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Global Investor 1.
14, August 2014

Expert know-how for Credit Suisse investment clients
Europe
From crisis to opportunity
Oliver Adler Charting a sustainable path to European reform and recovery.

Lorenzo Bini Smaghi/GUUCIGVQVJGPCPEKCNOCTMGVU$GYCTGQH
animal spirits. Harold James How to ensure truly effective capital markets
across borders? Think boldly. Joe Prendergast6JGGWTQVCNMUDCEM
The milk is in the coffee and cannot now be practically separated.
Important disclosures are found in the Disclosure appendix.

Credit Suisse does and seeks to do business with companies covered in its research
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03
Photos: Martin Stollenwerk, Chou Chiang
GLOBAL INVESTOR 1.14
Responsible for coordinating the focus

themes in this issue:
Nilanjan Das, CFA , is Research Editor
of Global Investor and Head of Global
Research KPO. He leads a crossasset research team covering global
equities, bonds, currencies, economic
and thematic research. He joined
Credit Suisse in 2009, bringing 15 years
of research and banking experience,
including positions at J. P. Morgan Global
Research and ICICI Bank. He is a
postgraduate from the Indian Institute
of Management Bangalore.
Dan Scott is a research analyst with over
ten years of capital market experience.
Dan is in charge of key Investment
Strategy & Research initiatives including
the Credit Suisse Top Investment Ideas,
Dividend Strategies, the Top 30
(a managed portfolio that reflects Credit
Suisses equity strategy), the M&A15
(a list of equities set to benefit from
M&A activity), and is the metals and
mining sector specialist.
The Eurozone economy has now emerged from the recession that
followed the 2012 crisis. The pace of growth is still slow, but prospects
for future acceleration are underpinned by ongoing monetary easing
by the European Central Bank, a winding-down of earlier fiscal austerity and the gradual realization of gains from structural reforms that
are transforming the labor cost competitiveness of Spain and other
countries. Though recent European elections showed some dissatisfaction with the Eurozone, the results do not fundamentally call the
project into question. Given its size, we expect a gradually strengthening Europe to play a crucial role in the global economic recovery.
In this issue of Global Investor, we explore the impact of Europes
improving macroeconomic outlook sector by sector. Broadly speaking,
in equities we anticipate an acceleration in earnings growth through
the end of the year. The automotive sector is a good example. We
examine why it is that German car companies are outperforming their
French counterparts. The pharmaceutical and technology sectors
represent another area of European strength, with leaders ranging
from business software to semiconductors. In telecoms, the EU s
single market initiative promises to promote investment in future
technologies through consolidation. Residential real estate prices in
Spain show some signs of bottoming, but have not yet turned decisively; the French market remains weak, while Germanys is strong.
Energy is a particularly hot topic for Europe, as higher prices have
the potential to derail the recovery. Finally, disruptive innovation
brought about by financial technology start-ups is shaking up traditional banking. How can banks compete in this brave new world ?
The issue begins with an overview of the state of the European
project and the reforms needed to sustain it. In a separate, witty chat
with the euro, our Head of Financial Markets Analysis discusses the
currencys origins and how likely it is to weather further crises. An
interview with Lorenzo Bini Smaghi, former member of the Governing
Board of the European Central Bank, sheds further light on the challenges to full European integration. Finally, Harold James, a noted
financial historian based at Princeton, puts the case for an effective
fiscal apparatus for Europe, as well as possible pathways to growth.
Giles Keating, Head of Research and Deputy Global CIO
04
Reform agenda
Toward a less imperfect

monetary union
The Eurozone lacked robust institutions to deal with the fallout from the Greek debt default and the
financial contagion that followed. In response to the crisis, the establishment of such institutions
has begun in earnest. However, the reform and economic recovery process of some of the member
states is far from complete.
TEXT OLIVER ADLER

Head of Economic Research
2014
ong before concrete plans for European Economic and
Monetary Union (EMU) were developed in the mid-1990 s, the
concept of a single currency had been perceived by many
as a means to boost not just economic, but above all political
convergence in Europe. Indeed, it proved easier to reach agreement
on the high-level principle of a common currency than on the nittygritty measures and reforms that would ultimately be needed to make
it work such as the integration and coordination of banking regulation and common fiscal policy. Consequently, the euro was launched
in 2002 without most of this crucial institutional structure. Some saw
this as a potentially fatal omission, while others viewed it as a gap
that could not have been filled beforehand, but which participants
would be able to tackle later to keep the euro together.
In the first years of its existence, the serious design flaws of the
monetary union were well disguised: Germany had entered the union
with an overvalued exchange rate, and the periphery generally with
undervalued exchange rates. While Germany struggled to regain competitiveness, the periphery economies were boosted. The economic
upswing in the south, combined with their seemingly cheap assets,
attracted enormous capital inflows not just from Germany, but from
other surplus countries and regions as well.
Credit expansion further boosted economic growth in the periphEU
Countries with euro
EEA
ery, but also drove up wages and prices, and generated asset bubbles
of varying dimensions the Spanish and Irish housing boom being the effectively a major step toward a political union. Contrary to the
most dramatic. By the time the global financial crisis hit, the periphery predictions of many skeptics, the institutions of EMU have been
had become uncompetitive as well as over-levered, and thus highly strengthened rather than weakened by the crisis.
vulnerable to economic or financial shocks. The event that triggered
As we show on the following pages, however, progress in indithe EMU crisis was the insolvency of the Greek government in early vidual member states is far more patchy. Some countries, such as
2010. It not only proved to investors that the rules for enforcing fiscal Spain, have made considerable strides in reforming their labor markets
discipline (the infamous Maastricht criteria) had failed, but also re- and their fiscal institutions. Others, notably Italy, and also France,
vealed the severe lack of stabilizing institutions in EMU.
have a much longer way to go. Meanwhile, a still partly dysfunctional
The history of the EMU crisis depicted on pages 6 to 7 is thus one and far from integrated Eurozone banking system and capital market
of a prolonged struggle between member states over how to construct remains a hindrance to a vigorous and synchronous economic recovery.
the missing institutions, what powers to give them and how to fund That said, the ascendance of the common central bank and financial
them. This process was uneven, but the outcome, in our view, is a regulator should continue to drive this integration process, while also
more complete though still imperfect monetary union and thus KORQUKPIHKPCPEKCNFKUEKRNKPGQPVJGOGODGTUQHVJGWPKQP
05
SPAIN
GERMANY
EUROZONE
FRANCE
ITALY
GREECE
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THE CRISIS
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The crisis in the Eurozone is often regarded as

primarily resulting from imbalances in the member
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is only part of the story. In fact, most governments,
with the exception of Greece, were running
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government, in particular, generated a surplus in
2007
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of EMU countries was no worse than that of other
advanced economies, such as the UK , not to menVKQP,CRCPUECNCEEQWPVUQPN[TGCNN[FGVGTKQTCVGF
in the wake of the crisis itself. The true story of the
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10
12
Source: EU Commission, Datastream, Credit Suisse
40
300
200
100
0
100
200
300
Source: Datastream, Credit Suisse
1999
2001
Spain
2003
2005
2007
2QTVWICN +VCN[ Greece
With devaluation and currency risk apparently

removed due to the creation of the single
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accelerated sharply from the mid- 2000 s on
UGG(KIWTG Accelerating import growth

needed to be funded internationally. Given
higher yields on government bonds and other
investments, attracting the funds was quite
easy. Low global interest rates, promulgated
by the Federal Reserves easy monetary
stance, added to the attractiveness of this
trade, while savings surpluses in Germany
and emerging markets were seeking an
outlet and better returns.
6JGQQFQHECRKVCNUQWVJYCTFTGCEJGF
its peak in 2008 . As the global recession hit
and the general deleveraging process set in,
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contraction only started about a year after the
120
160
200
Real estate bubbles,

busts and stabilization
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KP'74DP
France
80
)GPGTCNIQXGTPOGPVITQUUFGDVKPQH)&2
Current account balances of selected Eurozone members
1997
2011
but rather a balance of payments crisis
Germany
2014
Debt less than

