SOCIETE GENERALE PRIVATE BANKING HAMBROS

2016 OUTLOOK December 2015

Investment Strategy

Alan Mudie Head of Investment Strategy (41) 22 819 0255 [email protected] Mind the gaps

Xavier Denis Global strategist (852) 2166 4683 [email protected]

Antonio Bertone Global strategist (33 )3 90 41 91 86 [email protected]

© François Cardi Strategist (41) 22 819 0496 [email protected]

Paul Beecham Editor / DTP Images Getty Source (33) 1 56 37 39 61 [email protected] The global economy will continue to grow at a steady pace in 2016. The US is clearly the strongest

developed world economy, but the eurozone and Japan should also expand next year. Fears of a hard

landing are dissipating in China as the economy becomes more reliant on consumption and services. In accordance with the applicable As wage pressures begin to emerge in the United States and the impact of the slump in energy prices regulation, we inform the reader fades, we anticipate a modest pick-up in US consumer price inflation. The global outlook however will that this material is qualified as a remain dominated by disinflationary pressures. marketing document. As we go to press, the likelihood is strong that the first hike in US interest rates is imminent. On the other hand, the European Central Bank (ECB) has already eased monetary policy further and reaffirmed its commitment to use all available tools to achieve its objectives. Globally, monetary policies will remain very accommodative with low interest rates and sizable asset purchase programmes throughout 2016. With the Federal Reserve (Fed) hiking US rates, bond yields should rise across all maturities, which argues for a defensive stance. In this context, inflation-linked bonds and floating-rate notes in dollars offer diversification benefits. The gradual deterioration of US balance sheet quality warrants a gradual reduction in exposure to corporate bonds. In the eurozone, yields should remain low and investors will be better rewarded in non-core sovereign bonds and corporate securities.

The divergence between the Fed and ECB monetary policies has been well anticipated and we see only modest further downside for the euro against the USD. Similarly, the sharp devaluations in a number of emerging economies have improved their competitive position and reduced the potential for further slides Contents versus the USD.

3 | Editorial Potential upside in equity markets will be constrained by the current high valuations and the outlook for

4 | Fixed Income earnings growth. In this low growth environment, security selection becomes key – in particular, companies demonstrating an ability to grow their sales and cash flows despite new competitive pressures should do 8 | Currencies well. Further, Japanese and eurozone equities will remain supported by abundant liquidity.

13 | Equity markets The glut in the supply of crude oil shows no sign of abating, with Iran due to ramp up its exports in 2016. Given the modest growth in demand, oil prices should remain stuck at low levels and any upside is likely 19 | Hedge funds to be short-lived. In our view, the bulk of the correction in gold prices since 2011 is now complete. 20 | Commodities Demand for bullion remains strong in key markets such as India and China, and gold miners will struggle

21 | Tactical & Strategic themes to develop new supply at today’s prices. We continue to see potential in non-directional investment strategies. In particular, alternative investments 22 | Global economic forecasts should benefit from higher dispersion of performance, in strategies such as Global Macro and

24 | Market performance & forecasts Long/Short Equity. In addition, the unique characteristics of convertible bonds make them a valuable

25 | Important disclaimers adjunct to portfolios in a low-return world.

2016 is likely to be characterised by a number of gaps, between economic regions, between monetary policy settings and between market fundamentals and performance. Careful portfolio construction and diversification across themes will prove key.

Investment Strategy – 2016 Outlook

Detailed contents

Editorial – Mind the Gaps ...... 3 Fixed Income ...... 4 Rates: Diverging but not decoupling ...... 4

Credit: For the discerning buyer ...... 5

EM debt: Caution advised ...... 7

Fixed-income theme: US credit: prefer banks to corporates, floating to fixed ...... 8

Currencies ...... 9 Equity markets ...... 12 Developed markets ...... 12

Emerging markets ...... 13

Equity theme: Surviving Disruption...... 15

Equity theme: Convertible bonds - the best of both worlds ...... 16

Hedge funds ...... 17 Don’t Rely on Beta ...... 17

Hedge funds theme: Edge Funds ...... 18

Commodities: Bottoming out ...... 19 Tactical and strategic themes: open strategies ...... 20 Closing strategies ...... 20

Global economic forecasts ...... 21 Market performance ...... 22 Market performance and forecasts ...... 23

Important Disclaimers ...... 24

December 2015 2

Investment Strategy – 2016 Outlook

Editorial – Mind the Gaps

Financial markets often seem fickle. Some of the strongest returns in equities, for example, are recorded when the outlook appears bleakest. Part of the explanation for this can be found in the study of behavioural finance. The latter stages of a bear market often see investors herding together, all seeking to liquidate positions at the same time. And such consensus means that when the selling pressure is eventually exhausted, it becomes easier for the market to rally. In addition, such moves do not require a shift in fundamentals – the easing of negative news-flow can suffice.

In the same vein, markets often fail to move in line with improvements in the macro picture. As a bull market develops, valuations tend to rise and in its latter stages there remains little room for multiples to increase further. Such gaps between market performance and economic fundamentals can be tricky to navigate.

We also see a number of gaps looming in the economic background for 2016, in the outlook for inflation, in central bank policy settings, in corporate leverage and the credit cycle and in corporate earnings growth.

Regarding inflation, the picture has been muddied by the impact of the slump in energy prices, which has pushed the headline index close to zero in the US and below that in a number of euro zone economies. We expect the gap to widen in 2016. As the US reaches full employment, wage pressures will start to build, feeding a pick-up in core inflation in the US next year. In the eurozone on the other hand, unemployment has declined to 10.8% but remains well above the pre-crisis low of 7.2%. In consequence, wage pressures are largely absent and inflation is well below the European Central Bank’s 2% target.

As explained on page 4, the stage is now set for the first hike in the US Federal Reserve’s (Fed) interest rates in almost ten years – employment continues to improve and wage pressures to build, reducing the need for such extreme policy settings. In Europe, the ECB faces a sluggish economy, low core inflation and a banking sector which is trimming its loan book to bolster capital buffers. It is no surprise that Chairman Draghi was so vociferous about his intention to ease policy further.

This divergence has been widely flagged to markets, proof that the bout of nerves displayed by emerging market bond investors during 2013’s “taper tantrum” has taught policymakers a lesson. Back then, the Fed spooked markets by intimating an early “tapering” (reduction) of its Quantitative Easing (QE) programme, leading to worries of a sharp liquidity squeeze. This time, investors have had ample forewarning of the opposite moves planned by the Fed and the ECB.

The US economic cycle is well advanced, with the recovery now in its sixth year. We note however a steady rise in corporate borrowing (to refinance maturing debt, fund mergers and acquisitions and finance share buybacks). We view this as an early warning of a worsening in credit quality, which in due course will result in a rise in defaults. Prudence is warranted in the US. Conversely, credit trends are more supportive in the euro zone where balance sheets do not exhibit the same strains.

Over the past 18 months, two key factors have driven the outlook for corporate earnings in the US and the euro zone: oil prices and foreign exchange rates. Interestingly, the effects have been opposite on each shore of the Atlantic. US corporate profits have been hard hit by the decline in the energy sector and by the impact of a stronger dollar on multinationals and US exporters. On the other hand, a weaker Changes in inflation, interest rates euro and cuts in energy bills have boosted eurozone profitability. These effects will however begin to and the rate of exchange may have reverse from Q2 2016 onwards (see page 12). an adverse effect on the value, price In summary, the gaps listed above argue for another Out of Sync year for economies and the financial and income of investments. Your markets. As the global economy exits the Zone of Turbulence which will be generated by the shifts in capital may be at risk and you may monetary policy, the outlook for 2016 does look more attractive. However, high valuations in both fixed not get back the amount you invest. income and equity markets still translate into very slim Margins of Safety. Mind the Gaps indeed.

