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P E R S P E C T I V E S F R O M T H E G L O B A L P O R T F O L I O A D V I S O R Y C O M M I T T E E

MAY 2015

I N T H I S I S S U E > >

FOCUS ARTICLEOUTLOOK FOR CANADA BANKS

For Important and Required Non-U.S. Analyst Disclosures, see page 20.

R B C W E A L T H M A N A G E M E N T

GLOBAL INSIGHT

CURRENCIESTHE POUND’S ELECTION JITTERS

The BiosimilarrevoluTion

jkla A new treatment is storming the fortress, flinging open the door to

less expensive life-saving drugs

Bogdanov & Corney | Page 4

GLOBAL FIXED INCOMEUSE CAUTION AHEAD

GLOBAL EQUITYFINDING DIRECTION

2 GLOBAL INSIGHT | May 2015

Global InsightMay 2015

All values in U.S. dollars and priced as of April 30, 2015, market close, EST, unless otherwise noted.

TaBle of ConTenTs

4 The Biosimilar revoluTion Replicas of the most exotic, expensive specialty drugs are about to hit the U.S. for the first time. The coming transformation in the health care sector will likely bring major opportunities and challenges for biotech and pharma companies for years to come.

7 ouTlook for Canadian Banks The oil rout has created a volatile environment for Canada’s banks. Given the potential for another rate cut by the Bank of Canada and the possibility of going “toe-to-toe” with tech heavyweights in the payments system arena, it’s a good time to check in on the health of Canada’s banks.

10 GloBal equiTy: findinG direCTion The confident U.S. consumer has the global economy on an even keel. If growth continues at the current pace, earnings and share prices should advance. Our constructive outlook is intact.

13 GloBal fixed inCome: use CauTion ahead A “new normal” of central bank-induced volatility and illiquidity is emerging. Credit provides the best opportunities, but investors should be patient as they selectively look for better future entry points.

Inside the Markets

3 rBC’s invesTmenT sTanCe

10 gloBal equiTy

13 gloBal fixed inCome

15 CommodiTies

16 CurrenCies

17 Key foreCasTs

18 marKeT sCoreCard


Global Asset Class View

rBC’s invesTmenT sTanCe

Views Explanation (+/=/–) represents the Global Portfolio Advisory Committee’s (GPAC) view over a 12-month investment time horizon.

+ Positive implies the potential for better-than-average performance for the asset class or for the region relative to other asset classes or regions.

= In-line implies the potential for average performance for the asset class or for the region relative to other asset classes or regions.

– Negative implies the potential for below-average performance for the asset class or for the region relative to other asset classes or regions.

Global Asset Views

Source - RBC Wealth Management

Asset Class

View

— = +Equities

Fixed Income

See “Views Explanation” below for details

Expect below average

performance

Expect above average performance

EquitiEs – AvErAgE PErformAncE =�� Our long-term outlook for global equities remains constructive. U.S. GDP

should bounce back in Q2, European bank lending and money supply are

growing at the strongest levels in years, and China is implementing meaningful

reforms.

�� Monetary policy is more supportive of equities than markets were expecting

earlier this year. The Federal Reserve and Bank of England seem to have pushed

back their plans to raise interest rates until Q3 at the earliest. Other major

central banks seem willing to pump liquidity into 2016 at least.

�� U.S. equity valuations are somewhat stretched, but they are not so high as to

warrant reducing exposure. Valuations are less supportive in select European

sectors and Asian markets following the recent rallies.

fixEd incomE – BElow-AvErAgE PErformAncE –�� Below-trend economic growth and inflation rates in all major economies have

most central banks either on the sidelines or in stimulus mode. The near- to

below-zero percent rate policies and uncertainties about the timing of the

Federal Reserve’s first rate hike have created pockets of volatility and illiquidity

in the global fixed income market. This is becoming the norm across regions,

and is creating additional risks for investors.

�� We continue to anticipate coupon-like fixed income returns this year, not a

repeat of 2014’s strong performance. We see the best opportunities in credit,

but valuations, especially in higher-yielding sectors, have become stretched; it

may pay to wait for better entry points. We recommend diversifying holdings

across sectors.


Focus Article

The Biosimilar revoluTionexeCuTive summary

Old assumptions about the fortress-like environment protecting high-tech drugs from competition and patent cliff risk are no longer valid. The biotechnology and pharmaceuticals industries are entering a new phase of heightened competition following U.S. approval of its first biosimilar in March 2015. Investors need to be aware of how this burgeoning market could help determine biotech and pharma winners and losers in the years ahead.

Following is an executive summary of a special report, The Biosimilar Revolution. Please find the full report here.

whAt is A BiosimilAr?Biosimilar treatments are essentially copycats of biologic drugs—the most complex, exotic, and expensive specialty drugs on the market.

Understanding biosimilars starts with a basic understanding of biologic therapies.

Biologics are comprised of complex living organisms, including cells from humans or animals, or microorganisms (bacteria). In contrast, traditional drugs, such as Lipitor or Celebrex, are made up of chemical compounds.

A biosimilar is a therapy that is highly similar to an approved biologic product, and has no clinically meaningful differences in effectiveness, potency, purity, or safety compared to the reference product. Copycat biosimilars compete head-to-head with biologic drugs, but at reduced prices.

It’s important to recognize, however, biosimilars are not generic drugs. Generics are exact copies of branded pharmaceuticals. The active ingredients, which are made from chemical compounds, are 100% the same.

It’s technically impossible for a biosimilar to be an exact copy of a biologic drug. They are both derived from large, very complex proteins from living organisms. They have cells that naturally vary from one another. That variability is why biosimilars and biologics are “highly similar” rather than exactly the same.

u.s. APProvAl: A wAtErshEd momEnt

Last March represented a turning point for the industry when the U.S. Food and Drug Administration approved the country’s first biosimilar—a drug based off of Amgen’s Neupogen, a chemotherapy recovery treatment. The biosimilar was developed by Sandoz, the generic unit of Novartis.

