Deutsche Bank Research: The Equity View August, 2013

 Equities are trading close to record highs in developed markets despite an underwhelming Q2 earnings season.
Multiples have rallied to mid cycle levels as markets discount an imminent earnings recovery.
 Recent macro data has given the market considerable empirical cover to anticipate an inflection in earnings
momentum, particularly given bottom up consensus expectations are now muted (+1% Europe/+6% US for CY13):
– ISM Manufacturing and Services data for August posted strong gains, including the new orders component.
– European PMIs confirmed the uptrend in flash figures, with the strongest gains from the periphery suggesting a
more balanced pattern of growth. Our long-standing non consensus view of a return to growth in Europe in Q2
was confirmed with a +0.3% print.
– In July, the UK composite PMI hit its highest level since 1998 and retail sales surged to a 7 year high
– Bearish views on China had become consensual. July trade data surprised positively and IP accelerated in July
to 9.7%, a 5 month high with electricity consumption in August up 10%.
– Only Japan came in light of forecasts with 2.6% GDP (annualised) vs consensus of 3.6%.
 Money flows continue to provide support to DM equities. AUM inflows have spread to Europe and are now positive
YTD in addition to the US and Japan. This is providing a positive tone to markets, particularly on pull-backs.
 After a slow start to 2013, global M&A activity has accelerated in Q2 and June –July were ahead of the 5 year
average. Global ECM activity (placings, IPOs) is up 42% at the H1 stage, highlighting levels of risk appetite.
 Conclusion: Despite concerns over rising treasury yields/taper risk and markets near to their highs, equities are well
supported at these levels through to YE on greater confidence of an inflection in earnings momentum, based on
more evidence of a broadly based recovery than had been anticipated, plus continued inflows to the asset class.
 The biggest risk to our view is a disorderly market response to the end of QE that sees bond yields rise or equities
fall in a manner that would impede growth. We expect intermittent volatility spikes around events such as German
elections/US debt ceiling discussions and would buy such pull-backs.

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Equity multiples are near historical averages but look cheap both on an
absolute and relative basis
 Our baseline sees both higher rates and a higher
multiple from current levels
– Based on payout ratios, earnings, the 10y yield
and growth/inflation volatility, we estimate the fair
value trading multiple for the S&P500 to be 18.4x
– The current 2pt discount to fair value implies a
cushion to compensate for significantly higher
rates
… Simply put, the current multiple is pricing in a
5.1% 10y, meaning that the multiple can
expand even as rates rise
 On a relative basis, equities are still very cheap
– The current spread between S&P500 OCF yield
and credit/treasury yields implies that equities
are underpriced by 24-29%
– This again suggests that before equity fair value
is threatened, rates have room to rise
 Fair value is not the ceiling
– It is normal cyclical behaviour for the multiple to
rise well above fair value as inflows to equities
normalize and growth expectations improve

The backdrop of ISM at 55.4 and broadly better data is fuelling equity
inflows supporting our preference for of a rotation out of bonds
 Strong ISM data points to period of overweight
equity positioning
– During periods of strong ISM in this recovery,
aggregate equity beta has been 0.5-2.0 std
above average (current 0.8 std above average)
– We estimate that a 0.5 std move in beta is worth
3% for the S&P
 We expect inflows to support equities near term
with fund positioning overweight
– Global equity inflows have been strong with $54b
over the last 5 weeks (~1% of AUM)
– Equity mutual fund flows have turned positive
during the past two months after 7 months of
outflows
 Rates positions likely to be cut on solid ISM
– When the ISM and new orders were above 55 in
2010 and early 2011, rates positioning was
notably net short
– We expect rates positions to be pared further as
the path of the Fed has become more data
dependent

Sector Theme
The impact of a strong
US$
 We review the impact of a multi-year uptrend in the US$ on key sectors and
identify winners and losers by region
European Banks
European Banks have built capital through the reporting season at a far
faster rate that the market was expecting. This pulls forward cash return
prospects and offers upside risk to the real economy through a more
powerful credit impulse through 2014
China’s two-child policy
As part of China’s ongoing reforms, expect moves to promote higher birth
rates to slow the country’s aging process – will lead to a further 1.6m babies
annually and increase China’s peak population by 25m
Pharma productivity
improving
 Greater drug R&D productivity showing through in record FDA approvals
supporting continued positive view on European Pharma
Global Aerospace
manufacturer duopoly
 Commercial aerospace OE cycle is well underpinned and will prove
to be less cyclical, benefitting a global duopoly (Boeing and EADS)