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Contents
Stance Summary 5
Section One – Review of Markets 6
Equity Markets 6
Equity Sectors 7
Fixed Income 8
Commodities 9
Currencies 9
Section Two – Review of Global Economics 10
Inflation 10
Economic Data 11
Section Three – Views and Outlook 14
Economics 14
Equities 16
Bonds 18
Currencies 19
Commodities 19
Section Four – Special Features 20
Investment Strategies after a Summer of Volatility 20
Recent Developments in the Eurozone Sovereign Debt Crisis 23
Spotlight on the UK Stock Market 24
Brazil Interest Rate Cut 26
Section Five – Charts 27
Section Six – Appendix 41
All data source BlackRock September 2011 unless otherwise stated
4

Stance Summary
Equities
North America
Europe
Japan
UK
Asia ex-Japan
Latin America
Emerging Europe
Materials
Energy
Healthcare
Technology
Financials
Industrials
Cons. Discr.
Cons. Stap.
Telecoms
Utilities
Bonds
Government bonds
US
Euro
UK
Japan
IG Credit
High Yield
EM Debt Local Currency
Cash
US$
Euro
Yen
Sterling
Australian$
Canadian$
Swiss franc
Negative Neutral Positive
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Table reflects views of the Global BMACS Investment Strategy Group as of 13 September 2011
5

Section One – Review of Markets
• August was a very difficult and volatile month for investors, with losses for almost all financial markets except high
quality government bonds, despite a rebound in risk assets in the second half of the month. Volatility markets
increased significantly during the first half of August, causing equity markets to plummet and then seesaw, and
pushing Spanish and Italian government bond yields to new highs while some US Treasury yields hit new lows for
the year. A number of factors converged to shake investor confidence, including weak economic data suggesting
a slowdown in global growth, heightened fears of contagion from the sovereign debt crisis spreading beyond
Greece to Spain and Italy and, finally, Standard and Poor’s (S&P) downgrade of long-term US debt from AAA to
AA+.
Equity Markets
• World equities declined 6.7% in local currency terms and, overall, developed markets outperformed emerging.
Despite negative stock market returns almost across the board in August, all major equities rallied in the final
week. In light of the heightened sovereign debt concerns, ongoing geopolitical tensions, concerns about an
economic slowdown, the S&P’s downgrade of US long-term debt and generally higher levels of investor
uncertainty, the VIX increased significantly to measure an average of 35.9 in August, compared to 15.5 over 12
months.
• The S&P 500 Composite Index declined 5.7% in USD terms over the month, despite rallying 3.5% in the final
week. Year to date the index is now down 3.1%. The NASDAQ composite underperformed the S&P 500 in
August, with a 6.4% decline. S&P downgraded its rating for long-term US debt to AA+, from AAA, with a negative
outlook. The other ratings agencies did not follow suit, however, leaving US long-term credit with a split rating. The
US unemployment rate remained stable at 9.1% in August, while real GDP growth for the second quarter was
revised down to 1.0% q/q. The US manufacturing Purchasing Managers Index (PMI) declined to 50.6 in August,
down from 50.9 in July.
• European stock markets performed particularly badly in August. The eurozone was the worst performing region,
declining 12.9%, while Europe ex-UK fell 11.0%, both in local currency terms. Year to date the eurozone is now
down 16.6%. Poor equity market performance in the eurozone was not surprising, given the growing fears about
the sovereign debt crisis in the periphery as well as generally weaker economic data releases across the region.
By country, the German DAX declined by a massive 19.2% in August, significantly underperforming the French
CAC40 which still fell by 11.3% in EUR terms.
• Outside the eurozone, the UK FTSE 100 declined by 7.2% in August in GBP terms. Year to date the index is now
down by 8.6%, although over 12 months it still has a positive return of 3.2%. Meanwhile, the FTSE All-Share fell
by 7.5% in August. UK economic data releases were generally weak during the month, including declines in both
the manufacturing and services PMIs. CPI inflation increased to 4.5% in August and the Bank of England
downgraded its outlook for growth in its quarterly Inflation Report.
• In Japan, the Nikkei 225 Stock Average declined by 8.9% in August (in JPY terms), despite a 3.7% rally in the
final week. Year to date the index is down by 12.5%, while over 12 months it has returned 1.5%. The Topix
declined 9.8% in August, also in JPY terms. The manufacturing PMI declined slightly, to 52.0 in August, while the
unemployment rate increased to 4.7% in July. At the end of the month Yoshihiko Noda of the ruling Democratic
Party, and formerly the finance minister, replaced Naoto Kan to become Japan’s sixth prime minister in five years.
• Across the Pacific, the Australian stock market declined by 2.9% in AUD terms in August, giving it a negative yearto-date
performance of -9.5%. The Reserve Bank of Australia has held the cash rate steady at 4.75% since
6

Section One – Review of Markets
November 2010. In local currency terms, the Pacific ex-Japan region declined by 4.0% in August, while Asia as
whole declined 9.8%. By country, Taiwan declined 10.4%, while Hong Kong and Korea fell 8.5% and 11.9%
respectively. Although the Thai stock market declined by 5.6% in August, it is one of the few indices that still has
positive performance year to date, with a 3.6% return. The MSCI China declined by 9.4% in August, while China
A-shares fell by 5.0%. Year to date, the MSCI China and China A-shares are down 10.7% and 8.5% in local
currency terms.
• Emerging market stock markets declined by 7.6% in August in local currency terms (-11.8% year to date), or by
9.2% in USD terms (-10.3% year to date). Over 12 months, emerging market returns are flat in local currency
terms or up 6.5% in USD terms. Performance within emerging markets in August varied considerably by country
and region. By region, emerging Europe declined by 10.4%, compared to a 2.9% drop in Latin America, both in
local currency terms. South Africa was the best performing stock market, returning 2.7% in ZAR in terms, while
Mexico returned 0.7% in MXN terms. In contrast, Russia was one of the worst performers, declining by 13.4%,
while Turkey fell by 12.8% and Argentina declined by 11.9%, all in local currency terms.
Equity Sectors
• In the US, utilities and consumer staples were the best performing sectors in August, returning 1.6% and 0.4%
respectively. Year to date, utilities have returned 7.7% and consumer staples 5.5%. Every other major sector in
the US declined in August. The worst performing sector was energy, which declined by 10.2% in August and is
now down 0.5% year to date. Financials also relinquished 9.6% over the month, taking their year-to-date
performance down to -15.6%, amid ongoing concerns about exposure to peripheral Europe and signs that global
growth is slowing. Materials and industrials fell by 7.2% and 7.0% respectively in August.
• All major equity sectors recorded losses in Europe in August. Consumer staples was the best performing sector,
with a decline of 3.2%, while healthcare fell by 5.7%. Not surprisingly, given the increased concerns over the
sovereign debt issues in peripheral Europe and the European banking sector, the region’s worst performing sector
was financials, which declined by 14.6%. Financials are now down 22.3% year to date. Materials (-12.5%),
consumer discretionary (-12.0%) and utilities (-9.7%) also registered significant declines in August. Industrials also
performed badly, registering a 10.8% fall in August and a 17.8% decline year to date.
• In Japan, the utilities sector was the best performer, returning 2.2%. However, that sector is down 38.9% year to
date after being hardest hit by the events of 11 March and the aftermath. All other major sectors made losses in
August. The worst performer was energy which, with a 13.6% decline, was a reversal from July when it was the
country’s best performing sector. The consumer discretionary sector fell by 11.6% and materials declined by
10.5% in August. In addition, financials, healthcare and industrials all ended the month significantly lower.
• The financial sector declined by 10.1% globally in August and is down 13.4% year to date. Within the sector, the
banking industry remained under significant pressure. An intensification of the sovereign debt crisis in peripheral
Europe and inadequate system-wide levels of capital, despite some capital raising, remained key themes,
propelling eurozone banks to decline 16.6% in EUR terms in August. Meanwhile, UK and US banks declined by
13.6% and 10.1% respectively, in local currency terms, while Japanese banks declined by 7.7%. Year to date,
eurozone banks are down 26.6%, while UK and US banks have fallen by 24.7% and 19.1% respectively.
7

