Henley October Outlook 2012

Monthly Market Outlook
October 2012
September 2012 was one of the most important months for the
markets and the monetary crisis since that ‘other September’, in
2008, when the Lehman Brothers’ insolvency occurred. Within
eight days last month, both the European Central Bank and the
US Federal Reserve announced plans for open-ended, unlimited
monetary stimulus. Open-ended and unlimited.

The Henley Outlook
October 2012
THE WEALTH MANAGEMENT PROFESSIONALS

The Henley Outlook
October 2012

Overview

ASSET CLASS HOUSE VIEW REMARKS

Fixed Income Investment Grade

High Yield
Student accommodation only.
Property

High dividend stocks preferred.
Equities US

Japan

UK

Europe Ex UK

Australia

ASEAN
Broad equity exposure
Greater China including the region preferred.

India

Other Emerging Markets

Commodities Energy

Precious Metals

Industrial Metals
Agribusiness equities.
Agriculture
Selective strategies only.
Alternative Investments

Key: Positive Neutral Negative

The Henley Group Limited The Henley Outlook: 2
An SFC Licensed investment advisor in Hong Kong Hong Kong, Singapore & Shanghai
Suite 2004-08, 20/F, St George’s Building, 2 Ice House Street, Central, Hong Kong
info@thehenleygroup.com.hk www.thehenleygroup.com.hk

The Henley Outlook
October 2012

Global Overview
“Patience is bitter, but its fruit is sweet.”
Aristotle, Greek polymath, 384BC – 322BC

September 2012 was one of the most important months for the markets and the monetary crisis since that ‘other
September’, in 2008, when the Lehman Brothers’ insolvency occurred. Within eight days last month, both the European
Central Bank and the US Federal Reserve announced plans for open-ended, unlimited monetary stimulus. Open-ended
and unlimited.

At last I feel comfortable saying that we are probably nearer the end of this crisis than the beginning, mainly because
the open-ended and unlimited nature of the stimulus will bring matters to a head more quickly and accelerate the race
to debase paper currencies – the imperative on the agenda of the powers that be. The stimulus will be required for years
to come, or until there is a hyperinflation – whichever arrives first.

As a reminder, a hyperinflation, or “hyperdevaluation” as I prefer to call it, is the usual result of a failed attempt to print
money to avoid the deflation that would be caused by austerity. It’s not about prices rising extra quickly (in other words,
it’s not about demand), it’s about a collapse in confidence in a currency caused by printing too much of it.

How much is too much? That will be for the markets to decide. When they lose confidence in the ability of paper money
to hold its value, it will be game over. Think poker with the central banks.

As usual, the monetary stimulus itself is all about keeping the banking system, which is sitting on a quadrillion-dollar
confetti soufflé of derivatives and worthless collateral, solvent. It is also about manipulating interest rates downwards
so that the ever-growing government deficits become (Spain, Italy), or remain (USA) affordable. In the case of Europe,
the troika insist that a country apply to them for a bailout and agree to an austerity programme before any money will
be forthcoming. Candidates will all claim not to need a bailout, until they actually apply. It’s only a matter of time before
Spain succumbs: it will run out of cash this month, when some technocrat or other will doubtless be installed as Spanish
Prime Minister. And then Italy. And then France. And finally the euro?
As we have already seen with Greece, Europe’s tragic irony is that, in
order to be saved, countries must first agree to be destroyed. What a
price to pay for propping up a failed political experiment.

Needless to say, the effect of all this money printing will, by definition,
be inflationary in monetary terms; but we also expect consumer
prices to rise significantly in the short term, exacerbated by higher
food and energy prices.

For reasons best known to themselves, central banks and markets
are hoping that this new dose of liquidity will renew the animal
spirits of companies and consumers; but the reality is that we are
in the midst of a depression – defined as years of rolling recessions
interrupted by brief periods of recovery. Not surprisingly, however,
real assets – notably precious metals – have responded well to these
announcements of further monetary stimulus. We expect precious
metals and the associated mining funds to continue to perform
well for the foreseeable future, with the usual caveats about short-
term volatility. Cash, bonds and other financial assets are looking
increasingly risky in after-inflation terms.


