EFTA01475183.pdf

Deutsche Bank Research Global Strategy Asset Allocation The Arithmetic of EM and Global Growth: The $35 Trillion Myth IIThe recent slowing in China and EM more broadly has raised concerns about the level and sustainability of global growth; IIBut EM growth has been slowing for the last 5 years, while DM growth picked up and global growth over the last few years has been perfectly steady at near trend rates, measured using conventional PPP exchange rate weights; IIConventional PPP exchange rate based measures massively overstate the size of EM in the global economy: by $35 trillion or 2 US GDPs; IIGlobal growth has been rising over the last few years when measured using market exchange rate based weights; IIThe arithmetic of global growth: DM (60%) is still bigger than EM (40%) and 1pp of additional DM growth offsets 1.5pp of slower EM growth; IIWe expect a continued normalization of EM growth lower though we are almost there; DM growth to pick up; and global growth (i) at conventional PPP weights to be near trend rates while (ii) at market rate weights to accelerate above trend rates in 2016 The recent slowing in China has raised concerns about global growth It is widely believed that if China, and the emerging markets (EM) more broadly, which represent the faster growing part of the global economy, are slowing, it means a slowing in, if not the end of, global growth. The decline in commodity prices is often seen as evidence of this slowing in global growth and a driver of slow multinational corporate earnings growth. But growth in EM has been slowing for the last 5 years while global growth has been perfectly steady, measured using conventional PPP exchange rate weights EM real GDP growth, as measured by the IMF at purchasing power parity (PPP) exchange rates, fell from a peak of 7.4% in 2010 down to 4.6% in 2014. Developed markets (DM) growth on the other hand rose after the European financial crisis ended and was up from 1.2% in 2012 to 1.8% in 2014. The pickup in DM growth simply offset the slowing in EM growth and global growth was perfectly steady during 2012-2014 at slightly below its long run trend rate of 3.5%, its average over the last 40 years. Conventional PPP exchange rate based measures massively overstate the size of EM in the global economy: by $35 trillion or 2 US GDPs IIPPP vs market exchange rates for EM. The IMF's headline measure of global growth uses PPP exchange rates to aggregate country GDPs into a global composite. The approach seeks to avoid changes in measured EFTA01475183 global real GDP simply because of changes in the value of the dollar which has historically exhibited big (40-50%) long cycles (6-7 years). In our view, the approach makes sense for DM where PPP corresponds to the average Weights using PPP exchange rates Global growth (PPP) steady last 3 years World Real GDP Growth (%) -1 0 1 2 3 4 5 6 Avg: 3.5% Steady global growth -1 0 1 2 3 4 5 6 Weights using PPP exchange rates Source: Deutsche Bank Global growth with market weights rising 0.0 1.0 2.0 3.0 4.0 5.0 World Real GDP Growth (%) Avg: 2.9% Rising global growth 0.0 1.0 2.0 3.0 4.0 5.0 Weights using market exchange rates Source: IMF, Deutsche Bank Deutsche Bank Securities Inc. EFTA01475184 Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Date 11 September 2015 Binky Chadha Chief Strate ist Rajat Dua EM growth falling, DM growth rising -3 -1 1 3 5 7 9 Real GDP growth (yoy,%) (IMF data and forecast) EM DM -3 -1 1 3 5 7 9 Pa rag Thatte Strate ist Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08 Jan-12 Jan-16 Jan-75 EFTA01475185 Jan -79 Jan -83 Jan -87 Jan -91 Jan -95 Jan -99 Jan -03 Jan -07 Jan -11 Jan -15 Jan -75 Jan -79 Jan -83 Jan -87 Jan -91 Jan -95 Jan -99 Jan -03 Jan -07 Jan -11 Jan -15 EFTA01475186 11 September 2015 Asset Allocation real value of exchange rates over long periods, i.e., deviations are long lived but cyclical and mean reverting. But EM FX by contrast is massively structurally (always) cheap on a PPP basis, given their earlier stage of economic development. EM real exchange rates will likely converge to PPP only with the convergence of per capita incomes, i.e., in the very very long run. So the cheapness of EM FX on a PPP basis is not cyclical but structural (How Much Will Fast Growing EM Currencies Appreciate, Sep 2005). IIThe $35 trillion myth. Using PPP exchange rates raises the size and weight of EM in the global economy massively. To get some idea of how much, consider some of the bigger emerging markets exchange rates versus