Section One – Review of Markets
Fixed Income
• Government bond returns increased further in August, with a sharp drop in yields. They significantly outperformed
major equity markets on weaker than expected economic data as well as further concerns relating to peripheral
eurozone sovereign debt. Overall, the volatile and uncertain environment, and subsequent risk aversion, caused
investors to favour highly rated and liquid government bonds.
• The US ten-year Treasury returned 5.6% in August and has returned 12.4% year to date. US credit returned 2.2%
in August (8.6% year to date). In contrast, US high yield made a negative return of -3.2% over the month but has
returned 2.9% year to date. Standard and Poor’s downgraded US long-term debt on 6 August AA+, from AAA,
with a negative outlook. The other ratings agencies did not follow suit, leaving US credit with a split rating. The
yield on US Treasuries fell despite this downgrade as stock markets declined and investors sought safe havens.
The Federal Open Market Committee (FOMC) kept interest rates unchanged at the August meeting but
announced that they would maintain rates at the current low level until at least mid-2013. Data releases were
generally weak in August, including second-quarter GDP growth being revised down to 1.0% (from 1.3%).
• German bunds continued to rally strongly in August, with the ten year returning 3.6% (after returning 3.8% in July).
Year to date the ten year has returned 9.3%. The European Central Bank (ECB) kept the main refi rate on hold at
1.5%, as had been widely expected by the market. However, they reactivated their Securities Market Programme
(SMP), to buy bonds in the secondary markets. The ECB also reintroduced a six month long-term tender with full
allocation and will continue to supply unlimited liquidity in shorter tenders until year end as well. The ongoing
sovereign debt issues in the eurozone periphery rumbled on in August, however, the ECB’s actions including
announcing that it would purchase Italian and Spanish government bonds helped the yields of Italian bonds to
decline somewhat over the month. Italian Prime Minister Silvio Berlusconi also announced that Italy will speed up
its fiscal austerity plans to balance the budget by 2013.
• The rally in UK gilts continued in August, with the ten-year returning 2.2%, although they underperformed bunds
and treasuries. The ten year has returned 9.6% year to date. The Bank of England (BoE) maintained Bank Rate at
0.5% and kept its asset purchase programme at GBP 200 billion. The decision to keep interest rates on hold was
unanimous, with both Spencer Dale and Martin Weale dropping their previous vote for a 25bp rise, while Adam
Posen remained the sole member calling for further QE. In its quarterly Inflation Report the BoE lowered the
forecast for growth and inflation, while predicting that inflation may reach 5% this year before falling back next
year. The BoE believes that the decline in 10-year gilt yields over recent weeks partly reflects growing investor
concerns about the prospects for global growth and partly lower expectations for the path of monetary policy.
• Ten-year Japanese government bonds returned 0.5% in August, significantly underperforming the other majors.
Year to date they have returned 2.1%. There are signs that Japan is recovering from the disruptions caused by
the earthquake and tsunami in March, but it will take time to fully recover. The Japanese economy was also
hampered by the appreciation of the yen, which rose a further 1.2% in August on a trade-weighted basis, after an
increase of 4.3% in July. Real GDP growth contracted by 0.3% in the second quarter. Meanwhile, Yoshihiko Noda
replaced Naoto Kan as Prime Minister of Japan.
• Credit spreads generally widened again in August. US credit returned 2.2%, while European credit returns fell by
1.0%. Convertibles significantly underperformed, with a 5.1% decline in global convertibles returns, and year to
date they ended August 2.3% lower. US high yield corporate bonds also underperformed, with a negative return of
-3.2% in August, and US banks returned -1.5%. For emerging market debt, the Emerging Market Bond Index
(EMBI) returned 2.8% in August and has returned 7.3% year to date.
8

Section One – Review of Markets
Commodities
• The performance of commodity prices varied significantly in August, although the CRB commodity index was
essentially flat over the month, returning just 0.1%. Precious metals performed best, returning 10.9%, while
agriculture also rose by 9.4%. In contrast, industrial metals declined by 6.4% and energy fell by 4.3%. However,
the Baltic Dry Index increased by 28.1% in August.
• The price of oil fell in August. Brent crude declined by 2.1%, to end the month at USD 115.0/ barrel, while the
price of West Texas Crude Oil (WTI) fell by 7.2%. The turmoil in some oil-producing countries showed no sign of
abating. Using January data as context, Libya provides around 2.0% of global production. The price of petrol also
declined by 2.0% in August and natural gas declined by 2.2%.
• Year to date, precious metals have returned 29.3%, while gold and silver have returned 28.9% and 28.7%
respectively. In August gold performed best, returning 12.5%, as risk aversion increased and demand for
traditional safe haven assets rose amid the market volatility and uncertainty. Meanwhile, the price of silver
increased by 4.3% and the price of platinum increased by 3.4%. In contrast, the palladium fell by 6.9% in August
and it is now down by 3.8% year to date. Among industrial metals, which declined by 6.4% in August, nickel was
the worst performer with an 11.2% decline, after returning 8.3% in July. The prices of copper and aluminium
declined by 5.6% and 6.2% respectively over the month.
• Elsewhere in commodities, softs returned 7.5% in August and are down 3.7% year to date. The price of corn
increased by 15.3% and wheat rose by 17.7%, in August, while soya beans increased by 7.4%. Corn has returned
22.0% year to date, in contrast to wheat which is down 0.4%.
Currencies
• Despite the sovereign debt crisis in the eurozone periphery and generally weaker data from the single currency
area, the euro appreciated by 0.7% in August on a trade-weighted basis. In comparison, also on a trade weighted
basis, the yen appreciated by 1.2% and the US dollar rose by 0.5%, while sterling depreciated by 0.6%.
• The euro appreciated by 0.2% against the US dollar in August. The ECB kept the main refi rate on hold at 1.5% in
August, although HICP inflation remained above the central bank’s target of close to but below 2%. The ECB also
restarted its SMP bond purchase programme. The yen increased by 0.9% against the US dollar in August, despite
intervention in the currency market from the Ministry of Finance/ Bank of Japan. The Norwegian krone also
appreciated against the dollar, by 0.9%.
• The Australian and New Zealand dollars both depreciated in August, falling 2.5% and 2.3% respectively against
the US dollar, thereby reversing some of the gains that they had made in July. The Swiss franc also depreciated in
August, declining by 2.3% against the US dollar, amid attempts by the Swiss National Bank (SNB) to stem the rise
of the currency. Sterling declined by 0.8% against the dollar. The Bank of England kept Bank rate at its historically
low level of 0.5% and the asset purchase programme (quantitative easing) at GBP 200 billion.
9

Section Two – Review of Global Economics
Inflation
• In the eurozone, inflation has remained persistently above the ECB’s target of “close to, but below” 2%, despite
concerns over sluggish economic growth in some of the southern European countries, with economies operating
below full capacity and with little pressure from wage demands. The ECB kept interest rates on hold in August, as
had been widely expected by the market. Eurozone HICP inflation remained stable in August, registering 2.5% y/y
in the flash estimate.
• In the UK, inflation has remained stubbornly above the Bank of England’s 2% target for a prolonged period of
time. CPI inflation increased to 4.5% in August, up from 4.4% in July. The Office for National Statistics cited
clothing, fuels and lubricants, furniture and household goods and domestic heating as the main sources of upward
pressure on inflation. The BoE kept Bank rate on hold in August, at 0.5%, with no additional QE. The minutes from
the August Monetary Policy Committee (MPC) meeting showed that Spencer Dale and Martin Weale both
dropped their previous votes for a 25bp rise in Bank rate and, therefore, the interest rate decision was unanimous.
Meanwhile, Adam Posen remained the lone voice voting for additional QE. In its quarterly Inflation Report,
released on 10 August, the BoE lowered the forecast for growth and inflation, while predicting that inflation may
reach 5% this year before falling back next year. Meanwhile, the Citi/YouGov poll showed that inflation
expectations for the year ahead were unchanged in August from July at 3.5%, while expectations for the next five
to 10 years remained at 3.7%.
• In the US, CPI inflation increased by 0.5% m/m in July (or was stable at 3.6% y/y), after declining by 0.2% m/m in
June. Core CPI rose by 0.2% m/m and 1.8% y/y. Among the components, energy prices rose 2.8% in July m/m,
after declining by 4.4% in June. Fed Chairman Bernanke spoke at Jackson Hole, where he reiterated that the Fed
has a range of tools that they could use to provide monetary stimulus. He also announced that the September
FOMC meeting would be increased to two days instead of one to give them time to consider these tools.
• In Japan, CPI inflation increased by 0.2%y/y in July (or by 0.1% excluding fresh food), after a decline of 0.4% in
June. For Tokyo, CPI inflation declined by 0.2% in August, after falling 0.1% in July. The Bank of Japan kept
interest rates on hold in August. Meanwhile, the Ministry of Finance introduced a USD 100bn loan facility to help
to cope with JPY appreciation, aimed at urging domestic firms to increase merger and acquisition activities with
foreign firms, to secure energy resources and to help exports by SMEs.
• Inflation remained a concern for many emerging markets in August, although this concern appears to be
moderating. The Brazilian central bank surprised most market commentators with a 50bp cut just outside the
review period, at the start of September, taking the Selic rate down to 12.0%. After the rate cut, the COPOM
emphasised the potential impact on the local economy of the deterioration in the global economy. While the Banco
de Mexico’s monetary policy committee left the reference interest rate unchanged in August, it commented that
the global economic environment has deteriorated significantly and signalled that it would be prepared to adjust
interest rates if Mexican economic performance is weak or monetary conditions tighten. Elsewhere in emerging
markets, South African CPI inflation increased to 5.3% y/y in July, up from 5.0% in June. In China, CPI inflation fell
slightly to 6.2% y/y in August, down from 6.5% in July, largely due to the slower increase in the price of food.
Chinese food prices increased by 13.4% y/y in August, down from 14.8% in July, although the price of pork
remained high with a 45.5% y/y increase in August.
10

