investment insights emea

Investment InsightsOutlook 2012

RZ_Investment Insights_ENGL_12_Investment Insights 07.12.11 18:45 Seite 1

Introduction from the CIO 3

Regional perspective 4

Our House View: Economic and policy themes for 2012 5

Macroeconomic outlook 10

Portfolio management in 2012 17

Ten Investment topics for 2012 20

Forecasts and current data summarized 22

Asset Allocation 25

Key contacts: our Global Strategy Team 26

Table of contents

Our Global Investment Committee (GIC), Private Wealth Management

Kevin Lecocq (Chair)Global Chief Investment Officer

Arnaud de Servigny(Deputy)Global Head of DiscretionaryPortfolio Management andStrategy

Larry V. AdamChief Investment Strategist,US

Yves CochezSenior Portfolio Manager, Latin America

Owen FitzpatrickHead of Global EquityPractice, US

Björn JeschHead of Discretionary Portfolio Management, Germany

Stéphane JunodHead of Discretionary Portfolio Management, EMEA

Anurag MaheshHead of Global Investment and Key Client Solutions, Asia Pacific

Christian NoltingHead of Discretionary Portfolio Management andStrategy, Asia Pacific

Ben PaceChief Investment Officer, Americas

Elke Speidel-WalzChief Investment Strategist, Germany

Martyn SurguyHead of Discretionary Portfolio Management, UK

Art builds. Art questions. Art transcends borders. Art works.

Deutsche Bank has been opening up the world of contemporary art to the public through its own substantial collection, its exhibitions, and its joint projects with partners. Around the world. For thirty years.

More information can be found in the online art magazine at www.db-artmag.com.

Drawing a Curtain by Ken Kiff at Deutsche Bank, London© The Estate of the ArtistPhoto: Jacqueline Duschkin


Investment Insights December 2011

Dear reader,

The world is now changing fundamentally, after a 30-year period following market deregulation in theearly 1980s.

Developed economies’ governments must now face up to unsustainable fiscal positions. Economicgovernance will have to change as result. Social welfare systems developed since World War II are no longer workable, and this is likely to add to political and social stresses.

In this environment, any policy consensus is likely to be less assured. This is already being demonstratedby the debate over the desirable role for central banks.

There will be major implications for investment management. Under conditions of continued uncertaintyand volatility, it will be necessary to take a dynamic approach to portfolio rebalancing, and to use financialinstruments and other shock absorbers to reduce risk.

But remember that – assuming some resolution to the Eurozone crisis – global economic growth is still likely to be greater than 3 percent, and this will create investment opportunities. Equity in well-governed, flexible companies plugged into this global growth is trading at attractive valuations. Moretactical opportunities will exist as a result of policy changes. 2012 could still prove an interesting year for investors.

Best wishes for 2012.

Sincerely,

Kevin L. Lecocq,Global Chief Investment Officer

Introduction from the CIOKevin L. Lecocq



Perspective from EMEA

Stock markets around the world continue to be buffeted bythe Eurozone crisis and concerns about global growth. The USeconomy is expanding at below its historic potential growthrate, although corporate profits have done much better thanexpected.

The Eurozone crisis has reached a stage where major policycatalysts are needed to rejuvenate optimism, reduce the riskpremium and boost economic growth. Policy makers herehave had to deal with a very toxic brew of a banking systemcrisis and a sovereign debt crisis. The size of the problem is such that it will no longer be possible to solve the bankingcrisis without exacerbating the sovereign debt crisis. We

are already moving towards more European fiscal integrationand an enhanced role for the European Central Bank. Financialmarkets need a credible guarantor for euro-denominatedsovereign debt.

Over the world, the impact of the Eurozone crisis is being felt particularly acutely by China and the rest of Asia. Thereason is that Asia is heavily tied to manufacturing and trade,and as such, the fallout in European demand is filteringthrough to these economies quickly. Lower inflation in 2012should, however, give Asian monetary authorities scope to boost demand through monetary policy easing, and weexpect a only a small slowdown in growth in these economies.

As we approach the end of another challenging year in financialmarkets, we want to re-iterate our conviction that a flexibleand dynamic asset allocation approach, combined with strongrisk management, is key when managing your investmentportfolio. We have, once again, experimented extreme marketvolatility over the last few months, and I hope that you havefound the analysis in this monthly publication useful in thiscontext.

Stéphane Junod,Head of Portfolio Management EMEA

Stéphane Junod

RZ_Investment Insights_12_REGIO_Investment Insights_REGIO 07.12.11 18:31 Seite 2

Untitled A / 7, Untitled A /15, Untitled A /8. All by Ken Kiff at Deutsche Bank, London© The Estate of the ArtistPhoto: Jacqueline Duschkin

Our House View

Economic and policy themes for 2012: facing up to changeArnaud de Servigny



Past performance is not indicative of future returns. No assurance can be giventhat any forecast, investment objectives and/or expected returns will be achieved.

Investors will remember 2011 as the year of sovereign debtcrises, just as other previous years stay linked in the collectivememory with credit crunches, stock market rallies and so on.But, in reality, events do not arrange themselves so neatly tosuit calendar years, and we go into 2012 with many questionsstill unanswered. Most obviously, will the Eurozone survive in its current format? Will the sovereign debt crisis get worsein 2012? Will it mutate into a rather different form? Will thisinevitably further sharply reduce the performance of riskyassets? And in this environment of extreme uncertainty, is theconcept of a “risk free” asset still meaningful? Presumed safehavens as AAA-rated debt, gold, cash, and real estate (in someregions) are now looking increasingly uncertain.

Making an accurate prognosis based on tactical judgments is impossible in such a quickly evolving context. But there issome value in stepping back, looking at the world we live in,and identifying some key ongoing themes that will make thesituation look different in 2012 and influence asset prices.

The four themes below all demand substantial policy progressin 2012, if the situation is not to deteriorate further. So, while2011 was a year of challenges, 2012 will be a year ofunavoidable and major change – creating risks, but alsoopportunities.