While most developed countries and many developing countries had previously approved biosimilars, U.S. involvement greatly expands the global market. The U.S. consumes nearly half of biologics worldwide and represents roughly half of the industry’s growth.

KElly BogdAnov San Francisco, United States [email protected]

tim cornEy Toronto, Canada [email protected]

https://www.rbcinsight.com/WM/Share/ResearchViewer/?SSS_86E631760CC5D777798A2BB81252B116


Biosimilar Revolution

To understand the scope of the biosimilar market, it is important to get a sense of the size of the current biologic market. In 2014, over $150B was spent on biologics globally. Our research sources estimate that sales of biologic drugs could top over $270B by 2020.

Biologics have emerged as the fastest-growing segment of the pharmaceuticals industry. By the end of 2015, biologics will likely represent 70% of the top-10 drugs by sales, a near doubling in less than 10 years.

Importantly, during the next five years, patents will expire for nine biologics currently representing over $60B in annual sales (see table). Upon expiration, these drugs no longer will be shielded from competition, and approved biosimilars can be introduced into the market.

Top Biologic Drugs Nearing or Beyond Patent Expiration

Sales 2013

Company Drug Primary Use (US$B) FDA EU

AbbVie Humira Rheumatoid Arthritis $10.7 Dec 2016 Apr 2018

Amgen Enbrel Rheumatoid Arthritis $8.5 Aug 2019* Feb 2015

Sanofi Lantus Diabetes $7.5 Feb 2015 May 2015

Roche Herceptin Breast Cancer $6.7 Jul 2019 Jul 2014**

Roche Avastin Various cancers $6.6 Jul 2019 Jan 2022

Merck/JNJ Remicade Crohn's Disease $6.3 Sep 2018 Feb 2015

Biogen/Roche Rituxan Non-Hodgkin's Lymphoma $6.0 Sep 2018 Nov 2013

Roche/Novartis Lucentis Macular Degeneration $4.1 Jun 2020 Jun 2022

Teva/Sanofi Copaxone Multiple Sclerosis $3.8 May 2014 Jan 2015

Total $60.2

Patent Expiration

* Enbrel has multiple uses with U.S. patents expiring from 2019–2029; 2019 patent is for psoriatic arthritis ** In the U.K.; other major EU markets follow in August 2015 Source - RBC Dominion Securities, RBC Wealth Management, Corporate filings, Generics and Biosimilars Initiative, national research correspondent

Share of Biologic Sales by Country/Region

9.1%7.5%

13.2%

21.6%

48.6%

* “Pharmerging” represents seven emerging markets with strong pharmaceutical sales growth: Brazil, China, India, Mexico, Russia, South Korea, and Turkey. Source - IMS Health, MIDAS, MAT December 2012

8.1%

14.7%

13.3%

14.1%

49.8%

Japan

Pharmerging*

Rest of World

European Union

United States

The U.S. dominates biologic sales, followed by the EU.


Biosimilar Revolution

Biosimilar therapies are in the very early innings.

rEgulAtors ArE dEEPly incEntivizEd

There are significant incentives for governments and regulators to push appropriate biosimilars to market.

Currently, $4 out of every $10 the U.S. spends on prescription medication is being allocated to complex biologics, with the cost of just one treatment or dose often ranging from $1,000 to more than $50,000.

When one considers that health care spending in the U.S. as a percentage of GDP has been rising for years—a trend that should continue—while the public sector has been footing an increasing amount of the cost (see chart), the ability to reduce costs through the ongoing development and acceptance of biosimilars is a powerful tool for policymakers.

A number of analysts estimate biosimilars could shave 20%–30% off the price of competing biologics. However, management at CVS Caremark, one of the largest U.S. drug store chains and pharmacy benefit managers, believes copycat drugs could result in even greater price reductions to the tune of 40%–50% relative to current prices of branded biologics. The discount could be even greater for select biosimilars, depending on the country.

focus on comPAniEs with considErABlE rEsourcEs

In our view, we are currently in the very early innings of the emergence of biosimilar therapies.

The biosimilar market is already highly competitive. More than 140 companies of varying sizes and pedigrees around the world are involved in creating copycat treatments.

Given the ultra-competitive nature of the biosimilar market and the early stage of development, large pharma and biotech companies with substantial resources and know-how to develop biosimilar drugs will likely be the near-term winners, in our view.

The next few years should be an exciting period for these industries, as well as a promising time for patients who require advanced drug treatments. The regulatory groundwork has been laid for a truly global biosimilar market to take shape, with expanded U.S. consumption likely to be the major driver.

For more information, please see the complete report, The Biosimilar Revolution.

U.S. Government as % of Domestic Health Spending

Source - CMS, RBC Capital Markets. Note: Medicare, Medicaid, and other government programs (CHIP, Dept. of Defense, Dept. of Veterans’ Affairs)

The government is on track to pay 43% of total health expenses by 2023.

0

10

20

30

40

50

'60 '70 '80 '90 '00 '10 '20

%

Introduction of Medicare & Medicaid

CMS Projection

https://www.rbcinsight.com/WM/Share/ResearchViewer/?SSS_86E631760CC5D777798A2BB81252B116


Focus Article

ouTlooK for Canadian BanKsan inTerview wiTh darKo miheliC

The sharp drop in oil prices and the resultant impact on the Canadian economy has created a volatile backdrop for Canadian banks. In light of this, members of the Portfolio Advisory Group thought it would be a good time to sit down and speak with RBC Capital Markets, LLC’s Canadian Financials Analyst, Darko Mihelic, about the sector and what investors can expect moving forward.

Q. While Canadian bank stocks have rebounded in April, the first three months of the year saw considerable volatility. What has been weighing on investor sentiment?

DM. A number of factors contributed to the lackluster performance earlier this year with the main drivers including: the outlook for the Canadian economy, the risk of rising credit costs, potentially lower loan growth, and tail risks on real estate.