The Henley Outlook
October 2012

In the Middle East, tensions continue to rise. Israel and Iran are rattling sabres at each other and the US military build-
up in the Persian Gulf is the largest it has been since the Gulf War. Hopefully, this has more to do with Obama wanting
to make sure that nothing, especially an oil-price spike, happens before the elections on 6th November. Let’s hope the
Israelis are in on the plan! What happens after that, unfortunately, is another matter. Meanwhile, nearer home, the
Chinese and the Japanese are also doing the sabre thing. The Chinese are clearly testing American resolve, and perhaps
warning the Americans not to try anything vis-à-vis Iran (and Syria).

In such an environment, it is all too easy to focus on re-arranging the deckchairs and not notice that the ship is sinking.
We are in a monetary crisis affecting the whole system, and it is only possible to make sense of it by understanding it in
monetary terms and in terms of monetary history; but, for those who do make sense of it, there are great opportunities
to protect ourselves by holding real assets. Your Henley adviser will give you the details.

Peter Wynn Williams
Investment Director
pww@thehenleygroup.com.hk


The Henley Outlook
October 2012

Cash & Currencies

USD Index (Source: Bloomberg)

Summary
• his month the focus is on the USD. Further to the announcement of unlimited QE, the greenback has weakened, with
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the USD index at its lowest point since May and 6.5% lower than it was in July.
• he cable (the GBP/USD exchange rate pairing), saw a 5% move higher over 1.62, which was a 12-month high on USD
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weakness.
• he EUR gained over 8% against the USD to more than 1.3 before giving back some of those gains.
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• he EUR also reversed the longer trend against the GBP this month.
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• UD pulled back a little during the month, suffering from the data coming out of China and also the perceived easing
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of European tensions. The AUD remains above parity to the USD for the time being and with moderating inflation,
interest rates are expected to stay as they are. AUD/USD to remain rangebound.
• PY has maintained its strength, and as a safe haven, will continue to attract cash as the USD loses its appeal. This is
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not desirable but is maintained even after the BoJ increased its Asset Purchase Fund.
• he SGD has seen little change on the month.
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HENLEY ASSESSMENT:
Strongly Negative USD, GBP and EUR over medium-to-long term against trade-weighted basket of currencies,
given that all of these currencies are debasing and devaluing through significant Quantitative Easing. AUD to
remain volatile based around the Chinese data.


The Henley Outlook
October 2012

Fixed Income
Positives
• he Federal Reserve announced QE3 which includes a USD40bn purchase per month of agency mortgage backed
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securities (MBS) to lower long-term interest rates, specifically mortgage rates, until labour conditions improve. In
addition to bond purchases, The Federal Reserve will continue with Operation Twist (ZIRP) and buy USD85bn per
month of long bonds to year end. The Federal Reserve also committed to low levels of Federal Reserve funds rate to
“at least through mid-2015”.
• CB delivered its bond-buying plan, named Outright Monetary Transactions (OMT), as promised. Under OMT, ECB can
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conduct unlimited purchases of bond up to three-year maturity upon recipient nations making a formal request for
aid and agreeing to meet conditions set by EU. More importantly, ECB will waive its preferred creditor status, will not
target specific yield levels and will sterilise any purchases by taking deposits from the bank.
• he German constitutional court ruled the European Stability Mechanism (ESM) bailout fund constitutional and
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cleared the roadblock to effectively sign into law Germany’s commitment to ESM.
Negatives
• ield of 10-year US Treasury bonds spiked at 1.87%, the highest since May and a rise of almost 50bp from the historic
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low of 1.39% on 24 July. Investors sold off US treasuries sharply as haven demand weakened. Headline CPI rose 0.6%in
August. Core CPI inflation remained modest, however, rising 0.1% as in the previous month.
• ltra-low interest rates may persist for a rather long time. As in the case for Japan, its rates have remained stable at
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an extraordinarily low level for over a decade. Yet we are concerned about the current dynamic which is not entirely
stable and rates can possibly unwind quickly.