Section Two – Review of Global Economics
Economic Data
• Economic data releases in August continued to suggest, overall, that a slower growth trajectory is in place. US
real GDP growth for the second quarter was revised down to 1.0% q/q, from the previous 1.3% estimate. The US
manufacturing PMI declined to 50.6 in August, down from 50.9 in July and 55.3 in June, according to the Institute
for Supply Management (ISM). A figure above 50 generally indicates economic expansion. Among the
components, employment fell from 53.5 in July to 51.8 in August and export orders declined from 54.0 to 50.5. In
contrast, the ISM’s non-manufacturing index rose to 53.3 in August, returning to the same level as June after
declining in July. Performance of the index components were mixed, with declines in business activity and the
employment index but improvements in new orders and supplier deliveries. After improving in July, the
Conference Board consumer confidence index declined in August to 44.5, from 59.2 the previous month. It is now
at its lowest level since April 2009 and most of the decline occurred in the expectations component, which fell
sharply from 74.9 in July to 51.9 in August.
• One of the most worrying aspects of the US economy is the labour market. The employment report for August
was generally weak, with nonfarm payrolls unchanged in August and 17,000 new jobs in the private sector.
However, adjusted for the workers strike at telecoms giant Verizon, payrolls would be significantly higher
(approximately 45,000 workers went on strike at the company in August). Average weekly hours declined slightly,
to 34.2 hours per week in August from 34.3 in July, and hourly earnings also declined by 0.1% m/m. The
unemployment rate remained stable at 9.1% in August.
• In the US housing market, the Case-Shiller 20-city house price index fell by 4.5% in June y/y, or by 0.1% m/m
seasonally adjusted. Data for new home sales also showed a decline of 0.7% m/m in July, after falling by 2.9% in
June. Not all US data was weaker in August, however. In the factory goods report, new orders increased by 2.4%
in July, after a 0.4% decline in June, and shipments also increased by 1.6%. The durable goods report for July
also showed an improvement, with new orders growth of 4.0% m/m (after a decline of 1.3% in June) and
shipments rose 2.5% m/m in July, up from 1.1% in June.
• The eurozone macroeconomic backdrop continued to deteriorate with concerning evidence of a slowdown in core
nations adding to pre-existing peripheral weakness. This was highlighted by the European Commission (EC)’s
survey, which showed a sharp deterioration over the July reading. Consumer confidence declined to -16.5 in
August, from -11.2 in July, while economic sentiment fell to 98.3 from 103.2. By country, economic sentiment was
stable in Italy and Spain and actually increased in Greece. However, it fell sharply in Germany, where the IFO
survey also plunged in August with declines across all sectors (business climate, business expectations and
current conditions).
• PMI data for the eurozone disappointed in August. The manufacturing PMI for the region as a whole fell to 49.0,
from 50.4 in July. By country, the German manufacturing PMI dropped to 50.9, from 52.0, while the French and
Italian indices both fell below the important 50-level, to 49.1 and 47.0 respectively. The eurozone services PMI for
August registered 51.5, slightly down from 51.6 in July and the second-lowest reading since September 2009.
According to the accompanying report by Markit, “euro area service sector growth slid closer to stagnation in
August. A stalling of manufacturing growth, biting austerity measures and worries about the region’s deepening
financial crisis have all taken their toll on demand for services in the summer, and led to the largest drop in
optimism about prospects for the year ahead since the immediate aftermath of the collapse of Lehmans”.
• In August the ECB resumed the purchase of government bonds through the Securities Markets Programme
(SMP). It has also decided to continue conducting its refinancing operations as fixed-rate tender procedures with
full allotment, at least until mid-January 2012. In a speech on 29 August, Trichet stated: “The purchases made on
11

Section Two – Review of Global Economics
the secondary market cannot be used to circumvent the fundamental principle of budgetary discipline. The
Securities Markets Programme strictly aims at correcting malfunctioning of markets”. The region’s unemployment
rate was revised up for May, June and July to 10.0%. Amongst the member states, Spain continued to have the
highest unemployment rate, at 21.2%, while it remained lowest in Austria at 3.7%. Real GDP for the eurozone
grew 0.2% q/q in Q2, following 0.8% growth in Q1, while the German economy grew 0.1% q/q, following revised
down growth of 1.3% in Q1. Spanish GDP growth registered 0.2% q/q in the second quarter.
• In the UK, the Bank of England’s Inflation Report noted that growth is likely to ‘remain sluggish in the near term,
reflecting the continuing squeeze on households’ real incomes. Thereafter, GDP growth gently picks up,
underpinned by a steady recovery in business investment and a gradual rebalancing of the economy towards
external demand’. It also notes that the outlook for output growth remains highly uncertain and that the greatest
risk to global demand comes from the eurozone, which could also have a negative impact on the UK economy.
The BoE’s forecast for 2011 growth is now around 1.4-1.5%, down from its previous estimate of approximately
1.8%.
• UK economic data releases were generally weak in August. PMI data disappointed in August: the services PMI
dropped to 51.1 in August, from 55.4 in July, while the manufacturing PMI fell to 49.0 from a revised 49.4 in July
and construction dropped to 52.6 from 53.5. Among the components of the manufacturing PMI, output fell to 48.9,
new capital goods orders dropped to 47.1, new export orders fell to 46.6 and employment declined to 48.9 – its
first sub-50 reading since 2009. However, manufacturing output increased in July, by 0.1% month on month, after
a decline of 0.4% in July. Consumer and business sentiment has also softened. The Confederation of British
Industry’s survey on consumer and business services was weak for August, with a sharp drop in optimism from 10
to -29 in consumer services and from 23 to -22 in business services. Meanwhile, the Gfk consumer confidence
survey declined slightly in August to -31, from -30 in July.
• UK labour market data has also disappointed, with the unemployment rate rising to 7.9% in June, up from 7.7% in
March, according to the labour force survey However, retail sales volumes increased by 0.2% m/m in July and the
June data was also revised up to growth of 0.8%m/m. Labour market data remained weak, with a jobless total of
2.5 million in August. In some better news for the housing market, data releases from the Bank of England and
from the British Bankers’ Association both showed that mortgage approvals increased in July. According to the
BoE, mortgage approvals increased in July to 49,200 up from 48,500 in June and secured lending increased by
GBP 0.7bn m/m in July, while consumer credit remained flat.
• In Sweden, the National Institute of Economic Research revised down its forecast for Swedish GDP growth in
2012 to 2.0% y/y. In addition, the Ministry of Finance announced that some of the government’s planned fiscal
reforms would be put on hold given the uncertain global economic environment. The Swedish manufacturing PMI
for August declined to 48.7, from 50.1 in July. In Denmark, the economy grew by 1.0% q/q in the second quarter.
• In Japan, Yoshihiko Noda of the ruling Democratic Party became the country’s sixth prime minister in five years at
the end of August, replacing Naoto Kan. He won in a run-off against Banri Kaieda, who had the backing of Ichiro
Ozawa. August data releases for Japan showed that the economy continued to recover from the earthquake in
March and its aftermath, but at a slower rate than previously. Industrial production increased 0.6% m/m in July
(seasonally adjusted), following the 3.8% gain in June. Manufacturing PMI data for August declined slightly, with
the overall index registering 52.0 in August, down from 52.1 in July. Furthermore, the Shoko Chukin survey of
small firms suggested deterioration in business sentiment in August, with the headline index declining to 46.4,
from 47.1 in July. While the manufacturing component declined in August, by 2.8 points, sentiment among nonmanufacturers
increased by 1.1 point. Unemployment data was also disappointing, with the labour force survey
showing an increase in the unemployment rate to 4.7% in July, up from 4.6% in June and 4.5% in May. The
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Section Two – Review of Global Economics
Ministry of Finance’s corporate survey for the second quarter was significantly weaker than the first quarter. Sales
in Q2 fell by 11.6% y/y, after growth of 0.3% in Q1, and current profits declined by 14.6% y/y in Q2, after
increasing by 11.4% in Q1. Capital expenditure also decreased in Q2, by 7.8% y/y, after a 3.0% increase in Q1.
• In Chinese economic data, the NBS manufacturing PMI increased slightly to 50.9 in August, up from 50.7 in July,
with a rise in the output component of 2.2 points. Meanwhile, the Markit PMI also rose to 49.9 in August, up from
49.3 the previous month, with a 1.2 point increase in the output component. In Hong Kong, retail sales volumes
increased 22.4% y/y in July, up from 22.2% in June.
• Elsewhere in emerging markets, real GDP growth for Brazil in the second quarter was 3.2% q/q, down from 5.3%
in the first quarter, or 3.1% y/y (down from 4.1% in the first quarter). In India, real GDP growth for the second
quarter registered 7.7% y/y, slightly down from 7.8% in the first quarter.
13