The chief risk is the potential for Alberta to head into recession and possibly pull the rest of the nation along with it. While RBC Capital Markets has a reasonably optimistic outlook for Canada and the U.S., there is still noteworthy discord in Street estimates for Canada in particular.

mArK AllEn Toronto, Canada [email protected]

lindsAy BrEnt Toronto, Canada [email protected]

Canadian Bank Index Recurring Earnings Growth (y/y)

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1988 1992 1996 2000 2004 2008 2012

Source - RBC Capital Markets; Note: Light shaded bars represent recessions

Declining bank earnings typically accompany challenging economic conditions.

As economic conditions deteriorate, concerns about the potential for a spike in credit losses naturally arise. So far, credit quality looks robust for Canadian banks; however, we could see a rise in credit provisions by perhaps the third quarter of this year.

As the economy slows, it may be difficult to duplicate the impressive 25-year average loan growth trend of almost 8%. Growth in mortgages and personal loans has dropped to mid- and low single-digit levels in recent years, and overall loan growth has been supported by improving trends in commercial lending. However, commercial loan growth may not be able to sustain its current pace in the medium term as Canadian lenders tighten credit requirements for borrowers.


Canadian Banks

The outside risk of a sharp

decline in housing elicits

investor fear of regulatory

reform.

Finally, there is the tail risk on real estate should prices decline significantly in Western Canada and lead to contagion nationwide. Canadian bank balance sheets enjoy substantial protection through mortgage insurance provided by the federal government via the Canada Mortgage and Housing Corporation (CMHC). However, in a dire scenario, large losses incurred by the CMHC might elicit regulatory change that could alter Canadian bank return profiles.

Q. Where are Canadian banks trading in the context of historical valuations?

DM. The banks are trading at a modest discount to long-term historical averages on a price-to-book value basis with the sector at 1.8x versus the 10-year average of 2.0x. For context, during the global financial crisis, the sector fell to 1.1x book value. Even if Canada were to fall into a recession, we do not believe valuations would approach that trough.

Canadian Banks: Historical Price-to-Book Value

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1997 2001 2005 2009 2013

Source - RBC Capital Markets

Valuations not yet reflecting a soft patch in the economy.

Q. Which is your preferred Canadian bank stock?

DM. We continue to favor TD Bank (TSX: TD; Outperform; CA$55.70) for a number of reasons including exposure to the U.S. market, positioning in Western Canada, and dividend growth potential.

About one-quarter of TD’s earnings come from its U.S. business, which is benefiting from an economic recovery and the resultant trends in loan growth. Add to this positive currency translation effects and we have a fairly optimistic view of TD’s U.S. retail segment.

TD’s exposure to the energy sector is low compared to peers with only 0.7% of its total loans in direct commercial oil & gas exposure. Exposure to residential mortgages and home equity loans (HELOCs) in the Prairies is 9.6% of TD’s total loans, which is in the middle of the pack for the “Big 5” Canadian banks.

On dividend growth, TD is well positioned with RBC Capital Markets’ forecast dividend payout ratio for 2015 at 42%, which is at the low end of the peer group and TD’s targeted payout range of 40%–50%.

In summary, TD’s strong Canadian retail franchise is complemented by a sizeable U.S. business, modest exposure to the energy sector, and favorable positioning for future dividend growth.


Canadian Banks

Canadian banks are well positioned

for any economic headwinds given

capital levels and tight lending

policies.

Q. Are you worried about another interest rate cut by the Bank of Canada?

DM. The consensus view is for another cut by the Bank of Canada. It is unclear whether the banks would follow suit with a similar cut to the prime rate. Last time, the Bank of Canada cut its overnight lending rate by 25 basis points (bps), while the banks cut the prime rate by 15 bps with limited impact on margins. The greater risk is that another rate cut from the Bank of Canada would likely be coincident with a deteriorating economic outlook.

Q. Can you discuss the CMHC foreclosure process and could we see a loss-sharing mechanism in the future?

DM. In most cases today, CMHC pays out 100% of the loss to a bank, including eligible claims costs. However, well before a legal process is instituted, a bank will attempt to find creative ways to help the customer become current on a loan. The federal government backs 100% of CMHC’s obligations, and also backs private mortgage insurers’ obligations to lenders subject to a 10% deductible.

One way to reduce taxpayer exposure is to allow private mortgage insurers to increase their market share, which over time would raise the aggregate deductible in place. Another would be to consider policy changes that could introduce a deductible for lenders relying on CMHC mortgage insurance, a point which has been discussed in the media.

At this point, there’s nothing in the works as far as we know, but this would certainly be one avenue the government could take. Because this would have ramifications for capital and liquidity, such a change would likely take time.

Q. Last question, Darko. How would you characterize the current state of affairs for the Canadian banks versus, say, leading up to the financial crisis?

DM. The Canadian banks were well positioned heading into the financial crisis, especially when compared to their U.S. and global peers. Even so, banks have reduced risk by decreasing equity market-sensitive sources of income and increasing capital levels.

Fundamentally, many business practices today are also quite different as mortgage rules have changed since the crisis (tighter lending policies) and the banks are operating in a lower interest rate environment. Finally, in the past, the “shadow banking” system was threatening to eat into bank profits at the margin and that threat has diminished. Today, a bigger threat is emerging from technology companies wading into the payments system which could morph into numerous different business threats to all banks worldwide, not just Canadian banks.

This different paradigm may make it a little more difficult to keep a lid on costs because technology spending can easily accelerate if the Canadian banks have to go “toe-to-toe” with large technology companies like Apple, Google, Microsoft, and Facebook.


finding direCTionOur base case for the past three years is very much intact. The global economy is gradually returning to normal, led by the U.S. economy and, more specifically, the U.S. consumer.

Despite a weak first quarter for overall GDP growth, due mostly to weather, the West Coast port strike, and energy sector slowdown, the U.S. private sector clocked in with a robust 3.5% y/y gain. Leading indicators, wages, and employment are moving higher, with consumer and business confidence elevated.

In Europe, GDP growth is improving, led by Spain and Germany. Confidence is rising. Full-year growth estimates are being revised upward.

Equity investors like what they see. In the fall of last year, many major equity markets were trading at significant valuation discounts to the American market. Since then, P/E multiples for those markets have converged with that of the S&P 500 at around 17x earnings.