1. The year when the bills come due Unfortunately it is already clear that 2012 will be the yearwhen the bills come due for most developed economies.Paying them will be painful.

The “bills” were presented in 2011, as the size of the problemposed by fiscal and debt imbalances became evident. Thisproblem had been brewing for three years: after the 2008 creditshock, governments compensated for anaemic levels ofeconomic activity by expanding public spending, through taxreliefs to individuals, enhanced support to the unemployed or through ad hoc public capital spending. Increased spendingcombined with subdued levels of tax collection resulted inrapidly increasing public deficits, which in turn translated intohigher debt levels. It was soon evident to some observers that public debt might quickly reach unsupportable levels. In response, the much disparaged rating agencies downgradedseveral large developed economies. And, since June 2011,financial markets have become increasingly selective onEuropean sovereign debt, to the point where many of thesemarkets have, at times, almost frozen up. In a vicious spiral,the unfortunate interplay between rising fiscal deficits and sky-rocketing spreads, threatens to make debt servicing costsalmost unbearable.

There is now a consensus amongst both markets and policymakers that the developed economies cannot keep going in this fashion. Debt pressures mean that governments arerunning out of ammunition to support their economies viafiscal incentives. Moreover, the citizens and corporations ofthese economies – who have so far largely benefited fromgovernment support – are now affected too, and are beingasked to contribute more through higher overall rates oftaxation.

Arnaud de Servigny / Our House View




Scaling back current fiscal incentives is likely to have a bignegative impact on growth. In the US, it could take close to 2percentage points off GDP growth in 2012 – which, despitethis, is likely to exceed 2 percent – and possibly more in 2013(Figure 1). In Europe, with almost all countries implementingmore balanced and, one hopes, more sustainable fiscal policies,the region seems certain to be in recession in the first half of 2012.

2. Global economic governance in transition The second salient trend we have observed is a very strongcontrast between the effectiveness of public and privategovernance, with attention focused on some of the shortfallsof public governance. In response, global economicgovernance is in transition.

Companies are not economies! Most corporates – especiallylarger ones – have steered their way through the current crisis effectively, adjusting their activities to suit the ebbingstrengths of the domestic economies they operate in. Theyhave been aided, of course, by high levels of unemploymentexerting downwards pressure on wages. In contrast, public bodies in the US and in Europe have appeared to beperforming quite poorly. In the US, the embarrassing outcome of the negotiations on the “debt ceiling” in mid-2011damaged perceptions of the effectiveness of US policymakers; the failed negotiations of the “Super Committee”later in the year added to the scepticism. In Europe, enormousconfusion surrounds the decision making process at both a national and supranational European level, leaving thedamaging impression that policy makers are simply not up tothe task, and incentivising several countries to trust their fateto unelected “technocratic” administrations. It is hard to thinkthat this state of affairs can be sustained throughout 2012. At present, it appears that the needed reform will requireeither a higher degree of political and fiscal integration aroundthe Euro or a partial dismemberment of the Eurozone.

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Figure 1 Source: Deutsche Bank, Global Markets. As of November 29, 2011



In 2012, we need to get to the point where everybodyunderstands what the Eurozone stands for, with each memberstate having to make a choice to stay in it or not. Remaining a member will require a formal commitment to fiscalconvergence. Germany and France will have a historic role to play here, both in ensuring that the convergence process istotally transparent and also in supplying the determination to carry the process through to its conclusion. In this delicatesituation, financial institutions who were at the center of the2008 crisis will continue to find themselves at risk. They carry,in a sense, the collateral damage from previous Europeanfinancial opacity, in the form of their detrimentally large holdingsof Eurozone sovereign debt. The risk is that, because theyhave to deleverage their balance sheet to cope with potentiallosses on this debt, they cannot therefore properly fulfil theirrole of funding a Eurozone economy through domestic lending.This critical situation means that a clarification of proposedgovernance changes in Europe is needed very quickly, if weare to bolster confidence in the financial institutions and avoidsome defaults (Figure 2).

3. Rewriting the “social contract” Why is it proving so difficult to find solutions quickly, especiallygiven the shared sense of urgency, and the obviously awfulimplications of failing to do so? Our thesis is that thegovernments in developed economies are facing the challengeof rewriting their “social contract”. Economies rely primarilyon the dynamism of capital markets and labor forces to drivethe engine of economic growth. But, as a residual, there is, in effect, an implicit agreement between governments,populations and corporations whereby taxation andgovernment spending are used in part to make provision forthose who cannot work, for reasons of age, infirmity oradverse labor market conditions.

As has long been understood, the process of economicglobalization results in a heightened level of competition, with consumers benefiting greatly from abating market prices for goods and increasingly services set on a globalbasis. But this process of competition also translates intoincreased pressures on the financing of social systems, as the cost of them threatens both to make corporationsuncompetitive and to weaken the productive economyoverall. As we have noted above, governments’ financialresources are already stretched; increased taxation oncorporations, likely to be already struggling with theconsequences of bank deleveraging in 2012, risks makingthem uncompetitive – meaning that such a policy would likely be counterproductive.

The conclusion is that, as with government finance moregenerally, the current situation cannot continue for muchlonger, and that some major decisions will have to be taken in 2012. One central problem is that in most developedeconomies, the existing expectations of citizens regarding the state provisions – whether explicitly labelled the “welfarestate”, as in Europe, or regarding Medicare, Medicaid and the individual elements of state provision in the US – wereestablished several decades ago, in a very different economicenvironment. Not only was global competition much lessintense, demographics were also skewed towards the youngrather than the old, and healthcare provision did not entailsuch high costs. It is no longer possible to pretend thatimprovements in operating efficiency and spending controlcan, on their own, provide a remedy to the problemssurrounding social provision. It is particularly difficult tocurtail this social public spending to current realities at a

Arnaud de Servigny / Our House View – continued

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time when the divide between the rich and the poor is verylarge, having been increasing for at least a decade. Hence, we now need to rewrite the “social contract” between thestate and its citizens, something that will have majorimplications for corporates, too. The debate on the “socialcontract” is moving onto a deep and potentially disruptivelevel. In essence, what does fairness mean? In the US, many of the existing political divisions are prompted by preciselythis issue. Ideological divides in Europe may not appear soacute, but any redefinition of the European “welfare state” willrequire an answer to this question – and some major changesto the status quo.