December 2015 3

Investment Strategy – 2016 Outlook

Fixed Income Rates: Diverging but not decoupling

Monetary policy divergence Time has come for the US Federal Reserve (Fed) to lift rates. After an unexpected no-change materializes, widening yield decision in September following a soft patch in Q3 and Chinese hard-landing fears, the Federal spreads between the US and Open Market Committee (FOMC) may start tightening in December. eurozone. This would be justified by a solid recovery, improving labour data and a pick-up in inflation. Although Fed Funds rate: the US Federal Reserve’s key interest rate. falling oil prices will keep headline inflation low in the coming months, the gap between effective Fed funds rates and the Taylor rule’s theoretical target will remain close to 3%. Even if the Fed Taylor rule: monetary-policy rule does tighten by 75bp next year as we forecast, the Fed Funds rate would only stand at 1% by late that suggests how much the 2016 – the Fed’s monetary policy could hardly be called tight. Further, we do not believe the Fed will central bank should change the nominal interest rate in response to start deflating its balance sheet before early 2017. changes in inflation, output, or unemployment. Given its last rate hike was back in 2006, the FOMC will take it slow. While rate hikes are most often

associated with buoyant growth and outperforming risky assets, tighter policy can have many side effects on the global economy. The US dollar has already strengthened markedly, weighing on import prices, inflation and exports. While market participants have been looking for the Fed to move ever since the taper tantrum episode of 2013, any acceleration in outflows on emerging debt markets could trigger a renewed bond sell-off. This would impact those emerging economies (EM) which are heavily dependent on capital inflows and EM corporates would struggle to roll over their debt after heavy releveraging these last past years.

Inflation premium: return on an The long end of the US yield curve has remained well anchored so far but Fed tightening is set to investment over its normal rate of push yields up – current levels underestimate nominal growth prospects. Real interest rates and return. inflation premia should gain further ground, meaning that Treasury Inflation-Protected Securities

remain interesting diversifiers (see Zone of Turbulence). In the short run, we expect a steeper yield curve as the short end will rise less than longer maturities. In the longer term, we foresee renewed flattening once the market has a clearer view on the Fed’s monetary path. However, yields are unlikely to rise much, staying well below 3% in the 10-year sector because of the central bank’s gradual approach and low inflation risks. In addition, average yields in the euro zone remain well

below those in the US. On balance, this clearly suggests remaining on the sidelines given the poor returns it implies from US Treasuries.

In the UK, the Bank of England (BoE) seems in no rush to raise key rates although they will certainly hike before end 2016. Inflation will pick-up thanks to robust growth and further falls in unemployment. Although the timing remains quite uncertain, mid-2016 seems most likely. However, low

expectations for the EU membership referendum and the ongoing fiscal consolidation may prompt them to delay the first hike.

In the euro zone, ECB board members have hinted several times at further quantitative easing as inflation and credit growth remain low. In December, the ECB decided to extend its Public Sector Purchase Programme (PSPP) “at least” to March 2017, expand the scope of eligible assets and slash the deposit rate by 10bp. This should help keep nominal and real interest rates low. Short- term rates had already plunged to new lows ahead of the ECB statement.

In core countries, long-dated bonds look rather unattractive with risks tilted to the upside for yields and volatility expected. Yields should stay in a range but an upside breakout cannot be ruled out, in reaction to stronger-than-expected economic activity or a shift in the Fed stance. It is true that the ECB and BoJ quantitative easing schemes helped keep a cap on US Treasury yields after the Fed stopped its asset purchases in late 2014. However, a tighter Fed policy could reverse the causality with higher US yields influencing core eurozone yields despite further easing in Europe. This suggests that monetary policy divergence does not necessarily imply disconnection between bond

December 2015 4

Investment Strategy – 2016 Outlook

markets. With the ECB stepping up its easing measures, non-core spreads may start narrowing again across the board. However, idiosyncratic factors such as local politics, reforms and growth prospects need monitoring in the periphery countries. The recent widening of Portuguese spreads versus Italy and Spain is a useful reminder.

US and eurozone 10-year real yields are diverging

% 3

2

1

0

-1

US 10 yr real yield (based on CPI) -2 Euro area 10 yr real yield (based on CPI) -3 01-10 07-10 01-11 07-11 01-12 07-12 01-13 07-13 01-14 07-14 01-15 07-15

Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/10/2015.

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as Forward projections are not an indicator of future performance well as up. Your capital may be at risk and you may not get back the amount you invest.

Credit: For the discerning buyer Mixed outlook for US credit, In its October report, rating agency Moody’s showed the trailing twelve months default rate at more positive in the eurozone. 2.8%, slightly above last year’s baseline 12-month forecast of 2.5%. Its forecast for the coming year is higher still at 3.8%, with the Energy and Metals & Mining sectors hardest hit. Substantiation of this comes from the Moody’s speculative-grade liquidity stress ratio, viewed as a leading indicator of default rates among US issuers. The latest figures show a marked deterioration in Oil & Gas companies, while other sectors enjoy more comfortable liquidity conditions, proof that short- term risks are idiosyncratic rather than broad-based.

The outlook for non-financial companies is mixed next year. High levels of mergers and acquisitions (M&As) and share buybacks have been weakening credit quality as they lead to further deterioration in leverage ratios and other fundamentals, which is always bad news for bondholders. In this respect, Moody’s rating drift ratio, measured by the difference in rating upgrades and downgrades as a percentage of total rated issuers, is currently negative and decreasing.

High Yield bond: a high-paying bond Spreads have widened again since mid-2015 and High Yield now stands at levels close to those with a lower credit rating than reached in 2000 and 2008 when the US economy went into recession, causing a spike in default investment-grade and Treasury bonds. rates. Sure, we do not expect such a scenario to repeat in 2016 and current valuations offer some value in this respect. However, with the credit cycle already well advanced and moving further ahead next year, the asset class will need to be traded with increasing caution.

Investment-grade bond: a The rise in underlying rates and worsening in non-financial corporate fundamentals both leave the corporate bond with a relatively low Investment Grade market vulnerable. We prefer financial bonds with floating coupons, as explained risk of default. further in detail on page 8.

December 2015 5

Investment Strategy – 2016 Outlook

2016 should see an energy-driven rise in US defaults

16%

14%

12%

10%

8%

6%

4%

2%

0% 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

US Moody's Trailing 12 month defaults Moody's baseline US defaults forecast

Sources: Societe Generale Private Banking, Moody’s, Data as at 30/11/2015.

In Europe, default rates are rather stable, with Moody’s latest report for October showing a level of 2.4% against 2.2% one year ago. Over the coming twelve months, Moody’s only expects defaults to rise to 2.7%. We agree with this benign scenario as 2016 should again see above-trend economic growth, thanks to a weaker currency, lower commodity prices and massive monetary stimulus. All this will support corporate profits in a context where companies are not actively seeking to releverage, thus maintaining favourable conditions on credit markets.

More generally, two opposite forces will be at play on European credit markets in 2016. First, demand. The ECB will maintain a very accommodative policy. It has already stepped up economic stimulus by lengthening the target horizon for public securities purchases and by introducing the reinvestment of maturing bonds. The central bank also stands ready to do more if necessary, leaving the door open to higher monthly purchases and – possibly – an extension of the scheme to corporate bonds. In any case, credit markets will remain supported by strong demand for euro- denominated fixed-income instruments. Second, supply. Companies outside the eurozone have accelerated issuance of euro-denominated paper these last few years and they account for over half Investment Grade non-financial gross issuance year-to-date. This is especially true of the US, where the share of euros in total issuance has grown in line with the USD-EUR yield differential. We do not expect this trend to reverse next year, adding pressure on euro corporate markets from the supply side. All in all, we believe demand will be strong enough to offset supply, and we remain positive on euro Investment Grade and High Yield.

Euro Investment Grade – euro-denominated supply as a percentage of US corporate issuance vs US yield differential

2.5 30% 2.0 25% 1.5 20% 1.0

Past performance should not be seen 0.5 15% as an indication of future performance. 0.0 10% Investments may be subject to market -0.5 5% fluctuations, and the price and value of -1.0 investments and the income derived -1.5 0% from them can go down as well as up. 2010 2011 2012 2013 2014 2015 Your capital may be at risk and you may % of US risk-based corporates issuance in EUR (rhs) USD-EUR IG Yield difference (%, lhs) not get back the amount you invest. Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/10/2015.