It’s fair to say these stock markets are no longer cheap. Neither are they particularly expensive. Most major markets are somewhat above their long-term average P/E ratios. However, all markets are cheap relative to bonds.

Over the coming 12 months, if the major economies continue to expand at or above their current pace, then overall corporate earnings should advance commensurately, as should share prices. It would take a substantial weakening of the economic outlook to threaten a meaningful retrenchment in most stock markets. Current momentum combined with continued

Global Equity

Source - RBC Wealth Management; see “Views Explanation” on page 3 for details.

Jim Allworth Vancouver, Canada [email protected]

KElly BogdAnov

San Francisco, United States [email protected]

mAtt BArAsch Toronto, Canada [email protected]

frédériquE cArriEr London, United Kingdom [email protected]

JAy roBErts Hong Kong, China [email protected]

accommodative monetary policies persuade us this is unlikely.

Global portfolios should hold equities up to their long-term targeted allocation.

Equity Views

Region Current

Global =United States =Canada =Continental Europe =United Kingdom –Asia (ex Japan) +Japan +

rEgionAl highlights

unitEd stAtEs

�� So far, earnings estimates have crept higher during the Q1 reporting season (see chart next page), which has helped to quell fears of an “earnings recession.” Profit margins have unexpectedly improved, and sizeable stock buyback programs have provided support. Also, strong dollar headwinds have blown less forcefully than analysts initially expected. Even though 35%–45% of S&P 500 revenues are international, many multinational companies in the index produce their products offshore and, therefore, are less exposed to the strong dollar than one might think.

�� S&P 500 Q1 profits have the potential to be flat or grow slightly on a year-over-year basis despite the massive drag from the energy sector, which could see earnings cut in half. Excluding energy, the S&P 500 is on pace to grow Q1 earnings 9.7%.


Global Equity

�� We continue to view the U.S. equity market favorably. We would hold slight overweight positions in large-capitalization and midcap stocks. Small caps are more attractive than they were last year because the valuation gap relative to large caps has narrowed. However, small caps tend to underperform when the Federal Reserve begins to tighten policy, which it is expected to begin in the second half of the year. Among S&P 500 sectors, we would overweight technology, health care, and financials.

cAnAdA

The S&P/TSX is up 4% YTD with the energy sub-index up nearly 10%. We continue to recommend market weight exposure to Canadian stocks and would admit to some level of surprise at the market’s resilience in the face of the sharp decline in oil prices. We continue to position our portfolios in the following manner:

�� Market Weight Financials: We are concerned that credit losses, currently at very benign levels, could deteriorate to some degree in the back half of the year, although the Canadian banks remain very strong, well-run businesses.

�� Underweight Telecom: The potential emergence of a fourth national wireless competitor would have a negative effect on the incumbent providers.

�� Overweight Consumer: Consumer stocks continue to benefit from the decline in oil prices (which puts more money in consumers’ pockets). Furthermore, the weaker loonie should boost domestic consumption.

�� Overweight Industrials: The Canadian railroads in particular stand to benefit from a strengthening U.S. economy and operational efficiencies.

�� Underweight Energy: The large-cap Canadian energy names have mostly held in well, despite the drop in oil and natural gas prices. We are concerned that a good portion of any likely future price increases is already reflected in valuations.

�� Underweight Materials: China, the main driver of the commodity story, continues to manage down its growth rate, leaving many companies struggling to right-size production in the face of a significant downshift in demand.

Q1 2015 S&P 500 Consensus Earnings Forecasts

-10%

-5%

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5%

10%

15%

20%

Hea

lth

Care

Fina

ncia

ls

S&

P 50

0ex

-Ene

rgy

Tech

nolo

gy

Cons

. Dis

c.

Indu

stri

als

Uti

litie

s

Mat

eria

ls

Cons

. Sta

p.

Tele

com

1 May 1 April

Note: Chart excludes energy sector, for which earnings growth forecasts have risen to -54.5% from -63.7%. S&P 500 growth forecast including energy is 2.0%. Source - RBC Wealth Management, Thomson Reuters I/B/E/S; data is a blend of estimated and actual results.

As companies have reported better-than expected results, estimates have risen.


Global Equity

continEntAl EuroPE & u.K.�� In the U.K., the Conservatives and

Labour remain neck and neck in the May 7 general election polls. Each party is unlikely to amass enough votes to form a majority government. The chances of a coalition of several parties or a minority government are high—raising the prospect of an unstable government.

�� This risk is not discounted in the equities market, in our view. We expect this may well change. For equities, should volatility increase before or after the election, we would look to increase positions in companies with large global platforms and limited exposure to domestic turmoil (media, health care, industrials). The Labour Party has indicated it would increase regulatory requirements in some industries, which would impact their profitability. We would be mindful of companies operating in these sectors: utilities, banks, and real estate. Overall, a weak pound could be positive for exporters. For more on the U.K. election, please click here.

�� In Europe, the Greek saga continues. The fate of Greece is politically important, but economically less relevant, in our view. Unlike two or three years ago, we believe Europe is better positioned to absorb the potential cost of writing off Greek loans and that the contagion risk is small. Low oil prices are supportive for the region, which also benefits from QE support. Nevertheless, after a strong run in most European markets, a flare-up of the situation could encourage profit-taking.

AsiA

�� Asian equities continue to outperform. The MSCI AC Asia ex-Japan Index rallied strongly in April to a new high and is up 12.1% in 2015. Chinese stocks, which constitute approximately one-quarter of the index, have been a major contributor, despite tighter restrictions on margin trading and uninspiring data from the manufacturing sector.

�� The Shanghai Composite rose to a new high last month and has risen for eight consecutive weeks. The index is up 37% in 2015 and has more than doubled since summer 2014. In March, equities, especially financials, were boosted by the announcement of a major local government debt-swap plan. Last month, more fuel was thrown on the fire with a reduction in the reserve-requirement ratio (RRR) for Chinese banks, which should enable them to lend more. The reduction was 1% for the largest banks. Banks that lend more to small and medium-sized enterprise were given a greater reduction. Equities rallied. After its dramatic re-rating, the Shanghai Composite trades at 18.0x consensus forward earnings estimates and 2.6x book value and may be vulnerable to a pause, in our view.