It is worth stressing that a resolution to the debate around thesocial contract would be equally to the wealthy’s advantage, as to the recipients of government spending. One of the mostinteresting observations from 2011 is that financial assets do not tend to do well when there is uncertainty around the“social contract” and its sustainability – this is at the root ofthe European crises. It is therefore in the interest of all citizens,at all wealth levels, to find a compromise, for both economicand social reasons. We need a lot of clarification on this issuein 2012, but must accept that the complexity of the underlyingissues here will work against immediate progress.

4. The world is also getting smaller, but more complex Precisely because of globalisation, the world is also gettingsmaller, but more complex to navigate.

This has already had a major impact on investment decisionmaking. Until recently, the received wisdom had been thatportfolio diversification across regions would help mitigatelosses. But the events of 2011, and of 2008– 2009, have shownus that, during a period of economic tension, investors cannotrely on regional asset valuation independence to provide safehavens. Markets in Asia, Europe and the US are largelyintertwined, so asset prices have been moving together with ahigh degree of correlation. This probably corresponds to astructural trend, and one that will continue to be particularlyobservable during highly stressed market conditions. Put thisway around, this observation might be taken as unfavorable to globalization, but this view would be over-simplistic ascloser integration obviously has its positive side too, with, forexample, the Chinese government’s efforts in 2009 to supportgrowth through very aggressive state-driven investmentprograms having had substantial positive side-effects globally.

A more highly integrated environment is not a simpler one,however. In fact, its functioning appears more complex. Oldeconomic rules may now look either less universal or lesseffective, as policy makers, central bankers and regulators areforced to sail into uncharted seas. The policy consensus is as a result less solid. One illustration of this is the disputedrole of central banks as “market makers of last resort”, inorder to stop a drying up of liquidity. The Fed has been doingthis most willingly, to protect the mortgage market in the US, while the European Central Bank (ECB) is proceeding muchmore cautiously regarding the sovereign debt market in the Eurozone. The reality is that we cannot fully assess all thelong-run positive / negative consequences of these policyactions for the economies concerned and must accept the factthat we will have to operate under conditions of considerableuncertainty in the foreseeable future. In the following pages wetherefore highlight some of the immediate economic problemsthat we face in the key regions of the US, Eurozone and Asiabefore returning to their investment implications.



Macroeconomic outlook

The Estate by Sigmar Polke at Deutsche Bank, London© VG Bild-Kunst, Bonn 2011.Photo: Jacqueline Duschkin

Larry V. Adam, Christian Nolting, Elke Speidel-Walz



Larry V. Adam

Our base case scenario is that the US grows at 2– 2.5 percent(Figure 1) in 2012, having picked up pace in Q3 2011, butsubstantial domestic and external risks remain. Uncertaintymeans that our market forecasts must be muted, if positive,too. 2013 could, in fact, prove to be worse than 2012, as theeconomy is simultaneously hit by the “automatic”Congressional budget cuts, the expiration of the Bush taxcuts, the likely end of the 2 percent payroll tax cuts and theintroduction of taxes tied to healthcare reform.

ChallengesWhile a recession is likely avoidable in 2012 – thanks to strongbusiness spending, robust exports to the emerging markets,positive job growth and some politically-driven initiatives in an election year – the US economy will not be without itschallenges. The most immediate domestic risk is a tampingdown of consumer and business confidence by economic,political and international uncertainty. Depressed consumerconfidence could lead to reduced consumer spending andheightened risk aversion while weak business confidence couldlimit job creation: together, they could lead to a self-fulfillingrecession.

Retail sales have been resilient so far, despite poor consumerconfidence, but this situation cannot continue indefinitely. Weakwage growth would be one factor holding back a recoveryof consumer confidence, and we are concerned that the labormarket will remain tepid in 2012, with the unemployment rateremaining above 8.5 percent.

Another – linked – risk to sustainable US economic growth is the still poor state of the US housing market. A weakhousing market stifles economic growth as job seekers arenot able to move to take new jobs (because their existinghome is difficult to sell, or because negative equity meansthat selling it would crystallize a loss that they cannot fund).Moreover, declining house prices can trigger a negative netwealth effect, reducing consumer spending; further declines in home prices would of course also put the banking sector at risk of further write downs. It is becoming increasinglyevident that some sort of government intervention in thehousing market may be necessary, something that mightappeal to the current administration in an election year –although its ability to implement stimulus measures would be limited by the US’s debt and deficit situation.

Policy responseIf the US economy were to show substantial signs of stress,we believe that the Federal Reserve would be inclined to engagein further quantitative easing. Fed Chairman Bernankecontinues to make it clear that he will use all policy measuresto avoid a recession. With headline inflation pressures likely to subside, helped by recent falls for many commodity prices,the Fed should have ample room to implement further non-traditional monetary policy initiatives, and they may be in theform of mortgage-backed security purchases in order to offer more aid to the housing market. Declining inflationarypressures will also allow the European Central Bank andemerging market central banks to cut interest rates as well to stimulate their economies.

The US in 2012: it’s all about confidence

Economic growth of 2– 2.5 percent expectedin 2012, but substantial domestic and externalrisks

Federal Reserve can implement further non-traditional policy stimulus if necessary

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Larry V. Adam / The US in 2012 – continued

The improvement in US economic data in the second half of2011 has been in contrast to the increasingly poor outlook for the Eurozone outlook. But the US economy cannot decouplefrom trouble in other economic regions. A European creditcontagion or a Chinese hard landing would have negativerepercussions for an already vulnerable US economy. Investorscannot ignore the outcomes to these potential risks.