60% of GDP
and budget
FGEKV below
% of GDP
0QVRTKOCTKN[CUECNETKUKUe
2007
2009
2011
2013
Eurozone
Greek blowup. Private funds dried up as fears

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via the central banks Target2 system made
up for some of the remaining shortfall. In
addition, demand for external capital dropped
sharply in response to the crisis and recession itself.
In the meantime, the periphery has
started to generate surpluses, i.e. it has begun to export capital. This is, in part, due
to the improved competitiveness and trade
surpluses, but also results from ongoing
private sector deleveraging in the periphery.
Unless domestic demand picks up much
more decisively, the Eurozone as a whole will
continue to generate surpluses and export
capital to the rest of the world, and contribute
to what former Fed Chairman Ben Bernanke
has called the global savings glut.
Economic boom, falling interest rates, easy lending

U VCPFCTFURQUUKDN[EQWRNGFYKVJCNNVQQEQ\[TGNCVKQPUJKRU
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estate bubbles within the Eurozone. Not all countries were
affected similarly. Neither the German nor the French
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Spain, Ireland or the Netherlands. Tougher regulators
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U VCDKNK\CVKQPVQUGVKPCUVJGGEQPQO[RKEMUWRCPFOQTV
gage rates decline. The latest data also show a slight
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90
80
70
60
50
40
30
Source: Bloomberg, Datastream, Credit Suisse
10
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50
45
Mario Draghi, 26 July 2012
9G
will do
what is
needed
40
Ten[GCTIQXGTPOGPVDQPF[KGNFUKP
5
10 May 2010
EUPCPEGOKPKUVGTU
agree on a temporary
EUR 500 bn facility
VQRTGUGTXGPCPEKCN
stability, the European
Financial Stability
Facility (EFSF), and
on the creation of
a permanent successor
to it, the European
Stability Mechanism
(ESM). The IMF commits
another EUR 250 bn.
The ECB unveils its
Securities Markets
Programme (SMP).
0
25
6 April 2011
Portugal asks for
an EU bailout.
20
&GEGODGT
Fitch downgrades
Greece from
A to BBB +.
5GRVGODGT
Lehman Brothers
NGUHQTDCPMTWRVE[
0QXGODGT
Ireland is bailed out by
the EU and IMF.
15
10
GREECE
ITALY
PORTUGAL
SPAIN
19 October 2009
The newly elected
Greek government announces a budget
shortfall of 12.7%
of GDP, more than
twice what was
initially expected.
Source: Bloomberg, Credit Suisse
SEP 0
JAN 09
JAN 10
JAN 11
9 March 2012
Greece reaches
an agreement with
investors to restructure
EUR 200 bn of
its debt.
&GEGODGT
The ECB launches
KVUNQPIVGTOTGPCPEing operation (LTRO),
providing unlimited
credit to banks.
07
Jos Manuel Barroso, 7 January 201
9 June 2012
Spain requests support
from the EU to support
its banking sector.
26 July 2012
ECB President Mario
Draghi pledges to
do whatever it takes
to save the euro
currency.
+VJKPMYG
can say that the
GZKUVGPVKCN
threat against
the euro has
essentially been
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1EVQDGT
The European Stability
Mechanism (ESM),
situated in Luxembourg,
is formally launched.
19 September 2011
S&P downgrades
Italys debt from
A+ to A .
JAN 12
,CPWCT[
Jos Manuel Barroso
declares the euro
crisis is over.
,#0
5GRVGODGT
The European
Parliament approves
the Single Supervisory
Mechanism (SSM)
for banks.
7 February 2014
The German
Constitutional Court
expresses reservations on the ECBs
bond-buying
program OMT but
delegates judgment
to the European
Court of Justice.
5 June 2014
The ECB
launches socalled targeted
long-term
TGPCPEKPI
operations
( TLTROs) to
boost bank
lending to small
and mediumsized companies.
JAN 14
Photos: AFP/Getty Images, Getty Images, NY Daily News/Getty Images, Bloomberg/Getty Images
,WPG
Latvia joins
the Eurozone.

ADJUSTMENT REFORM AND RECOVERY

.QUUQHEQORGVKVKXGPGUUGZCEGTDCVGFVJGFQYPVWTP
As noted above, the competitiveness of the periphery countries had
FGVGTKQTCVGFUWDUVCPVKCNN[QXGTVJGTUV[GCTUQHVJGEQOOQPEWTTGPcys existence. Labor costs had shot up substantially, and productivity growth had not kept up with costs. As a result, unit labor costs
among the EMU countries drifted apart: between 2000 and 2008 ,
French, Italian and Spanish unit labor costs had risen relative to
Germanys by 20%, 30% and 35%, respectively. The consequence
was that these economies were affected far more severely by the
global downturn in 2008 09GXGPVJQWIJVJGPCPEKCNUVTGUUGU
within the Eurozone had not yet really erupted. When they did after
2010CPFUECNCWUVGTKV[OGCUWTGUYGTGCFFGFVJGFKXGTIGPEG
was accentuated. Between the trough in the global economy in mid2009 and mid- 2013 , the gap in overall production levels between,
for example, Spain and Germany had widened by a stunning 35%
UGG(KIWTG. In the less cyclical (but far larger) services sectors,

the divergence was less pronounced and therefore the divergence
in per capita income between the north and south over the course of
the crisis was not quite as dramatic. Yet, the massive gap in industrial production which opened over these years is one measure of
the fact that the economic dominance of Germany within EMU has
been enormously accentuated by the crisis. Even though most

countries have seen more or less clear signs of economic recovery
since mid- 2013 , this gap will take years to close, if at all.
Industrial production
+PFGZ/OQXKPICXGTCIG