HENLEY ASSESSMENT:

Negative. Yields on emerging market bonds
are priced on average of 5.5%, near multi-year
lows. Low yields in emerging market bonds are
a function of current low-interest environment
that has persisted since the financial crisis. US
treasuries are a benchmark for pricing high-yield
bonds. Investors receive a higher interest rate
for emerging market bonds to compensate for
their higher risks. Interest rates on developed
government bonds are so low with 10-yr US
Treasury bonds paying only 1.85%. Emerging
markets in good fiscal health are attractive by
comparison and they are required to pay as
much on their debt. Prices of emerging market
bonds are far from a bargain even though in
the near-term rates will likely go even lower as Source: JP Morgan Chase, BCA Research

monetary policy easing continues in response to
slower growth.


The Henley Outlook
October 2012

Property
Positives
• he Hong Kong government has announced further plans to try and cool the city’s overheating property market, but
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already some analysts are suggesting that the new measures will not be enough to dampen prices. Firstly, there is a
proposal to only allow Hong Kong permanent residents to purchase within certain property developments. Secondly,
the Hong Kong Monetary Authority (HKMA) has moved to make mortgages on second properties harder to obtain,
as borrowers will be limited to a maximum loan of 40% of monthly income. This follows a recent announcement by
the US Federal Reserve for unlimited quantitative easing, with the aim to keep US interest rates low until 2015 at the
earliest, thus underpinning Hong Kong property prices. According to Centaline Property Agency, Hong Kong property
prices have soared 240%since the market low in 2003, and have now exceeded their 1997 peak.
• ondon luxury home purchases more than doubled in May from a year earlier, according Land Registry data. This is
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despite the UK government raising purchase taxes in the 2012 UK budget. Many purchases are thought to be from
mainland Europe and the Middle East, and are continuing to take advantage of Britain’s safe haven status. Prime
central London property prices rose 10% in value over the last year, averaging GBP1,302,292 in the year ending 2Q12.
Negatives
• Many indicators point to a bottom forming in the US residential housing market. For example the S&P/Case Schiller index
of 20 cities gained 0.9% on a seasonably adjusted basis in June, beating expectations of 0.5%, and for the first time in 21
months the index is up YoY. However, Robert Shiller, one of the earliest experts to indentify the real estate bubble, is not yet
convinced the market has momentum, which he suggests is the most powerful driver of home prices. Shiller also lists the large
overhang of homes that are either in foreclosure or close to it, as another reason to be wary. Additionally, the number two
driver of prices is the unemployment rate, and this is still well over 8%, and proving difficult to reduce.

Sources: S&P/Case-Shiller; FHFA; US Department of Commerce via Federal Reserve Bank of St. Louis

• A ccording to the Halifax House Price Index, UK home prices fell for a second month in August, and the Halifax believes
that prices will remain little changed into 2013. Prices were down 0.4% MoM, and 1.1% YoY. The property market (ex
London) remains under pressure as the economy struggles to recover from a double-dip recession, and the euro-area
debt crisis drags on. Prospective buyers continue to be put off by big deposit demands from lending institutions, rising
borrowing costs and a lack of job security.
• ustralian home loan approvals unexpectedly fell 1% MoM in July. This was the most in five months, as high interest rates and
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poor sentiment continue to discourage residential property buyers. Additional interest rate cuts are expected later this year from
the Reserve Bank of Australia, which it is hoped will encourage buyers, but at present home prices continue to move sideways.

HENLEY ASSESSMENT:
Neutral. Property prices generally, after significant falls in 2009, have stabilised between 2010 and 2012.
Property values have recovered in selected areas such as Asia and London but fundamentals remain weak
elsewhere. However, we still consider some specialised property assets, such as student accommodation/
ground rent income, to merit inclusion in our portfolios. Other than these investments, we would suggest that
clients do not invest further at this time.