�� Japanese equities extended their rally with the Nikkei breaking through 20,000 for the first time in 15 years. The benchmark TOPIX index also reached a new cycle-high. It has rallied 15% in 2015 despite the stability of the yen against the dollar. This is a good sign, in our view. We remain cautious on a tactical (short-term) basis because of the sharp run-up, but we maintain our overweight position as we continue to have a positive long-term view.

https://www.rbcinsight.com/WM/Share/ResearchViewer/?SSS_24154BF2888F2676567B633014ADEEDF


use CauTion ahead

Uneven economic growth and persistently low inflation have pushed out expectations for diverging policy paths amongst global central banks. The Federal Reserve and the Bank of England, both expected to raise rates in mid-2015, have guided forecasts to Q3 at the earliest, while the Bank of Canada appears to be on hold for now.

The European Central Bank is two months into its quantitative easing program with early indications the program has gained some traction. Nonetheless, even with this success and despite some early calls for “tapering,” we believe the program will likely go the full duration, ending in September 2016.

Data dependency, a key focus at the Federal Reserve, provides central banks the flexibility to act when necessary, but this unfortunately creates volatile market conditions for investors. These pockets of volatility and the accompanying illiquidity will create a “new normal” and additional risks for investors, in our view.

We continue to look for selective opportunities in credit, but valuations in many sectors are stretched. Further, specific sectors are under pressure for a myriad of reasons, including: strong fund inflows, which have buoyed prices but decreased relative value opportunities; central bank activity; and the tighter regulatory environment. We have not moved from our “lower for longer” view on rates, nor are we predicting another “taper tantrum.” However, with heightened chances for Federal Reserve-induced volatility in the near term, investors may want to exercise caution in anticipation of better entry points.

Sovereign Yield Curves

Source - RBC Wealth Management, Bloomberg

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1Yr 5Yr 9Yr 13Yr 17Yr 21Yr 25Yr 29Yr

UK

US

Canada

crAig BishoP

Minneapolis, United States [email protected]

tom gArrEtson Minneapolis, United States [email protected]

RBC Capital Markets, LLC

AlAnA AwAd Toronto, Canada [email protected]

hAKAn EnoKsson London, United Kingdom [email protected]

Global Fixed Income

*1-yr base lending rate for working capital, PBoC Source - RBC Investment Strategy Committee, RBC Capital Markets, Global Portfolio Advisory Committee (GPAC), Consensus Economics

Central Bank Rate (%)

0.10

4.85

0.75

0.05

0.65

0.75

0.10

5.35*

0.50

0.05

0.75

0.25

Japan

China

U.K.

Eurozone

Canada

U.S.04/30/15

1-Year Out

rEgionAl highlights

unitEd stAtEs

�� Though we continue to stress, as does the Federal Reserve, that the timing of the first rate hike doesn’t matter so much as the path, we believe markets remain focused on timing as weak economic data has led to delayed expectations. As a result, the dollar’s rally has paused, which has helped to push oil prices higher. In turn, Treasury yields were driven lower amid renewed complacency in credit markets.

�� But just as weak data pushes back rate hike expectations, stronger data can pull them forward. We expect the economy to turn the corner in Q2 and for investors to turn their focus back to the Federal Reserve. We would take a cautious approach to the fixed income space with the potential for further volatility and higher yields ahead.

�� High-yield credit, and particularly high-yield energy, looks the most vulnerable to a reversal in Federal Reserve sentiment and oil prices. After significant fund outflows into the end of 2014, these sectors have experienced significant inflows driven in part by delayed Federal Reserve expectations,


Global Fixed Income

0.50

NA

2.25

0.70

2.00

2.50

0.34

3.41

1.83

0.37

1.59

2.03

Japan

China

U.K.

Eurozone*

Canada

U.S.

04/30/15

1-Year Out

10-Year Rate (%)

*Eurozone utilizes German bunds.Source - RBC Investment Strategy Committee, RBC Capital Markets, GPAC

sending valuations toward exceedingly rich levels, in our view.

cAnAdA

�� On April 15, the Bank of Canada (BoC) held the overnight rate constant at 0.75%. In the accompanying statement, BoC Governor Stephen Poloz acknowledged the economy had experienced a weak first quarter but expected the economy to pick up in the second half of the year.

�� The preferred share market continued its decline and was down over 10% YTD before finding a short-term bottom on April 22. The recent move higher in Government of Canada 5-year yields has been supportive of rate-reset preferred shares and helped spur a 3.5% rally off the lows late in the month.

�� The Canadian dollar rallied over 5% and is back to January levels as a rally in oil prices and diminished expectations for an imminent BoC rate cut have proven supportive.

continEntAl EuroPE & u.K.�� The European Central Bank has

successfully implemented its QE program, which has resulted in a rally across eurozone government debt. We believe yields on eurozone debt will continue to drop below zero in the coming months as the QE

program absorbs most of the supply of eurozone sovereign debt.

�� The risk of broader contagion from the Greek situation is low, in our view, as holdings of Greek debt in the broader eurozone are low. The situation continues to be very fluid and a default in some form cannot be ruled out.

�� We continue to see value in long- dated peripheral bonds that still have a positive yield, and corporate bonds, which are likely to see second order effects from QE. We believe QE could lead to stronger growth, which would be good for corporates, and could push demand from the sovereign market to the corporate market.

�� The U.K. market is likely to see some increased volatility stemming from the uncertainty around the upcoming election. Regardless of the outcome, we do not see the Bank of England altering its rate hiking path, which would leave short-term rates stable.

�� We err to caution running up to the election of taking long-dated exposure due to volatility. We continue to see better value in corporate bonds. However, Labour-led outcomes could see some marginal sell-off in financials due to the perception that this would lead to a tighter regulatory environment.