120
110
100
90
80
70
2005
2006
Germany France
Eurozone
2007
2008
Italy
2009
Spain
2010
Greece
2011
2012
Portugal
2013
2014
Netherlands
$CPMKPIWPKQP#MG[DWVJGUKVCPVUVGRHQTYCTF
2TKQTVQVJGPCPEKCNCPF'WTQ\QPGETKUKUUWD
UVCPVKXGECRKVCNQYUCETQUUVJGEMU countries
ICXGVJGKORTGUUKQPQHCHWNN[KPVGITCVGFPCP
EKCNOCTMGVGXGPVJQWIJDCPMKPIU[UVGOU
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NKPPCVWTG#UPQVGFCDQXGVJG
crisis led to a disruption and fragmentation of
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KORQTVCPVTGHQTOOGCUWTGCVVJGQXGTCNN'WTQ
\QPGNGXGNVQUVCDKNK\GCPFTGKPVGITCVGVJGPCP
EKCNU [UVGOKUVJGETGCVKQPQHCDCPMKPIWPKQP
Common standards and regulation, common
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JGNRGPUWTGVJCVTGPGYGFGEQPQOKEUJQEMU
would not lead to renewed fragmentation.
Agreement in principle to push ahead with
CDCPMKPIWPKQPYCUCEJKGXGFCVVJGGPFQH
DWVVJGRTQEGUUQHDWKNFKPIVJGWPKQP
YKNNDGCXGT[ITCFWCNQPG5QHCTVJGWPKQPKP
XQNXGUQPN[VYQGNGOGPVUC5KPING5WRGTXKUQT[
/GEJCPKUO
SSM HQTNCTIGDCPMU
VJGECB
CPFCUQECNNGF5KPING4GUQNWVKQP/GEJCPKUO
SRM RQNKVKECNNGCFGTUJCXGPQVDGGPCDNG
VQOWUVGTUWRRQTVHQTVJGETGCVKQPQHCLQKPV
deposit insurance scheme that would pool
HWPFUCETQUUVJG'WTQ\QPGVQGPUWTGVJCVDCPM
runs do not occur. The SSM is to control and
enforce adherence to rules, regulations and
PCPEKCNUVCPFCTFUYJKNGVJGSRM is to ensure
VJCVDCPMUYJKEJCTGWPCDNGVQUVCPFQPVJGKT
own feet are wound down in a timely way and
YKVJQWVIGPGTCVKPIPCPEKCNKPUVCDKNKV[6JCV
said, the SRMKUTGNCVKXGN[YGCMDQVJKPVGTOU
The ECBs new building in Frankfurt is currently under construction.
QHRTQEGUUGUsCOWNVKVWFGQHPCVKQPCNCPF
UWRTCPCVKQPCNKPUVKVWVKQPUPGGFVQIKXGVJGKT
CRRTQXCNHQTCYKPFFQYPsCPFGXGPYGCMGT
KPVGTOUQHPCPEKCNRQYGT9JKNGKVYKNNJCXG
EUR 50 billion at its disposal for the recapital
K\CVKQPQHDCPMUVJGUGHWPFUYKNNPGGFVQDG
EQPVTKDWVGFQXGTCPGZVGPFGFRGTKQFQHVKOGD[
DCPMU
VJG'WTQRGCP5VCDKNKV[/GEJCPKUO
ESM EQWNFKPRTKPEKRNGHWPFDCPMTGECRKVCNK\C
VKQPKPVJGOGCPVKOGDWVVJKUYQWNFDGUWDLGEV
VQCITGGOGPVD['WTQ\QPGNGCFGTU+PGHHGEV
pPQTVJGTPqIQXGTPOGPVUKPUKUVGFVJCVPCVKQPCN
IQXGTPOGPVUYKNNEQPVKPWGVQDGTGSWKTGFVQ
RTQXKFGECRKVCNCJGCFQHVJGSRM . It was also
CITGGFKPRTKPEKRNGVJCVRTKXCVGETGFKVQTUYQWNF
PGGFVQVCMGVJGpTUVJKVqKPCDCPMTGECRKVCN
K\CVKQP9JKNGVJKUKUTGCUQPCDNGKPQTFGTVQNKOKV
moral hazard, it could lead to further delays
KPpENGCPKPIWRqDCPMU6JKUEQWNFTGUWNVKPVJG
EQPVKPWGFUWTXKXCNQHp\QODKGqDCPMUYJKEJ
JQNFDCEMVJGGHECE[CPFRTQVCDKNKV[QHVJG
UGEVQTCUCYJQNG0GXGTVJGNGUUVJGETGCVKQP
QHVJGDCPMKPIWPKQPKUCMG[UVGRHQTYCTF
for EMUGURGEKCNN[KHVJGWREQOKPIDCPM
UVTGUUVGUVUIGPGTCVGUWHEKGPVRTGUUWTGVQ
accelerate the cleanup. In the long run,
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'WTQ\QPGPCPEKCNOCTMGVYJKEJYQWNF
JGNRTGXKXGETQUUDQTFGTPCPEKCNQYUCPF
economic growth.
09
CONCLUSIONS
5KIPKECPVTGHQTOUNCWPEJGF in response to crisis
The Eurozone crisis has clearly triggered a series of reform efforts in
many countries. For one, the countries
that were rescued by the Troika (European Union, International Monetary
Fund and ECB ) had to submit to significant reform programs in the context
of the bailout agreements. In other
countries, notably Italy, market pressures and the associated fear of being
subjected to such a formal program

led governments to adopt some
reforms. Finally, the slump in the
economy as well as weak poll results
have added to reform pressure in
countries such as France. In the end,
the proof of the pudding as regards
the reach and effectiveness of reforms will be economic performance.
To assess where countries stand on
reforms, we have devised a reform

heat map
UGG(KIWTG It compares
indicators devised by the OECD and
the World Bank which measure the
overall ease of doing business as well
as the restrictiveness of both labor
and product market regulation. Additionally, we included a direct and
KPFKTGEVOGCUWTGQHUECNEQPUQNKFCtion, i. e. the underlying primary
Reform map
Ease of
doing business
2TQFWEVOCTMGV
regulation
Employment
protection
Minimum wage
balance and the retirement age.

What is apparent from the picture is
that none of the peripheral economies
has gone as far with reform efforts
and market liberalization as, say,
Margaret Thatcher did in the UK or
Estonia implemented after its
post- 2008 crisis.
)GPGTCNIQXGTP
ment underlying
primary balances
#XGTCIG
retirement age
Greece
Ireland
Portugal
Spain
Italy
Estonia
Czech Republic
Hungary
Poland
France
Germany
United Kingdom
5QWTEG1'%&9QTNF$CPM%TGFKV5WKUUG
Reforms
complete/
CFXCPEGF

Reforms
initiated/
Reforms
under way
NCEMKPI
Photos: Helmut Vogler/Fotolia, petra b./Fotolia
9KVJXGT[NKOKVGFUECNWPKQPVJGECB will remain the central anchor of stability

The SRM and the ESM are the two new
Eurozone -wide financial organizations that
have the mandate to prevent or rapidly
resolve financial crises like the one we have
witnessed over the past years (in contrast,
the European Bank for Reconstruction and
Development and the European Investment
Bank have the function to foster long-term
investment in Europe). The ESM and SRM
can thus be thought of as a form of fiscal
stabilizer. However, in contrast to how such
stabilizers function within national borders,
they do not fulfill their role automatically.
Taxes, be they assessed on income or

expenditures, act to stabilize the business
cycle as taxes charged are reduced when
incomes decline in a downturn, and vice
versa. The same goes for fiscal stabilizers
on the expenditure side, such as unemployment insurance. Eurozone -wide tax or
expenditure schemes would act to reduce
the divergence of business cycles within
the zone as a whole, which would, for
example, arise as a result of countryspecific economic disturbances. However,
such common schemes would of course
also imply substantial transfers between

member states. It seems quite unlikely
for the foreseeable future that solidarity
among EMU countries will develop sufficiently to allow for the introduction of
such schemes. This, in turn, implies that
the ECB will need to continue playing the
dominant role in maintaining stability
within the Eurozone. That said, opposition
to tools such as the so-called Outright
Monetary Transactions program of the
ECB will likely restrain the ECB in its
actions to some extent.
10
How much growth ahead?
)TQYVJQHDCPMNQCPUVQPQPPCPEKCNEQTRQTCVKQPU
% YoY
40
30
20
10
0
10
20
30
2006
Germany
2007
2008
2009
2010
France
Italy
Spain
2011
Eurozone
2012
2013
2014
Pronouncing the verdict on the European Stability Mechanism, 2014 .
refinancing operations, i.e. preferential loans to banks to boost their