The Henley Outlook
October 2012

Equities
US
Positives
• he US economy is highly flexible and resilient, and leads the world in technology and innovation.
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• he Federal Reserve has forecast rates unchanged until at least 2015.
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• n the long term, demographics and returned energy self-sufficiency bode well.
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Negatives
• ational debt is at USD16bn and rising; debt to GDP is at 104%and rising. Both are absurdly unsustainable.
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• E to infinity promises currency debasement, rising prices and lowering discretionary spending.
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• abour force participation rate is at 30-year low (63.5%).
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• olitical system is dysfunctional, fiscal cliff and debt ceiling to negotiate at end of 2012.
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HENLEY ASSESSMENT:
Negative. There is a growing risk that QE3, by debasing the currency, will trigger a massive dollar-selling
crisis and begin the process of a rapid upturn in domestic consumer price inflation. The QE3 boost in asset
prices may already have fizzled. The disconnect between confetti-soufflé asset prices and an economy at stall
speed is startling. As during QE1 and QE2, broad economic activity remains likely to bottom bounce for the
foreseeable future.

JAPAN
Positives
• J PY has weakened to JPY79.23 vs USD. The yield of the 10-yr Japanese Government Bond (JGB) slipped to 0.795% after
the announcement of more quantitative easing. BOJ has increased the size of asset purchase program by JPY10tn to
JYP80tn. The central bank will buy an additional JPY5tn of treasury discount bills between January and June 2013, as
well as an additional JPY5tn of JGB between the end of June 2013 and the end of December 2013.
• G overnment subsidies and reconstruction are supporting housing demand after the earthquake and tsunami disasters.
Japan projected its nominal economic growth to exceed real growth for first time in 16 years in 2013.
Negatives
• ikkei 225 Stock Average gained over 8.4%year-to-date but
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lagged behind most developed markets. Investors are not
keen on Japanese stocks even when the broad Topix index was
closed at 0.89x book value.
• apan’s economy seems to lose its steam. GDP in Q2 grew by
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an annualised 0.7%, half of the government’s initial estimate.
• urrent-account surplus fell 41% from a year earlier to
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JPY625.4bn (USD8 bn) in July. It was the smallest current
account for July since 1996 as nuclear-reactor shutdowns
after earthquake and the tsunami drove up energy imports. If
the current economic model remains unchanged, fiscal deficit
could easily skyrocket (as shown in graph right).
Japanese Government Revenues vs. Expenditures: Sources: Ministry of
Finance, CFA Institute.

HENLEY ASSESSMENT:
Neutral. Japan’s nationwide compensation fell to JPY243.5tn (USD3.1tn) in Q2. The number was nearly the
lowest since 1991. Cost-cutting efforts in the corporates are dragging on wages and resulting in weaker
consumer demand. THG is expecting more stimulus from Bank of Japan in the near future.


The Henley Outlook
October 2012

UK
Positives
• he rate of inflation dropped by 0.1% last month, from 2.6% to 2.5% – the lowest it has been this year. This has significantly
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increased the probability of continued monetary easing policies when the current round of QE expires in November.
• Sir John Major, a previous Conservative Party prime minister has courted controversy by predicting that the ‘green
shoots’ of recovery are on the way in the UK, stating the economy had now passed the ‘darkest moment’ of the recession.

Negatives
• olitically, the UK coalition government is coming under increased pressure as the Liberal Democrats attempt to
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rebrand themselves after what is becoming apparent, has been a disastrous power sharing arrangement for the party.
The consequences being that unity on budgets and tax cuts is very unlikely in the coming months, which could hurt
the UK economy as it struggles to move on from a sustained period of zero growth rates.
• ir Mervyn King, the Bank of England governor, has admitted UK plc growth was intrinsically linked to a resolution in
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the continuing euro zone crisis, which he stated was hanging over the UK like a “black cloud”.
• he budget deficit last month was more than GBP14bn, slightly up on the previous year and a record for any August.
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On budget day, the UK chancellor George Osborne said he expected the deficit to fall by more than 4% in the current
financial year; in the first five months of 2012-13 it is 21% up on 2011-12. It will take a rapid and wholly unlikely
acceleration in growth over the next few months for Osborne to have the remotest chance of hitting his forecasts.

HENLEY ASSESSMENT:
Negative. Four years after the start of the financial crisis, Sir Mervyn King, the Bank of England governor, said it would
be a long while before the economy returned to normal – and the most important task for Britain was now to reform
bank regulation to reduce the chances of a future crisis. However, the UK is home to many multinational corporations
that are heavily exposed to areas of the world exhibiting strong growth rates. UK dividends rose by 18.4% in the
second quarter to a record high of GBP22.6bn, surpassing the previous peak in the same period back in the pre-crisis
days of 2007. They are expected to continue rising.