Source - RBC Wealth Management, EPFR Global, Bloomberg, data through 4/22/15

Bad News Is Good News for U.S. High-Yield Credit

-20-15-10-50510152025

-$8,000

-$6,000

-$4,000

-$2,000

$0

$2,000

$4,000

$6,000

09/

03/1

40

9/17

/14

10/0

1/14

10/1

5/14

10/2

9/14

11/1

2/14

11/2

6/14

12/1

0/14

12/2

4/14

01/

07/

150

1/21

/15

02/

04/1

50

2/18

/15

03/

04/

150

3/18

/15

04/

01/

150

4/15

/15

RBC Econom

ic Scorecard

Hig

h-Yi

eld

Fund

Flo

ws

(M)

High-Yield Fund Flows RBC Economic Scorecard Investors have poured money back into high-yield bonds as the decline in economic data potentially delays Federal Reserve action on rates.


mArK AllEn Toronto, Canada [email protected]

2015E 2016E

Oil (WTI $/bbl) 54.00 74.00

Natural Gas ($/mmBtu) 2.97 3.45

Gold ($/oz) 1,250 1,300

Copper ($/lb) 2.75 3.00

Corn ($/bu) 3.92 4.19

Wheat ($/bu) 5.44 4.79

Source - RBC Capital Markets forecasts (oil, natural gas, gold, and copper), Bloomberg consensus forecasts (corn and wheat)

Commodities

Commodity Forecasts

coPPEr And industriAl mEtAls

�� Chinese fixed asset investment growth is moderating as the economy shifts towards domestic consumption. Chinese demand for copper continues to grow at a rapid pace with a 7.7% increase expected for 2015, albeit lower than 2014’s 9.0%, per RBC Capital Markets.

�� Many Chinese banks have cut credit for metal imports in the last several quarters, which has led to lower imports. In Q1 2015, Chinese copper imports fell 17% y/y.

�� Overall, the copper market has been in surplus from H2 2014 through Q1 2015, but RBC Capital Markets expects this to gradually change beginning in H2 2015.

�� We believe a reasonable price range for copper is $2.50–$3.00/lb in the near term.

oil �� The recent rally has been spurred by

an expected plateauing of U.S. oil production, suggesting a bottoming process for oil prices may have begun.

�� In the U.S., the oil rig count is down about 50% from the fall 2014 peak.

Source - RBC Dominion Securities, Bloomberg

Fixed Asset Investment Growth for China (y/y)

10

15

20

25

30

35

Mar 2009 Mar 2011 Mar 2013 Mar 2015

China’s pace of investment in hard assets is slowing.

Producers are shifting their focus to the highest-quality portions of their fields, are deferring the completion (“fracking”) of drilled wells, and pressuring energy services companies to reduce the cost of drilling by 20% or more.

�� A large shadow inventory has developed with some 4,000+ shale oil wells in the U.S. drilled but not yet completed at the end of 2014.

�� The shadow inventory, combined with current deferrals, and lower drilling costs could surprise the market in terms of how long U.S. production continues to hold steady, despite the sharp drop in the rig count.

�� RBC Capital Markets forecasts U.S. oil and liquids production to continue to grow by 630,000 barrels of oil per day in 2015 and 580,000 in 2016.

�� Key drivers of the oil price in the near term include: storage levels in the U.S., Iranian sanctions, Libyan production, U.S. drilling activity and production levels, and any reaction from OPEC.


AlAn roBinson Seattle, United States [email protected]

u.s. dollAr �� The weaker-than-expected U.S. jobs

report in April rounded off a first quarter of disappointing economic data and pushed back expectations for the Fed’s first rate hike closer to the end of the year. This seems to have at least temporarily put the brakes on the near 20% rally in the dollar underway since last summer.

�� We may not have seen the peak in the dollar, but we think the pace of appreciation will slow considerably. Outright economic growth is still faster in the U.S. than that of most of the U.S.’s G10 trading partners. However, as most of the rest of the world continues with monetary easing, the growth gap could eventually narrow, in our view.

Euro �� Against this backdrop, the euro

appears to have found a floor in recent months. We believe this is a reaction to positive economic data in the eurozone and resistance from traders to push the currency too far below its fair valuation measures.

�� At its recent lows, the euro traded close to a 20% discount to the level suggested by fair value models. While currencies rarely trade at fair value, we have found that they also rarely trade outside of +/- 20% from fair value for any prolonged period of time.

�� We see scope for a modest euro recovery over the summer months as the positive effects of credit easing feed through to the economy.

cAnAdiAn dollAr �� The sensitivity of the loonie to

movements in the price of oil has been clear this year, and our view for the currency leans heavily on our outlook for the energy sector.

�� We expect the Canadian dollar to slide lower against the greenback through Q3 2015, before settling in a lower range as oil recovers. Canada’s persistent current account deficit should act as a cap on longer-term strength in the loonie.

British Pound �� As we go to press, the opinion polls

ahead of the May 7 U.K. general election fail to point to a clear outcome. We believe this political uncertainty has been the main factor in the pound’s Q1 weakness, given that interest rate forecasts have remained steady.

�� With a weak multiparty coalition appearing to be a likely outcome (see chart), we expect political risk will dominate the outlook for sterling as fears of increasing fiscal deficits and/or a referendum on EU membership serve to weaken the currency.