lending to private sector companies), will aid the recovery. A more
forceful policy stance by the ECB that pushes down interest rates
along the entire yield curve may still be needed.
Second, demographics suggest that the outlook for growth is
rather subdued over the longer term. While projections for population
growth are less dire than in Japan, not least because of still strong
immigration in Europe, demographics will not be a growth driver.
Third, as noted, productivity and employment-enhancing reform efforts
remain patchy in many Eurozone economies. Finally, high government
debt combined with high household debt in some countries (such as
Spain) implies that both the government and private citizens will need
to maintain high savings rates for a prolonged period of time. High
savings would, of course, provide an ever greater pool of investable
funds. So, the ultimate question is whether entrepreneurial spirit
returns to Europe in a meaningful way. Clearly, greater stability in the
monetary union is a prerequisite for higher investment spending, but
it remains to be seen to what extent private investors will pick up the
baton. Given the weakness of both private and especially public sector investment since the start of the crisis, significant and profitable
investment opportunities would certainly appear to exist. In the following sections, our research analysts provide bottom-up insights
KPVQYJGTGUWEJITQYVJQRRQTVWPKVKGUOC[DGHQWPF
EUROPE
FROM CRISIS TO OPPORTUNITY
Photo: Kai Pfaffenbach/Reuters
The economic outlook for the Eurozone has clearly improved since
mid- 2013 , and we expect the economic recovery to gradually strengthen over the coming years, absent major external shocks. That said,
the outlook for both medium- and longer-term growth remains somewhat subdued. Over the medium term, a still very weak banking system is likely to hold back the upturn. With banks still tending to reduce
exposure, and regulators pushing them to raise capital, lending to
the all-important small and medium-sized enterprise ( SME ) sector is
likely to pick up quite slowly. Loan growth was still negative at the
start of 2014 in countries such as Italy and Spain
UGG(KIWTG This may
in part be due to weak demand, and also a result of capital market
finance replacing bank loans. At the same time, interest rates charged
on SME loans are declining only very slowly in the periphery. It remains
to be seen to what extent the measures announced by the ECB in
May, in particular the launch of so-called TLTRO s (targeted long-term
11
Contents
Global Investor 1.14
12
Doing what it takes
Europe has strengthened after every crisis.

Lorenzo Bini Smaghi talks reform, fiscal
discipline and his guarded optimism.
15
Room to rise
The gradual macroeconomic recovery

should give European equities further
upward potential, says Michael Ghler.
18
Banking today
The banking sector was hit hard by the

PCPEKCNETKUKU0QYUC[UChristine Schmid,
theres a paradigm shift to contend with.
22
German cars in top gear
Audi, BMW and Mercedes-Benz are on a

roll. But, as Reto Hess explains, French
automakers dont have the same cachet.
24
Boom, bust, recovery
Dominik Garcia and Philip Kaufmann

point out that European real estate
markets may be on the rise.
26
A culture of innovation
According to Thomas C. Kaufmann and

Ulrich Kaiser, Europe scores well when it
comes to investing in its future be it
through venture capital, R&D or education.
30
Airports gates to the world
Airport usage is set to take off in Europe

over the next 15 years. Reto Hess, Romano
Monsch and Stefanie Kluge look at wholl
likely benefit, and who might not.
36
Corporates to loosen
their purse strings
Economic trends are improving.
Michael Weber reports that companies
seem ready to pursue growth.
40
Money talks
The euro seldom gives interviews.

Joe Prendergast chats with the single
currency about its past, present and future.
42
Has Spanish competitiveness

become more German?
Spain is taking the bull by the horns.

Bjrn Eberhardt and Javier J. Lodeiro
highlight how labor reforms are working.
44
Spains new businesses:

Small, but fierce
Spanish SME s are flourishing as the

economic recovery progresses. Avelina
Fras looks at two success stories.
52
The scope of energy security

in Europe
Europes heavy energy dependence gives
some cause for concern. Markus Stierli
explores the continents various options.
56
European telecom sector ready

to deploy cash
Some 70 telecoms service 28 countries in

Europe. Uwe Neumann reports on the
move from fragmentation to consolidation.
59
Ratings and risks
Crisis and convergence
What exactly is an asset worth? Antonios

Koutsoukis and James Gavin explain
how its done, and why its no easy task.
As the worst of the euro crisis begins

to wane, Harold James examines the
need for a coherent European response.
Disclaimer > Page 65
32
12
Photo: Hollandse Hoogte/laif
Reform agenda
Doing what
it takes
13
Europe has strengthened after every crisis and become

more competitive, observes Lorenzo Bini Smaghi. Moreover,
the incentive to move forward is high. But many challenges
lie along the path to full integration. Their solution is complicated by complacency resulting from the improved economic
situation and reform fatigue, both at the level of the euro
area and within the member states.
INTERVIEW BY OLIVER ADLER
Lorenzo Bini Smaghi

takes stock of the
current state of affairs
relating to the Economic and Monetary
Union (EMU), economic reform and
fiscal discipline,
and shares his insights
on reviving growth
with in the Eurozone.
Oliver Adler: Six years on from the

collapse of Lehman Brothers, almost two
years from Mr. Draghis We will do what
is needed, and with periphery bond
yields back to precrisis levels, how do you
assess the chances for continuing sta bilization, or conversely, the risks of a
resurgence of the financial crisis within
the monetary union ?
Lorenzo Bini Smaghi: Financial markets
are always ahead, but this time they may
have moved from being overly pessimistic
about the ability of the euro area to overcome the crisis to now being overly optimistic. Some imbalances have been corrected,
but not all. Growth is still sluggish in the
periphery, and public debt has not yet started to fall relative to GDP. Several countries
have yet to implement structural reforms
to strengthen their growth potential and
improve competitiveness. In addition, there
are several sources of external fragility,
particularly in emerging markets, and a
resurgence of financial tensions cannot be
excluded. There is still a long way to go
before we can safely say that we are out
of the crisis.
What is the outlook for political cooperation
and ongoing reform within the European
Union, especially in view of the outcome of
the European elections?
Lorenzo Bini Smaghi: There is a risk of
complacency insofar as the improved
financial environment relieves the pressure
on politicians. There is reform fatigue with
respect to the completion of the institutional framework of the euro area and economic reforms in the member states. I dont
think that some euro skeptics being elected
in the new European Parliament is necessarily negative, to the extent that it should
urge the pro-European parties to get
their act together and push more forcefully