December 2015 6

Investment Strategy – 2016 Outlook

EM debt: Caution advised Cyclical factors and structural Clouds are still overhanging EM fixed-income markets. The backdrop remains unsupportive overall flaws will drive foreign investors – persistent domestic and/or external imbalances and heavy corporate releveraging over recent away from EM debt, with only a years – with most emerging economies bracing for slowdown. The US Federal Reserve’s rate lift- few exceptions. off will only make things worse, although risks are limited given the Fed should stay dovish and only move gradually. What is more worrying is the persistent capital outflows from the impressive stocks of EM debt that foreign investors had built during their yield hunt. In particular, retail investors, who are even more concerned by EM economic prospects than institutional investors, are likely to liquidate holdings. Markets will remain focused on the Chinese slowdown given its deep implications for neighbouring Asian economies and the commodity complex. We still believe China will avoid a hard landing but this will come at a price of further weakness for the yuan in 2016 and consequently for the other EM currencies, especially in Asia.

Investors should avoid most EM local currency debt, with only a few exceptions. Although worsening terms of trade and lower growth potential have already seen EM currencies plummet against the USD, further weakness is to be expected, at least in the short run. A decline that will CEE: Central & Eastern Europe. also dent bond performance. However, CEE sovereign bond markets should benefit from further ECB easing and mild growth prospects. We are also constructive on Mexico given spreads are wide, the currency is already weak and growth prospects are favourable.

EMEA: Europe, the Middle East & We are less negative on hard currency EM debt and prefer sovereign bonds to corporate debt Africa. from a top-down approach. Sovereign fundamentals have seen gradual improvement, whereas the private sector has piled up debt – sometimes too aggressively. Asia looks less exposed to risk reversals than Latin America or EMEA – its macro fundamentals are healthier and there is room for further monetary easing. But again, China remains the big question as this is where most of the build-up in EM corporate debt occurred. In the other regions, Brazil and, to a lesser extent, Turkey are faced with challenging conditions including stubborn inflation, large external deficits, and highly leveraged corporate sectors. As the credit cycle matures with lending conditions only beginning to tighten, bond markets could feel the pain.

US yield pickup still a structural risk for EM debt (EM debt total return and UST yield, basis 100 = 01/01/2012)

Index inv. scale, % 140 1 135 130 1.5 125 120 2 115 Past performance should not be seen 110 2.5 as an indication of future performance. 105 Investments may be subject to market 100 3 fluctuations, and the price and value of 95 investments and the income derived 90 3.5 from them can go down as well as up. 2012 2013 2014 2015 Your capital may be at risk and you may EM sovereign EM composite EM IG EM HY UST 10 year (rhs) not get back the amount you invest. Sources: Societe Generale Private Banking, Bloomberg. Data as at 02/12/2015.

December 2015 7

Investment Strategy – 2016 Outlook

Fixed-income theme US credit: prefer banks to corporates, floating to fixed Favour Banks over non-financial As explained earlier (see page 5), US Investment Grade (IG) credit is increasingly vulnerable. companies. However, while non-financial companies will be faced with worsening fundamentals, the financial Investment-grade bond: a sector – roughly 30% of the IG index today, mainly in banks – will prove more resilient. corporate bond with a relatively low risk of default. This is due to the fact that banks came under closer regulatory scrutiny following the 2008 financial crisis, having been in the eye of the storm. New rules were introduced, typically in the form of capital or liquidity ratios, forcing financial institutions to enhance their capital base. The best known set of international rules is the Basel III framework with which banks must comply by 2019.

These last few years, US banks have worked hard to improve their capital ratios, leaving them in a much stronger position today, whereas non-financial corporates have seen their balance sheets Releveraging: building up new deteriorate through regular releveraging. Recently, concerns emerged that the Financial Stability debt. Board might impose even more stringent new rules on systemically-important banks. This standard, known as the Total Loss-Absorbing Capacity (TLAC), is designed to ensure that such banks can continue to carry out critical functions even in cases of failure. High requirements would have triggered greater issuance from banks, with a negative impact on spreads. However, the rules proved less restrictive than feared, which should benefit the banking sector.

Before the financial crisis, US bank spreads would trade below corporates. But when markets came under pressure in 2007, bank spreads widened well above corporate bonds. The gap eventually began to close in 2013 and has now inverted, due to banks’ strengthening fundamentals. We expect this trend to continue, and banks to outperform non-financials over the next quarters. Importantly, it is advisable to cover duration exposure as higher underlying rates could LIBOR rate: benchmark rate that weigh on total return. One way to do so is through floating-rate bonds which are mainly issued by some of the world’s leading banks charge each other for short-term financials. Coupons are linked to USD Libor rates, which should rise along with Fed rates. loans. Banks improved their capital ratios

12 Wtd Avg Tangible Equity/Tangible Assets Ratio, % 10

8

6

4

2

0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/09/2015.

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.

December 2015 8

Investment Strategy – 2016 Outlook

Currencies EUR/USD: Limited downside for the euro USD left with little upside While the US Federal Reserve (Fed) seems poised for a December rate lift-off after its no-change decision in September, the European Central Bank (ECB) has announced further easing via a 6-month extension of the existing quantitative easing (QE) scheme and another deposit rate cut.

Purchasing power parity (PPP): an Expectations of monetary policy divergence explain the euro’s slide since mid-October but a break economic theory that estimates the below parity is unlikely in our view. First, the single currency has already lost around 25% versus the amount of adjustment needed on USD since its 2011 high. It now looks rather undervalued on a purchasing power parity (PPP) basis, the exchange rate between countries in order for the exchange leaving little downside potential. Second, a faster recovery in the eurozone will help narrow the growth to be equivalent to each currency's gap, capping interest-rate differentials. The US/German 2-year rate differential – a good indicator of the purchasing power. monetary path – offers little upside at 130bp. Fed rate hike expectations have been upgraded and it would be reasonable to see a 75bp rise in the Fed Funds rate over 2016. However, such a tightening would not send the US dollar flying vs the euro given the cross rate is more sensitive to the 10-year rate differential, which is close to its historic highs.

A prolonged rise in the USD has seen import prices plunging – a major source of disinflation. Gradual monetary policy tightening will be required as both effective inflation and long-term expectations remain

low – the 5-year rate 5 years forward is still below 2%. This will prevent a surge in the greenback.

The cross last traded below parity from 2000 to 2001 but the situation has evolved considerably since, in particular the euro zone’s oft-overlooked current account. Back then, the current account deficit was over 2% of GDP. Today, we have a surplus of almost 3%, mainly thanks to Germany. This entails a growing net financial asset position and a steady increase in capital revenues from overseas, a positive for the exchange rate.

Also, a further drop in the euro would boost foreign inflows – more especially foreign direct investments (FDIs) and equity portfolio investments – limiting the euro’s depreciation versus the dollar despite continuous outflows on fixed-income products.

We rule out a sharp depreciation in the euro versus the dollar, and the latest ECB decisions support our view. However, as the central bank left the door open to further easing if necessary, there remains downside risks to our scenario that could push the cross rate closer to parity.

In a nutshell, we see the EUR/USD back at 1.05 in 6 months’ time. The cross should then edge back up to 1.10 by year-end 2016 as global risk appetite may fade later in 2016.

EUR/USD cross rate and US Treasuries/Bund spread

1.45 2 EURUSD 10 Yr spread 2 Yr spread 1.4 1.5

1.35 1

1.3 0.5

1.25 0

1.2 -0.5

1.15 -1

1.1 -1.5

1.05 -2

1 -2.5 01-13 04-13 07-13 10-13 01-14 04-14 07-14 10-14 01-15 04-15 07-15 10-15

Sources: Societe Generale Private Banking, Bloomberg. Data as at 27/11/2015.

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Investment Strategy – 2016 Outlook

GBP/USD: Political risks to weigh on the pound Brexit referendum the main risk. The Bank of England (BoE) has kept all options open. Core inflation has bottomed out while unemployment is falling rapidly. We should see domestic price pressure via a slow rise in wage inflation. The central bank has made clear that it does not intend to hike rates ahead of the Fed. However, monetary policy normalization is coming, most likely around mid-2016. The BoE is in less of a hurry than the Fed thanks to a tight fiscal policy.

