19 March 2013 Stocks Advance, With the S&P 500 Closing in on a New High Once again, stocks advanced last week, thanks in large part to upside surprises in the economic data. For the week, the Dow Jones Industrial Average increased 0.8% to 14,514, hitting several new highs along the way. The S&P 500 Index also advanced, rising 0.6% to 1,560. That index nearly reached its all-time high of 1,565, but lost some steam on Friday. For its part, the Nasdaq Composite edged up 0.1% to 3,249. US Economy Shrugs Off Higher Tax Rates Outside of a disappointing consumer confidence number that was reported last week, virtually all of the data has been coming in at a better-than-expected rate. Looking ahead, expect the US economy to hit a modest speed bump in the second quarter given the spending cuts associated with the sequester. For now, however, the evidence suggests that the economy is picking up momentum. Last week, we saw some evidence that the manufacturing sector is continuing to improve, with industrial production rates and factory capacity levels both moving higher. Additionally, February’s retail sales figures were released last week and showed a 1.1% increase, double what consensus expectations had forecasted. This increase is particularly noticeable, since it comes on the heels of higher marginal tax rates for the wealthy and higher payroll taxes for everyone. Despite the fears of many that the higher taxes that went into effect in January might put a damper on economic growth in general and on consumer spending in particular, so far, the economy has been able to weather the impact. To some extent, the resilience of the consumer can be attributed to improvements in the US labour market: with more people working, it is hardly surprising that more people are spending. But there is also another factor at work: a declining savings rate. After the financial crisis, many were predicting a long-term increase in the savings rate. Although we did see a brief spike in savings rates in 2008, they have since been grinding lower, with January’s personal savings rate plunging to 2.4%, the lowest level since late 2007. Reductions in savings do provide a boost to near term spending levels, but falling also clearly presents some risks since it is an unsustainable trend.

Global Outlook There is no real change in the general growth backdrop: global growth is positive but below trend and is reasonably supportive for risk assets. For example, the US is expected to grow by around 2% again this year, hampered a little by fiscal measures but a stabilising housing market may help consumer confidence. Analysts see eurozone growth remaining in mildly negative territory this year but this again masks divergences among countries. China, which dominates the Asian growth picture, is expected to grow around 8% in 2013, similar to last year’s rate. Inflation is seen to be a non-issue for investors again this year. Short rates are likely to stay at ultra-low levels in the major economies for a protracted period to come. In the US, the Fed has made its policy conditional on trends in the unemployment and inflation rates but, barring a major reversal, overall policy is expected to remain very supportive. Other central banks are either neutral in their stance or will ease policy further. For the ECB, the key issue remains how peripheral economies develop over the year. Most analysts expect that the ECB will stay highly accommodative during 2013 as it continues to try to heal the peripheral debt crisis and support economic growth in the region. Many commentators speak of a ‘bubble’ in the bond market although most of them still see rates rising gently – rather than significantly - over the next year. The main reason for this is that it is expected that central banks will continue to ‘sponsor’ a low interest rate structure until economic recovery is more durable. Italian bond spreads have risen modestly as a result of the political uncertainty there but the knock-on impact to other markets has been very limited so far. Similarly, the immediate impact of the Cyprus situation has been very modest, albeit both situations have the potential for additional negative impact, if only in the short term. Positive investor sentiment on the periphery is now quite high and this always makes such situations more vulnerable to bad news flow; setbacks would not be unusual. Equity market valuations are within historic ranges and, hence, are reasonably valued. Earnings’ expectations are reasonably strong for 2013, although most investors are likely discounting a slower earnings scenario than published consensus estimates. On a relative basis, most market strategists view equities as being much better value than bonds and, additionally, the general view is that equities are also being supported by central bank liquidity and that any falls will be short-lived and will be bought by investors. Global equities in euro terms have gained 8% so far this year – similar to 2012’s start – with the Dow Jones notably making a new high. Positive sentiment is pretty strong in general and, currently, any market setbacks are likely to be seen as buying opportunities by most investors. Bonds Before Friday’s announcement of the Cypriot bank levy, eurozone bond markets were quiet, trading in a narrow range. There was good news for Ireland, which managed to sell €5 billion of 10-year bonds at a satisfactory yield of a little over 4%. The initial plan had been to sell €3 billion but very

strong bidding encouraged the authorities to push this out to €5 billion. Monday saw something of a flight to quality. German and US bonds jumped, while yields in Spain and Italy rose sharply. The net effect on the Merrill Lynch over 5 year government bond index was a rise of 0.4% over the extended period. Cyprus bailout Cyprus became the fifth eurozone country to require a financial bailout, of €10 billion, last week. Uniquely, bank depositors in Cyprus will be asked to shoulder a levy of €5.8 billion, with larger depositors paying more, in a so-called ‘bail-in’. The Cypriot economy accounts for only half of one percent of the total eurozone economy. Currencies The euro was mildly stronger last week, before reversing course yesterday on the back of the news of the levy on Cypriot deposit holders. The €/$ rate finished yesterday just shy of 1.30. The euro weakened more than 1% against sterling over the same period. Source: Bloomberg, Zurich Investment Managers, Aviva Investments & Blackrock