Wednesday, 13 April 2013 Page 1

EEccoonnoommiicc CCoommmmeennttaarryy

AApprriill 22001133

US and Developed Markets We were surprised by the bungled bailout of Cyprus, more so that markets were largely unaffected by it. Although the €100,000 deposit guarantee was eventually reinstated to Cypriot depositors, the very fact that it could be apparently removed at the whim of politicians should make all depositors in peripheral countries very nervous. Perversely, we may find that more money finds its way into the market, as depositors now reason that as well as ultra-low interest rates, they now have the risk of having their money arbitrarily taken away from them as well.

The U.S. budget negotiations continue to linger. While there is some uncertainty about how the U.S. will resolve the unsustainably large budget deficits, we continue to believe that neither the tax hikes earlier this year nor the start of sequester spending cuts will likely derail the economic expansion. One sign of robustness we see is the improving U.S. employment situation. According to the non-farm establishment survey, employment has been growing at close to 200,000 jobs per month in the last three months (December through February). At the same time, the Purchasing Managers Index (PMI), a leading economic indicator, which had weakened to just under 50 in November is now above 50.

Persistently low yields are doing funny things to credit. The increasingly desperate hunt for yield is fuelling increasingly irrational behaviour. Low yields are also focusing investors’ minds on what might happen when rates rise, they would do well to do so. What has shielded fixed-income investors and lulled them into a false sense of security is the 30-year bull market in government bonds. It is obvious that with 10-year US treasuries yielding 1.7% the risk-return looks asymmetric. When yields eventually rise your returns are quickly eaten away and you are not adequately protected by carry. Aside from blind panic, one reaction from both equity and fixed-income investors has been to search for ways to protect themselves. This is driving some of them away from traditional market cap-weighted indices and towards alternatives. “Over the last six months there has been a confluence of three different strands of debate that have come together under the aegis of alternative beta.

In fixed income the expectation of rising yields and inflation is intensifying the search for new investment strategies.

Three key strategies for managing rising rates are sector allocation, yield curve positioning (shifting fixed-income allocations to shorter maturity mandates) and rate hedge overlay (keeping broad fixed-income exposure alongside the purchase of insurance against specific interest rate outcomes). What is certain is that simply buying a market cap-weighted index of bonds isn’t going to be safe or add any value.

Wednesday, 13 April 2013 Page 2

March 2013 was yet another month driven by central banks and political activity globally. The Japanese are just entering the QE party now; markets wait with baited breath to see the outcome of incoming BOJ Governor Kuroda’s first meeting, which took place on 4th April 2013. The Japanese story has developed quickly – Prime Minister Abe has been like the “conductor” of an orchestra. It has been impressive to watch him align politics with BOJ objectives and the overall interests of the Japanese public. The QE experiment (aka “Abenomics”) he advocates is indeed a risky experiment.

Whilst the Japanese are entering the QE world, in the US the Fed is getting more deliberate in its communication with respect to scaling back its QE activities. The most important economic number of the month continues to be the US non-farm payrolls number, given its direct linkage to QE removal. Long-USD has been a popular trade, given expectations of QE removal; whilst we agree with this in the medium to longer term, short term we would not be surprised to see some softer seasonal second quarter US economics numbers, as has been the trend for the last two years.

Australia

The S&P/ASX200 Accumulation Index finished down ‐2.21% in March putting an end to a nine month positive streak. Within the Aussie Index, Australian banks continued to perform relatively well and again it was resources that lead the market lower. Of note, both BHP and RIO fell by more than 10%. This has been a window into the weakening commodity prices which have continued to fall into April. This will have a direct effect on the strength of our economy, the ability of the government to raise taxes and the increasing the chance of a rate cut down the line. This will also likely continue to weaken the Australian dollar. Commodity price declines also weighed heavily on our market as lower demand lead to lower spot pricing; iron ore was particularly topical.

Australia now has an economic outlook which is generally quite subdued, but we still have high investor complacency, valuations of decent quality companies with a growth profile are off the charts, costs (currency, energy, labour) are extremely high and Australian companies are only just starting to make the hard decisions to improve productivity. (Where allowed by the unions and union friendly legislation.)

The recent growth figures out of China show continued sowing of their economy. This will continue to weaken commodity prices and adversely impact on our economy.