The GBP/USD should be mainly driven by both structural and political factors in 2016. First, the large current account deficit carries downside risks to the currency, should capital inflows slow. Second, the European Union membership referendum scheduled in 2016 could deter foreign investors and rising political uncertainty may weigh on the pound.

All in all, we expect the currency to ease gradually towards 1.48 in 6 months’ time and 1.45 in 1 year.

EUR/CHF: Fighting upward pressure It will all depend on the SNB’s Since the Swiss National Bank (SNB) scrapped its 1.20 floor against the euro in January 2015, reaction to ECB easing. aggressive policy measures have helped curb the franc’s appreciation, keeping it in a 1.05-1.10 range versus the euro. The SNB remains concerned by the currency’s overvaluation, translating into lingering deflationary pressure – consumer prices have declined more than 1% YoY. Further easing from the ECB would encourage the SNB to cut the deposit rate again – at -0.75% since early 2015 – and extend the panel of retail deposits yielding negative rates. The central bank may also have to conduct additional interventions. The SNB has already been very active on foreign exchange markets since last summer, as reflected in its growing foreign exchange reserves. And as seen in Sweden, introducing negative deposit rates can be a powerful lever to weaken a currency and push inflation up.

If the SNB follows the ECB’s suit, the Swiss franc will shed a little ground against the euro over the coming year. We target 1.10 in 6 months’ time and 1.14 in 1 year.

USD/JPY: Range trading The yen is undervalued but the The yen stopped falling against the dollar in early 2015 and is now 15 to 25% undervalued depending BoJ may not intervene as the on valuation models. Although the Bank of Japan (BoJ) has pushed the deadline for achieving its 2% decline is over. inflation target further back, a new round of quantitative easing now seems more unlikely. First, Japanese policymakers no longer see the point in dragging the yen lower as this may dent purchasing power and confidence. Second, while headline inflation has moved lower, core inflation has stabilised around 1%. Falling unemployment and moral suasion from the government on the corporate sector may eventually lift wages, underpinning inflation. The impact of Fed rate hikes and Japanese capital outflows argue for a further slide in the yen. However, a better current account balance and revived risk aversion in 2016 may see the BoJ intervening to avoid a surge in the yen. The tug of war between upward and downward forces will leave the yen directionless.

All in all, we see the yen quite stable at 123 against the USD over the coming 6 months and year.

USD/CNY: Gradual currency depreciation Traditionally, the yuan has been loosely pegged to the USD but 2016 should see a decoupling. To avoid wild currency shifts, Chinese authorities will act gradually. The country cannot maintain the “impossible trinity” of a fixed exchange rate policy, perfect capital mobility and monetary autonomy and now has to choose. Capital outflows may accelerate as a result of carry trade unwinding and further monetary easing is needed to offset them and stop the ongoing slowdown. This would normally lead to a weaker yuan but authorities want to keep a strong hand on the currency. A sharp sell-off would indeed be damaging for the central bank’s credibility and trigger defaults in a corporate sector that has heavily tapped the USD bond market to take advantage of low yields. Now that the

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Investment Strategy – 2016 Outlook

CNY has been recognized as an international reserve currency through its inclusion in the special drawing rights basket, we could see greater exchange flexibility and more volatility with an expected further widening of the trading range. Although key measures were announced (e.g. the opening of the domestic bond market to foreign financial institutions last summer), some restrictions on capital account transactions remain. As such, China will need to find the right balance between a more market-based exchange-rate policy and managed depreciation.

The yuan should see further depreciation. The government’s key priority will be stabilising growth and an overvalued currency is not helpful. We expect the yuan to trade around 6.6 against the USD in six months’ time and 6.8 in one year.

Other emerging currencies: Dispersion ahead The first Fed rate hike and The long-awaited Fed lift-off remains key for most emerging currencies. If some currencies are well weak fundamentals will keep prepared to a Fed rate hike, others could lose further ground. A stronger US dollar could weigh on many EM currencies under commodity prices and in turn on commodity exporters’ currencies. Also, currencies with weak downward pressure. fundamentals (large current account deficits, high inflation and high foreign ownership of bonds and equities) face major downside risks. This applies, for instance, to the Turkish lira (TRY), South-African Rand (ZAR), Brazilian real (BRL) and Malaysian ringgit (MYR). These currencies should lose further ground against the USD despite an already sharp drop. But intrinsic fundamentals still look weak especially in Turkey and also Brazil, where political risks also add to economic imbalances. Large current account deficits and stubbornly high inflation are the best cocktail for continued weakness as witnessed by the BRL. Some other EM currencies are better positioned to weather the US rate lift-off. In Asia, the Chinese yuan (CNY) is of course key, being the linchpin of the regional currency system (see above). Elsewhere in the region, we view downside risks as limited given countries like Korea and Taiwan may benefit from a growth uptick in China and stronger economic momentum in industrialized economies and the United States in particular. India has gone through an impressive macro revival with a steady fall in inflation and a meaningful contraction in the current account deficit thanks to lower oil prices and restored monetary policy credibility. Outside Asia, the MXN has suffered an indiscriminate sell-off but should recover thanks to stronger US growth. In Central and Eastern Europe, the Polish Zloty (PLN) and Hungarian forint (HUF) are likely to benefit from extended quantitative easing in the eurozone as this would encourage investors to increase their local bond holdings. In Russia, the rouble slide could well be over and the first signs of economic stabilization together with receding risk premia are providing the currency with a floor. However, the central bank may keep easing its policy to kick-start economic growth and the currency would head south again should oil prices take another plunge – though this is not our central scenario (see page 19). All in all, if some emerging currencies may bottom out in 2016, emerging currencies will be driven by Fed statements and US rate hike expectations.

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as

well as up. Your capital may be at risk and you may not get back the amount you invest.

December 2015 11

Investment Strategy – 2016 Outlook

Equity markets Developed markets What value was created during the summer storm on financial markets then melted away as October’s bull market advanced. Most developed markets are again trading at double-digit premia above historical multiples. However, corporate profit forecasts for this year and next continue to be cut. Against this background, we believe that value creation will inevitably require careful stock picking.

Emerging equities seem a little less expensive, for good reason. Volatility has eased as investors started factoring in China’s structural slowdown. And indeed we believe that a hard landing can now be ruled out given the latest data point to stronger growth, as outlined in our past research.

Globally, two sectors stand out. First, Telecoms, which benefit from strong growth, rather low valuations and useful defensive characteristics when faced with low upside potential. Second, Healthcare, which looks overvalued after a merger & acquisition boom this year, leaving little further upside in our view.

After a year’s wait, Janet Yellen is about to embark the Fed on a new tightening cycle – we expect the first rate hike in December 2015. Past monetary tightening cycles saw higher equity volatility. This time, the context is slightly different. The Fed has never been as accommodative and a 25bp hike in Fed Funds would still leave rates at historically low levels. In other words, a December lift-off would probably trigger short-term volatility on US markets but no long-term bear market given the world’s largest economy continues to fare well. Should US stocks really fear the Fed lift-off? Strong US job data and declining unemployment will eventually fuel wage 2.3 7 growth. As a result, domestic 2.1 6 1.9 consumption should further support the 5 Consumer Discretionary sector. Also, 1.7 4 rising US yields will help banks improve 1.5 3 their margins, supporting Financials. US 1.3 2 banks will take advantage of the 1.1 acceleration in credit growth and we find 0.9 1 them cheap at around 11.9x expected 0.7 0 2015 earnings. While a strong dollar will continue to weigh on US competitivity, our dollar views suggest that this negative MSCI US vs 10yr US Government bonds (lhs) US Fed Funds rate (%, rhs) impact will diminish (see page 9). Sources: Societe Generale Private Banking, MRB, DataStream. Data as at 23/11/2015. Eurozone equities will remain supported by an accommodative ECB policy. As the year draws to a close, two sectors are worthy of mention. First, Consumer Discretionary is running out of steam. Year-to-date, the MSCI EMU Consumer Discretionary has indeed outperformed the MSCI EMU by 1.8% (as at 23/11/2015). However, for sub- sectors like Hotels & Leisure, Media, or Luxury Goods, valuations are no longer attractive. Second, we are slightly more optimistic than before regarding Energy. This sector – mainly composed of oil majors (Total, ENI, Royal Dutch Shell, etc.) – now seems attractively priced. Since the beginning of the oil Past performance should not be plunge in mid-June 2014, the MSCI EMU Energy index has dropped 21.8% (as at 23/11/2015) and the seen as an indication of future majors have cut costs. However, given we do not expect oil prices to fall below current levels, these performance. Investments may be highly diversified companies should be able to cope with the “new normal” of crude oil prices ($40-60). subject to market fluctuations, and the price and value of investments In terms of profits, the eurozone will enjoy double-digit expansion this year and our forecast is slightly and the income derived from them above consensus. Next year however, we expect the low euro and low energy prices to be of less can go down as well as up. Your support, starting from mid-2016 according to our models. Furthermore, we believe these very same capital may be at risk and you may external factors will have the opposite effect in the US, where profit should recover next year (see table not get back the amount you invest. overleaf).