EUROPE ex UK
Positives
• he German Federal Constitutional Court gave an initial blessing to the permanent ESM. The court rejected bids for
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an injunction to halt the ESM and said that Germany’s participation in the fund was constitutional as long as there
was a cap on Germany’s liability. The cap could be raised at any time with German parliamentary approval.
• he ECB agreed to a framework for buying the bonds of troubled euro zone countries on the open market in unlimited
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quantities, but it left the timing unclear. Beleaguered governments would have to agree to follow detailed conditions
for paying down their debt, and hewing to fiscal discipline. It would be up to the ECB to determine whether the terms
of the agreement were acceptable, and whether the government was meeting those conditions over time.
Negatives
• uro zone finance ministers at their meeting were unable to agree on a timetable for a European banking supervision
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plan. There was also uncertainty about the terms of the ECB/ESM bond-buying bailout plan and whether Spain will
formally request participation.
• Lenders in the euro zone increased assets by seven percent to EUR34.4tn in the year ended July 31, according to data
compiled by the ECB. BNP Paribas SA (BNP), Banco Santander SA, and UniCredit SpA, the biggest banks in France, Spain and
Italy, all expanded their balance sheets in the 12 months through the end of June. This comes on the back of a pledge made
by European banks last year to cut more than EUR1.2tn of assets to help them weather the sovereign debt crisis.

HENLEY ASSESSMENT:
Strongly negative. ECB’s outright monetary transactions (OMT) is technically strong, and a smart, if covert,
way of doing something that has been rejected formally, namely leveraging the EFSF/ESM euro zone bailout
funds. Unfortunately, the plan is also economically unsound. ECB president Mario Draghi’s insistence that
the ECB’s actions are dependent on strict conditions is the price for German and other creditor government
support. But this is precisely the problem. The single-minded emphasis on rapid fiscal restraint has created an
unsustainable, pro-cyclical austerity zone. It is undermining weak sovereign and bank funding and solvency,
and substituting national central banks, notably the Bundesbank, for private investors in financing regional
capital flow imbalances, especially deposit flight from the periphery.


The Henley Outlook
October 2012

AUSTRALIA
Positives:
• nemployment is at 5.1%.
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• nterest rates are falling, the RBA cash rate is now at a lowly 3.5% and is likely to fall further. Lower domestic interest
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rates should prompt more domestic investors to put their money to work in ‘riskier’ assets, like shares and property,
rather than cash.
• cut in Chinese interest rates is giving the Chinese government more room to stimulate the economy. Global
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commodity markets are highly dependent on Chinese demand.
• overnment finances are rated triple-A rated and budget deficit is relatively small.
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Negatives:
• verage household debt is high.
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• xposure to base metals sector and reliance on trade with China for this falling consumer spending.
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• hare market is more than 40% below highs of 2007, although this can be seen as a positive!
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Henley Assessment:
Positive for clients with a long-term view who are prepared to accept short-term volatility. Those investing
in Australia should heed this warning from Robert Carey, the chief investment officer of the USD53bn fund
manager First Trust Portfolios: “Individual investors tend to get in when the markets are red hot and they
tend to get out when the markets are at the bottom,” he said. “It’s been one series of issues after another,
but, ultimately, fundamentals will weigh out and overwhelm any sentiment that people have.” And by that
time, much of the early profits will have been made. Trying to time the market succesfully is immensely
difficult. I have yet to see evidence it can be done in a repeatable way. Instead, riding the market’s waves has
successfully provided returns of between 9%–11% per annum,with dividends reinvested,over the last century.
Lumpy, bumpy and uncomfortable waves, I’ll grant you, but a rate that has provided impressive compound
returns over time.

