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Capital Markets Outlook 2008 The World in Transition

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Presentation on theme: "Capital Markets Outlook 2008 The World in Transition"— Presentation transcript:

1 Capital Markets Outlook 2008 The World in Transition
Ben Pace, U.S. Chief Investment Officer New York, December 6, 2007

2 Agenda Growing Recession Fears 1 The World in Transition 2
Outlook 2008: World Economy and Asset Classes 3 Investment Philosophy: Broad asset class diversification 4 Page 2

3 Growing Recession Fears

4 U.S.: Growing recession fears
Rate hike cycle Financial crisis Economy 1970 Penn Central (Jan) Recession 1974 Franklin National (May) 1980 First Penn (Feb) 1982 Latin America (Jul) 1984 Continental Illinois Slowdown 1987 Black Monday (Oct) 1990 Savings & Loan (Apr) 1995 Mexico 1997 Pac Rim (Aug) 1998 Russia / LTCM 2000 Nasdaq Bubble 2007 Subprime ? Source: ISI Every rate hike cycle of the Fed ended with a financial crisis Page 4

5 How has the Fed reacted in a recession scenario?
Year Crisis Length S&P 500 Loss Rate Cut 1987 Black Monday / Stop Loss 6 months - 35% -70 bps 1990 Savings & Loan 7 months - 20% -680 bps 1998 Russia / LTCM 4 months -75 bps 2007 Subprime So far 4 months - 10% So far -75 bps Source: ISI Page 5

6 Likelihood of a U.S. recession
Negative Factors Positive Factors Subprime and housing crisis Decelerating U.S. consumption triggered by the housing market Crisis of confidence in U.S. financial markets Rising financing costs – swap and credit spreads strongly widened Rising oil prices High leverage of U.S. consumers Growing inflationary fears caused by USD weakness may keep Fed from easing Never fight the Fed Never underestimate the U.S. consumer Low bond yields External demand and low USD Stable labor market Profit margins and Corporate America in good shape Probability of a U.S. recession: One third Baseline scenario: A growth dip in the winter half-year, recovery thereafter Page 6

7 U.S.: Never underestimate the U.S. consumer
U.S. real private consumer expenditure Record: consecutive quarters with positive real consumer expenditure since 1991 Only 13 negative quarters since 1960 QoQ, seasonally adjusted, projected for the whole year in % 15 10 5 -5 -10 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 Sources: T.F. Datastream, Deutsche Bank Private Asset Management Page 7

8 The World in Transition

9 Extreme price volatilities (I)
Oil price: Rising from 25 to 90 USD/barrel since 2002 USD/EUR: Euro on new record high USD/Barrel (WTI) USD/EUR 100 100 1.50 1.50 90 90 1.40 1.40 80 80 1.30 1.30 70 70 1.20 1.20 60 60 1.10 1.10 50 50 1.00 1.00 40 40 0.90 0.90 30 30 0.80 0.80 20 20 0.70 0.70 10 10 0.60 0.60 82 84 86 88 90 92 94 96 98 00 02 04 06 08 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Source: T.F. Datastream, Deutsche Bank Private Asset Management Source: T.F. Datastream, Deutsche Bank Private Asset Management 11/12/07 11/12/07 Oil price driven by rising geopolitical risks in the Middle East Oil prices remain highly volatile Will the U.S. dollar continue to depreciate at this pace? Page 9

10 Extreme price volatilities (II)
Gold: Price has doubled in 25 years (on USD basis) Source: T.F. Datastream, Deutsche Bank Private Asset Management USD/ounce 82 84 86 88 90 92 94 96 98 00 02 04 06 08 200 300 400 500 600 700 800 Gold: Price boosted by growing wealth, demand for luxury goods and the search for safety Page 10

11 Markets driven by money supply and liquidity
Money supply growth undampened China: Money and loan growth %, yoy %, yoy % % 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 -2 2 4 6 8 10 12 14 16 Euroland USA Japan United Kingdom 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 8 10 12 14 16 18 20 22 24 26 China: M1 (yoy chg) M2 (yoy chg) RMB loan growth (yoy chg) Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management High money supply growth in the last few years and the corresponding liquidity has contributed to excessive pricing in many asset classes Money and loan growth in China undampened by rate hikes Page 11