Section Three – Views and Outlook
• The global economy has slowed in recent months from the robust growth rate that we witnessed around the turn
of the year, while inflation has remained stubbornly high in many countries. In addition, ongoing concerns about
the sovereign debt crisis in the eurozone, numerous downgrades of sovereign debt over the past few months by
the ratings agencies, as well as the downgrade of two large French banks and government/ central bank
intervention in the currency markets, have conspired to increase investor uncertainty. However, the exceptionally
low level of real interest rates in many developed economies suggests that monetary conditions still remain very
supportive. In addition, some of the emerging markets are now commencing or starting to contemplate looser
monetary policy, for example the recent cut in the Selic rate in Brazil.
Economics
• For the US economy, an elevated level of unemployment is a key obstacle for a stronger recovery in activity.
President Obama has now attempted to directly target this problem, with a larger than expected stimulus plan at
USD 447bn. However, this has done little to ease markets thus far as critics point to the failures of previous
stimulus packages, the lack of detail and a questionable ability of the US government to fund the proposed
measures given the recent political agreement over the debt ceiling.
• The announcement of a coordinated move by the ECB, the Fed, the Bank of England, the Bank of Japan and the
Swiss National Bank (SNB) to provide additional US dollar liquidity to the banking system, in three tranches with a
three-month maturity, dramatically alleviates pressure on US dollar funding for the European banks. Most
European banks are long of lending in dollars and short of funding in them, relying on wholesale markets to make
up the gap. If the wholesale markets are closed to them, as they have been now for some time, they have no
option but to shrink their balance sheets. As they shrink their balance sheets they are forced into fire sales, asset
prices roll downwards and we move into the very unpleasant scenario which we have seen before in this crisis –
of falling prices and forced liquidation. Therefore, the announcement from a group of central banks that they
are going to extend dollar swap lines to the ECB, and therefore to the banks in Europe, has helped put off
some of the immediate concerns about funding.
• The next few weeks will be key for developments concerning the sovereign debt crisis in the eurozone.
Concerns persist about the falling price of sovereign debt and that a Greek default, which is almost inevitable, will
set off a daisy chain of other defaults across Europe. There is an expectation that concerted action from European
governments and beyond will provide a springboard to buy enough bonds from forced sellers in order to avoid
keeping bond yields from rising too high and putting governments under pressure in terms of funding in 2012.
There is nothing yet to report on this; at the moment it is supposition. Meanwhile, although an agreement was
reached in July to extend the powers of the European Financial Stability Facility (EFSF) to offer assistance to
countries not currently in a formal programme and to buy bank debt, this requires formal approval by the member
countries. This process will now begin and probably continue through October.
• We expect headline inflation rates in many developed economies to stabilise and trend modestly lower in
2012. The ECB has now hiked interest rates twice this year and QE2 has come to an end in the US. However, the
Federal Open Market Committee (FOMC) announced after its recent meeting that benchmark rates would remain
very low through mid-2013, noting in the press statement: "The Committee currently anticipates that economic
conditions - including low rates of resource utilization and a subdued outlook for inflation over the medium run -
are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013". Unemployment
rates are generally high and unlikely to fall quickly, there is little or no sign of accelerating wage growth and in
many cases longer-term inflation expectations in financial markets are close to central bank targets. Therefore, we
continue to envisage an extended period of exceptionally low short-term rates in the developed economies.
14

Section Three – Views and Outlook
• Recent developments in the UK economy appear to be concerning, with data suggesting that persistently high
inflation and unemployment is resulting in retrenchment by the UK consumer. We continue to take a negative
view on sterling.
• Despite the announcement by eurozone policymakers on 21 July of a new package of measures aimed at
alleviating some of the sovereign debt issues in the periphery, fears of contagion beyond Greece still escalated in
the following weeks, prompting the ECB to announce that it would intervene to buy Spanish and Italian bonds.
That the private sector now has clarity about the terms of a haircut on the Greek bailout is helpful, but the problem
has not gone away and banks are still undercapitalised. A real long-term solution would first involve some serious
pain and readjustment for the banking sector. We expect that austerity programmes and slowing year-on-year
growth rates on industrial production will affect trend growth.
• Regarding Japan, the earthquake and its devastating aftermath had a substantial negative impact on the
economy. The typical pattern of recovery after events such as those in March is “V-shaped”, as an initial sharp fall
in economic activity is followed several quarters later by a reconstruction-led rebound. The historic template that
investors have focused on is the Kobe earthquake in 1995. Using this as a roadmap for future economic activity in
the coming quarters, the size of the fall in growth will depend on recovery of essential services. However, the
adverse impact of this shock event may now be peaking and industrial output growth is rebounding strongly. In
addition, exports are starting to recover rapidly, suggesting that supply chain issues are also being resolved. For
now the yen remains supported by flows and the preference of domestic investors for domestic assets,
however, our view on the yen is negative, reflecting our preference for holding the US dollar given its
current level.
• The global economy remains two-paced as China’s August Industrial Production number came in at 14.2%, in line
with expectations. This was supported by Chinese trade data which showed no slowdown in commodity demand
and highlights the dilemma faced by the Reserve Bank of Australia which is grappling with elevated terms of trade
against a backdrop of an over-levered domestic economy. The weakening trend in Australian unemployment,
which crept up to 5.3% in August, highlights their dilemma of controlling inflation whilst ensuring that they do not
stifle the domestic economy.
• In emerging markets there has been a focus on tackling inflation over recent months, with several EM economies
raising interest rates and enacting other monetary tightening measures, including China, Brazil and India. As
many developed nations lag behind in the tightening road this may lay the foundations for EM outperformance.
We recommend a positive view on short duration local currency debt and, in the equity space, exposure
to domestic growth stories in Taiwan, Thailand and Emerging Europe.
15

Section Three – Views and Outlook
Equities
• Growth rates and forecasts will continue to be the central focus for investors as we move into 2012. A significant
slump in global growth would lead to a reduction in tax revenues and acceleration in the fiscal crises across the
globe. In a world where sovereign debt is no longer regarded as risk free, this would make it very difficult to value
assets effectively.
• We retain a broadly neutral stance on equities, and believe that the themes of income yield and emerging
market growth remain attractive. We note that valuations are currently at attractive levels, even allowing for the
increased but still moderate chances of a developed economies recession, and that recent price action and
anecdotal comments suggest a degree of capitulation. Despite this, we do not feel that there is currently support
for a sustained improvement in macro data and note that, whilst we may see further easing from monetary
policymakers, we appear to be running out of policy levers.
• We have a preference for emerging markets over developed markets and we note that the recent sell-off in
emerging markets has made valuations particularly attractive. Increased evidence that countries such as China
have successfully achieved a soft landing may provide an interesting entry point.
• In light of the slow growth environment globally, we maintain our interest in high dividend equities. Both
the ending of QE2 in the US and the recent shifts in commodity prices are broadly positive for inflation and growth
prospects, though there is some uncertainty in the near term.
• In the eurozone, despite the package of measures announced towards the end of July and the intervention of the
ECB to buy Spanish and Italian bonds, the lack of transparency and political leadership makes it difficult to be
constructive on risk assets. Furthermore, the risk of contagion beyond Greece to other peripheral nations still
remains and additional chapters in the Greek crisis are likely in the future. Economic data from the region has also
weakened recently, causing many observers to reduce their growth forecasts for the eurozone in 2011.
• We remain neutral overall in US equities. For US assets, dollar-based liquidity thus far remains ample,
however, QE2 stopped at the end of June and the possibility that emerging market currencies may rise further will
reduce support from reserve accumulation. Equity investors may need to focus on the potential for tighter profit
margins but slowing economic growth momentum, coupled with higher input and financing costs, could mean a
more challenging quarter for equities. However, equity valuations remain neutral to slightly cheap and earnings
expectations are plausible. In selecting equities, high dividend yields and free cash flows would be our measures
of choice for this quarter and beyond.
• We remain broadly neutral on Japanese equities but are becoming incrementally more positive. Negative
growth in the first half of 2011 is mostly priced into Japanese assets but we expect more positive support for
Japanese equities later in the year. This view is based on currently attractive book valuations and trending return
on capital, as well as the anticipation of a weakening yen, based on the government’s need for extremely loose
monetary policy to meet the demands of reconstruction. We do not see Japan’s expected short-term drop in GDP
as significant globally. Foreign companies have exported less to Japan in recent years due to weak demand, while
some Asian economies may benefit as their exports are substituted for lost Japanese output. As a rule of thumb
we believe that each 1% lower rate of Japanese growth in 2011 than previously forecast removes around 0.1%
from world growth rates taking into account multiplier effects.
16