ASEAN
Positives:
• ndonesia, Malaysia, Philippine and Thailand left their key rates unchanged as accelerating economic growth and
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inflation reduced the scope for monetary easing to counter an export slump.
• he Malaysian and Singaporean stock exchanges had taken the first step in creating a Southeast Asian platform,
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while the Stock Exchange of Thailand is poised to join the link-up between the ASEAN members next month. The
three account for 67% of the total market capitalisation of the ASEAN Exchanges group, which includes Indonesia,
the Philippines and Vietnam’s two bourses. The ASEAN trading link is the first step in the process of capital-markets
integration and collaboration, and offers stockbrokers more cross-border opportunities.
Negatives:
• nflation is likely to accelerate in the coming months due to rebounding food prices, strong credit growth, and loose
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monetary policy.
• etail investors in one country may have very little knowledge of companies in neighbouring countries. A lack of
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knowledge of overseas companies may hamper individual investors’ ability to trade shares outside their home market.
The governments will now embark on education, marketing and promotion at the ASEAN level. It will take a little bit
of time for traction.

Henley Assessment:
Neutral. The ASEAN trading platform follows a similar initiative connecting Colombia, Chile and Peru that
opened on May 30, 2011. Mila, as the Latin American market is known, handled USD2.3m of stocks in August,
up from USD854,000 a year earlier.


The Henley Outlook
October 2012

GREATER CHINA
Positives
• hina’s net new loans for August amounted to RMB703.9bn, which is increased from RMB540bn in July, well above
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consensus of RMB600bn.
• hina’s retail sales were RMB1.67tn in August, up 13.2% YoY in nominal terms or 1.28% MoM.
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• conomists from Nomura are expecting China’s growth to rebound visibly in 4Q12 to 8.8%, driven by stronger
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infrastructure investment and a rebound in housing investment, which combined account for half of total investment.
Negatives
• hina’s August macro data is bad, but not
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surprisingly bad. The country’s industrial value-
added output expanded 8.9% YoY in August,
slower than the 9.2% percent growth in July.
• hina imported less in August than in the same
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month a year ago and saw its exports continue
to increase at a slow pace. The drop in imports
(-2.6%YoY) happened unexpectedly, suggesting
the nation’s economic growth continues to slow
down.
• hina continued to experience money outflow in
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August. Official data shows RMB187bn apparently
leaving the country, showing no sign of slowing.

Source: Wind Information, Zhang Ye / China Daily

Henley Assessment:
Neutral. The anti-Japan sentiment in China, caused by the territorial dispute between China and Japan over
Diaoyu Islands, or the Senkaku Islands in Japan, has not only led to widespread protests and looting of
Japanese shops and restaurants in China, but also added additional political uncertainties during transition of
the leadership. There remain a lot of people who argue that the landing of China economy will be a soft one,
however we believe a hard landing is currently happening in terms of the dramatic number of profit warnings
of those Chinese companies this year.

INDIA
Positives
• ignalling the end of the policy paralysis, the government announced a slew of economic reforms. Vital among these
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is a 51% foreign direct invesment in multi-brand retail and 49% in aviation; previously foreign investment was not
allowed in either of these sectors
• eduction in subsidies on domestic LPG cylinders and diesel will reduce the fiscal deficit though not substantially.
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• he rainfall surge during September has reduced the deficit from 30% early July to 6%; this will facilitate the targeted
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food grain production of 250 million tonnes this year.
Negatives
• T he 14% rise in diesel prices announced on 14th September is expected to have a ripple effect across industries raising
fears about pushing the inflation to double digits.
• igher food prices due to low rain drove India’s Wholesale Price Index (WPI) from 6.87% in July to 7.55% in August
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2012.
• ith the biggest ally pulling out of the ruling coalition, the minority government in New Delhi now has to rely on the
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external support of regional parties.

HENLEY ASSESSMENT:
Neutral. After a dormant eight-year stint in the office, the economist prime minister has woken up to ‘big
bang reforms’. Though it is widely anticipated that the government will announce further reforms to overhaul
the economy, the political instability remains the biggest hurdle to notify these decisions. Indeed, reforms
alone are not expected to improve the country’s credit ratings; the central bank is continuously challenged to
find that right balance between slowing growth and higher inflation.