their PPP levels. For China, a market CNY of 6.4 versus the dollar compares with a PPP rate of 3.6. So measuring Chinese GDP at PPP exchange rates raises it 1.8 times. For India, a market INR of 66.5 compares with a PPP rate of 18, which is 3.7 times higher. For EM as a whole, nominal GDP of $30 trillion at current market exchange rates compares with $65 trillion at PPP rates, i.e., a more than doubling. This is $35 trillion of EM and global GDP which does not and has never existed. To put it in perspective another way, the size of the overstatement is about two US GDPs. Global growth has been rising when measured using market rate based weights Using rolling market exchange rate based weights global GDP growth has historically been lower than the IMF's headline measure based on PPP rates, averaging 2.9% versus 3.5% at PPP weights. Global growth bottomed with the European financial crisis in 2012 at 2.4% then rose to 2.7% by 2014, still somewhat below trend or average rates. The arithmetic of EM and global growth: IIDM still bigger than EM. At PPP rates, EM accounts for 57% and DM 43% of global GDP. This differential is the source of current perceptions that EM is more important for the global economy than DM. At market exchange rate weights on the other hand, EM accounts for a smaller 40% and DM for 60%. Some other arithmetic facts of note: the US and Eurozone together (24%+16%) equal the size of all of EM (40%) in the global economy, while the US is 1.5 times the size of China (24%:16%); IIlpp of DM growth equals 1.5pp of EM growth. The weights at market exchange rates (60:40) imply that 1pp of additional DM growth offsets a 1.5pp slowing in EM. The arithmetic of the US vs China (24:16) is similar in that 1pp of additional US growth offsets 1.5pp of slowing in China. Where is global growth going? What about commodities? Earnings? IIContinued normalization of EM growth but almost there, while DM growth picks up. We have long argued that the large multi-year outperformance of EM during 2001-2010 represented the confluence of a variety of circumstantial factors. That each of the factors had gone into reverse, but had not run its course (When Will EM Stop Derating, Sep 2013). EM growth in 2015 is expected to have reverted further back into its historical EFTA01475187 range though still above the mid-point of the range and we expect it to be nearing the bottom. EM growth should be supported by a pickup in DM growth which DB economists and the consensus see continuing to pick up in 2016 (China's impact on the global economy and the Fed, Sep 3 2015). IIExpect global growth to hold steady at near trend rates, measured at conventional PPP weights and accelerate above trend at market weights in 2016. The EM growth advantage will continue to erode further and fall to the middle of the historical pre-boom range. With the EM-DM growth differential back to modest levels, we expect the EM share of global GDP to rise only modestly further whether measured in PPP weights or market weights. Page 2 Deutsche Bank Securities Inc. EFTA01475188 11 September 2015 Asset Allocation IIThe commodity price declines underway since 2011 have been primarily a reflection of the rising dollar and a correction of overvaluation not slower global growth (Trading The Commodity Underperformance Cycle, Apr 2013). We expect the dollar to remain the primary driver of the complex and while we expect the dollar pause to continue near-term the dollar up cycle has further to run medium term. Oil is a little above fair value currently while gold and especially industrial metals remain expensive and should remain under pressure even if the dollar remains flat. IIStrong trend-like underlying earnings growth is consistent with trend like global GDP growth; low headline growth reflects impact of past dollar and oil price moves. Attention has continued to focus on the weak headline earnings growth in the US. However, adjusted for the impacts of oil price declines and the higher dollar, underlying earnings growth in Q3 remained robust across all of DM: US (10.6%); Europe (7.4%) and Japan (29.4%). Unless the declines in oil prices and appreciation in the dollar continue at the extreme pace of the last year, the drags will subside as a matter of arithmetic and earnings growth will converge to the 8-10% underlying rate prevailing for the last 2 years. Deutsche Bank Securities Inc. Page 3 EFTA01475189 11 September 2015 Asset Allocation Figure 1: EM growth has been slowing for 5 years, normalizing back to its historical