Asset classesGiven this uncertainty, our financial market outlook must bemuted as well. Continued volatility will dampen investorsentiment, especially with ongoing risks in the run-up to theelection. Political positioning seen during the debt ceilingdebate and the failed “Super Committee” deliberations suggestpartisanship will remain in the fore. While heightened riskaversion and uncertainty are likely to keep Treasury rates “lowerfor longer”, our economic growth forecasts are supportive ofa modest rise in Treasury yields from current levels, which aremore consistent with recessionary conditions. As a result, weremain cautious on US Treasuries and encourage investors todiversify into higher yielding, lower duration sectors such ashigh yield and emerging market debt.

US equities, while volatile, are likely to be one of the betterperforming asset classes in 2012. US corporations remain abright spot for the US economy, recording record earnings in Q 3 2011 (Figure 2). Based on fundamentals, the S&P 500should trade upwards to 1.375 by the end of 2012. Whilecorrelations are likely to remain high, we believe selectivelywill remain critical as investors become more discerning and assess the visibility and sustainability of earnings forinternational regions, sectors, and individual securities. Withearnings growth set to decelerate, strong operating leverage is likely to be replaced by financial leverage. With the Fedkeeping interest rates low through mid-2013, corporations are likely to issue debt and/or use the record amount of cash on balance sheets for stock repurchases to bolsterearnings. Similarly, low interest rates make dividends moreattractive and we expect corporations to continue to increasetheir dividend payments to attract investors.

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Figure 2 Sources: FactSet; FirstCall. As of November 29, 2011

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Christian Nolting

Asia in 2012: resilience in adversity

Asian economic growth is expected to continue to slow (albeitgradually) in 2012, because of the impact of slower growth inthe developed economies. Intra-Asian trade and further growthin domestic consumption is likely to cushion the blow, however.Sustainable wage growth, low unemployment and low debt-to-GDP ratios will be supportive of our positive stance on Asia.

ChallengesOne of the key challenges that Asian economies must face willbe the impact on Asian exports of lower growth in the developedeconomies. The more open and trade-reliant Asian economiessuch as Singapore, Hong Kong, Taiwan and South Korea arelikely to suffer most from slower EU and US growth, and thusslower growth in exports to the developed markets. But, setagainst this, stronger demand from the developing world hasbecome increasingly important in driving Asia’s exports inrecent years.

In addition, domestic consumption in Asian economies has, so far, proved resilient to slower exports and has become an increasingly important source of GDP growth for Asianeconomies. Over the coming years, it will be interesting to see whether Asian policy makers can steer their economiestoward being rather more consumption-oriented.

But just how much can Asian consumption growth offset the impact of slower developed markets growth? Looking first at past consumption trends if, for example, we look at correlation data for the last six years, then it would appearthat Chinese retail sales (taken as a proxy for domesticconsumption) are much more correlated with householddisposable income levels than with US and Eurozone growth. A broader look at pan-Asian consumption trends also reminds us that Asian consumption continued to grow in 2009 despite the collapse in US demand in that year.The last time Asian consumption contracted was after the Asian crisis of 1997– 1998.

A second, and very immediate, challenge could be posed bypossible foreign investor money outflows if global risk aversionrises. Previous global equity sell-offs have been accompaniedby strong outflows from Asia, for example during the 2008/2009 world financial crisis and in mid-2011.

There are various ways of measuring this. Figure 1 below looksat the size of foreign portfolio debt relative to FX reserves;comparing October 2011 with November 2008 (at the heightof the credit crunch). It suggests that Indonesia, South Koreaand India could now suffer more from a sudden withdrawalof foreign portfolio holdings than in 2008. Alternatively, onecan compare the size of Asian economies’ short-term debtrelative to GDP in October 2011 and November 2008. This israther more reassuring, as the size of short-term debt relativeto GDP has increased only in India, and there not substantially.

Yet another approach is to look at the size of the Asianeconomies’ financing gap (their foreign exchange requirementsto fund debt service and imports, minus the revenue fromexports). On this measure, Asian economies have become morevulnerable to outflows, if not by an alarming amount. India has seen the largest increase in vulnerability on this measure,thanks to a large increase in foreign investment inflowscombined with weak foreign reserves accumulation. Korea andTaiwan would appear to have become less vulnerable. Overall,China, the Philippines and Thailand would appear to be theleast vulnerable economies, on this financing gap measure.

Growth slowdown is likely to be braked byintra-Asian trade and domestic consumption

Falling inflation should give policymakersroom for maneuver

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Policy responseHowever, we should not forget that markets have already beenpricing in slower growth in 2012. This has prompted manyinvestors to anticipate some form of policy easing or stimuluspackages from many Asian policy makers in response. Indeed,with trade slowing and a broader slowdown now becomingevident in Asia, Asian central banks are already beginning toact. For instance in China, we have started to see some modestsigns of credit easing with the monthly level of new lendingeasing upwards. In the near term, we could see more crediteasing policies coming from the Chinese policy makers albeitstill at a gradual and modest pace. They could, for example,stop the issuance of People’s Bank of China (PBoC, the centralbank) bills or cut further the banks’ reserve requirement ratio(RRR). Recent announcements by the Reserve Bank of India(RBI) have also indicated a willingness on the part of Indianpolicymakers to ease their grip on liquidity for the first time inseveral months.

If inflation in many Asian economies has peaked and continuesto trend lower over coming months, this would provide somescope for Asian policymakers to further ease policy. Our viewon inflation is supported by falling food prices, given that foodaccounts for about one-third of the CPI baskets for countriessuch as China and India. In addition, industrial metal priceshave also declined as a result of fears over global growth in2012.