toward greater integration. The first battle
for Parliament will be the choice of the next
European Commission president.
What is the state of institutional reforms
at the EMU level ? What are the main reform
achievements? What more is needed ?
Lorenzo Bini Smaghi: The impact of
banking union, in particular the single
supervisor, is in my view a key change
not just economically, but especially in
political terms. It will drastically change
the financial environment in the euro
area. However, more needs to be done to
ensure that there is a credible backstop
in case of systemic crisis. We also need
to strengthen the safety net for countries
undergoing macroeconomic adjustment
be cause such adjustment takes time, with
high unemployment in several countries.
The pro-cyclical component of macro
policies must be reduced if adjustment is
to succeed.
Do you worry about the comingling
of monetary policy and regulatory powers
within the European Central Bank ?
Lorenzo Bini Smaghi: I do not. The
separation between supervisory powers
and monetary policy has, in fact, been
a handicap during the crisis, because the
ECB could not assess independently
whether the banking system was sound
in the various countries. If the central
bank is independent, there is no risk that
monetary policy will be polluted by the
exercise of supervisory powers by the
same institution.
Is fiscal union critical to achieving a stable
monetary union?
Lorenzo Bini Smaghi: I am not convinced
that we need a fully fledged fiscal union
like in the USA , but we certainly need
>
14
a strong safety net in case of asymmetric

shocks. I mentioned earlier that countries
must continue implementing reforms,
for instance in the labor market, which will
inevitably take time before they produce
their effects. This adjustment should be
reinforced through some form of transfers,
but only on the condition that the adjustment takes place.
Will the fiscal stability and growth pact
remain key elements of the EMU? Can
these rules be enforced absent a deeper
political union?
Lorenzo Bini Smaghi: Political union is
the result of the implementation of common
rules, with exceptions and interpretations.
This was the case in 2003 , for instance,
when more leeway was given to Germany
and France. It was a political decision.
Also, the recent decision to give more
leeway to France and Spain was a political
decision. The decision-making process
might not be effective and democratic,
as the European Parliament is not involved,
for instance, but the decision itself is
highly political because it impacts the fiscal
policy of the member states.
What is the state of economic reform in
the various member countries of the EMU?
Which elements of reform are key to a revival
of growth? Is the German model the one
that needs to be applied across the EMU?
Lorenzo Bini Smaghi: Some countries
have implemented important reforms, while
others are just starting. I dont think that
we all need to be Germans. But for sure we
have to avoid the accumulation of excess
private and public debt, which ultimately
means that remunerations must grow in line
with productivity. These constraints must
be entrenched in the functioning of the
economic and social system, which is the
case in countries like Germany, but not
yet in other countries.
In particular, how do you assess the outlook
for your home country Italy ?
Lorenzo Bini Smaghi: Italy has started
to implement reforms of the institutional
system, in particular the electoral law
and the bicameral parliamentary system,
which are very inefficient. Its a good
starting point. But other reforms need to
follow, affecting the labor market, bureaucracy, the judicial system, education,
taxation. Its a long agenda.
You seem to favor a policy of quantitative
easing by the ECB to combat the risk of
deflation. What form should it take? How
I am not
convinced that
we need a
HWNN[GFIGF
UECNWPKQP
like in the
USADWVYG
certainly need
a strong
safety net in
case of
asymmetric
shocks.
LORENZO BINI SMAGHI
LORENZO BINI SMAGHI

.QTGP\Q$KPK5OCIJKKU%JCKTOCPQH5PCO
CP+VCNKCPNKUVGFEQORCP[CPF8KUKVKPI5EJQNCT
at Harvard Universitys Weatherhead Center
for International Affairs. He has a PhD in
Economics from the University of Chicago.
(TQO,WPGVQ0QXGODGTJGYCU
COGODGTQHVJG) QXGTPKPI$QCTFQHVJG
European Central Bank.
would you respond to critics who argue that

this would further undermine the no-bailout
principle and generate moral hazard by
weakening the need for fiscal discipline?
Lorenzo Bini Smaghi: There is now no
room left for interest rate cuts, while longterm refinancing operations have been
stretched to four years and targeted to
financing SME s (small and medium-sized
enterprises). The next step will have
to be asset purchases, either private but
there may not be enough of these assets
or government bonds, which is QE.
The ECB and others are suggesting that
a key to reviving growth in the Eurozone is
to create an integrated capital market.
Lorenzo Bini Smaghi: I fully agree,
but its not easy. Revitalizing a market is
complex. We need public institutions that
can act as brokers, or a group of private
institutions willing to create an initial
mass of trans actions that can generate
the incentive to further integrate markets.
Regulation is also needed to encourage
investment diversification, especially in
stocks (rather than in bonds).
Where do you see Europe, and in particular
the EMU, ten years from now ?
Lorenzo Bini Smaghi: Europe has
strengthened after each crisis, and become
more competitive. I tend to be more optimistic over the medium term than the very
short term, where I see reform fatigue.
The more Europe integrates, the greater
is the cost of disintegrating it, and thus
the higher the incentive to move forward.
It will take time, but, after all, it took
the USA over a century to create its own
fed eral central bank.
What role will, and can, the euro play
as a global reserve currency ?
Lorenzo Bini Smaghi: The euro is
already a reserve currency, and we can see
the effects in the recent portfolio rebalancing at the global level. This is a burden over
the short term because it keeps the value
of the euro higher.
Will a two-speed Europe persist ? And
can it endure? In particular, how do you see
the relationship between the EMU and
Britain evolving?
Lorenzo Bini Smaghi: It is increasingly
difficult to be outside the euro but in the
EU. The euro is the core of further integration, as we have seen with the banking
union and the fiscal compact. The position
of the in-betweens is getting weaker and
YGCMGTQXGTVKOG
15
Room
to rise
Earnings in Europe
160
140
European equities have further upside potential. A major driver

for the coming quarters will be earnings growth as European
companies benefit from the gradual macroeconomic recovery.
Index (1 January 2007 = 100 )
120
100
80
60
40
MSCI USA total return

MSCI Europe total return
2007
2008
2009
2010
2011
2012
2013
2014
01_Total return MSCI Europe vs. MSCI USA , in local currency

This chart highlights the underperformance of the MSCI Europe versus the MSCI USA during the sovereign debt crisis. While both indices were
able to regain part of their lost valuation between 2009 and mid- 2011, the European began to underperform their US peers thereafter. Since 2012 ,
European equities have started to perform well again, but still have room to recover further. Source: Datastream, Credit Suisse / IDC
16
e believe that the macroeconomic contraction in the Eurozone has bottomed out and
should see further stabilization
over the next few quarters. Headwinds from
austerity measures are easing, while the long
period of low capital spending should allow
for investments to catch up. Macroeconomic
data in the Eurozone already reveals that consumer sentiment and investment spending
have improved. Also, the recent easing actions
by the European Central Bank (ECB) signal
a dovish stance and will diminish funding
costs for banks, while reducing further appreciation pressure on the euro.
02_The phases of a valuation cycle

A valuation cycle can be divided into four phases that are characterized by how earnings develop
against multiples. Source: Credit Suisse
Fantasy P/E expands:

Price increases strongly,
earnings grow
but at a slower pace
Optimism P/E expands:

Price increases sharply,
GCTPKPIUCTGCV
Multiple
expansion
Multiple
contraction
Pessimism P/E falls:
Price falls, earnings
CTGCVVQFQYP
Reality P/E falls:

2TKEGKPETGCUGUOKNFN[
earnings recover
European equities have re -rated
Stock markets in Europe have not remained

unaffected by the improving economic conditions. Lagging the recovery in the USA , they
have started to perform well since early 2012 ,
and we expect them to continue delivering
solid returns (see Figure 1). The strong performance has been driven by an expansion
of valuation multiples, while earnings have
still been muted (see Figure 3). This is consistent with the optimism phase of the valuation cycle (see Figure 2). Although earnings
03_Twelve-month forward
P/E MSCI Europe
This chart puts the current valuation of the MSCI
Europe into perspective with its history. Multiples
have recovered from their lows in 2011 and are
now slightly above their long-term historical
average. However, there is still some scope for
multiples to rise further even as we view earnings
growth as the main driver for performance at
this stage. Source: Datastream, Credit Suisse / IDC
growth has been lackluster, investors have

been willing to pay for expected future
earnings growth, thus pushing up valuation
multiples.
Markets entering the reality phase
In our view, markets are now at the stage

where the valuation expansion has to be
backed by actual earnings growth (the reality

phase) making earnings growth the key
driver for further higher equity levels.
Following a long period of negative earnings revisions for the MSCI Europe, we are
more constructive on earnings growth. Indeed, there are several factors at play that
should support earnings. Among these, we
04_EMU manufacturing PMI

vs. 12-month forward earnings
MSCI Europe
This chart indicates how earnings follow the
development of PMI s with a certain time lag.
There is some correlation, but since 2013 it broke
down as the earnings growth did not catch up
with the PMI expansion. Given the recent widening of the two lines, we view this as an indication
that earnings growth will pick up again.
Source: Bloomberg, Datastream, Credit Suisse / IDC
12-month forward P/E
Index
24
60
% YoY
50
40
22
55
30
20
18
20
50
10
16
45
14
10
40
12
20
10
30
35
8
40
50
30
1988
1992
MSCI Europe
Average
1996
2000
2004
2008
+1 standard deviation
1 standard deviation
2012
2006
2008
2010
2012
2014
EMU manufacturing PMI (l.h.s.)

MSCI Europe 12M forward earnings (r.h.s.)
view the following as most important: first,

the macroeconomic recovery bodes well for
earnings growth. Figure 4 depicts the relationship between the Eurozone manufactur ing
PMI (Purchasing Managers Index) and the
yearly change in 12 -month forward earnings
of the MSCI Europe. We see the recent
widening as an indication of earnings growth
ahead. Second, net profit margins in Europe
have lagged behind the recovery experienced
in the USA and we expect European firms to
catch up following cost-cutting and lower
financing costs, which supports the bottom
line (see Figure 5). Third, the recent monetary
stimulus by the ECB should help to limit further appreciation pressure on the euro, which
has challenged European corporates with a
strong export base outside the euro area.
Sectors exposed to macro improvement
Not all sectors are geared to the recovering

economic situation in the Eurozone to the
same extent. For instance, the impact on
energy and healthcare earnings should be
rather limited. In contrast, bank earnings depend directly on the macro environment they
operate in. Improving economic growth is positively correlated with bank earnings given
increasing lending volumes, but also rising

interest rates. While the impact of the recent
easing measures including negative deposit
rates and targeted LTRO s (long-term
refinancing operations) on lending growth
should be limited, these measures are nevertheless positive for banks as their funding
costs and costs of equity decline. Moreover,
the ongoing asset quality review by the ECB
might be a positive catalyst for banks as it
will increase transparency and reduce uncertainty once the results are published in Q4
2014 . Banks have to rebuild client and investor trust the stress test is one support. More
importantly, however, banks need to adapt to
the new competitive environment, facing potentially disruptive innovators. For more details on financials, please refer to page 18.
Likewise, industrials are sensitive to an
economic recovery and face structural changes as well. We believe growth in industrial
production and related operating expenses
is the first major revenue driver. While we
are not yet in the sweet spot for capital investments (capacity utilization above 80 %),
we expect capex to continue growing gradually. On the structural side, the strong trend
toward increased automation should impact
05_Net profit margin ex.

financials, USA vs. Europe
Net profit margins in both the USA and Europe have
exhibited some volatility historically. Although they
tend to be higher in the USA than in Europe, the
currently large spread leaves scope for a recovery.
In the USA , they have rapidly expanded since 2010
and stayed at high levels since, but in Europe,
margins have only recently started to stabilize.
Better margins are a key support of earnings
growth in Europe. Source: Datastream, Credit Suisse / IDC
in %
9
8
7
6
5
4
3
2
1
0
2000 2002 2004 2006 2008 2010 2012 2014
USA
Europe
17
the industrials segment. For more details on

industrials, please refer to page 22.
In the telecom sector, a decline in negative
structural effects together with a more business-friendly regulatory environment bodes
well for a recovery of the sector. Revenues
were pressured amid the shift from high-margin text messaging toward mobile Internet,
the effect of which is now easing. The improving regulation is being driven by efforts to
facilitate a single market and remove barriers
for consolidation. We think this should further
support M&A activity in the sector and result
in an oligopolistic market structure similar to
the USA . Over time, this easing competitive
environment should lead to both rising prices
and improving margins. For more details on
telecoms, please refer to page 56.
Michael Ghler
Co-Head Global Equity & Credit Research
+41 44 333 51 84
michael.gaehler@credit-suisse.com
Roman Ochsner
Junior Research Analyst
+41 44 332 03 72
roman.ochsner@credit-suisse.com
We expect European equity

markets to further outperform
on the back of an improving
macroeconomic outlook
and earnings growth, which
should compensate for a
slowdown in multiple expansion. This is consistent with
the current phase of the
valuation cycle, where earnings growth is essential
to bring equities to higher
levels. Compared to the
USA , where the economic
recovery has been faster,
we view the earnings growth
potential of European
equities as more attractive.
Earnings should be well
supported by monetary
stimulus, a potentially weaker
euro and net profit margins
that have more room to rise
than in the USA .
18
Banking today
Even as banking continues to cope with the aftermath of the financial crisis, completely new competition
is arising. Disruptive innovation through FinTech start-ups questions the banks value chain.
MARKET CAPITALIZATION
NET INCOME
EQUITY
RoE
in%
in billion
in billion
in%
EUR 1,748.48 bn
106
702
15.1
48
801
6.0
62
16
1,063
1.5
From 2007 until the trough in 2009,

banks lost a staggering 80% of their
market capitalization and only recovered
to just over 60% as of end-2013.
2013 profitability was

impacted by the cleanup
mode that banks were
in, anticipating the asset
quality review and
European Central Bank
stress test.
100
20
EUR 349.00 bn
EUR 1,083.72 bn
Source: Credit Suisse coverage, company data
The impact of Basel III

regulation is that equity
has risen by 51%. Thus
high return on equity
(RoE) numbers are more
difficult to achieve.
With an RoE of 1.5%