Currency Pair

Current Rate

Forecast Jun 2016 Change*

USD Index 94.60 94.56 0%

CAD/USD 0.83 0.76 -8%

USD/CAD 1.21 1.31 8%

EUR/USD 1.12 1.16 4%

GBP/USD 1.54 1.49 -3%

USD/CHF 0.93 0.97 4%

USD/JPY 119.38 126.00 6%

AUD/USD 0.79 0.71 -10%

NZD/USD 0.76 0.69 -9%

EUR/JPY 133.99 146.16 9%

EUR/GBP 0.73 0.78 7%

EUR/CHF 1.05 1.13 7%

Emerging Currencies

USD/CNY 6.20 6.90 11%

USD/INR 63.42 66.00 4%

USD/SGD 1.32 1.47 11%

USD/TRY 2.67 2.80 5%

USD/PLN 3.60 3.34 -7%

USD/MXN 15.35 14.25 -7%

USD/BRL 3.01 3.65 21%

* Defined as the implied appreciation or depreciation of the first currency in the pair quote. Examples of how to interpret data found in the Market Scorecard. Source - RBC Capital Markets, Bloomberg

Currency Forecasts

Currencies

Source - RBC Wealth Management, Sporting Index for projected seat totals

U.K. Election Outcome Not Getting Any Clearer

0

50

100

150

200

250

300

350

Conserv. Liberal-Democrat

Labour ScottishNationalist

Other

Current

Projected

326 seats required to form a majority Pre-election projections point to the likelihood of a weak coalition government. An uncertain policy outlook may increase risk aversion toward the currency.


Canada — Energy Weakness�� Q4 stronger than expected despite oil woes. Q1 feeling

the brunt. April was 3rd month of negative readings for RBC Canadian PMI. New orders off highs. Weather an issue in Q1.

�� Mfg. unfilled orders off in April but near all-time high. Housing construction rising after weather-related weakness. Energy capital spending plans down sharply.

Eurozone — Improving�� Q1 to be 7th successive quarter of positive growth,

including for Spain, which may be accelerating. Germany, Netherlands, Ireland solid. France lagging. Private sector lending up 4 mos. running after 2-year decline.

�� Region’s PMI off in April, still solidly above “50” expansion/contraction boundary. Germany, Spain leading the way, Italy in positive territory, France soft. Russia, Greece weighing.

United Kingdom — Electoral Uncertainty�� Q1 GDP up (9th in a row) but weakest since Q4 2102.

Services eased, construction and business capex weak. Oil sector subtracted from growth. Employment and wages solid. April PMI weaker. New orders and export orders both higher.

�� Growth pace sustainable for 2015, but potentially vulnerable to parliamentary outcome.

China — Stabilising�� Q1 GDP at 7.0% in line with gov’t full-year target, but

industrial output, fixed asset investment, and retail sales all slowed. Manufacturing PMI back above 50, but weak LEIs confidence suggests slowdown not over. New orders and exports weak.

�� Loan growth still running faster than GDP growth. Government easing credit conditions.

Japan — Volatile�� GDP growth rate rebounded in Q4. Leading indicators,

new orders, corporate earnings, and business confidence all better.

�� Consumer confident but not yet spending, wages growing. Falling oil prices putting inflation targets in jeopardy.

United States — Solid Growth�� Q1 growth hit by weather, port strike, weak oil sector,

gov’t drag. Private sector grew by 3.5%. Wage growth speeding up. Home sales, prices strong. Leading indicators, confidence elevated.

�� ISM manufacturing index flat in April, new orders and production both up. Unemployment claims at 30-yr low. 2.2% more jobs in last 12 months.

1.9% 2.4%3.3% 3.3%

1.5% 1.6% 0.5% 2.3%

2013 2014 2015E 2016E

2.2% 1.9% 3.2% 3.2%1.8%1.8%1.5%1.7%2012 2013 2014E 2015E

Real GDP Growth Inflation Rate

(

2.0% 2.4% 2.0% 2.3%

1.0%1.9%

1.3%2.3%

2013 2014 2015E 2016E

1.7%2.6% 2.8% 2.5%2.6%

1.5%0.8% 2.0%

2013 2014 2015E 2016E

7.8% 7.4%6.8% 6.3%

2.6%2.0% 2.0%

3.3%

2013 2014 2015E 2016E

-0.4%

0.9% 1.3%2.0%

1.3%0.4% 0.3% 1.5%

2013 2014 2015E 2016E

1.5%

0.0%1.3%

1.5%0.3%

2.8%

1.0%

1.5%

2013 2014 2015E 2016E

Source - RBC Investment Strategy Committee, RBC Capital Markets, and GPAC

Key Forecasts


Index (local currency) Level 1 Month YTD 12 Months

S&P 500 2,085.51 0.9% 1.3% 10.7%

Dow Industrials (DJIA) 17,840.52 0.4% 0.1% 7.6%

NASDAQ 4,941.42 0.8% 4.3% 20.1%

Russell 2000 1,220.13 -2.6% 1.3% 8.3%

S&P/TSX Comp 15,224.52 2.2% 4.0% 3.9%

FTSE All Share 3,760.06 2.6% 6.4% 3.9%

STOXX Europe 600 395.79 -0.4% 15.5% 17.1%

German DAX 11,454.38 -4.3% 16.8% 19.3%

Hang Seng 28,133.00 13.0% 19.2% 27.1%

Shanghai Comp 4,441.66 18.5% 37.3% 119.2%

Nikkei 225 19,520.01 1.6% 11.9% 36.5%

India Sensex 27,011.31 -3.4% -1.8% 20.5%

Singapore Straits Times 3,487.39 1.2% 3.6% 6.8%

Brazil Ibovespa 56,229.38 9.9% 12.4% 8.9%

Mexican Bolsa IPC 44,582.39 2.0% 3.3% 9.5% Bond Yields 4/30/15 12/31/14 4/30/14 12-mo. Chg

US 2-Yr Tsy 0.567% 0.555% 0.410% 0.16%

US 10-Yr Tsy 2.032% 1.923% 2.646% -0.61%

Canada 2-Yr 0.676% 0.506% 1.061% -0.39%

Canada 10-Yr 1.581% 1.357% 2.404% -0.82%

UK 2-Yr 0.535% 0.423% 0.687% -0.15%

UK 10-Yr 1.834% 1.576% 2.663% -0.83%

Germany 2-Yr -0.221% -0.252% 0.141% -0.36%

Germany 10-Yr 0.366% 0.180% 1.469% -1.10% Commodities (USD) Price 1 Month YTD 12 Months

