PE ratio of 70x, while
peak in the working age share of the the subsequent recovery. The collapse China’s stock market currently trades
population in Japan coincided with the in the real policy rate from 4.6% in at 2.3x book and 14x PE, and with a
top in equity and land prices. China’s 1983 to -0.5% in 1989 helped fan the considerably lower degree of bank
working age share of the population is flames of the asset bubble. cross-shareholdings. Fourth, China’s


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