range 1 2 3 4 5 6 7 8 9 2011 forecast 2012 forecast 2013 forecast 2014 forecast Consensus forecast 2015 forecast EM: Real GDP growth rate (%) (IMF data and forecasts) 2015 1 2 3 4 5 6 7 8 9 Source: IMF, Haver, Bloomberg Finance LP, Deutsche Bank Figure 2: Even as EM growth continued slowing, DM growth has been rising since the European financial crisis ended in 2012 -3 -1 1 3 5 7 9 EM DM Real GDP growth (yoy,%) (IMF data and forecast) 2015 -3 -1 1 3 5 EFTA01475190 7 9 Weights using PPP exchange rates Source: IMF, Haver, Deutsche Bank Page 4 Deutsche Bank Securities Inc. Jan-75 Jan-78 Jan-81 Jan-84 Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14 Jan-17 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 EFTA01475191 11 September 2015 Asset Allocation Figure 3: Global GDP growth measured at conventional PPP weights has been steady at near trend rates for the last 3 years. EM slowing was perfectly offset by the DM pickup -1 0 1 2 3 4 5 6 World Real GDP growth rate (IMF data and forecast) 2015 Average = 3.5% Steady global growth -1 0 1 2 3 4 5 6 Weights using PPP exchange rates Source: IMF, Haver, Deutsche Bank Figure 4: The conventional method of aggregating global GDP employs PPP exchange rates which tend to be systematically higher than market rates for EM but in-line for DM 0.5 1.0 1.5 2.0 2.5 3.0 3.5 PPP to market exchange rate ratio EM DM 0.5 1.0 1.5 2.0 2.5 3.0 3.5 Source: IMF, Haver, Deutsche Bank EFTA01475192 Deutsche Bank Securities Inc. Page 5 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-75 Jan-78 Jan-81 Jan-84 Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11 Jan-14 Jan-17 EFTA01475193 11 September 2015 Asset Allocation Figure 5: For DM the PPP methodology smoothens out cyclical variations in exchange rates but has minimal impact on the trend in the level of DM GDP 10 15 20 25 30 35 40 45 50 5 DM GDP ($tn) Using PPP Exchange Weights Using Mkt Exch Rate Weights 10 15 20 25 30 35 40 45 50 5 Source: IMF, Haver, Deutsche Bank Figure 6: For EM, the PPP methodology massively overstates the size of GDP relative to market exchange rates, more than doubling the current size 10 15 20 25 30 35 40 45 50 55 60 65 70 0 5 EM GDP ($tn) Using PPP Exchange Weights Using Mkt Exch Rate Weights $30tn $65tn $35 to EFTA01475194  10 15 20 25 30 35 40 45 50 55 60 65 70 0 5 Source: IMF, Haver, Deutsche Bank Page 6 Deutsche Bank Securities Inc. Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 EFTA01475195 Jan -04 Jan -06 Jan -08 Jan -10 Jan -12 Jan -14 Jan -16 Jan -18 EFTA01475196 11 September 2015 Asset Allocation Figure 7: At PPP weights EM is already almost 1.5x larger than DM 35 40 45 50 55 60 65 Share of EM vs DM in World GDP (PPP weights) EM DM 35 40 45 50 55 60 65 Source: IMF, Haver, Deutsche Bank Figure 8: At market exchange rate weights EM has seen its share in global GDP rise but is still much smaller than DM 10 20 30 40 50 60 70 80 90 Share of EM vs DM in World GDP (mkt exch rate wts) EM DM 10 20 30 40 50 60 70 80 90 Source: IMF, Haver, Deutsche Bank Deutsche Bank Securities Inc Page 7 Jan-80 Jan-82 Jan-84 Jan-86 EFTA01475197 Jan -88 Jan -90 Jan -92 Jan -94 Jan -96 Jan -98 Jan -00 Jan -02 Jan -04 Jan -06 Jan -08 Jan -10 Jan -12 Jan -14 Jan -16 Jan -80 Jan -82 Jan -84 Jan -86 Jan -88 Jan -90 Jan -92 Jan -94 Jan -96 Jan -98 Jan -00 Jan -02 Jan -04 Jan -06 Jan -08 Jan -10 Jan -12 Jan -14 Jan -16 EFTA01475198 11 September 2015 Asset Allocation Figure 9: At market exchange rate weights global GDP growth has been rising over the last 3 years 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 World Real GDP growth rate (IMF data and forecast) 2015 Average = 2.9% 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 Weights using market exchange rates Source: IMF, Haver, Deutsche Bank Figure 10: At market weights DM is still much larger than EM with just the US and Eurozone together equal to all of EM Shares in Global GDP Nominal GDP ($tn) Market PPP Region DM US Eurozone Japan EM Asia ex-Japan China India Latam Brazil EMEA Russia weights EFTA01475199 43% 16% 12% 4% 57% 31% 17% 7% 6% 3% 7% 3% Source: IMF, Haver, Deutsche Bank exch rate weights 60% 24% 16% 6% 40% 23% 15% 3% 5% 3% 4% 2% PPP based 48.1 18.1 18.0 4.8 64.5 35.4 19.0 8.0 6.3 3.3 7.3 3.5 Market exch rate weights 44.9 18.1 11.7 4.2 29.6 17.4 11.2 EFTA01475200 2.3 3.6 1.9 3.1 1.2 PPP based NA 0.7 104.0 NA 3.6 17.9 NA 1.8 NA 19.7 Exchange rate Market exch rate NA 0.9 121.7 NA 6.4 66.1 NA 3.6 NA 65.2 Market to PPP exch rate ratio NA 1.2 1.2 NA 1.8 3.7 NA 2.1 NA 3.3 Page 8 Deutsche Bank Securities Inc. Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 EFTA01475201 Jan -90 Jan -92 Jan -94 Jan -96 Jan -98 Jan -00 Jan -02 Jan -04 Jan -06 Jan -08 Jan -10 Jan -12 Jan -14 Jan -16 EFTA01475202 11 September 2015 Asset Allocation Figure 11: We expect the EM growth advantage of DM will erode further and fall to the middle of its historical range -1 0 1 2 3 4 5 6 7 EM minus DM: Real GDP growth rate (%) (IMF data and forecasts) 2011 forecast 2012 forecast 2013 forecast 2014 forecast Consensus forecast 2015 forecast 2015 -1 0 1 2 3 4 5 6 7 Source: IMF, Haver, Deutsche Bank Figure 12: Global growth steady at trend like rates as measured at PPP weights, rising above trend as measured at market weights -2 -1 0 1 2 3 4 5 6 World Real GDP Growth (%) (IMF data and forecast) 2015 PPP weights Market exchange rate weights -2 -1 0 EFTA01475203 1 2 3 4 5 6 Source: IMF, Haver, Deutsche Bank Deutsche Bank Securities Inc. Page 9 Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 EFTA01475204 11 September 2015 Asset Allocation Figure 13: Falling commodity prices primarily reflect a rising dollar_ Commodity prices and the dollar 65 70 75 80 85 90 95 US Trade Weighted Dollar (lhs) S&P GS Commodity Index (rhs) 300 350 400 450 500 550 600 650 700 750 800 Source: Bloomberg Finance LP, Deutsche Bank Figure 14: ...and a correction of overvaluation, not slower global growth Brent Oil Price WTI Oil Price 110 130 150 10 30 50 70 90 Estimated Sample Period: Nov 1999 to Feb 2013 R-Squared = 82% Fitted (Real log Oil Price) = 19.6 -3.50*(Ln USDTWI) + 1.89*(World Output Gap) (-130.2) Fair value model oil price (17.9) 110 130 150 10 30 50 70 90 EFTA01475205 Source: Bloomberg Finance LP, Haver, Deutsche Bank Page 10 Deutsche Bank Securities Inc. Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 EFTA01475206 11 September 2015 Asset Allocation Figure 15: Gold and industrial metals in particular still remain very expensive Industrial metals price Fitted model ind metals price index 100 150 200 250 300 350 400 450 500 550 Fitted (Log Real Ind Metals Price) = 16.9 -2.54*(Ln USDTWI) + 3.7*(World Output Gap) (-172.2) (63.6) Estimated Sample Period: Jan 1993 to Feb 2013 R-Squared = 86% 100 150 200 250 300 350 400 450 500 550 Source: Bloomberg Finance LP, Haver, Deutsche Bank Figure 16: Underlying earnings growth, i.e., adjusted for the impacts of oil price declines and the dollar up cycle are robust across the developed markets Q2 2015 Earnings growth yoy excl crude and currency Impacts # companies reported Proportion of companies beating estimates (%) Initial headline growth expectation (%) Size of beat (blended, pp) Final headline growth (%) Energy sector impact on headline (pp) Currency impact on headline (pp) Growth ex oil and FX impacts, % Source: Factset, Deutsche Bank US EMU Japan 487 73.1 -5.1 4.9 EFTA01475207 -0.3 -6.1 -4.8 10.6 132 60.6 10.7 0.6 11.3 168 68.5 14.5 18.8 33.3 -0.1 NM 4.0 3.9 7.4 29.4 Deutsche Bank Securities Inc. Page 11 Oct-93 Oct-95 Oct-97 Oct-99 Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Oct-11 Oct-13 Oct-15 EFTA01475208 11 September 2015 Asset Allocation The primary author of this report, Binky Chadha, wishes to acknowledge the contributions made by Jebin MS, Karthik Prabhu, Magesh Kumar and Prakash Chithambaram, employees of Irevna, a division of CRISIL Limited, a third - party provider of offshore research support services to Deutsche Bank Page 12 Deutsche Bank Securities Inc. EFTA01475209 11 September 2015 Asset Allocation Appendix 1 Important Disclosures Additional information available upon request *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/- ger/disclosure/DisclosureDirectory.eqsr Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Binky Chadha/Parag Thatte/Rajat Dua Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock. Sell: Based on a current 12-month view of total shareholder return, we recommend that investors sell the stock Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell. Notes: 1. Newly issued research recommendations and target prices always supersede previously published research. 2. Ratings definitions prior to 27 January, 2007 were: Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12month period Sell: Expected total return (including dividends) of -10% or worse over a 12-month period 200 400 600 800 EFTA01475210 1000 1200 1400 1600 0 Buy Companies Covered Hold Sell Cos. w/ Banking Relationship Global Universe 46 % 39 % 48 % 30 % 6% 21 % Deutsche Bank Securities Inc. 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