Gold (spot $/oz) 1,184.37 0.1% 0.0% -8.3%

Silver (spot $/oz) 16.15 -3.1% 2.8% -15.9%

Copper ($/metric ton) 6,364.50 4.9% -0.1% -4.4%

Uranium ($/lb) 38.25 -3.2% -4.4% 10.2%

Oil (WTI spot/bbl) 59.63 25.3% 11.9% -40.2%

Oil (Brent spot/bbl) 66.78 21.2% 16.5% -38.2%

Natural Gas ($/mmBtu) 2.75 4.2% -4.8% -42.9%

Agriculture Index 290.58 -1.0% -9.9% -31.4% Currencies Rate 1 Month YTD 12 Months

US Dollar Index 94.60 -3.8% 4.8% 19.0%

CAD/USD 0.83 5.1% -3.7% -9.2%

USD/CAD 1.21 -4.8% 3.9% 10.2%

EUR/USD 1.12 4.6% -7.2% -19.1%

GBP/USD 1.54 3.6% -1.5% -9.0%

AUD/USD 0.79 3.9% -3.3% -14.9%

USD/CHF 0.93 -4.1% -6.2% 5.9%

USD/JPY 119.38 -0.6% -0.3% 16.8%

EUR/JPY 133.99 3.9% -7.5% -5.5%

EUR/GBP 0.73 0.9% -5.9% -11.0%

EUR/CHF 1.05 0.2% -13.0% -14.3%

USD/SGD 1.32 -3.5% -0.1% 5.6%

USD/CNY 6.20 0.1% 0.0% -0.9%

USD/BRL 3.01 -5.7% 13.4% 35.0%

Equity returns do not include dividends, except for the German DAX. Equity performance and bond yields in local currencies. U.S. Dollar Index measures USD vs. six major currencies. Currency rates reflect market convention (CAD/USD is the exception). Currency returns quoted in terms of the first currency in each pairing. Examples of how to interpret currency data: CAD/USD 0.83 means 1 Canadian dollar will buy 0.83 U.S. dollar. CAD/USD -9.2% return means the Canadian dollar has fallen 9.2% vs. the U.S. dollar during the past 12 months. USD/JPY 119.38 means 1 U.S. dollar will buy 119.38 yen. USD/JPY 16.8% return means the U.S. dollar has risen 16.8% vs. the yen during the past 12 months.

Source - RBC Wealth Management, RBC Capital Markets, Bloomberg; data through 4/30/15.

Market Scorecard

Weak U.S. data hits greenback.

China surges on debt swap plan and friendly PBOC policies.

U.S. 10-year back above 2% despite weak economy.

Oil rallies off depressed levels as supply concerns ease.

Brazil hikes rates to 13.25%.


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Maarten Jansen – Head, Investments & Trading, RBC Wealth Management Global Wealth Services Group, RBC Dominion Securities Inc.

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Rajan Bansi – Head of Fixed Income Strategies, RBC Wealth Management Portfolio Advisory Group, RBC Dominion Securities Inc.

Matt Barasch – Head of Canadian Equities, RBC Wealth Management Portfolio Advisory Group, RBC Dominion Securities Inc.

Craig Bishop – Lead Strategist, U.S. Fixed Income Strategies Group, RBC Wealth Management Portfolio Advisory Group, RBC Capital Markets, LLC

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George King IV – Head of Portfolio Strategy, Royal Bank of Canada Investment Management (U.K.) Ltd.

René Morgenthaler – Head of Investment, RBC (Suisse) SA, RBC International Wealth Management

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researCh resourCes


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As of March 31, 2015

Rating Count Percent Count PercentBuy [Top Pick & Outperform] 909 52.33 280 30.80Hold [Sector Perform] 713 41.05 125 17.53Sell [Underperform] 115 6.62 5 4.35

Investment Banking Serv ices Prov ided During Past 12 Months

Distribution of Ratings - RBC Capital Markets, LLC Equity Research


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To U.S. Residents: This publication has been approved by RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC, which is a U.S. registered broker-dealer and which accepts responsibility for this report and its dissemination in the United States. RBC Capital Markets, LLC, is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Any U.S. recipient of this report that is not a registered broker-dealer or a bank acting in a broker or dealer capacity and that wishes further information regard-ing, or to effect any transaction in, any of the securities discussed in this report, should contact and place orders with RBC Capital Markets, LLC. International investing involves risks not typically associated with U.S. investing, including currency fluctuation, foreign taxation, political instability and different account-ing standards.

To Canadian Residents: This publication has been approved by RBC Dominion Securities Inc. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. ®Registered trademark of Royal Bank of Canada. Used under license. RBC Wealth Management is a registered trademark of Royal Bank of Canada. Used under license.

To European Residents: Clients of United Kingdom subsidiaries may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of busi-ness and the circumstances of the claim. Most types of investment business are covered for up to a total of £50,000. The Channel Islands subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.

To Hong Kong Residents: This publication is distributed in Hong Kong by RBC Investment Services (Asia) Limited and RBC Investment Management (Asia) Limited, licensed corporations under the Securities and Futures Ordinance or, by Royal Bank of Canada, Hong Kong Branch, a registered institution under the Securities and Futures Ordinance. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. Hong Kong persons wishing to obtain further informa-tion on any of the securities mentioned in this publication should contact RBC Investment Services (Asia) Limited, RBC Investment Management (Asia) Limited or Royal Bank of Canada, Hong Kong Branch at 17/Floor, Cheung Kong Center, 2 Queen’s Road Central, Hong Kong (telephone number is 2848-1388).

To Singapore Residents: This publication is distributed in Singapore by RBC (Singapore Branch) and RBC (Asia) Limited, registered entities granted offshore bank status by the Monetary Authority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. You are advised to seek indepen-dent advice from a financial adviser before purchasing any product. If you do not obtain independent advice, you should consider whether the product is suitable for you. Past performance is not indicative of future performance.

Copyright © RBC Capital Markets, LLC 2015 - Member NYSE/FINRA/SIPCCopyright © RBC Dominion Securities Inc. 2015 - Member CIPF Copyright © RBC Europe Limited 2015Copyright © Royal Bank of Canada 2015All rights reserved

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