Section Three – Views and Outlook
• We retain a slight bias towards emerging market stock markets. We note that inflationary pressures in
emerging markets continue to abate and feel that, in the short term, this disinflationary trend should continue.
Specifically, the dip in oil prices and the excess liquidity in the US remove some of the inflationary pressures that
have been plaguing the emerging markets and threatening to negatively impact growth in the developing world.
This may mean that the pace of monetary policy tightening could slow or even cease in some cases, throughout
the second half of the year, removing one of the key headwinds to EM equity performance. Valuations currently
favour emerging over developed markets, adding further support to the case for emerging markets. This relatively
constructive view on emerging markets is consistent with our central case that the recent slowdown in the pace of
Chinese growth will not become a hard landing.
• However, emerging markets are far from uniform and we are being tactical within our country selections. We are
positive on emerging Europe, with preferences towards the strong Turkish economy and Russia as a view on
the energy price.
• Our view on Asia is mixed. We are positive on Korea, Taiwan and Thailand because these markets are
supported by strong domestic demand and could benefit in export terms from lost Japanese output. As a key
agricultural exporter to China, Thailand’s growth is also supported by demand for food. We remain neutral on
Chinese equities because, although we expect further monetary policy tightening and concerns about a property
bubble and double dip persist, we believe negative real interest rates and restrictions on real estate investment
leave domestic savers the choice of commodities or equities as inflation hedges. We are less positive on India,
where valuations are relatively high, earnings momentum has peaked, more action is needed to prevent
inflationary overheating and domestic investors are switching from risk assets into bank deposits offering nominal
yields of around 9%.
• In terms of sectors, the prospect of energy prices remaining high, despite the recent pullback, means that we
continue to be positive on energy companies for the time being. Current oil and natural gas prices would
support potential upside surprises in profits but we are conscious that valuations may become stretched, partly
due to the potential for “demand destruction” at an oil price much higher than USD120/bbl.
• Technology seems to be performing as a low beta sector and we remain positive on technology companies
globally, which are benefiting from secular demand, and where we perceive valuations to be attractive given our
strong expectations for earnings growth. Within the healthcare sector we see medical device manufacturers and
biotechnology companies performing well. In contrast we retain a negative view on banking shares in all regions,
due to the combination of uncertainty over regulatory changes, capital requirements and the potential for reduced
profitability in the near term due to expectations of higher interest rates in many regions. We remain neutral on
industrials, but have a slight preference for US industrials while underweighting European industrials.
17

Section Three – Views and Outlook
Bonds
• We retain a neutral view on fixed income at the broad allocation level. Although valuations are unattractive
we feel that this is partially offset by diversification benefits. Within the asset class, we are most constructive on
high yield and local currency emerging market debt.
• We remain in a situation where bond yields are exceptionally low in both nominal and real terms and it is difficult
to consider government bonds a worthy investment unless you believe in strong deflation risk. To believe in this,
you also have to believe in a very deep recession. At the moment, most of the core industrial output and
consumer numbers, although not very good, are not in deeper recessionary mode. This holds true for the US, Asia
and Northern Europe.
• In government bonds, the decision of Standard and Poor’s to downgrade US debt to AA+ seems to have had little
impact on the appetite of investors to hold US treasuries as a safe-haven asset. Indeed, the downgrade has been
taken by many investors as yet another sign that the world is a risky place, reinforcing their inclination to reduce
risk. The FOMC's statement on 9 August acknowledged that the Fed's outlook is for US growth to be extremely
slow. By suggesting that short-term interest rates would be held near zero through mid-2013, the Fed
demonstrated its still-considerable power over the shape of the yield curve by pulling down two-year interest rates
even further.
• The eurozone fiscal crisis continues to impact valuations in peripheral countries and support already low bund
yields. For Japan, we expect the demands of reconstruction will lead to further government borrowing and loose
monetary policy, limiting the upside prospects for both Japanese government bonds and the yen.
• Within corporate bonds, we prefer high yield credit over investment grade. Default activity has been minimal
and, we expect, is likely to remain low. In addition, the Fed's (lack of) action will push fixed income investors into
longer maturities, high-quality credit and eventually, high-yield bonds. We do also note, however, that corporations
are well financed and pose limited credit risk.
• We also maintain our preference for local currency emerging market debt, as recent rises in interest rates
give us confidence that inflation is being addressed and offer support for currency values relative to the developed
world.
18

Section Three – Views and Outlook
Currencies
• We retain our neutral view of the US dollar. Accommodative US monetary policy will result in an interest rate
differential dynamic that is not conducive to dollar strength. We also retain out negative view of the Japanese
yen, which is a reflection of our preference for holding the US dollar over the yen given its current level.
• We now have a negative view towards the euro. With economic growth slowing across the eurozone, worsening
German politics, the likely eventual Greek default and possible ECB rate cuts, we believe that recent euro support
is disappearing and see the US dollar as a beneficiary of any flight to quality.
• We expect UK economic growth to remain poor and inflation to remain stubbornly high and therefore continue to
take a negative view on sterling against the euro. We retain our positive view on the Canadian dollar, but
note that the Swiss franc looks expensive on valuation measures and is now beginning to impact the earnings of
Swiss companies.
Commodities
• We maintain our overall positive view on commodities, as they continue to be supported by underlying supply
and demand fundamentals. Unsurprisingly, given sovereign stresses, gold has seen significant gains recently. We
also note that recently released Chinese GDP figures are most consistent with a soft landing than anything more
severe.
• We favour precious metals over industrial metals and energy related commodities, as these commodities
are not pricing in an economic slowdown and although we still like the structural story and remain in the China soft
landing camp, we see more value in basic resources equities. Our view of UK property is mildly constructive for
those portfolios required to hold the asset class, however, we harbour some concerns over refinancing in 2012.
• We are neutral overall in agriculture but believe that fundamental supply constraints in agricultural commodities
will be supportive in the short term, particularly due to poor weather conditions.
19

Section Four – Special Features
Special Feature One: Investment strategies after a summer of volatility
A special market update based on a panel discussion between: Ewen Cameron Watt, Bob Doll, Rick Rieder and Scott
Thiel that took place on 8 September 2011.
• The summer of 2011 is one that investors will long remember — and not for good reasons. The first-ever ratings
downgrade for the United States, escalating uncertainty over the European debt crisis, weak economic data that
is sparking renewed concerns over the possibility of a recession and political turmoil around the world have all
contributed to an enormous spike in volatility and a sharp selloff in risk assets.
• In this sort of environment, many investors are looking for guidance as they seek out strategies to navigate
through these difficult markets. Despite these challenges investment opportunities do exist, and in the following
pages we discuss the issues weighing on the markets and offer some specific investment ideas that can help
investors recalibrate their portfolios following this eventful summer.
Europe Holds the Key
• For some time we have been focused on four major risks to financial markets: the US debt ceiling debate; the
potential for a hard landing in emerging markets as they seek to manage growth and inflation pressures; the
slowdown in US economic growth; and the debt crisis in Europe. The good news is that the first two of these risks
appear to have passed as potential negative shocks to markets. The other half of the equation, however, is less
clear. The risks of a US slowdown have been heightened in recent weeks. While the markets may be pricing in a
recession, we believe that risk is overstated and do not see the US slowdown as the key driver of volatility.
• In our view, the most profound driver of financial market volatility is European sovereign debt risk. We still believe
on balance that survival of EMU is more likely than not but recent events and political realities are testing this faith.
• Outside of Greece, given the elevated interest rates on their debt, Spain and Italy are ill-equipped to maintain any
sort of fiscal stability without clearer European Central Bank (ECB) support or the European Financial Stability
Facility (EFSF) properly in place. In addition, the current funding stress the financial sector is enduring cannot
continue without a material risk of a major negative event sometime in the near term. With a much flatter growth
trajectory in Europe than previously expected, banks will continue to be ever more unable and unwilling to extend
credit. Compounding the issue, we are seeing many more European corporates warn of profit estimate shortfalls,
which will continue to drive European equity risk. Commentators have slammed Europe and its institutions for
being behind the curve. In our opinion these shrill voices miss the point. ‘Europe’ is a geographical as well as
political term. The European Union comprises 17 countries with at least 70 meaningful political parties. Much of its
legislative and organizational structure requires unanimity or majority decision making. Many of the solutions
proposed by pundits require some surrender of sovereignty by lender and borrower and are therefore subject to
domestic political risk (just as the deficit ceiling negotiations in a single country, the US, have been subject to
paralysis arising from similar risk).
• That said we do believe that European policy makers decision making speed has been more leisurely than
required. We also believe that this speed only accelerates in the face of crisis heightening. Hence: a) the ECB as
a non-political body becomes ever more crucial in problem solving; b) there will likely be more spikes in this crisis
episode followed by action; and c) given a and b, the euro is vulnerable to downside risk. It is also worth noting
that no legal process allows for a country seceding from or otherwise exiting the EMU. Any exit would be messy,
subject to capital flight not confined to a single country and have material global consequences.
20