Besides monetary policy easing, Asian central banks couldalso probably consider implementing some stimulus packagesto support growth, if necessary. Most Asian economies stillappear to have fairly strong fiscal positions, characterized bylow and stable deficits and debt (Figure 2), thus providingthem with much more potential “firepower” than governmentsin the developed world to combat slower growth next year.

Asset classesAsian equities’ prices will also likely remain sensitive todeveloped markets, as historically they have had a high betarelative to the developed world. Having said that, valuationsare starting to look attractive to us and we are seeingpotential opportunities for investors with a medium to longterm perspective. Compared to their historical average,

Asian equities look moderately undervalued based on both a price-to-book (P / B) and price-to-earnings (P / E) basis. Ourexpectation is that margins should hold up relatively well, helpedby decreases in the many of the prices of raw materials.

In the absence of any policy actions, high dividend yieldingsectors in Asia such as REITs, telecoms and utilities couldremain attractive. Besides their stable yields, these sectors are relatively less exposed to a slowdown in the developedeconomies and more dependent on local consumption.

On fixed income, Asian sovereign re-rating could be a positiveissue running through the year, given that the ratios of Asiancountries’ public debt-to-GDP remain low relative to developedeconomies.

Christian Nolting / Asia in 2012 – continued

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Elke Speidel-Walz

The Eurozone in 2012: no quick fix

At best, the Eurozone will experience a controllable recessionin 2012, with all economies contracting apart from Germany’s(Figure 1). Uncertainties will weigh on government bondmarkets, in the first half of the year at least. The second half ofthe year could be rather better. The alternative is a full-blowndownturn, with several economies exiting the Eurozone.

ChallengesThe fundamental problem for the Eurozone is how to maintaina currency system where monetary policy is centralized, butwhere members have very different approaches to fiscal policy.The latest policy initiatives attempt to to tackle this. Previousattempts to regain financial markets’ confidence by puttingtogether impressive-sounding rescue programs, while grantinghelp only in exchange for progress on fiscal austerity, have notmanaged to contain the crisis. And with one member, Greece,having a still unsustainable debt load, there is a possibility of further debt defaults (above the already agreed 50 percent“haircut”) and possibly a Greek exit from the Eurozone nextyear.

A combination of fiscal austerity, rising financing costs andheightened uncertainty over the future of the Euro, is pushingthe region into a recession. Recession, through lowering the

tax take and boosting spending (through “automatic stabilizers”such as unemployment benefit) makes fiscal consolidation,already a major problem (Figure 2) even more difficult. One“rule of thumb” reckons that fiscal tightening equivalent to 1percentage point of GDP pulls down GDP growth by 0.7percentage points. On the other hand, a 1 percentage pointreduction in GDP growth leads to a cyclical widening of thefiscal deficit equivalent to 0.4 percentage points of GDP. Thismakes the necessary fiscal adjustment in some countriesextremely ambitious. Some countries have, so far, managedbetter in this environment than others, but none lookcompletely secure.

Limited cash, together with political and legal hurdles, meanthat further single-country rescue programs look unlikely. TheEuropean Financial Stability Facility (EFSF) and its plannedsuccessor, the European Stability Mechanism (ESM) cannotdeal with a problem of the size of the Italian bond market(Euro 2 trillion, the world’s third largest). One initial idea wasto leverage the available capital via an insurance program, but this seems unlikely to work due to the insufficient meansof the EFSF, the result both of its limited financial firepowerand also the expectation that the number of Eurozone countriesable to finance a rescue package will fall.

Our base case forecast is for a controllableEurozone recession in 2012

But the risk remains of a very sharpcontraction and Eurozone disintegration

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Figure 2 Sources: Deutsche Bank, Global Markets; EU Commission. As of November 29, 2011



Elke Speidel-Walz / The Eurozone in 2012 – continued

Both the German Bundesbank and the President of the ECB,Mario Draghi, do not want the ECB to assume the role of alender of last resort for governments, and it is supported in thiswish by the German government. Even if a majority of theECB’s Council were to try and overrule the German position,this might not be well received by the financial markets as it could be seen as endangering Germany’s commitment tothe Eurozone. Jointly-issued Eurobonds would also be nomiracle solution: the pre-condition – fiscal union – needstime, and the risk that large-scale issuance of Eurobonds couldtrigger a rise in German bund yields has clearly risen.

Policy responseOverall, we expect a disruptive first half of 2012 for the Eurozonebut more clarity in the second half of the year. In our basescenario, Eurozone output as a whole contracts by 0.5 percentin 2012, pulled down by fiscal tightening, higher financingcosts in most countries, and uncertainty damaging sentiment.But continued global growth, falling Eurozone inflation (below2 percent) and ECB rate cuts will, we hope, limit the downside.

In our base case scenario, the expectation is that the drive forfiscal and structural reform would gather pace in the largercountries, with Italy starting structural reforms and restoringmarket confidence (helped by ECB purchases in the firstquarter of 2012, due to the country’s large financing need).Reforms in France could step up a gear after the May 2012elections. Spain, Ireland and Portugal are likely to make furtherprogress on their fiscal and reform agendas. They could getfurther help and / or limited debt relief to ease fiscal and socialproblems. But in Greece there is a high risk of a disorderlydefault, with losses much greater than the planned 50 percent.

It is easy to envisage a much worse scenario, however, with a deeper recession in the Eurozone. This could be either theresult of weaker global growth and/or a more serious creditcrunch in the Eurozone as banks opt to sell assets rather

than raise capital. Another risk stems from the very challengingpolicy outlook. Fiscal austerity-fatigue and rescue-fatigue,already on the rise, could become more serious. And if thenumber of AAA-rated sovereigns gets reduced, Germanycould lose credibility due to stretched guarantees, and marketsmight then lose confidence in any bail-out program. Were Italy to embark too late on reform plans, or were France not tostep up its reform drive after its May elections, there could be a much worse outcome. In this scenario, the Euro systemcould break down in its current form and leave only a fewcountries with a common currency.