12 World economy: A historical turning point?
There is a shift in the share of local global economic performance China and India gaining significance in the wake of globalization However, both are still well off the heights of historic economic powers GDP from AD, shares by countries and regions in % 100% 80% 60% 40% 20% 0% 1 201 401 601 801 1001 1201 1401 1601 1801 2003 year China India Europe / North America Japan Rest of the world Sources: Bloomberg, Angus Madison “Historical Statistics for the World Economy: AD”, DB GMR Page 12

13 New investor pools gaining importance
New investors: Sharp rise of assets under management in the last six years Sources: McKinsey Global Institute, **Hedge Fund Research, Venture Economics, PE Analyst; International Financial Services, Deutsche Bank Private Asset Management *Growth rate calculated on data reported to IMF (USD 2.5trn excl. UAE and Qatar) USD trn 0.7 3.6 8.9 3.1 1.5 Petrodollar assets Asian central banks Hedge funds Private equity New investors total amount + 19%* + 20% + 19% 20% Petrodollar investments have grown most Assets under management for new investors are estimated at USD 15 to 20 trillion by 2012** Traditional Investors Pension Funds: USD 21.6trn*** Investment Funds: USD 19.3trn*** Insurance: USD 18.5trn*** ***Year end 2006 Page 13

14 Outlook 2008: World Economy and Asset Classes

15 Global Investment Committee Forecasts as of December 1, 2007
Page 15

16 Outlook as of December 2007 World economy Inflation & currencies
Monetary policy & bond markets Equity markets Alternative investments Slowdown in U.S. economic growth. Final quarter of 2007 and first half of 2008 should be below trend due to the effects of the housing recession. Clear shift in international growth: Higher growth contribution by emerging markets; potential rates of growth in the G3 countries converge. While food and energy prices remain volatile, and are impacted by strong world growth and supply disruptions, core inflation has eased and the disinflationary impact of globalization continues. U.S. dollar depreciation continues, but the majority of the depreciation will occur against emerging market and commodity currencies. Tightening in the developed economies has ended while tightening continues in the high-growth Asian and Latin American economies. The Federal Reserve began its easing cycle with a 50 bps cut in September, followed by a 25 bps cut in October. We are forecasting a 3.0% Fed funds rate by year-end 2008. We continue to favor emerging market debt, especially local currency-denominated markets. Investment grade and high yield corporate debt spreads have widened to rather attractive levels. While equities will remain volatile, we still find valuation levels attractive, especially in an environment of monetary easing. Equities should benefit from both positive profit growth and low interest rates. Diversification benefits of funds of hedge funds most pronounced in volatile markets. In commodities, we are most bullish towards grains complex and gold. Real estate continues to be an important asset class, but should be viewed in a global context. Page 16

17 Global growth: Remains solid, with good prospects
Global Economy: Growth rates around 4.5% set to continue into the next decade World economic growth (in % compared to last year) 5-year average Source: IMF, Deutsche Bank Private Asset Management Page 17

18 Emerging markets as drivers of the world economy
Labor force is growing, especially in Asia Emerging markets leading global productivity trend * Index, 1980 = 100 in %, yoy * Measured as real GDP divided by working-age population Source: IMF, Deutsche Bank Private Asset Management Source: IMF, Deutsche Bank Private Asset Management Labor force has increased fourfold worldwide over the past two decades Productivity rising strongly in emerging markets Global economy increasingly less dependent on U.S. than in the 1980s and 1990s Page 18

19 Reemergence of inflation...
China: Inflation driven by food prices Euroland: Towards 3% at year-end? Inflation rate, in % yoy Inflation rate, in % yoy 20 3.00 Forecast 15 2.50 10 2.00 5 1.50 -5 1.00 -10 0.50 -15 0.00 Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Apr 06 Aug 06 Dec 06 Apr 07 Aug 07 Dec 07 Apr 08 Aug 08 Dec 08 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 Total inflation rate Food Services Inflation rate Core rate Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management China: Inflation driven by food prices, supply reaction should relieve the strain on some goods in 2008 U.S. and Euroland: Sharp rise of inflation rates due to drastically higher oil prices Euroland inflation again close to 2% in the medium term, core inflation remains at roughly 2%: Economy slows down Strong trade-weighted euro revaluation No wage price spiral yet USA: Rising oil causes temporary inflationary push Inflation rate, in % yoy 0.00 1.00 2.00 3.00 4.00 5.00 Feb 06 Apr Jun Aug Oct Dec 07 Inflation rate Core rate (ex-energy & food) Forecast Sources: T.F. Datastream, Deutsche Bank Private Asset Management Page 19