December 2015 12

Investment Strategy – 2016 Outlook

Earnings per share (EPS) forecasts: US vs Eurozone 2015 EPS growth 2016 EPS growth

SGPB* Consensus SGPB* Consensus

US -1.0% +0.1% +9.6% +8.1% Eurozone +13.9% +10.8% +7.7% +8.0% Sources: DataStream, Societe Generale Private Banking. Data as at 23/11/2015. * SGPB: proprietary quantitative model.

Switzerland still offers upside potential. The market is structurally defensive, which could prove useful in the current context. We also see the upcoming depreciation of the Swiss franc (see page 10), along with the ongoing transformation of the banking sector, as strong catalysts.

Within developed markets, Japan remains our preferred country. Although the economy contracted at an annualised pace of 0.8% in Q3 according to the Ministry of Internal Affairs & Communications – the second technical recession since Shinzo Abe came into power – we would not read too much into this. Japan’s population began to decline in 2008, which has lowered potential growth to around 0.4-0.5% in SGCIB’s view. At such low rates, technical recessions will become more frequent. However, GDP per capita remains high, unemployment is extremely low and consumer confidence measures and spending are robust.

With the Bank of Japan (BoJ) at least Japan: Equity Risk Premium (%)

maintaining, if not increasing, its current pace of 14% monetary stimulus, there are reasons to believe 12% that Japanese equities will continue to do well. 10% It is worth noting, however, that after a strong 8% CHEAP Equity Risk Premium (ERP): excess performance since the August lows, Japanese 6% Long-term average return that investing in the stock stocks are slightly less attractive in terms of 4% market provides over a risk-free valuations. They are currently trading at 14.8x rate 2% current year forecast earnings (source: IBES, 0% 23/11/2015), still a 12% discount to the 10- -2% EXPENSIVE year average, but less than the 20% discount -4% when we upgraded our positive view last

quarter. 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Sources: Societe Generale Private Banking, DataStream. Data as at 23/11/2015. Emerging markets China’s transition continues apace. On one hand, the manufacturing sector is running out of steam, with for instance Industrial Production growth falling to a 6-month low in October. On the other, retail sales remain robust (+11% in October, according to the National Bureau of Statistics of China, the strongest expansion in 2015). A telling example is Alibaba, the online retail giant, which on Singles Day – China’s version of Cyber Monday – recorded USD 14.3 billion of sales, up 54% from the same day last year (source : Financial Times). Here again, Industrials should be avoided, while Consumer Discretionary could perform better.

Asia as a whole has clearly been hit by the Chinese slowdown, though with marked contrast between Past performance should not be the various countries. Although South Korea and Taiwan seem resilient, exporters like Thailand, seen as an indication of future Malaysia or Indonesia have suffered more. To sum up, even though a Chinese hard landing has now performance. Investments may be been dismissed by investors, risk-aversion could persist as macro data are unlikely to show marked subject to market fluctuations, and improvement next year. the price and value of investments and the income derived from them The past year has also seen a broad slump in commodity prices (-22.4% for the Bloomberg can go down as well as up. Your Commodity Index as at 23/11/2015). Needless to say, 2015 has proved tricky for commodity capital may be at risk and you may exporters. Although raw material prices may be close to a bottom – implying that 2016 will not be as not get back the amount you invest. disastrous as this year – it still seems too early to return to these markets.

December 2015 13

Investment Strategy – 2016 Outlook

For example, Russian stocks are among the top performers year-to-date (as at 23/11/2015; +33.6% in RUB and +19.0% in USD for the MSCI Russia, thanks to the currency effect). Despite that, valuations remain extremely low, at 5.3x expected 2015 Russia: Profit growth expectations (%, consensus) earnings, a ca.26% discount to their 10-year 40.0 average. Such cheapness may seem attractive 30.0 at first glance and outperformance may continue 20.0 short-term. However, when taking into account 10.0 the poor outlook for company profits, dubious 0.0 corporate governance, and the ever-present -10.0 economic and geopolitical risks, it appears that -20.0 2015e Russia’s valuations are low for good reason. -30.0 2016e -40.0 In Brazil, the story is a bit different. Like Russia, 2017e -50.0 15 15 15 15 15 15 15 14 15 15 15 14 the country is faced with low growth and high 15 ------Jul Apr Jan Jun - Oct Mar Feb Aug Nov Nov Sep Dec - inflation along with political turmoil. The big May difference is that Brazilian equities are expensive Sources: Societe Generale Private Banking, DataStream. Data as of 23/11/2015. (trading at a 20% premium to their 10-year average)! However, the conclusion is the same: avoid Brazilian equities.

In Turkey, given the strong profit growth outlook for the next few years (+7.2% in 2015e and +16.3% in 2016e, according to IBES) and historically cheap prices, we believe there might be some opportunities for investors comfortable with the regional situation.

To end on an even more positive note, we reiterate that our top conviction within emerging equity markets is India. Indian stocks are expensive compared with other emerging markets, but we believe that this premium is justified by the strong macro and micro backdrop. India’s equity outperformance will be driven by earnings growth rather than multiple expansion. And indeed, most sectors enjoy a double- digit profit growth outlook, the only exceptions being Telecoms and, unsurprisingly, Materials and Energy. Overall, analysts estimate that company earnings per share will gain 18.7% this year, 22.2% in 2016 and 17.9% in 2017 (source: IBES). The only fly in India’s ointment is the recent defeat of Narendra Modi’s party in the Bihar elections. Bihar is one of the poorest states in India, at the heart of Modi’s ambitious reform programme in terms of economic development. Losing such a strategic region could well dent India’s Prime Minister political credibility, and slightly delay his reform agenda. Longer term though, we believe there will be no major impact on Modi’s broad economic plan. The “Make in India” initiative, designed to boost India’s manufacturing sector, will be of clear benefit to the Information Technology and Industrials sectors and create tens of millions of jobs. Improving household conditions should lead in a continued boom in consumption, thus supporting the Consumer Discretionary sector. Coupling these with the accommodative monetary stance adopted by the Reserve Bank of India, it seems that most – if not all – the conditions are in place for outperformance.

MSCI India – Market structure and consensus EPS growth estimates by sector (%)

2015e 2016e

+9.6% +12.1%

+3 .1% +11.1%

Past performance should not be +25.1% +18.1% seen as an indication of future +16.5% +17.3% performance. Investments may be +22.5% +33.0% subject to market fluctuations, and +9.9% +25.6% the price and value of investments +15.6% +30.0% and the income derived from them -22.4% +45.5% can go down as well as up. Your +6.2% +4.3 % +7.1% +18.1% capital may be at risk and you may not get back the amount you invest. Sources: Societe Generale Private Banking, DataStream. Data as at 22/11/2015.

December 2015 14

Investment Strategy – 2016 Outlook

Equity theme Surviving Disruption Recent decades have been marked by a seeming acceleration of technological change and disruption. Moore’s Law: a law suggesting It is as if Gordon Moore’s Law had become applicable to our daily working lives. Most business people exponential growth. will recall that not so long ago, the Blackberry was considered a smart-phone. And every business

leader has had to think long and hard about the challenges to margins, and often to the business itself, presented by disruptive newcomers with innovative business practices or technologies.