The Henley Outlook
October 2012

Other Emerging Markets (South Korea, Russia, Brazil)
Positives
• razil’s central bank reduced reserve requirements to free up BRL30bn in credit as President Dilma Rousseff pushes
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banks to lower borrowing costs in the world’s second-biggest emerging market. Over the past year, the central bank
has cut its benchmark rate by 500bp, more than all Group of 20 nations, though borrowing costs are still among the
highest in the world. As part of the new rules, the monetary authority eliminated the so-called additional reserve
requirement rate for cash deposits, which had been at 6%, and also reduced the rate for time deposits to 11% from
12% starting 29th October.
Negatives
• T he land dispute between Japan and China raised concerns that it may have a negative impact on trade ties. Japanese
retailers in China closed their doors to thwart attacks as demonstrations spread over Japan’s plan to buy islands
claimed by both countries, which have a USD340bn trade relationship.
• he Korea Development Institute cut its 2012 growth rate to 2.5% from a 3.6% forecast made in May. It will be much
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lower than last year’s 3.6% economic growth, but it is commonly agreed that the government’s 3.3% and the Bank
of Korea’s 3.0% growth targets for this year are unrealistic as the country battles strong headwinds from the US and
Europe.
• he most obvious risk to Russia’s performance in 2013 is that a sharp decline in oil prices will result in a rapid
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deterioration of the country’s macroeconomic environment. Foreign multinationals operating in the market, however,
have a much more immediate issue to deal with – the Russian economy is slowing, even as Brent prices remain above
USD110. Demand from consumers and the Russian government will be trending down in the next several months and
continue in 2013. As a result, multinationals selling to the government can expect reductions in public sector demand
starting from next year, or at best a slowdown in the implementation of existing public commitments.

Henley Assessment:
Neutral. Growth in emerging-market economies is decelerating, but consumer demand in these countries is
more resilient than exports, which are feeling the drag from a slowing global economy. Existing leeway to
loosen monetary and fiscal policy, however, should underpin emerging markets’ growth, ensuring that, in
aggregate, they continue to deliver faster gross domestic product (GDP) growth than developed markets.
China is under mounting pressure to boost its economy, but policymaking will remain piecemeal. With public
debt equal to about 50% of GDP, Beijing still has scope to stimulate growth, albeit less than four years ago.
However, monetary easing alone will not be enough to arrest China’s slowdown


The Henley Outlook
October 2012

Commodities
Energy
Positives
• ngoing differences between Iran and the West provide support to energy prices.
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• ore monetary easing will benefit real assets, including energy.
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Negatives
• ngoing debt concerns in Europe and signs of a slowdown in China are adding to negative sentiment and make future
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demand for oil and energy look uncertain.

HENLEY ASSESSMENT:
We remain neutral. The lack of clear progress in negotiations between Iran and the West continues to underpin
energy prices which otherwise would have been lower given the relatively gloomy macro outlook for many
major economies around the world. In Syria, the conflict continues to take its toll while outside powers bicker
about what to do. This adds to the current instability in the region, which as long as it remains, will balance
the otherwise somewhat gloomy demand situation.

Precious Metals
Positives:
• old and silver are a good hedge against financial instability.
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• Q E3.
Negatives
• rices could come under short-term pressure as some investors take profits.
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HENLEY ASSESSMENT:
We remain strongly positive on precious metals.
The latest measures from the ECB in which it will
buy short-term bonds issued by struggling euro
nations in the secondary market may provide
some respite for the EUR and the euro zone.
But lower short-term yields will not solve the
fundamental problem; there is too much debt.
The can continues to be kicked down the road,
but it is getting heaver.

The US national debt has just passed USD16tn
and is quickly making its way to the debt ceiling
again. The combination of spending cuts and tax
increases known as the “fiscal cliff” is threatening
to push the US economy into a tailspin.
Policymakers face a very difficult situation: debt
has to come down, yet the economy needs to grow to generate enough jobs to bring unemployment down.
This is, of course, an impossible equation.

QE3 has just been announced and ostensibly it is to battle unemployment, however the real reason is to
keep the Treasury’s borrowing costs manageable. The need for suppressed borrowing costs will not disappear
anytime soon; neither will the The Federal Reserve’s money printing. We believe the printing press will continue
to run hot for the foreseeable future making precious metals our preferred asset class.