20 …is only an interlude Strongly rising oil prices…
…and USD heading further downwards... 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 20 30 40 50 60 70 80 100 USD/Barrel (WTI) 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 70 100 110 120 130 140 150 1990=100, trade-weighted U.S. dollar index Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management U.S. inflation around 2% although oil prices have increased ninefold since 1998 and the USD has fallen by over 20% since 2002 Strong disinflationary forces: Globalization of the markets for goods, services, capital and labor Deregulations and political reforms IT revolution and quadrupling of the world’s effective labor force since 1990 …but U.S. core inflation under 3% since 1998 %, yoy 98 99 00 01 02 03 04 05 06 07 08 1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40 2.60 2.80 3.00 Sources: T.F. Datastream, Deutsche Bank Private Asset Management Page 20

21 Currencies: Interest rate differential turning, yen remaining volatile
Bond yields: The yield gap… …between euro and USD is turning Yields on 10Y government bonds, in % Yields on 2Y government bonds, in % 2006 2007 3.00 3.50 4.00 4.50 5.00 5.50 Euroland USA 2006 2007 2.50 3.00 3.50 4.00 4.50 5.00 5.50 Euroland USA Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management Yen continues to be dominated by carry trades Rate expectations support the euro Dollar remains weak, yen volatile, euro at record levels Index points YEN/USD 2006 2007 1200 1250 1300 1350 1400 1450 1500 1550 1600 105 110 115 120 125 130 YEN/USD (RS) S&P 500 Sources: T.F. Datastream, Deutsche Bank Private Asset Management Page 21

22 Monetary policy: Fed caught between inflation concerns and a slowing economy
Official rates: Global upwards trend over Further rate cuts expected in the U.S. ECB remains on hold for now but the probability of rate cuts in 2008 has risen In Japan, rates are normalizing very slowly: Key rates expected at 1% in 12 months in % in % 2001 2002 2003 2004 2005 2006 2007 2008 1 2 3 4 5 6 7 Euroland USA Japan UK Sources: T.F. Datastream, Deutsche Bank Private Asset Management 11/12/07 Page 22

23 Bonds continue to be relatively unattractive
10-year government bonds: spread narrows Yield spread widens: 10-year government bonds vs. 2-year government bonds in % in % in %-pts. in %-pts. 7.00 7.00 1.00 1.00 6.50 6.50 0.80 0.80 6.00 6.00 0.60 0.60 5.50 5.50 0.40 0.40 5.00 5.00 0.20 0.20 4.50 4.50 4.00 4.00 3.50 3.50 -0.20 -0.20 3.00 3.00 -0.40 -0.40 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2006 2007 Euroland USA Euroland USA Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management Bond yields should pick up again in the medium term as the global capital markets normalize (subprime crisis overcome) The trend towards steeper yield curves should continue, especially if the Fed continues with rate cuts Page 23

24 Equity markets: conflicting forces
Weaker U.S. growth Rising credit costs Profit growth has peaked Equity markets Liquidity Robust world economy, particularly in the emerging markets Fed rate cuts Page 24

25 Valuations in 2007 are significantly lower than in 2000
Sources: T.F. Datastream; T.F. I/B/E/S; Private Asset Management Investment region Index Price earnings ratio Nov. 23, 2007 Long term average* March 2000 U.S. S&P 500 13.9 15.0 25.8 Europe MSCI Europe 11.9 25.7 Germany DAX 11.8 15.5 30.8 Japan TOPIX 34.5 46.4 Emerging Markets MSCI Emerging Markets 14.0 16.4** 23.9 World MSCI World 13.4 16.2 27.2 * since 1980; ** since 1990 Valuations remain attractive compared to bonds Long and medium-term outlook for equity markets is constructive Page 25