The net effect of these new arrivals has been substantial. Part of this is driven by technology. According to Experts Exchange, the recently-launched Apple Watch has more raw processing power than 1985’s Cray-2 supercomputer. And the generalisation of mobile high-speed internet connections has enabled whole new business segments to emerge.

A number of common factors stand out: individual and collective productivity is enhanced; fixed assets are used more intensively; costs are low and prices are pushed down; and the barriers to launch a product or service globally are lower than ever before. In macro-economic terms, this also has profound repercussions. The new businesses are much more difficult to measure than the incumbents they are attacking and may not be properly accounted for in the calculation of gross domestic product. The same holds true for productivity gains. However, the impact of the traditional businesses being disrupted is measurable, as is the push downwards on inflation.

Disruptive newcomers are attacking more and more business segments. From accommodation (Airbnb, Homestay) to transportation (Uber, BlaBlaCar) to household services (TaskRabbit) to business services (HourlyNerd, ShareDesk). Not all new entrants will be successful of course but their ready access to capital from private equity investors (or indeed, disruptors such as Kickstarter) means that they will have the backing to wreak havoc with many traditional businesses’ profitability.

There are also numerous second-round effects to consider. If, for example, the growth of driverless cars and car-sharing services means that cars are left parked for 22 hours per day on average rather than 23 hours as at present, auto sales volumes may feel the pinch. Or if house owners are able to generate sufficient revenue from a spare room, they may decide to build their new home with extra rooms to increase earning power.

As we have seen, the economic and business ramifications will be far-reaching, and in particular for equity investors. Crucially, most of the new entrants are privately or tightly held and not easily accessible to investors, whereas the disrupted businesses are by and large listed corporations. In our view, this calls for some fresh thinking on security selection.

Focusing on companies which are set to continue to grow their top-line sales, which generate a high cash-flow return on investment and amply cover their cost of capital is likely to help identify businesses which seem well placed to survive the disruption of their industry.

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Investment Strategy – 2016 Outlook

Equity theme Convertible bonds – the best of both worlds What is a convertible bond? A convertible bond – or convert, or CB – is a corporate bond that can be exchanged for a predefined number of common shares of the underlying company. Simply put, a convertible bond is a bond with an embedded equity call option. As these securities can be converted into stocks, they combine features specific to both bonds and equities. This is the primary interest of the asset class. Also note that, all else being equal, converts allow the issuing companies to pay a lower coupon than with a standard bond, given the value attached to the conversion option.

Pricing of a convertible bond The convexity of converts. CBs generate higher total return than standard fixed-income

200 instruments, and are less risky than equities. In a bull market, they will capture the positive

180 performance of equities. WORST CASE 160 Co nvertible Conversely, when markets decline, they offer far better capital protection, as they start 140 b o nd value behaving like bonds again. In that, they are considered as hybrid instruments. That duality is E Q UI TY L IKE 120 BEHAVIOUR called “convexity” given the asymmetrical behaviour. 100 B o nd floor Delta: a key metric. The delta measures CBs’ sensitivity to underlying equities in %. The higher 80 the delta, the more CBs behave like stocks. Also, when the stock price rises, the delta 60 increases, helping CBs better capture equity performances. Conversely, when it falls, the 40 Eq uity price delta decreases and CBs behave more like bonds. 20

0 Icing on the cake: dividend protection and ratchet clauses. As its name suggests, the 0 20 40 60 80 100 120 140 160 180 200 dividend protection clause protects CB holders from dividend payments. At first, it could Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/11/2015. seem surprising to hedge against dividend payments. But underlying stock prices often decline when dividends are paid. The clause compensates CB holders via an upward revision in the conversion ratio – i.e. for each bond owned, they will get more shares upon conversion. The ratchet clause is designed to protect the convertible bond holder if the issuing company is taken over. As a change of control is not necessarily in the holder’s interest, he will have to be compensated for it. As with dividend protection, the ratchet clause involves an upward revision in the conversion ratio upon acquisition. With time, both clauses have become common to most converts. Is the timing right? We believe so! After strong years, equities have become expensive, and bonds are even more over-valued. Equities may rise further, in which case convertibles will benefit via a higher delta. Moreover, CBs enjoy better risk-adjusted performance than equities, meaning that investors can expect a sizeable portion of equity returns without suffering the same level of volatility. Further, with rates extremely low, interest rate risk is tilted to the upside, and higher yields mean lower bond prices. Convertible bonds, however, are less interest rate sensitive than standard bonds because of their embedded equity call. However, their bond-like characteristics will gradually strengthen if the underlying equity falls, thereby helping to protect invested capital. In short, CBs are clearly attractive, acting more like bonds in bear markets and equities in bull markets, which should prove valuable in 2016.

MSCI Europe vs European convertible bonds (base 100 = 01/01/1991) (red background = bear market)

900 Co nvertible M S CI Exane Convertible Europe Index 800 E urope E urope MSCI Europe 700 Annual perf. 8.5% 6.0% -14.2% p.a. +8.6% p.a. Past performance should not be Ann. volatility 8.0% 16.8% 600 +10.2% p.a. seen as an indication of future Max drawdown -31.4% -59% -6.8% p.a. 500 performance. Investments may be 400 subject to market fluctuations, and +18.2% p.a. 300 the price and value of investments 200 and the income derived from them -24.1% p.a. 100 -40.3% p.a. +13.2% p.a. can go down as well as up. Your +18.0% p.a. +20.9% p.a. 0 capital may be at risk and you may 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 not get back the amount you invest. Source: Societe Generale Private Banking, Bloomberg (data as at 26/11/2015)

December 2015 16

Investment Strategy – 2016 Outlook

Hedge funds Don’t Rely on Beta The overall environment for hedge fund managers is improving (see the “Edge Funds” theme on page 18). Within the industry, we continue to favour flexible traders and managers who do not rely on rising prices to generate returns.

Long/Short Equity. Like equities (see page 12), Long/Short Equity funds have recorded contrasted performances depending on the regions.

In the US, a stronger USD and plunging oil prices have lead to greater dispersion across securities and sectors. Add to that lower correlations and you end up with a market offering many opportunities to stock pickers. The share of return resulting from security selection (aka alpha) has risen while exposure to the market as a whole (aka beta) has proved unrewarding. Against such a background, Market Neutral strategies should outperform.

Meanwhile, in Europe and Japan, favourable monetary policies and a cyclical upturn could lead to wilder equity swings. This argues for a more flexible approach and we suggest focusing on Variable Bias funds that can adjust their beta to changing conditions.

Event Driven. Managers who specialise in Special Situations may now find the environment more challenging. With equity prices rising faster than profitability, valuations have become stretched, leaving fewer hidden value pockets.

The boom in mergers and acquisitions (M&As) has further to go but as the cycle matures and regulatory risks increase, striking a deal becomes harder. Add to that a worsening credit cycle (see page 5) and it becomes obvious that here too high returns will be harder to generate.

Distressed/Credit. The worsening credit cycle also makes life harder for Long/Short Credit managers. Corporate defaults are at their highest level since 2008-2009. Managers with a more diversified approach to arbitraging fixed income will find better opportunities given the growing divergence in macro outlooks.

Global Macro/CTAs. Global Macro managers and trend-following Commodity Trading Advisors also benefit from macro divergence. Dispersion across asset classes has increased sharply and the trading environment has improved. After a period where some of the macro relationships used by traders proved less reliable, visibility has improved, leaving Global Macro managers and CTAs with a more stable context. CTA investors should look to combine managers with different time horizons – long-term traders may struggle when trends reverse and should be combined with more flexible short-term approaches to limit the damage.

Correlation & Dispersion: US Equities (Top 50 S&P500 Companies)

0.8 Correlation (12wk pair wise) Price Dispersion (12wk avg, rhs) 0.08 0.7 PE Fwd Dispersion (12wk avg, rhs) 0.07 0.6 Past performance should not be 0.06 0.5 seen as an indication of future 0.05 0.4 performance. Investments may be 0.04 subject to market fluctuations, and 0.3 the price and value of investments 0.2 0.03 and the income derived from them 0.1 0.02 can go down as well as up. Your capital may be at risk and you may 0.0 0.01 2011 2012 2013 2014 2015 2016 not get back the amount you invest. Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/11/2015.