Asset classesEven under our base case scenario, government bonds wouldstill have substantial risk. (Consider, for example, what wouldhappen in the new Greek government did not stick to reformsafter its election in February or were Italy’s very high financingneeds in Q 1 to cause problems.) In the course of 2012, reformsin Spain and Ireland could start to have more obvious resultsand the high spreads available on these countries’ bonds mighteventually become attractive.

Our overall view is that equities are likely to be the mostattractive asset class in the Eurozone in 2012. But this assumesthat global growth remains robust, supported by emergingmarkets and moderate but decent growth in the US; also, wecontinue to dislike Eurozone financials. Equities valuations are attractive, and corporate fundamentals and balance sheetsappear sound.


Arnaud de Servigny

Portfolio management in 2012

Coping with risk, capturingopportunities.

Untitled by Richard Smith at Deutsche Bank, London© Richard Smith, Flowers Galleries London. Photo: Jacqueline Duschkin




In the context of all this transition – of global governance, ofsocial provision systems, and of policy responses – we think it is possible to make two, very broad observations on portfoliomanagement.

1. We should expect sustained volatility in 2012, which willrequire a careful, structured but active investment approachOne positive is that, as argued above, we know that thingswill have to change — there can be no more “kicking the candown the road”. These necessary changes are likely to createsustained volatility on the markets, which we can prepare for.

The traditional reaction in a situation of high volatility is almostalways to “fly to quality and then do nothing”, that is to avoidrisky assets and to go instead for cash, sovereign bonds, realestate and precious metals. But what is clear to us is that thistime is different and that, because of the nature of this crisis,none of these options can guarantee wealth preservation.Looking at these investment areas in turn:

— Cash highlights some potential dilemmas. In a situation ofhigh sovereign debt tension, one traditional tool used bygovernments has been currency debasement. Moreover,this process is not always voluntary, as the strength of acurrency is linked with the stability of its government. So,with this crisis deeply related to governments’ effectivenessand thus stability, some real caution is needed here: cash is by no means as “safe” as it might appear.

— Among sovereign debt, the current safe haven wouldappear to be US Treasuries but fundamentals-drivenmodels suggest a fair value for US rates of around 3.20percent rather than their current levels of close to 2 percent (Figure 1). So, again, “safe” could prove very risky, if Treasuries start being driven more by reality than by an emotional response.

— Real Estate valuation depends largely on the availability of mortgages. But in the current environment where banksare being forced to deleverage massively, credit will bescarcer and thus more expensive. The US is still dealing withthe aftermath of a burst housing bubble and it is highlyunlikely that, in the future, limited capital resources elsewherewill be deliberately funnelled into unproductive real estate,particularly in a context of subdued growth.

— Lastly, while precious metals make sense in an inflationarycontext, they should appeal less in the present environmentwhere inflation risk is receding quickly, at least in Asia andin Europe. Of course, individual policy events may push upthe gold price, probably temporarily, but a sustained andsubstantial rise in precious metals prices is unlikely to be onthe agenda in 2012.

So investors find themselves in a situation where “safe” assetscannot guarantee wealth preservation, and therefore mustcontemplate how best to invest in risky assets. Doing this well requires several things. The first requirement is to buildactive risk management into the portfolio, using eitherfinancial instruments that reduce downside risks, or assetsthat constitute shock absorbers. The second requirement is to manage a portfolio dynamically through a robust investmentprocess that captures which investment “regime” we are in, while avoiding the expensive pitfalls of spurious markettiming.

7

6

5

4

3

2

1

2000 2002 2004 2006 2008 2010

Actual vs. model-predicted levels for US 10-year Treasury yieldsin percent

Actual Model-predicted forecast


Arnaud de Servigny / Portfolio management in 2012



Current price / earnings ratios (LTM*) inthe US and Europe

* Last twelve months

Figure 2 Source: Bloomberg Finance L. P. As of December 2, 2011

S&P 500 MSCI Europe

14

12

10

8

6

4

2

0


2. There are ways to leverage this global growth throughsmart asset selectionMore fundamentally, it is important to realise that risky assetscan offer opportunities in 2012. Global growth in 2012 shouldstill be close to 3 percent, which is substantial. So our secondportfolio management theme is that we strongly believe thatthere are ways to leverage this global growth through smartasset selection.

For very opportunistic investors, focused on trading, 2012could represent a year of many opportunities, with periods of market dislocation (and thus rapid price change) coming as a consequence of a likely raft of policy announcements,together with central banks and regulator intervention.Remember, too, that banks may well be in such a weak positionthat they cannot provide their usual market-making smoothingfunction, potentially increasing the scope for tactical gains.

But there should be longer-term, more fundamentals-driven,opportunities. Large firms, well organized from a governanceperspective, and fully plugged into global growth, should bein a position to take advantage of the situation, with sustainedor growing earnings. In addition, valuations currently appearvery low with price / earnings (P/E) ratios that are typically around12 in the US and below 10 in Europe (Figure 2). This situationshould not last forever. Market sentiment is very negative at themoment, but periods of negative sentiment have in the pastoften been very good entry points into risky assets. One couldadd that, from a behavioural finance perspective, the perfecttiming for entering into such investments is when one iscomfortable with them from a rational perspective, but mustfirst overcome an emotional reluctance to invest. During 2012,we could encounter such a “tipping” point but it will alwaysbe difficult to time the entry point precisely. Of course, thejourney to this tipping moment may well prove bumpy, and thecomplexities outlined above could lead to some accidentsalong the way. A gradual stepping up of exposure to riskyassets could be one solution. Overall, it will be important toremember that financial markets do not wait for solutions tobe implemented before they adjust. Instead, they are primarilylooking for credible solutions to be outlined, accompaniedwith a degree of certainty on their execution – then they move.