Section Four – Special Features
Three Crucial Near-Term European Hurdles
• In the next several months, we see three crucial hurdles to European financial system and market stability. The
first is the Greek debt restructuring. Greece is in process of its debt exchange offer and looking for 90% of its
bonds to be exchanged, which we do not believe is likely. However, we do believe the exchange could reach 75%,
which would be a high enough hurdle for the IMF and the EU to disburse the funds promised to Greece at the end
of September, which is our second crucial hurdle. If the IMF does not disburse funds, Greece will run out of money
within a month thereafter. It is critical that the IMF disburse these funds, and our base forecast is that this will take
place.
• Ultimately, the role of the ECB as facilitator of solutions is our key third hurdle. We were somewhat surprised at
the lack of urgency behind the central bank’s most recent comments on September 8, and our concern is that their
critical support may arrive slower than the markets need it. The ECB needs to continue its debt-purchase
programme and must continue to provide market liquidity, which remains our base case.
Investment Opportunities: Fixed Income
• Our base case for the US economy is that it will continue to muddle through with data indicating not recession, but
not substantial growth either. We expect a return to an environment where one positive data point is followed by
one negative, such as was the pattern before the mid-August volatility spike. The environment will be driven by
risks such as the aforementioned European debt crisis, US growth, and US fiscal policy and political wrangling.
• Given our central assumption that economic growth will be sluggish and the Fed will maintain rates at an
exceptionally low level for a long time, investors are struggling with obtaining sufficient yield and income. We see
just a couple of ways to do it: Investors can either invest further out the yield curve with longer maturities and
greater duration (a measurement of sensitivity to interest rate risk), or take on credit risk. We would argue that this
is not a time to take on significant duration risk, but to focus on supplementing yield via credit.
• Our favoured approach is a barbell strategy incorporating exposures at both the short and long end of the curve,
as well as “rolling down the curve.” By this we mean buying maturities of 3-5 years with higher yield and trading
out of them when opportunity for total returns is at its height. Then doing it over again. At the short end, we like
high yield assets, whereas we prefer investment-grade credit and high-quality munis at the longer end. Since we
believe default rates will remain historically low, we also like certain asset backed securities, bank loans and high
yield for their higher coupon. In terms of sectors, we like tactically adding some financial company debt, though
this requires diligent credit research. Some insurance companies also offer opportunities to pick up some yield.
• Outside of the US, we believe rates will continue to fall. Like the US Federal Reserve, the Bank of England and
the Bank of Japan will maintain exceptionally low interest rates for a long time. As the European debt markets
reopen, we like high-quality corporate bonds since we should see new supply and opportunities in the corporate
markets. Other areas to consider are high-quality sovereign issuers in the EU and select emerging market names
where we have seen spread widening. Some of the semi-core European issuers outside of Germany have shown
value, but again, due diligence will be key.
• Investment opportunities in other areas including emerging markets remain, but growth risks have taken over from
inflation risks in most nations. We have begun to see central banks in Australia and Brazil cut interest rates in
response to the slowing economic environment. China is working on fiscal proposals as well and we expect to see
a plan in the next several months. With additional clarity in Russian leadership this fall, we believe risk premiums
may offer an investment opportunity.
21

Section Four – Special Features
• Absent a depression, we believe emerging market growth should continue to slow, but will still be higher than
developed markets. With emerging market debt having low correlations to developed markets, investors should
consider opportunities for exposure. Investors should consider frontier markets subset (i.e. Argentina, Romania,
Vietnam, etc.) as well, as they are uncorrelated to the more developed emerging market economies, and offer
inexpensive investment opportunities. The risk of financial repression remains however. In this context the recent
pinning of the Swiss Franc to the euro is risk asset friendly as it represents a mild form of quantitative easing. At
the same time, policy shifts in the emerging markets world will lead to some relaxation of monetary policy which
would help emerging market equities.
Investment Opportunities: Equities
• A review of the US stock market’s recent correction from peak to trough shows that US equities have fallen about
18% from their April high. In comparison, when equity markets began to price in a double-dip recession last
summer, US stocks fell 17%. The issues remain very similar as well: rising oil and gasoline prices, credit concerns
in Greece, and fiscal policy concerns in the US. Last year the economy did not succumb to a recession, and we
continue to believe it won’t happen this time either.
• Even while US real GDP growth for the first half of the year was only 1%, corporate earnings growth was 17%, as
many corporations have learned to run their businesses efficiently in a low growth environment and have
managed to gain market share despite the economic backdrop. The fact that economic growth remains positive,
even if incrementally so, is important to corporate operating leverage, an indicator that bears close watching.
• At the recent 1,100 low point for the S&P 500, the market was pricing in earnings declines of 10% to 15% for the
next year, while consensus earnings estimates currently model growth of 10% to 15%. Our view is that corporate
earnings will come in the middle of these outlooks, leaving earnings at flat or a little higher. At the same time,
however, S&P 500 valuations remain at historic lows at 11 times earnings. The last time that was the case the 10
year US Treasury had an interest rate in the 8% range, not in the 2% range. Furthermore, with equities currently
returning more yield than the 10 year Treasury, valuations are clearly attractive.
• Within this environment, stock selection is critically important. Investors should focus on companies with positive
and accelerating free cash flow, offering them the flexibility to raise dividends, buy back stock, or engage in
merger and acquisition activity. Ultimately, however, the most beneficial activity for the economy would be
business reinvestment and expansion through hiring. Second, companies that are gaining market share will
perform better in this muddle-through economy. From a US sector perspective investors should also gain
exposure to some cyclical and defensive (less dependent on economic growth) areas given the slow growth and
uncertain environment. We favour technology and energy companies in the former and healthcare companies in
the latter.
22

Section Four – Special Features
Special Feature Two: Recent Developments in the Eurozone Sovereign Debt Crisis
• Jürgen Stark, the ECB’s Chief Economist, announced on 9 September that he will step down early. Although his
tenure was due to expire in 2014, Stark apparently disagrees with the Securities Markets Programme (SMP). In
August the ECB resumed the purchase of government bonds through the SMP, which is essentially a de facto
monetisation of peripheral debt. The ECB has effectively become a lender of last resort for governments as well
as banks and, by monetising the sovereign debt problem, risks undermining confidence in the currency.
Bundesbank President Jens Weidmann also commented that people within the eurozone are worried about their
currency and criticised the bond purchases, saying that the ECB has burdened itself with considerable risks.
• On 15 September the ECB, US Federal Reserve, Bank of England, Bank of Japan (BoJ) and Swiss National Bank
(SNB) announced a coordinated move to provide additional US dollar liquidity to the banking system, in three
tranches with a three-month maturity. This coordinated move helped to boost equity markets and dramatically
alleviates pressure on US dollar funding for the European banks.
• Christine Lagarde, Head of the International Monetary Fund, said on 15 September: “There is still too much debt
in the system. Uncertainty hovers over sovereigns across the advanced economies, banks in Europe, and
households in the United States. Weak growth and weak balance sheets—of governments, financial institutions,
and households—are feeding negatively on each other, fueling a crisis of confidence and holding back demand,
investment, and job creation. This vicious cycle is gaining momentum and, frankly, it has been exacerbated by
policy indecision and political dysfunction."
Credit rating movements
• In September Moody’s cut the long-term debt rating of two large French banks by one notch each, Credit Agricole
and Societe Generale, on concerns over their exposure to Greek debt and potential funding difficulties.
Meanwhile, regarding Spain, Fitch has stated that the risks for the country’s credit rating are “clearly on the
downside”. Data released last week showed that most regions are behind schedule to meet deficit targets and
Fitch has now downgraded the ratings of five Spanish regions, including Catalonia. Spain currently has an AA+
rating with negative outlook from Fitch.
• On 20 September S&P surprised the market by cutting Italy’s credit rating by one notch to A, from A+, with a
negative outlook. Italy is currently under review for a possible downgrade by Moody’s, who presently rate it Aa2.
The Italian government will hope that the successful passage of their contentious austerity budget on 14
September will prevent the need for further downgrades.
Currency manipulation
• The SNB announced on 6 September that they will maintain a minimum EUR/CHF exchange rate of 1.20 by
purchasing unlimited quantities of foreign currency. The timing of the announcement was a surprise which, in
conjunction with a large intervention in the FX spot market, caused EUR/CHF to increase sharply. Philipp
Hildebrand, Chairman of the SNB, stated that international developments have “resulted in a massive
overvaluation of our national currency. Switzerland is a small and very open economy. Every second franc is
earned abroad. A massive overvaluation carries the risk of a recession as well as deflationary developments. The
Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc.”
• There has been no mention of the EUR/CHF floor being temporary. The policy also means that CHF is no longer a
liquid hedge for the eurozone crisis. Since the announcement, demand for the Scandinavian currencies and JPY
has increased. The real test will be in the coming months as the eurozone debt crisis develops. It is highly likely
that the external environment that the SNB is trying to counter will not be helpful towards the SNB’s objective.
23