Recent aggressive market returns, which are a bet on continued strong growth in our economy, are looking a little less secure and presage a pullback in the markets.

Wednesday, 13 April 2013 Page 3

Emerging Markets The MSCI Emerging Markets Index lost 3.3% in AUD terms and reached a 3-month low in March.

Among the core emerging market countries, Mexico was the best performing market gaining 1.5% in AUD terms, followed by India (-1.9%). Both markets finished the month flat in local currency terms. South African equities had a positive month in local currency terms, finishing the month up 1.2%, but lost 2.8% in AUD terms as the South African rand continues its downward trend.

Brazil’s Ibovespa index finished the month down 5.6% in AUD terms and posted its worst quarter since 1995. Russian equities lost 6.2% in AUD terms. Eastern European markets were more affected by the crisis in Cyprus than other emerging markets due to their proximity to the bailed-out country.

Chinese stocks lost ground as the government unveiled a new round of property-tightening policies and new wealth management rules. China A-Shares lost 6.8% in AUD terms, while China H-Shares finished the month down by 6.4% in AUD terms. Elsewhere in Asia, the Southeast Asian markets were standout performers for a second consecutive month. Thailand, Indonesia, Malaysia and the Philippines gained 1.9%, 0.9%, 0.7% and 0.4% in AUD terms, respectively.

Korea outperformed following previous weak performance on won versus yen depreciation concerns. On the political front, Park Geun-hye was inaugurated as Korea’s first female president. Park pledged to improve ties with North Korea (clearly this is not going well!) and implement widespread reform to support the economy.

Despite some positive data releases from China during the month, including strong export growth and rising house prices, concerns that authorities may act to restrict real-estate price growth weighed on the market. In India, a further reduction in the government’s growth forecasts (from 5.5% to 5% for the year ending 31 March 2013) weighed on the market. Inflationary pressure also led to strike action during the month, although demonstrations were not widespread. The emerging Latin America markets, with the exception of Chile, underperformed wider emerging markets. Chile outperformed aided by better-than-expected economic activity of 4.7% year on year in December. Brazil and Mexico both underperformed amid some negative macroeconomic data releases. In Brazil, this included weaker-than-expected retail sales growth and higher inflation. Commodity price weakness also weighed on the market. In Mexico, index heavyweight America Movil fell sharply following disappointing Q4 results.

Wednesday, 13 April 2013 Page 4

Summary

The outlook for global growth will remain below trend as most developed countries continue to deleverage against a very benign inflation backdrop. As a consequence, it will allow most developed market Central banks to maintain an accommodative policy stance until the economic recovery is on a much firmer footing. This policy mix should continue to be supportive for global fixed income markets generally. Near term risks to inflation remain low and monetary policy should remain supportive. While valuations across many fixed income asset classes do not look particularly attractive, sentiment and cyclical factors remain very supportive for bond markets. Intervention by global central banks in many sectors has taken supply out of the market while demand remains relatively strong. The search for yield is likely to continue as investors look further out the yield curve and down in credit quality to escape near zero cash rates. Although spreads have tightened significantly over the last few months, we still see selective opportunities across the US, Europe and Emerging Markets.

Equity markets remain susceptible to macro-economic shocks as news of more counties admitting that their banking systems are overloaded with debt and need bailing out. The latest country teetering on the edge of default seems to be Slovakia. What this space!

Wednesday, 13 April 2013 Page 5

Disclaimer

The information and any recommendations contained in this document are for the benefit of the addressee only and are made as at the date of this document. Nothing in this document constitutes “personal advice.”

Any investments made as a result of any of these recommendations are subject to investment risks including loss of income and capital. The performances of all investments are subject to a range of external factors, including economic and political factors that at any time may change the outlook. 358 Pty Ltd does not guarantee any rate of return, the performance of an investment nor the repayment of capital. Nothing in this document constitutes an offer to invest.

This document may include information that was prepared or compiled by third parties. 358 Pty Ltd believe the information to be reliable at the date of this document. However, 358 Pty Ltd make no warranties or representations as to the accuracy or completeness of the document or its contents.

To the extent permitted by law, 358 Pty Ltd excludes all liability to any party for any loss, costs or damage incurred as a result of reliance on this document or its contents.