At some point, we will also need to revisit the geography“dimension”. At the moment, as we have observed above,market correlation means that geography does not make a vast difference, although US equities have beenoutperforming other regions recently. Conversely, Asianequities have not done well, despite the secular upward trend of the Asian economies – a useful reminder that marketsdo not always follow macroeconomic developments. Webelieve that all regions will benefit in the first instance fromclarification on our four economic and policy themes that will drive developments in Europe and in the US. Once wehave passed this tipping point, then fundamentals will start to matter more.



Arnaud de Servigny, Christian Nolting, Larry V. Adam, Elke Speidel-Walz, Paul Wharton

10 Investment topics for 2012

Investor focus

1. Safe may not be safe.

Don’t react to future periods of uncertainty by taking refuge in traditional safe havens such as cash, sovereign bonds, real estate or precious metals without realizing that the currentrisk environment means that they may prove less safe than they appear, and be vulnerable to the effects of frequentpolicy change – the likely backdrop to 2012.

2. Walk before you run.

After a bruising 2011, and in a context of continuing uncertainty,investors will be understandably wary of investing in riskyassets. One strategy to overcome reluctance may be to buildup holdings gradually, first focusing on “equity lite” typeholdings (e.g. high dividend-paying stocks, convertibles andhigh grade corporate debt) which are supported byfundamentals.

3. Ready, steady…go?

Fixing Eurozone and other problems will take time in 2012. Butwhen we get some clarity on progress, not only equities butalso bond markets will start to have a different momentum andregional dynamics will reassert themselves. Timing will be keyfor investments in both Asia and, more selectively, in Europe.

4. Be nimble, but with a safety net.

Risk management will remain key throughout 2012, boththrough use of options and through shock absorbing assets(including through equities sector rotation). Consider resortingto regular, dynamic portfolio rebalancing to adjust to economicand market developments.

5. Reason should dominate emotion.

Investor responses to longer-term changes – as well as short-term market dislocations – will be driven by fear followed, at some stage, by relief. Avoid an emotion-driven responsethat is likely to result in wrong investment decisions, andwrong timing, and make sure that reason always dominatesthe decision-making process.

Past performance is not indicative of future returns. No assurance can be giventhat any forecast, investment objectives and /or expected returns will be achieved.

We now suggest 10 investment topics that we think will run through portfoliomanagement decisions in 2012.



Past performance is not indicative of future returns. No assurance can be giventhat any forecast, investment objectives and /or expected returns will be achieved.

Investment focus

6. Big will grow bigger.

Large multinational corporations, especially in the US butelsewhere too, should be able to take better advantage of stillstrong global growth, and able to control costs through strong governance, which they have exhibited since the 2008crisis. Sectoral and other preferences will change as the year progresses, with an initial preference for defensive, highdividend-paying stocks. In the US, we like technology, energy and healthcare stocks; in Europe ex-UK and UK, wefavor oil and industrials.

7. Capital over labor.

Medium-sized companies will find it more difficult to copewith a lower growth environment, as bank lending becomesmore restricted, with their management looking moredefensive. But significant opportunities may exist to restructure,consolidate and revive companies, particularly throughprivate equity investments, potentially boosting productivityagainst the background of a difficult labor market.

8. Asian growth generates performance at last.

Despite continued strong Asian growth in 2011, Asian equitiesperformed poorly, with fund flows a major performancecontributor. However, with rising clarity on the developedeconomies’ recovery, the scene may be set for a recovery in Asian equities and some possible decoupling later in 2012.Look for local longer-term trends too, for example anincreasing emphasis on domestic consumption. And withfalling rates of inflation giving Asian policy makers a degree of leeway for monetary policy easing, Asian bonds shouldoffer an attractive risk / return balance.

9. Phoenix companies in Europe.

Later in 2012, the European market is likely to offer somestrong opportunities for longer-term investors. Strong,undervalued, truly global companies may merit consideration,particularly in the larger peripheral economies of Italy andSpain.

10. Volatility can be your short-term friend.

While the topics above reflect a fundamentals-driven approach,remain aware that volatility and market dislocation in thewake of expected policy actions are likely to cause substantial,very specific, short-term trading opportunities.


Forecasts and current data summarized

Untitled – Motif by Karl Horst Hödicke at Deutsche Bank, London© VG Bild-Kunst, Bonn 2011Photo: Jacqueline Duschkin



Economics

Markets

Light blue colored forecasts indicate upward revisions and italicized forecasts indicatedownward revisions to the numbers published in last month’s Investment Insights. *As of December 1, 2011

2010 and current numbers are actual. 2011, 2012, 3 month and 12 month numbers areDeutsche Bank forecasts, as of December 1, 2011

Sources: Deutsche Bank, PWM Global Investment Committee; Deutsche Bank, Global Markets.

Past performance is not indicative of future returns. No assurance can be given that anyforecast or target will be achieved. Forecasts are based on assumptions, estimates, opinionsand hypothetical models or analysis which may prove to be incorrect.

GDP growthin percent

2010 2011 2012

USA 3.0 1.8 2.3Eurozone 1.8 1.6 -0.5UK 1.8 1.1 1.3Japan 4.1 -0.4 0.5Asia ex Japan 9.5 7.6 7.2Latin America 6.3 4.1 3.6EMEA 4.7 4.3 3.8World 5.1 3.7 3.5

Inflationin percent

2010 2011 2012

USA 1.6 3.3 3.2Eurozone 1.6 2.7 1.8UK 3.3 4.5 3.2Japan -0.7 -0.3 -0.3Asia ex Japan 4.6 6.0 4.0Latin America 8.4 8.2 8.2EMEA 7.6 7.1 6.7

Current account balancesin percent of GDP

2010 2011 2012

USA -3.2 -3.1 -2.7Eurozone -0.5 -0.7 -0.3UK -2.5 -2.5 -2.4Japan 3.6 2.2 1.9Asia ex Japan 4.0 3.1 2.3Latin America -0.9 -0.9 -1.3EMEA 0.3 0.3 -0.5