Section Four – Special Features
Special Feature Three: Spotlight on the UK Equity Market
• Over the last three months (to 20 September), the UK equity market has underperformed the US but significantly
outperformed Europe and, in particular, the eurozone. In absolute terms, the FTSE 100 is up 4.3% at the time of
writing and has fallen by 8.0% over three months (both to 20 September). This compares to a three-month decline
of 5.3% in the S&P 500 composite, a 15.8% fall in European stock markets and a 22.4% decline in the eurozone.
• Where does the current UK stock market level leave investors Perhaps unsurprisingly, valuations now look
compelling on a historic basis as forward PEs near 9.6x, compared to a historic average of 15.2x. In a worldwide
context this is perhaps starker, as 80% of UK sectors are trading at a discount to global peers. This valuation is
best considered in the context of the “safety” of earnings expectations. Only 40% of earnings growth in the UK is
attributable to margin expansion, whilst the US, Europe and Japan all look more reliant on growing what are
already peak margins (45%, 60% and 80% respectively). Finally, with bond yields tightening aggressively in recent
weeks we have seen the equity risk premium revert to more extreme levels: the FTSE now yields 3.7% versus
2.39% on the 10 year gilt.
• The outlook for the UK economy, however, remains grim. Headline and core measures of inflation are nearing
their peaks, while unit labour costs, the key driver contributing some 70%, are growing at a meagre 1.5%. Recent
PMI levels are consistent with 0% GDP growth and vacancy growth rates in the job market are consistent with
minimal employment growth and, by extension, the outlook for the UK residential property market also remains
soft. This is before we account for planned fiscal tightening, which is expected to be 1.5% of GDP. With trend
growth currently sub 1% the outlook for the UK economy is not healthy.
• There are, thankfully, mitigating factors. Firstly, the UK equity market is truly global, deriving 78% of revenues
from sources outside the UK meaning that domestic weakness is certainly dissipated. The bulk of this 78% comes
from Europe and the US, but a growing percentage is from emerging markets. A deteriorating domestic economy
may also have a positive effect in that it is likely to encourage policy makers, who have more levers at their
disposal than their counterparts in Europe, to instigate a second round of QE. Clearly lower real bond yields and a
cheaper cost of debt would aid the fiscal situation in the UK. Such a policy has arguably more likelihood of
success if used here and it is less controversial than in the US, where two rounds have had limited impact on the
domestic economy.
• In the UK, the average maturity of debt is roughly three times longer than the US (at 15 years) and relatively little
is stock-index linked, thus, the ability to meaningfully shift the yield curve is more pronounced. Reducing real
returns on UK government bonds by creating money to buy them will weaken the currency and likely push up
inflation. Given the high proportion of export-derived income in UK GDP (31%), weaker sterling would be
supportive of export-related UK business. Furthermore, incremental inflation will help deal with the debt burden at
the margin. The timing of such implementation of this policy by the MPC is unclear but the inclusion of the hawkish
Martin Weale is likely to support such moves.
• Further quantitative easing is, however, no sure thing. As such we retain a neutral view on the UK. The defensive
status of the market is attractive, valuations are compelling and certain sectors look attractive. However, there are
issues and we think that the appealing themes contained within the market are perhaps best played elsewhere.
We are concerned about the outlook for the banking sector, where anaemic domestic loan growth has been
compounded by continued political and regulatory risk, by peripheral sovereign exposure (primarily via Ireland)
and an uncertain earnings outlook. The Independent Commission on Banking report offered increased clarity over
regulatory expectations but left much of the real decision making for what is ultimately “ring fenced” to the financial
institutions in question. It is also potentially damaging to profitability in the fact that expected changes are likely to
24

Section Four – Special Features
cost around 30% of banks’ PBT, albeit spread over a 10 year period. Thus we are likely to see continued political
interference within the banking system.
• The second major detractor from performance in the past three months has been the basic materials sector. We
view this as more of an opportunity but one perhaps better expressed more purely. Mining companies suffered as
investors shunned the sector, fearing a drop off in earnings as an economic slowdown takes hold – as in 2007.
There are differences between now and 2007, however, in that the large mining companies’ balance sheets are
stronger with more cash and lower gearing, and global commodity inventories are lower than 2007 where excess
supplies led to a sharper decline in demand. Thus, the sharp disparity between equities and their underlying
commodities offers opportunities.
• Overall, we remain neutral on the UK equity market. Although a safe haven amongst European equity markets in
times of distress, in the event of a concerted recovery in risk assets there are more distressed European markets
which are likely to outperform the UK. An indication of further changes to fiscal policy would potentially change our
view.
Figure 1: MSCI UK Sector 3 Month Performance
Source: Data is 3 months to 14 Sept 2011, BlackRock DataStream
Figure 2: MSCI UK Sector Weighted 3 Month Performance
Source: Data is 3 months to 14 Sept 2011, BlackRock DataStream
25

Section Four – Special Features
Special Feature Four: Brazil Interest Rate Cut
• In the first week of September the Central Bank of Brazil (BCB) surprised the market with an unexpected 50bp
interest rate cut. In a 5-2 decision, the central bank’s monetary policy committee, known as COPOM, reduced the
SELIC rate by 50bp, to 12.00%. With CPI inflation above target, this move was against market consensus and no
market analysts forecasted a rate cut. While interest rate futures were discounting a 25bp cut, it was not at the
time unique in that rates markets discounted further loose monetary policy, ahead of other asset classes and
analyst consensus.
• What made the move more surprising was the fact that inflation is running above target, while domestic demand
and labour market conditions are very strong. As a consequence, break-even inflation and inflation expectations
spiked.
• Prior to the surprise cut the BCB had raised interest rates at each of its previous five policy meetings,
accumulating 175bp of hikes this year. The COPOM minutes revealed that the current global cyclical slowdown is
estimated to have a negative impact on the Brazilian economy, equal to a quarter of the 2008 global demand
disruption.
• It is worth highlighting that Brazil, unlike many other countries, is in the strong position of having room to loosen
monetary policy as the downside risks to growth increase. It also seems we moved to a policy mix that does not
favour currency appreciation. Fiscal tightening and monetary easing, together with not so long imposed measures
to curb BRL strength, have changed the fundamental picture for the Brazilian currency. With BRL being a
relatively crowded investment, it seems there is some scope for further weakness, particularly if commodities sell
off from here.
• Looking at the broader monetary policy implications, it seems somewhat surprising that an emerging market
central bank was the first to deliver a surprise cut following a deterioration in global economic activity. Historically
the G3 central banks have usually led the way. What makes Brazil's move even more unusual is that its economy
is far less exposed to the global trade cycle. One would expect the smaller, more exposed economies to cut first.
Figure 1: SELIC rate and Brazil 2-year yield
Source: Bloomberg September 2011
26

Section Four – Special Features
Source: Thomson Datastream, BlackRock
27

Section Four – Special Features
Source: Thomson Datastream, BlackRock
28

Section Four – Special Features
Source: Thomson Datastream, BlackRock
29

Section Four – Special Features
Source: Thomson Datastream, BlackRock
30

Section Four – Special Features
Source: Thomson Datastream, BlackRock
31

Section Four – Special Features
Source: Thomson Datastream, BlackRock
32

Section Four – Special Features
Source: Thomson Datastream, BlackRock
33

Section Four – Special Features
Source: Thomson Datastream, BlackRock
34

Section Four – Special Features
Source: Thomson Datastream, BlackRock
35

Section Four – Special Features
Source: Thomson Datastream, BlackRock
36

37
Section Four – Special Features

38
Section Four – Special Features

Section Four – Special Features
Source: Thomson Datastream, BlackRock
39

Section Four – Special Features
Source: Thomson Datastream, BlackRock
40

Section Six - Appendix
Statistical Appendix
41

Market Performance to 20 th September 2011
-1M Dollar
-3M Dollar
-12M Dollar
Category Local
Euro Local
Euro Local
Euro
World 4.5 2.4 8.5 -8.3 -9.2 -4.5 -0.3 2.7 -1.5
North America 6.9 6.8 13.1 -4.7 -4.8 0.1 8.8 9.2 4.6
S&P 500 7.4 7.4 13.7 -4.8 -4.8 0.1 9.1 9.1 4.6
Nasdaq 100 11.6 11.6 18.2 -0.1 -0.1 5.0 12.8 12.8 8.1
Canada 1.6 0.9 6.9 -4.2 -5.4 -0.6 2.6 6.9 2.5
Japan 2.2 2.0 8.1 -4.5 0.1 5.2 -7.9 3.5 -0.8
Jasdaq 0.2 0.0 4.4 -4.3 1.6 4.4 2.2 16.1 9.3
Europe - MSCI 1.9 -4.6 1.1 -15.5 -19.1 -14.9 -11.1 -7.4 -11.3
UK 4.5 -1.4 4.5 -7.8 -10.8 -6.2 -0.9 -0.9 -5.0
Europe ex UK 0.5 -6.3 -0.8 -19.4 -23.4 -19.5 -15.8 -10.7 -14.4
Asia Pacific -0.4 -3.4 3.2 -8.1 -12.0 -6.1 -8.2 -6.0 -6.2
Emerging Markets 3.0 -1.9 4.0 -7.9 -13.1 -8.6 -5.1 -5.8 -9.8
Asia 0.9 -1.6 4.2 -10.2 -12.5 -8.1 -7.1 -6.1 -10.0
Latin America 7.9 -1.5 4.4 -3.1 -11.9 -7.4 -5.5 -8.1 -11.9
Europe 2.0 -4.5 1.2 -13.6 -22.2 -18.2 -2.2 -5.8 -9.8
Large Cap 2.3 8.4 -9.4 -4.8 2.6 -1.7
Small Cap 3.2 9.3 -10.8 -6.2 6.7 2.3
Growth 2.9 9.0 -8.4 -3.7 5.0 0.6
Value 2.1 8.1 -10.8 -6.3 1.5 -2.7
BONDS
US 0.8 0.8 6.8 5.2 5.2 10.6 7.0 7.0 2.5
Germany 2.1 -3.6 2.1 7.7 2.5 7.7 6.2 10.8 6.2
UK 1.7 -4.0 1.6 7.1 3.6 8.9 9.8 9.9 5.3
UK Index Linked 0.4 -5.2 0.4 5.5 2.1 7.3 13.8 13.8 9.1
Japan 0.3 0.0 6.0 1.2 6.1 11.5 1.7 14.3 9.5
Investment Grade -2.6 3.2 -0.5 4.6 5.8 1.4
High Yield -1.7 4.1 -4.7 0.2 4.3 0.0
Emerging Market -1.0 4.8 1.9 7.1 6.1 1.7
CURRENCIES
Euro/$ -5.6 -4.9 4.4
Euro/£ 0.0 0.1 5.5
$/Yen 0.2 -4.6 -11.0
Notes: 1 Price Index
Indices
Equities
World – MSCI World
North America – MSCI North America
Canada – Toronto 300
UK – FTSE All Share
Europe Ex. UK- MSCI Europe Ex. UK
Japan – Topix
Asia Pacific – MSCI Asia Ex. Japan
Emerging Markets – MSCI Emerging Mkts
Large/Small cap – S&P Citigroup World
Growth/Value – S&P Citigroup World
Bonds
US – JPM U.S. Govt. Bond Index
Germany – JPM Germ. Govt. Bond Index
Gilts – Fta Govt. All Stock
UK Index Linked – Fta Brit. Govt. Index Linked
Japan – JPM Japan Govt. Bond Index
Investment Grade – Salomon Global Broad Index
High Yield – Merrill Lynch Global Index
Emerging market – JP Morgan EMBI
Source: Thomson Datastream
42