(down 90% in recent
years), banks seem to
have become utilities.
The low RoE is partially
due to low profitability
but also higher equity.
Photos: Getty Images Europe, Ulrik Tofte/Getty Images, Steven Puetzer/Getty Images, Andrzej Podulka/Getty Images
2013
2009
2007
Key figures of European banks
Christine Schmid
+ 41 44 334 56 43
christine.schmid@credit-suisse.com
The last seven years have been a rollercoaster ride for European banks, driven by
the aftermath of the financial crisis, stricter
regulatory rules and, last but not least, the
Eurozone breakup concerns. From end- 2007
until 9 March 2009, European banks lost a
staggering 80% of their market capitalization.
Remarkably, it recovered to reach roughly
60% of its original size by 2014 . But in terms
of relative market weight and importance,
the banking sector never recouped. Down
from 20% market weight in 2007, its share
remained at 13%. This could change if the
European economy recovers. Banks are a
direct proxy for indicating expected eco nomic
development. But economic development
also depends highly on banks and their
lending capacity. In Europe, where the capital
market is less mature, bank lending constitutes roughly 70% of company financing; for
small and medium-sized enterprises ( SME s)
VJGIWTGKUGXGPWRVQ100%. Thus, no longerterm economic recovery can occur without
expanding lending in Europe, where up to 70%
of the jobs are provided by SME s. But banks
are still in deleveraging mode (see Figure 1),
shrinking their balance sheets to meet stricter capital and leverage ratio requirements.
The aggregated equity position of European
banks has increased by 51% since 2007
as a reflection of stricter capital rules. The
equity position, and with it the capital ratio,
has constantly improved over the last few
years, but the balance sheet size has remained largely unchanged. Driven by European Central Bank ( ECB ) liquidity measures,
the banks engaged in sovereign debt carry
trades. With zero risk weight imposed by
regulators on sovereign debt, the capital ratio
was not affected. The 2014 ECB stress test
seeks to change this delusive incentive.
2014 lost in transition?
2014 is a transition year for European banks
as the ECB conducts a harmonized asset
quality review and subsequent stress tests

later this year. In anticipation of these events,
various banks have raised capital, revalued
their assets and continued to divest assets.
This illustrates how, even seven years after
the financial crisis, European banks still lack
a proper capital level under more severe
economic conditions.
Capital market and securitization gaining
importance
Tight capitalization and ongoing regulatory

pressure are limiting bank lending and the
economy. The Eurozone urgently needs to

revive securitization as well as develop its
capital market facilities to foster economic
growth. At the same time, banks will go
through a phase of radical changes be it
their business models, their value chain or the
channels used.
Banks offer high potential going forward,
but only if they adjust their business
models and communication channels
Banking is the global industry expected to

change most in the coming years as a result
of client demand and cost pressure combined
with technological development. Despite cost
constraints and regulatory pressure, European banks need to find ways to serve their
ENKGPVUDGUV
19
FinTech
According to Cisco, the number
of mobile -connected devices will
exceed the world population by
the end of 2014. This rapid pace of
accelerating technology interaction
affects both our daily lives and,
increasingly, the financial industry.
The term FinTech addresses this
convergence of financial services
with technology. Big Data analytics,
cloud computing, mobile solutions
and social media have also become
essential in banking. This is driven
by changing customer behavior
as well as by new profit pools and
the entry of new digital competitors
such as retailers, mobile phone
operators, IT giants and start-ups.
32%
of banking revenues
at risk from
new digital competitors
by 2020
01_European economic growth

difficult to achieve as
no support from lending
Lending in Europe is in negative territory as banks
continue to deleverage, driven by the pending asset
quality review and stress test by the European
Central Bank. Simplified rules for securitization
as well as concerted actions to support
capital market growth are needed to foster
economic growth. Source: Datastream, Credit Suisse/IDC
% YoY
15
10
5
0
5
10
2000 2002 2004 2006 2008 2010 2012 2014
USA
Eurozone
They challenge existing business

models and have the potential
to disrupt the industry. In a world
of growing regulatory requirements
that must be implemented constantly, we think it is crucial that
banks develop innovative technology
to deal with these new challengers,
while also improving efficiency.
Financial centers have also recognized the benefits of closer
interaction between banks and
start-ups. Over the last three years,
New York and London have adopted
so-called FinTech innovation labs
that aim to facilitate their collaboration. This is a good opportunity
to foster innovation among banks
while providing IT entrepreneurs
with contacts in the financial
industry. In our view, other financial
centers are likely to pick up similar
projects to strengthen their banks
competitiveness.
20
Five years left

for banks
02_The Internet of Things

The number of devices per person connected
to the Internet will surge further. The Internet
of Things is one of the main drivers, e.g.,
through wearables such as the Google Glass
and smartphones.
Source: Ericsson, Cisco VNI Mobile 2012, Credit Suisse Megatrends,

April 2014
d
uil
BANKS
Buy/joint venture
Cloud computing and mobile

solutions are already essential
technologies for banks.
To compete, they will have
to develop new channels.
Joint ventures
represent an alternative
response to convergent disruption
(the threat to
banks from
all sides).
2005
IT GIANTS
IT giants and start-ups challenge

existing banking business models
and could transform the banking
industry as we know it.
START-UPS/
FINTECH
0.3
devices
2020
devices
03_Adoption cycle halved

Banks are increasingly competing with start-ups in the FinTech
in last 25 years
area as well as existing IT giants. The financial sector has focused The adoption cycle of new technological developments has halved. Mobile phones in particular
on surviving, followed by regulatory implementation, and less on
smartphones offer full access to the Internet
innovation. Meanwhile, however, a whole new competitive landand thus change the way business is done. The
scape has emerged, disrupting parts of the financial value chain or remittance business and mobile payments were
just the beginning, in our view. Todays wealth
whole banking businesses. Banks have three options to react:
management and corporate banking will be
building new platforms and offers, acquiring start-ups or engaging challenged going forward.
in joint ventures. The build approach is often chosen in retail
Years
150
banking, based on already existing platforms. BNP Paribas,
ds
roa
ail
125
R
ne
for example, decided to launch a pure Internet channel called
ho
lep
e
100
T
HelloBank in various European countries in 2013 . In contrast, BBVA
n
dio sio
75
s
Ra levi
ter
(Banco Bilbao Vizcaya Argentaria) engaged in acquisitions through 50
e
pu
T
om
c
l
na et
bile
the start-ups Wizzo in Spain and Simple in the USA . Simples
rso ern
25
Mo ones
Pe Int
ph
success is based on an easy-to-use budget application that
0
combines the current account balance with upcoming payments
1750 1900 1900 1950 1950 1975 1975 2000
such as rent, healthcare or food costs for the rest of the month.
Years between invention and 80% diffusion
The application helps clients to avoid overdrafts and to save. The
third approach is engaging in joint ventures. Santander and Caixa
Bank, for example, are working closely together with Telefnica
VQNCWPEJ;CCR6JGTUVUGTXKEGUVJCVYKNNDGNCWPEJGFVJKU[GCT
are Yaap Shopping and Yaap Money. Yaap goes beyond banking.
Source: World Bank, Credit Suisse
Banking 2020
Today, every business is a digital business. To meet the challenges
posed by emerging trends from outside the traditional banking
sector, banks must rethink their operating models. Therein lies
opportunity, says Accentures Alexander Kettenbach.
INTERVIEW BY CHRISTINE SCHMID
Photos: Accenture, bioraven/Shutterstock
Christine Schmid: According to the Millennial