Fiscal balancesin percent of GDP

2010 2011 2012

USA -8.8 -8.5 -6.2Eurozone -6.0 -4.7 -3.7UK -10.3 -8.2 -6.9Japan -8.7 -8.7 -9.1Asia ex Japan -2.9 -2.3 -2.9Latin America -2.4 -2.0 -1.8 EMEA -4.7 -2.1 -2.3

Key interest ratesofficial, in percent

Current* 3month 12month

USA 0.25 0.25 0.25(Fed funds)Eurozone 1.25 1.00 1.00(Ref. rate)UK 0.50 0.50 0.50(Base rate)Japan 0.10 0.10 0.10(Ref. rate)

Key sovereign bond yields (10-year)in percent


USA 2.08 2.25 2.75Eurozone 2.27 1.90 2.30UK 2.14 2.60 3.10Japan 1.08 1.00 1.25

Equities index levels


USA(S&P 500) 1,247 1,305 1,375Eurozone 2,330 2,275 2,360(EuroSTOXX 50)Germany (DAX) 6,089 6,000 6,500UK (FTSE 100) 5,505 5,650 6,000Japan (Nikkei) 8,435 8,750 9,200Asia ex Japan 456 500 535(MSCI, $)Latin America 3,670 3,750 4,050(MSCI, $)

Currencies

Current* 3month 12 month

EUR/USD 1.35 1.30 1.35USD/JPY 77.63 77.00 80.00EUR/CHF 1.23 1.25 1.25GBP/USD 1.57 1.55 1.55EUR/GBP 0.86 0.87 0.87

Commodities


Oil ($, WTI) 100 95 100Gold ($) 1,750 1,750 1,850



Asset classes in 2012 in summary

Fixed income – sovereign, developed and emerging markets.

US Treasuries could do a good job at helping protect againstagainst a further sharp deterioration in the investmentenvironment, but yields could increase (i.e. prices fall) undermore favorable scenarios. European debt is unlikely to fulfill this protective role, but could offer some value opportunities.Emerging market sovereigns appear better placed thandeveloped market sovereigns, but there is currency risk to beconsidered.

Fixed income – corporate, investment grade and high yield.

US high yield is likely to appeal, but has some liquidity andvolatility risk. Investment grade corporate bonds are likely to outperform government bonds.

Developed market equity.

US equities are likely to outperform European equities, earlyin the year at least. Improving price multiples could offset the effect of decelerating earnings growth. Prefer large caps.Look for longer-term opportunities in globally-focusedmultinationals in Europe.

Emerging market equity.

If there is a sustained recovery in the developed economies,particularly in Europe, Asian equities could eventually start tobetter reflect strong regional growth, after poor recentperformance.

Private equity.

This will have a role to play in financing the consolidation of medium-sized companies, and in distressed debt andequities opportunities in Europe.

Absolute return.

Increasing clarity on the Eurozone – which would allow anincreasing range of approaches, rather than simple good/badoutcome plays, and a greater focus on fundamentals – couldenable some hedge fund strategies to perform better in 2012than in 2011.

Commodities.

There is some moderate possible upside in gold, but there islikely to be no clear direction. Elsewhere, many cyclicalcommodities prices may struggle, particularly if global growthdrops below 3 percent. Oil could be slightly more resilient tolower economic growth.

Opportunities and concerns for each of themain asset classes in our Global InvestmentCommittee (GIC) model portfolio.



GIC December 2011 Recommended Asset Allocation

Asset allocation over the history of the GIC portfolioin percent

Cash

FI-Sovereign

FI-Corporate and EM

Developed Market Equity

Emerging Market Equity

Private Equity

Absolute Return

Real Estate & Infrastructure

Commodities & FX

100

90

80

70

60

50

40

30

20

10

0

Source: Deutsche Bank, Global Investment Solutions. As of November 29, 2011

2009 2010 2011

Asset allocation changes at the November 29,2011 GIC meeting

In highly uncertain market conditions, European policymakers have been trying to adjust policy, workingtowards a structural solution to the Eurozone’s problems.The end-October European summit did not prove assuccessful as expected, and the tensions in the financialsystem, and in particular around the sovereign bondmarkets, increased during November. We believe thatEurozone leaders will now be forced to react to thecurrent situation and announce some major policyinitiatives at or around the time of the December 9summit. It is also increasingly likely that the ECB will

provide some liquidity and help to abate sovereign debtspreads, in the context of a likely move towards fiscal union.

In this environment, which looks likely to be more favorableto risky assets, at least temporarily, the Global InvestmentCommittee, on November 29, decided to stay cautious(increasing cash by 2 percent), while redirecting risky assetsfrom those asset classes thought less likely to perform(commodities -2 percent and absolute return, also -2percent), in favor of developed equities (+2 percent). Thistactical move may be revisited during January 2012.

Asset Class Change* Recommended Weight (from November 29, 2011)

Cash +2% 15%FI-Sovereign No change 9% 44%FI-Corporate No change 20%

Developed Market Equity +2% 18%Emerging Market Equity No change 14 % 37%Private Equity No change 5 %

Absolute Return -2% 8%Real Estate & Infrastructure No change 5% 19%Commodities & FX -2% 6%

Total 100% 100%

}

}

}*Relative to asset allocation from the

GIC meeting on October 27, 2011

Source: Deutsche Bank, PWM Global Investment Committee (GIC);subject to change without notice. As of November 29, 2011


Key contacts: our Global Strategy Team

GlobalArnaud de Servigny [email protected]

US Larry V. Adam [email protected] Asset class expertise:Equities

US Megan Horneman [email protected] Asset class expertise:Fixed income

Germany Elke Speidel-Walz [email protected] Asset class expertise:Emerging markets

EMEA (pro tem)Stéphane [email protected]

APACChristian Nolting [email protected] Asset class expertise:Commodities

UK Paul Wharton [email protected] Asset class expertise: Equities


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