The Henley Outlook
October 2012

Industrial Metals
Positives
• urrency debasement will support real asset prices.
C
Negatives
• MI indicators worldwide indicate that economies are facing headwinds.
P
• hinese electricity production indicate lacklustre activity.
C

HENLEY ASSESSMENT:
We maintain our neutral view on base metals. PMI indicators worldwide suggest that economic activity
worldwide is sluggish. PMI for China has now been in contraction for 10 consecutive months, the first time
ever. Given this backdrop, we prefer other commodities at the moment.

Agriculture
Positives
• he UN’s food and agriculture organisation
T
estimates there will be over nine billion mouths
to feed on the planet by 2050.
• iddle class consumers in BRIC economies
M
are increasingly demanding more varied and
protein-rich foods. As affluence increases,
protein from beef, sheep, poultry, pigs, cows and
fish may in turn displace grains in diets.
• rbanisation and life expectancy are expected
U
to increase.
Negatives
• rices are subject to many uncontrollable risks,
P
Source: The Fertilizer Institute
eg, weather and natural disasters, politics and
other pests.
• ue to recent drought conditions in the American Mid-West and Russian Black Sea regions we have seen corn, wheat
D
and soy prices increase on average over 50% within a few months.

HENLEY ASSESSMENT:
Positive and Negative: There are two very different markets playing out in the agriculture sector, physical and
equity. Many physical soft commodity prices have exploded due to changing global weather patterns over
the past few months, however these sharp price increases tend to be followed with just as sharp falls; there
is a very seasonal and cyclical pattern with these movements. Currently, with many soft commodity prices
at or near record highs we have a negative view on investing at these levels and encourage profit taking. On
the equity side, the largest weighting funds have to this sector is via fertilizer and seed companies. These
industries are having a significantly more important role to play to help increase yield, and in the case of
seed companies, invent seed which is more tolerant to changing global weather patterns. We remain positive
agriculture equity funds.


The Henley Outlook
October 2012

Alternative Investment
Positives
• verall, hedge funds made money in August; the HFRX
O
global index rose by 0.5%. Given the general “risk-on”
sentiment, particularly during the first half of September,
the best performers were market-sensitive strategies such
as long-bias equity and credit managers.
• ispersion both between and within financial markets
D
improved during the month, which was a positive factor for
long-short hedge funds.
• Total asset under management (AUM) increased by USD7bn
during the month, bring the size of the hedge fund industry
to USD1tn.
Negatives
Source: FRM Viewpoint
• he main detractors for Managed Futures/CTA in August
T
were long bonds positioning, short EUR bias and long AUD
exposure. All of these exposures were progressively reduced while risk asset exposures such as long equities and
commodities produced positive contributions in August.
• here are a series of fundamental issues that remain unresolved with a lot political turbulence continuing in the next
T
few months. Trading strategies are less attractive since economic intervention by politicians and central banks remains
frequent and uncertain. It is extremely hard to make the right call on market timings.

HENLEY ASSESSMENT:
Cautiously positive. “QE unlimited” is definitely fantastic news for most of long-only funds however this
doesn’t sound that good for most of the hedge funds. Market dynamics remain unfavourable in terms of
attractiveness on a valuation basis as managers have to work harder to extract returns from niche areas in
order to keep positive Alphas instead of being trapped in Beta plays.

General disclaimer and warning

The Henley Group Limited (“The Henley Group”) has produced this document for your private use only and you must not distribute it to any other person
in Hong Kong. Re-distribution or reproduction in whole or in part of this document by any means is strictly prohibited and The Henley Group accepts
no liability for the actions of third parties in this respect.Funds not authorized by the Securities and Futures Commission may involve more risk and
distribution or re-distribution of information relating to such funds to the public of Hong Kong may constitute an offence under the Securities and Futures
Ordinance.Notwithstanding that the information contained herein has been obtained from sources which The Henley Group believes to be reliable, The
Henley Group makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy, completeness or correctness.
The information in this document, including any expressions of opinions or estimates, should neither be relied upon nor used in any way as indication
of the future performance of any financial products, as prices of assets and currencies may go down as well as up and past performance should not be
taken as indication of future performance.


Henley October Outlook 2012

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