26 U.S.: Price earnings expansion driven by rate cuts
Fed rate cuts cause valuation levels to rise In the past, there has been a significant correlation between short rates and valuation The Fed is at the start of a rate-cutting cycle Past experience is that rate cuts lead to rising P/E’s % PER 45 50 40 40 35 30 30 20 25 10 20 15 -10 10 5 -20 -30 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Fed rate (lhs) S&P500 trailing PE ratio (rhs) Falling Fed rate periods Sources: T.F. Datastream, Deutsche Bank Private Asset Management Page 26

27 Emerging markets: Some valuations very high - danger of a bubble?
Japan of the 1980s as a model? Rally of the BRIC*markets in 2007 TEXT aus HH-Präsentation HK End-of-month values (incl. last available value of November 2007) = 100, * RTS Russia, Hang Seng China Enterprise, Brazil Bovespa, India BSE30 1200 1200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 80 100 120 140 160 180 200 China Russia India Brazil 1000 1000 800 800 600 600 400 400 200 200 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 TOPIX in USD since 12/31/1979; rebased on 12/31/1999 = 100 Sensex since 12/31/1998; rebased on 12/31/1999 = 100 Chinese H-shares since 12/31/1999; rebased on 100 Sources: T.F. Datastream, Deutsche Bank Private Asset Management Sources: T.F. Datastream, Deutsche Bank Private Asset Management Performance of Chinese and Indian equities recalls the bubble in Japan in the 1980s BRIC story increasingly priced in Page 27

28 Hedge Funds: Good performance expected for 2007
Hedge funds: Strong performance continues Sources: Bloomberg, Edhec, $-performance, Deutsche Bank Private Asset Management 15.3% 15.5% 13.7% 5.2% 11.2% 11.8% 7.4% 7.5% 18.8% 5.9% 12.3% 13.1% 12.8% 9.3% 6.3% 4.1% 6.6% 12.4% 22.2% 10.6% 11.1% 7.9% 0% 5% 10% 15% 20% 25% Convertible Arbitrage CTA Global Distressed Securities Emerging Markets Equity Market Neutral Event Driven Fixed Income Arbitrage Global Macro Long/Short Equity Merger Arbitrage Funds of hedge funds Cash (1M USD Libor) $ 2006 Year-to-date (as of end of October) Hedge funds managed to close a difficult third quarter in positive territory Performance year-to-date remains on a competitive level Page 28

29 Commodities: Greatest potential in agricultural sector
Energy Energy Oil prices are expected to trade in a range around the current level. Crude oil price near-term forecast: USD 85 (12m horizon). Base Metals Base Metals Supply bottlenecks are overcome for most base metals. Industrial metals especially are sensitive to a downturn in world economic growth. Precious Metals Precious Metals Gold is likely to benefit from renewed USD weakness and falling U.S. real interest rates on a 12M horizon. Agriculture Agriculture Valuation of corn and wheat still low with further upside potential. Reasons: Increased demand for protein in Asia, rising ethanol production and further decline in inventories. Source: Deutsche Bank Global Markets Page 29

30 Investment Philosophy: Broad Asset Class Diversification

31 Broad asset class diversification benefited clients in 2007
Performance of international equities and bonds augmented by currency appreciation Returns in alternative asset classes, particularly commodities and funds of hedge funds Strong implementation vehicle performance in key asset classes Risk mitigation through uncorrelated asset classes Page 31

32 Our investment approach
We employ a modern portfolio theory approach to investing through: An optimal mix of asset classes driven by our quantitative analysis Broad asset class diversification Proprietary investment expertise for core asset classes Top quartile external managers We seek to broaden the diversification available to our clients by: Exploring and implementing new asset classes Utilizing Deutsche Bank’s Global Manager Research team to provide clients with open architecture solutions Broadening client exposure to alternative asset classes, where appropriate Page 32

33 A mixture of traditional and alternative assets can reduce risk and enhance performance
Traditional Assets U.S. equities International equities Emerging market equities U.S. bonds TIPS International bonds High yield bonds Cash Alternative Assets Hedge funds Private equity Liquid real estate Commodities Availability of alternative investments, such as hedge funds, is subject to regulatory requirements, and is available only for “Qualified Purchasers” as defined by the U.S. Investment Company Act of 1940 and ”Accredited Investors,” as defined in Regulation D of the 1933 Securities Act. Page 33