December 2015 17

Investment Strategy – 2016 Outlook

Hedge funds theme Edge Funds It is well known that market timing is one of the most difficult investment skills. And the problems are exacerbated when it comes to investing in sophisticated strategies such as those employed by alternative investment managers. In this context, it may be useful to consider what some of the main drivers of their performance might be, and how the environment might be changing.

In the past few years, the performance of alternative investment managers has proved somewhat disappointing when compared with the period running up to the financial crisis and Great Recession (2007-2009). Between 1999 and 2008, the average annual performance of the broad Hedge Fund Research index was 6.3%. Since 2009, this has fallen to 3.2%.

What has caused this underwhelming series of returns? We would highlight a number of factors:

Dispersion and Correlations. We have experienced a prolonged period of high correlations between assets, which makes life difficult for Macro managers – if correlations are high between favoured and unfavoured positions, diversification benefits are reduced and, again, losses on bearish views eat into gains on bullish positions. And for Long/Short managers, when dispersion between stocks is low, returns tend to struggle. This choppy pattern has also proved problematic for trend-followers – no sooner had a trend emerged and the manager had taken position, than it began to reverse, forcing the trend-follower to cut his/her losses.

Declining Volatility. The volatility of gross domestic product growth rates has fallen and the same phenomenon has infected financial markets – in the United States, for example, the S&P 500 index has experienced only one correction greater than 10% since the eurozone crisis in mid-2011. This makes life difficult for those strategies (such as Global Macro) which thrive on volatility.

Financial Repression. With policy rates at zero since the crisis, central banks have begun to use their balance sheets to accumulate vast quantities of government bonds, thereby pushing yields lower. This then encourages investors to seek higher, riskier yields which in turn fall, meaning that yields across all maturities and credit qualities converge towards zero. For relative value traders of bonds, potential returns have suffered.

Zero-Interest Rate Policy. It is often forgotten what an important source of hedge fund returns interest rates can be. When a fund shorts a security, it receives the sale proceeds which are invested in low-risk notes until the security is repurchased. It makes a big difference if the proceeds are invested at 5% or at zero. The chart illustrates the influence of the decline in rates on historical returns since the crisis.

As US interest rates begin to normalise, financial repression will dissipate, volatility will rise, and the combination of higher rates, lower correlations and increased dispersion should translate into better returns from hedge funds. Global Hedge Fund Index performances (12-month trailing vs average performance)

35%

25%

Past performance should not be 7.0% 15% 2.1% seen as an indication of future performance. Investments may be 5% subject to market fluctuations, and -5% the price and value of investments 3.2% Trailing 12m performance 1.8% and the income derived from them -15% Average performance can go down as well as up. Your Average real performance (vs Citi 3M USD) capital may be at risk and you may -25% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 not get back the amount you invest. Sources: Societe Generale Private Banking, Bloomberg. Data as at 30/11/2015.

December 2015 18

Investment Strategy – 2016 Outlook

Commodities Bottoming out The oil plunge has had both positive and negative effects. On the positive side, it has triggered massive income transfers from oil producers to consumers and been of great support to global consumption via lower inflation. On the negative side, it has seen spreads widen in the US energy sector, with overleveraged commodity-related companies under growing risk of default – mostly in the emerging world but not only.

OPEC: the Organisation of Petrol- At around $40/barrel, we believe oil prices have overshot on the downside, mainly because of excess Exporting Countries. supply. OPEC and non-OPEC producers are competing fiercely for market share, producing heavily despite weaker demand. So far, US non-conventional oil output has fallen only slightly but further cutbacks are to be expected given the breakeven cost stands around $60/barrel on average with wide discrepancies between oil rigs. Given these factors, oil prices may fall further in H1 especially with Iran back to the market and a further build-up in reserves. However, we do not see oil remaining much below $40 for long – the price war is already quite painful for key players like Saudi Arabia and we expect greater cooperation among producers to prevent a further slide. High-cost producers have already done heavy cost-cutting, which could have a major impact on future oil production and eventually on prices.

All in all, we expect Brent to trade in a $40-60 range in 2016. Oil prices should stay in the lower part of the range in H1 and then recover gradually in H2 - supply/demand rebalancing will be slow.

Stronger production from Saudi Arabia has worsened the oil glut

11000 1800

1600 10000 1400

9000 1200

1000 8000 800

7000 600

400 US oil production (thousands b/d) 6000 Saudi Arabia oil production (thousands b/d) 200 US oil rigs (units, rhs) 5000 0 2010 2011 2012 2013 2014 2015

Source: Societe Generale Private Banking (data as at 30/10/2015)

ETF: an Exchange-Traded Fund is Gold prices have eased down with investors cutting their exposure – ETF gold holdings have returned to a marketable security that tracks an their early 2009 levels. Obviously, Fed rate hike expectations and a stronger USD have weighed on index, a commodity, bonds, or a basket of assets. prices, especially as they are heavily influenced by US short-term real interest rates. Chinese and Indian savers – who are highly sensitive to spot prices – have helped limit but not reverse the damage. Next year, we expect a cautious Fed, higher inflation worldwide and a pause in the dollar bull-run, reducing downside risks to gold prices. On the supply side, the marginal cost of production stands around $1050, which should help gold resist in the medium term. Given the current headwinds, we believe that gold prices will edge further down before stabilizing above $1000/oz later in the year. As such, we are neutral on gold.

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up.

Your capital may be at risk and you may not get back the amount you invest.

December 2015 19

Investment Strategy – 2016 Outlook

Tactical and strategic themes: open strategies

Inception Time Conviction CUR Strategy description date horizon* European banks beauty contest Accommodative monetary policy will ease funding conditions. Bond redemptions will continue to 01/12/2013 EUR Strategic (Bonds) outpace bond issuance. TOPIX - Multiples rerating still We believe that Japan is moving towards a structural change. The exit from deflation should strongly 19/03/2014 JPY Strategic underway support stock market re-rating. 12/06/2014 Eastern Europe back in the game EUR The macroeconomic backdrop in Eastern Europe has improved. Strategic

27/11/2014 Blue gold (Water) EUR Many regions of the world face large water supply disruptions. Water remains underpriced. Strategic Sustained upturn in the German High demand and short supply have led to an increase in German property prices. However, 27/11/2014 EUR Strategic housing market. residential housing still looks affordable compared with London and Paris. Higher shareholders’ return should Shareholder returns are clearly the main structural and cyclical factors supporting Japanese stocks. 13/03/2015 JPY Strategic further sustain Japanese stocks When companies launch share buybacks, their performance is more resilient to external shocks. Declining oil prices to fuel global The decline in energy and other commodity prices, combined with the low interest rate environment, 13/03/2015 USD Strategic consumption will foster consumer appetite. Internet of things: are you 13/03/2015 USD The inexorable advance of the Internet of Things will change our lives - again. Strategic connected? Chindia (China & India) : becoming China and India are set to shape the future of the global economy given their size, favourable growth 13/03/2015 USD Strategic global leaders prospects and their increasing global footprint. 01/06/2015 Fed rate hike raises volatility USD Expensive valuation and Fed’s rate hike should drive stocks’ volatility up. Tactical Fed rate hike will warrant change in With the increase in interest rates and the appreciation of the USD, expensive growth sectors will 01/06/2015 USD Tactical US investment style come under pressure in the medium term. Switch into US value stocks. 01/06/2015 Capturing (US high) yield USD With Brent prices up, US high yield corporate bonds now offer relatively high yield. Tactical With global infrastructure spending set to double by 2015, stocks exposed to long-term dynamics 01/06/2015 Infrastructure: building the future EUR Strategic of population growth and urbanization will enjoy an increase in revenues.