43
Global Sector % Relative Performance, US$

Valuation Framework as at 20 th September 2011
PE
Price/
Normalised
EPS
Dividend yield
% P/Cashflow P/Book value
Equity Risk
Premium(3)
IBES EPS
Growth
%
IBES Revisions
– Estimate
Changes, %(4)
IBES Revisions
– Upgrade Rate,
%(5)
Equity Market 2010 2011 2012 Curr Avg (2) Curr Avg (2) Curr Avg (2) Curr Avg (2) Curr Avg (2) 2009 2010 +5 yr 2010 2011 2010 2011
World 12.8 11.3 10.0 14.1 21.3 2.9 0.0 7.8 0.0 1.6 0.0 6.6 2.3 13 13 12 -28 -43 -2.8 -3.3
US 14.3 12.3 10.8 16.2 19.9 2.1 0.0 9.0 0.0 2.0 0.0 6.1 3.1 16 14 12 -28 -43 -1.7 -1.5
Japan 12.8 10.4 10.4 23.6 50.8 2.1 0.0 5.4 0.0 1.0 0.0 3.1 -0.6 23 11 17 -24 12 -2.9 -4.5
Europe 9.8 9.1 8.2 19.7 18.3 4.3 0.0 6.5 0.0 1.3 0.0 5.0 2.8 7 12 11 -41 -55 -4.6 -5.6
Europe ex UK 9.3 9.1 8.1 11.7 20.0 4.7 0.0 5.9 0.0 1.2 0.0 8.4 3.4 3 12 10 -49 -64 -5.6 -7.2
Germany 8.0 8.0 7.1 17.4 20.8 4.4 0.0 5.5 0.0 1.1 0.0 5.0 2.8 1 11 9 -59 -74 -2.2 -5.9
France 8.4 7.9 7.2 10.4 22.6 4.9 0.0 5.3 0.0 1.1 0.0 8.8 3.8 6 9 9 -53 -68 -5.5 -7.4
UK 10.7 9.2 8.3 12.6 15.5 3.6 0.0 7.9 0.0 1.6 0.0 7.8 4.1 17 11 13 -11 -26 -2.7 -2.5
Australia 11.7 10.5 9.6 15.3 17.0 5.0 0.0 10.6 0.0 1.7 0.0 5.8 3.4 10 9 12 -23 -40 -5.1 -4.0
Asia ex Japan 12.3 11.0 9.8 18.0 16.2 2.6 0.0 7.9 0.0 1.7 0.0 5.4 4.0 12 12 14 -17 -32 -3.7 -4.5
Latin America 11.2 10.2 9.2 21.5 15.4 3.0 0.0 7.5 0.0 1.7 0.0 4.7 5.8 10 11 13 -21 -37 -3.2 -3.6
Emerging Europe 6.9 5.7 5.6 15.0 20.5 2.7 0.0 4.6 0.0 1.1 0.0 6.5 3.1 22 1 n.a -27 -53 2.6 -2.2
Note: (1) Source IBES. (2) All averages are 1984- where available. (3) Equity Risk Premium is versus US real interest rates. (4) "Est changes" is number up-down/forecast changes. (5) "Upgrade rate" is change to
earnings level in past 3 months.
44

Summary of current sector valuations as at 20 th September 2011
Price to book value Price to cash earnings Price to earnings Dividend Yield %
Current Trend Current Trend Current Trend Current Trend
Energy 1.7 2.7 6.4 8.8 11.5 17.5 2.6 2.6
Materials 1.8 2.1 7.8 8.6 13.1 21.0 2.1 2.3
Industrials 1.8 2.6 7.8 10.7 13.3 22.2 2.7 1.9
Capital Goods 1.8 2.6 8.0 11.6 12.7 22.5 2.7 2.0
Commercial Services & Supplies 2.4 3.5 9.0 12.4 17.0 24.4 2.7 1.7
Transportation 1.7 2.1 6.7 7.8 15.3 21.6 2.4 1.7
Consumer Discretionary 1.8 2.3 7.4 10.3 14.6 26.5 2.0 1.5
Automobiles & Components 1.1 1.7 4.1 5.6 8.7 14.8 1.6 1.9
Consumer Durables & Apparel 1.7 1.9 10.2 11.3 29.1 28.5 1.6 1.4
Hotels Restaurants & Leisure 3.2 2.9 12.3 12.9 19.0 21.9 2.2 1.9
Media 1.8 2.5 7.0 16.8 14.6 60.8 2.6 1.5
Retailing 2.9 3.4 11.3 14.4 17.7 24.1 1.8 1.3
Consumer Staples 2.8 4.0 11.0 13.5 15.8 20.7 3.1 2.3
Food & Drug Retailing 1.9 3.3 8.2 11.7 14.3 21.4 3.0 1.9
Food Beverage & Tobacco 3.3 4.0 12.0 13.3 16.3 19.3 3.2 2.6
Household & Personal Products 3.3 5.8 12.6 17.0 16.5 25.3 3.0 1.9
Health Care 2.4 4.9 10.5 18.1 15.1 23.8 2.9 1.8
Health Care Equipment & Services 2.4 3.1 10.5 15.2 14.4 22.7 1.2 0.8
Pharmaceuticals & Biotechnology 2.5 5.5 10.5 18.5 15.4 23.9 3.5 2.1
Financials 0.9 1.9 9.7 19.0 10.9 6.9 3.6 2.7
Banks 0.9 1.9 -- 0.0 9.6 18.0 4.4 3.2
Diversified Financials 0.8 2.1 8.7 11.3 11.4 16.5 1.9 2.2
Insurance 0.9 2.0 -- 7.9 10.7 20.6 3.9 2.0
Real Estate 1.3 1.4 11.6 16.2 17.1 22.7 3.7 3.5
Information Technology 2.6 4.4 9.4 18.2 13.8 21.2 1.3 0.7
Software & Services 3.7 7.5 12.0 26.4 15.7 36.4 1.2 0.5
Technology Hardware & Equipment 2.0 3.8 8.2 16.6 13.1 22.3 1.0 0.7
Telecommunications Services 1.6 2.5 4.4 7.3 11.3 31.6 5.9 3.2
Diversified Telecommunications 2.2 4.4 7.4 20.0 11.1 36.7 2.5 0.9
Wireless Telecommunications 1.7 2.7 4.0 6.7 10.4 -41.1 7.0 3.6
Utilities 1.3 1.9 5.6 6.7 18.5 16.2 4.9 3.8
Total Market 1.6 2.5 7.8 11.0 12.8 21.2 2.8 2.1
Price to book, price to cash earnings, price to earnings and dividend yield figures are top-down sector aggregates; the trends are 20 year historic means. For Food & Drug Retailing, Food, Beverage & Tobacco,
Household & Personal Products, Health Care Equipment & Services, Pharmaceuticals and Biotechnology, Diversified Telecoms and Wireless Telecoms, all top-down trends are 6 year historic means. This is due to the
non-existence of these sector classifications under old MSCI aggregation. In these cases only the history available under current classifications has been used. For Financials and Diversified Financials, the price to
cash earnings trends are 6 year historic means, as the old MSCI aggregation did not generate figures for these multiples. Bottom-up valuations Implied growth figures are annual percentage growth rates derived from
bottom-up, company-specific calculations; the trends are 12-year historic means.
45

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Abbreviations:
MSCI – Morgan Stanley Capital International
S&P GSCI – Standard & Poor’s / Goldman Sachs Commodities Index
46