34 Benjamin A. Pace III Chief Investment Officer, PWM-U.S.
Benjamin Pace is a Managing Director and Chief Investment Officer of Deutsche Bank Private Wealth Management in the U.S. He sits on the PWM Global Investment Committee, providing input on the U.S. economy and capital markets. His primary responsibilities include chairing the U.S. Investment Committee which determines investment strategy and asset allocation for the U.S. discretionary portfolio management team. He also oversees the U.S. Equity Strategy, the Quantitative and Fixed Income groups along with the Performance Measurement team to ensure overall consistency with investment policy. Mr. Pace is a member of the PWM-U.S. Executive Committee. Mr. Pace has more than 20 years of experience in investment management. Prior to joining Deutsche Bank in 1994, he managed equity income funds for two investment organizations. During his tenure with those institutions, he also served as a security analyst with particular emphasis on the financial services and healthcare industries. Mr. Pace earned his B.A. in economics from Columbia University and M.B.A. in finance from New York University. He can be reached at (212) or ed at Page 34

35 Disclaimer All opinions and estimates, including forecast returns, reflect our judgment at the time of publication and are subject to change without notice. These opinions and analyses involve a number of assumptions that may not prove valid. The opinions are of the authors and do not necessarily reflect those of Deutsche Bank AG or any of its affiliates. Deutsche Bank makes no warranty or representation, express or implied, nor does it accept any liability with respect to the information and data set forth. The information in this document was obtained from sources we believe are reliable, but we do not guarantee its accuracy, completeness or fairness. All information should be verified and supplemented by professional advice before any action is taken. The sole purpose of this document is to inform, and it in no way constitutes a solicitation of orders to buy or sell securities or other instruments. This document contains forward-looking statements. Forward-looking statements are statements that are not historical facts; they include statements about our beliefs and expectations. Any statement in this document that states our intentions, beliefs, expectations or predictions (and the assumptions underlying them) is a forward-looking statement. These statements are based on plans, estimates and projections as they are currently available to the management of Deutsche Bank. Forward-looking statements therefore speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events. Hedge Funds: An investment in a hedge fund is speculative and involves a high degree of risk, and is suitable only for “Qualified Purchasers” as defined by the U.S. Investment Company act of 1940 and ”Accredited Investors,” as defined in Regulation D of the 1933 Securities Act. No assurance can be given that a hedge fund’s investment objective will be achieved, or that investors will receive a return of all or part of their investment. Investments in hedge funds are suitable only for persons who can afford to lose their entire investment. Prospective investors should carefully consider these risks before investing. Commodities: The risk of loss in trading commodities can be substantial. The price of commodities (e.g., raw industrial products such as gold, copper and aluminum) may be subject to substantial fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. Additionally, valuations of commodities may be susceptible to such adverse global economic, political or regulatory developments. Prospective investors must independently assess the appropriateness of an investment in commodities in light of their own financial condition and objectives. Not all affiliates or subsidiaries of Deutsche Bank Group offer commodities or commodities-related products and services. Please be aware that investments in international markets, including the foreign exchange markets, can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets or imposition of (or change in) exchange control or tax regulation. Investments denominated in an alternative currency will be subject to changes in exchange rates, which may have adverse effects on the value, price or income of the investment. Investments in structured products are speculative and include a high degree of risk. Structured products investing is suitable only for persons who can afford to lose their entire investment. Prospective investors should carefully consider these risks before investing. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of Deutsche Bank. These products are subject to investment risk, including possible loss of principal. Past performance of a product or service does not guarantee or predict future performance. Distribution hereof does not constitute financial, legal, tax, accounting or other professional advice. It is also not intended to offer penalty protection or to promote, market or recommend any transaction or matter addressed herein. Recipients should consult their applicable professional advisors prior to acting on the information set forth herein. All trademarks and service marks on this statement belong to Deutsche Bank AG or its affiliates, except third-party trademarks or service marks, which are the property of their respective owners. “Deutsche Bank” means Deutsche Bank AG and its affiliated companies, including Deutsche Bank Trust Company Americas, as the context requires. Deutsche Bank Private Wealth Management refers to Deutsche Bank’s wealth management activities for high-net-worth clients around the world. Page 35

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