04/12/2015 Surviving Disruption USD Focus on high quality companies with clear growth prospects Strategic Convertible bonds - the best of 04/12/2015 EUR Upside participation and capital preservation in one package Strategic both worlds US credit: prefer banks to 04/12/2015 USD Favour Banks over non-financial companies in the US Tactical corporates, floating to fixed 04/12/2015 Edge Funds USD Enhanced performance potential with rising dispersion, volatility and interest rates Strategic

Sources: Societe Generale Private Banking, DataStream. Data as at 30/11/2015 * Strategic: 1-3 years. Tactical: 3-12 months

Denotes a change from our previous quarterly Closing strategies

Inception Conviction CUR Closing rationale Type date

. The strength of the USD has pressured performance since inception. 27/11/2014 Made in the USA USD Strategic . US manufacturing sector seems running out of steam, not much upside to expect.

. Robust performance since inception. Currencies: looking for . After a steep fall of commodities and emerging currencies in 2015 against the USD, not much 13/03/2015 USD Tactical investment opportunities downside risk left. . It is time to close this tactical recommendation.

Higher volatility: across . Now that worries about China’s slowdown have eased, cross-asset volatility should follow suit. 24/09/2015 USD Tactical the board . Volatility should remain on stock markets though (see “Fed rate hike raises volatility”).

Sources: Societe Generale Private Banking, DataStream (data as at 30/11/2015).

Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.

December 2015 20

Investment Strategy – 2016 Outlook

Global economic forecasts GDP and CPI forecasts

% changes yoy Real GDP* CPI* 2014 2015f 2016f 2017f 2014 2015f 2016f 2017f World (Mkt FX weights) 2.8 2.8 3.1 3.2 2.7 2.2 3.0 3.5 World (PPP** weights) 3.4 3.1 3.5 3.7 3.6 3.7 4.1 4.3 Developed countries (PPP) 1.8 1.9 2.3 2.2 1.4 0.3 1.4 2.3 Emerging countries (PPP) 4.6 4.0 4.4 4.7 5.3 6.2 6.1 5.7

Developed countries US 2.4 2.5 2.8 2.7 1.6 0.1 1.8 3.2 Euro area 0.9 1.5 1.6 1.5 0.4 0.1 1.1 1.5 Germany 1.6 1.5 1.6 1.6 0.8 0.2 1.3 1.6 France 0.2 1.2 1.4 1.5 0.6 0.2 1.1 1.5 Italy -0.4 0.7 1.2 0.9 0.2 0.2 1.1 1.6 Spain 1.4 3.1 2.5 1.7 -0.2 -0.7 0.7 1.1 UK 2.9 2.4 2.0 1.8 1.5 0.0 1.1 2.1 Japan -0.1 0.6 1.7 1.0 2.7 0.8 0.5 2.3 Switzerland 1.9 1.0 1.3 1.7 0.0 -1.1 -0.4 0.5 Australia 2.6 2.4 2.9 3.3 2.5 1.5 2.1 2.4

Emerging countries China 7.3 6.9 6.0 6.0 2.0 1.5 2.0 2.4 South Korea 3.3 2.6 3.2 3.5 1.3 0.7 1.8 2.1 Taiwan 3.8 1.0 1.8 2.9 1.2 -0.3 1.5 1.2 India*** 6.9 7.3 7.3 7.4 9.7 5.9 5.1 5.5 Indonesia 5.0 4.7 5.2 5.5 6.4 6.6 5.7 5.9 Brazil 0.1 -3.7 -3.2 -1.7 6.3 9.0 7.2 6.0 Mexico 2.3 2.5 3.2 3.4 4.0 2.8 3.5 3.3 Chile 1.9 2.3 2.5 2.7 4.4 4.3 3.6 3.3 Russia 0.6 -3.8 0.0 1.0 8.6 15.1 7.6 5.9 Poland 3.3 3.5 3.5 3.6 0.1 -0.9 0.9 2.0 Czech Republic 2.0 4.2 2.8 2.6 0.4 0.5 1.6 2.2

Sources: SG Cross Asset Research / Economics * (f: forecast) ** PPP: Purchasing Power Parity *** In India, the numbers are averaged over the Fiscal Year, ending in March

Forecast figures are not a reliable indicator of future performance

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Market performance

Developed equity markets performance (in local currency) Current level 1m total return 3m total return YTD total return 12m total return S&P500 2080 0.3% 6.1% 3.0% 2.8% DJ Euro Stoxx 50 3506 2.7% 7.7% 15.0% 11.5% FTSE100 6356 0.3% 2.5% 0.4% -1.9% Topix 1580 1.4% 3.6% 14.3% 14.2% MSCI AC World ($) 407 -0.8% 3.2% -0.1% -2.0%

Developed bond markets performance (in local currency) 1m total return 3m total return YTD total return 12m total return Citigroup US Sovereign 3-7y -0.4% 0.1% 2.0% 1.6% Citigroup Germany Sovereign 3-7y 0.5% 1.2% 1.2% 1.7% Citigroup UK Sovereign 3-7y 0.4% 1.0% 1.6% 2.2% Citigroup Japan Sovereign 3-7y 0.0% 0.2% 0.1% 0.5% Yield to maturity BAML Corp Euro IG 1.29% 0.7% 1.4% 0.4% 0.8% BAML Corp Euro HY 4.96% 0.6% 1.2% 3.2% 2.8% BAML Corp US IG 3.52% -0.2% 0.8% 0.2% 0.1% BAML Corp US HY 8.31% -2.2% -2.2% -2.1% -3.5% BAML Corp UK IG 3.43% 1.8% 1.8% 1.4% 2.7%

Emerging equity markets performance (in USD) Current level 1m total return 3m total return YTD total return 12m total return MSCI EM 814 -3.9% -0.1% -12.7% -16.7% MSCI EM Asia 408 -3.3% 2.7% -8.9% -10.5% MSCI EMEA 227 -6.2% -6.0% -13.5% -22.0% MSCI Latam 1919 -4.2% -6.1% -27.8% -34.4%

Emerging bond markets performance (in USD) Yield to maturity 1m total return 3m total return YTD total return 12m total return BAML EM Sovereign 5.36% -0.8% 0.7% 0.7% -1.7% Asia 4.59% -1.0% 1.1% 1.2% 0.5% EMEA 4.66% -1.1% 0.5% 2.5% -0.2% Latam 6.81% -0.3% 0.6% -2.3% -4.7%

BAML EM Corp 5.57% -0.5% 0.3% 1.5% -1.3% Asia 4.09% -0.2% 1.3% 2.6% 1.7% EMEA 5.18% -0.3% 1.7% 7.5% 2.5% Latam 7.98% -1.2% -2.3% -4.5% -7.7% Source: Societe Generale Private Banking, DataStream (data as at 30/11/2015)

BAML : Bank of America Merrill Lynch EM : Emerging Market Corp : Corporate EMEA : Europe, Middle East, Africa IG : Investment Grade Latam : Latin America HY : High Yield

Forecast figures are not a reliable indicator of future performance

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Market performance and forecasts Currencies Performance YTD Current 6-month forecast 12-month forecast EUR/USD -12.7% 1.06 1.05 1.10 USD/JPY 2.8% 123 123 123 EUR/CHF -9.7% 1.09 1.10 1.14 GBP/USD -3.1% 1.51 1.48 1.45 EUR/GBP -9.9% 0.70 0.71 0.76

10-year yields YTD change Current 6-month forecast 12-month forecast (in local currency) basis points USA 7 2.2% 2.5% 2.8% GER -5 0.5% 0.7% 1.0% UK -10 1.8% 2.1% 2.5%

Commodities Performance YTD Current 6-month forecast 12-month forecast Gold in USD -10.3% 1064 1050 1100 Oil (Brent) in USD -21.0% 44 50 50

Equities (in local currency) YTD Total return Current 6-month forecast 12-month forecast S&P 500 3.0% 2080 2150 2250

DJ Euro Stoxx 50 15.0% 3506 3550 3750

Topix 14.3% 1580 1675 1775 Source: Societe Generale Private Banking, DataStream (data as at 30/11/2015)

BAML : Bank of America Merrill Lynch EM : Emerging Market Corp : Corporate EMEA : Europe, Middle East, Africa IG : Investment Grade Latam : Latin America HY : High Yield

Forecast figures are not a reliable indicator of future performance

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Investment Strategy – 2016 Outlook

Important Disclaimers

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Investment Strategy – 2016 Outlook

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Investment Strategy – 2016 Outlook

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