Disruption Index, most people would rather
visit their dentist than listen to what banks
are saying. What is wrong with banks?
Alexander Kettenbach: Nothing is wrong
with banks per se. But banks are perceived
as only defending their fee -based business
models, when they should be meeting the
needs of Customer 3.0. Todays banking
clients seek highly individualized interactions
and a greater range of services. Starbucks,
Google or Alibaba new competitors to the
banking sector. Who would have expected
that five years ago ? Alibaba became a
USD 16 billion lender in less than three years.
How do you expect these new technologies
to develop and to be leveraged ?
Alexander Kettenbach: As we stated in
our Technology Vision, it is time for the
CIOs organization to decide the role it will
play in the emerging digital business. Banks
must not accept that retailers or telecommunication companies know more about their
clients than banks do. For example, in February 2014 Banco Bilbao Vizcaya Argentaria
acquired Simple, a banking start-up that
eschews fees and offers its customers datarich analysis of their transactions.
The risk of disruption is high in the banking
industry. Why ?
Alexander Kettenbach: What makes the
environment in banking especially challenging is a phenomenon we call convergent
disruption: banks are impacted from all sides.
Examples include new competition and
innovative ways to do business from outside
the industry think of Fruitfulll (formerly
Crowd Mortgage) or Zopa, both peer-topeer lenders changes to legal structures
and operating models, and the digital
shift that redefines the interaction between
customers and service providers. Our
analysis shows that full-service banks,
A fundamental
issue in the long term
is the question of
YJCVMKPFQHUECN
rules there will
be for Europe.
ALEXANDER KETTENBACH
Managing Director at Accenture AG
Head of Management Consulting Financial
Ser vices in ASG
as a homogeneous segment, could lose

about 36% of their market share by 2020
if they retain their traditional ways.
In which areas must banks prepare for
new incumbents?
Alexander Kettenbach: Areas in which
there is ongoing convergence with banks.
Think of Google offering mobile payments
through its Google Wallet. Our analysis
shows that up to 25% of payment revenues
could be taken over by alternative providers.
At what point do the activities of these tech
giants cross over from being complementary
to banks to becoming competitive with them?
Alexander Kettenbach: This has already
happened. PayPal has been a licensed bank
in Europe since 2007. Facebook, which
has more than 250 million users in Europe,
may soon be authorized by the Central Bank
of Ireland to handle payments across the
European Union. Regulations will provide
banks with some protection, but not for long.
21
How should banks be positioned strategically

to meet these trends?
Alexander Kettenbach: First, driving
efficiency by simplifying the current structure. That is todays baseline. Second,
to meet the 2020 baseline, banks must be
agile and able to manage change quickly.
Third, banks should differentiate themselves
through continuous innovation. Banks
currently innovate, but not on a consistent
basis across the organization.
What is the optimal innovation model
for a bank ?
Alexander Kettenbach: Being an Everyday Bank. These innovative banks will be
more customer-centric and organize their
business around client segments rather
than around products. Imagine you want to
buy a new car: the Everyday Bank will not
only recommend specific models that fit
your family situation and help you save on
fuel costs, it will also directly suggest a
payment plan tailored to you and bundle in
a car insurance.
EU banks currently offer around 10% RoE.
How do they get to the targeted 15%,
or even 25%?
Alexander Kettenbach: Banks that can
match the agility and innovation potential of
other industries could consistently reap pre tax RoE levels as high as 15%20% by 2020.
This assumption already considers the higher
equity requirements for Swiss banks that
will come into effect in 2018 . That represents
a huge jump over the average 11% pre-tax
RoE the largest banks in North America
managed at the end of 2012. This can be
achieved by increasing employee productivity,
improving customer relationships, reducing
cost-to-serve, managing risks, and
innovating both products and technology.
What makes you believe banks will overcome and outlive these challenging times?
Alexander Kettenbach: The last decade
was for start-ups to dominate digital. The
coming decade will see the emergence of
traditional companies as digital giants. With
the rich customer transaction data banks
possess, they are uniquely positioned to
create digital ecosystems, assembling existing partners and other key players, creating
digital connections and establishing equitable value sharing. Such banks will reinvent
themselves as value aggregators, advice
providers and access facilitators. Entry
barriers into other industries are low and
open as potential areas for growth. That
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22
German cars
in top gear
While Germany, which is considered to be the
birthplace of the modern automobile, is still
admired for its successful automobile industry, the French car industry has lost some
of its past glory. The car industry is economically important for both countries. In 2010, it
accounted for 749,000 and 225,000 direct
jobs in Germany and France, respectively.
However, the development of the industry
in the two countries could not be more different. According to PricewaterhouseCoopers
( PWC), production volumes in Germany rose
from 4.1 million autos in 1990 to 5.4 million
in 2010, while falling from 2.6 million to 2.2
million autos in France. And the outlook is
even more pronounced: while PWC forecasts

German domestic production to grow to 6.3
million by 2019 an increase of more than
50% from the 1990 level it assumes production in France will remain at the current
level. This implies a decline of 15% relative
to the 1990 production volume. But why the
large difference?
High demand for cars made in Germany
Demand for German cars is high in almost

every part of the world. This is mainly a result
of the strong premium brand image. People
are keen to buy German cars and are ready
to pay a high price particularly when they
see made in Germany. While currently the

production of most German car models is
global, the flagship cars A8 , the cars of BMW s
7 Series and Mercedes-Benz S-Class
the most profitable cars for their manufacturers are all made in Germany. However, the
French automobile industry remains trapped
to some extent in the mid-sized and compactcar segment, where competition is high and
basing production in Western Europe often
makes the cars too expensive to export to
other regions.
China: High growth for German carmakers
With the success of their brands, German

carmakers have also been able to grow their
exports strongly particularly outside of
Europe. According to the German Association
of the Automotive Industry ( VDA ), German
exports amounted to 4.2 million passenger
cars in 2013 , which is 77% of total German
production. While Europe still accounts for
59% of exports, the European premium market has been much more resilient (see BMW
example in Figure 1), while companies like PSA
Peugeot Citron have suffered much more in
the weak European market (see Figure 2).
Moreover, German manufacturers benefited
from their biggest export market, the USA ,

where 656,000 cars made in Germany were
imported in 2013 . After having fallen to a
trough of 10 million cars in 2009, the US market recovered strongly to 15.5 million units in
2013 . The French manufacturers have almost
no sales in the USA .
Despite a rapid increase in domestic
production, German cars exported to China
remained at a high level of 243,000 units in
2013 , similar to Germanys biggest European
export market France ( 252,000 cars), according to VDA data. While Chinese demand for
apparel, jewelry and handbags from Chanel,
Cartier and other French luxury brands remains high, they prefer German cars. Indeed,
sales in China currently account for between
15% and 3 5% of total car sales for German
manufacturers. While French carmakers also
enjoy strong growth of French cars produced
in China, the profit contribution is much lower.
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Photo: MyKarre.com
Profitability is very different for German and

French carmakers: the operating profit for the
global automobile business is a low to midthousand euro amount per car for the German
carmaker, while Renault earns only a low
triple-digit amount per car and Peugeot is

loss-making. The cost difference is difficult
to measure, as it includes global operations
and a different product mix. We assume
production is efficient in both the German
carmakers domestic and international operations. Nevertheless, compared to the EU
automotive industry average, labor productivity is 20% higher for Germany, but only around
10% higher in France according to a study
from Group Alpha and Alphametrics for the
European Commission published in 2008 .
And according to the Ernst & Young European
Automotive Survey 2013 , Germany was
ranked at the top with regard to productivity,
while France was only ranked eighth. However, we believe it is not the cost, but the
popularity of German cars that is important.
First, Germany can sell its cars for a much
higher price and, second, high demand results
in high factory utilization. And this may well
continue.
23
01_BMW global sales split

While European sales were stable, growth was
strong in China and the USA . Hence, the company
achieved record sales results. Source: BMW, Credit Suisse
2,000,000
1,500,000
1,000,000
500,000
0
06
07
08
09
10
11
12
13
Rest of the World (RoW) China (from 2009)

Asia ex- China Americas Europe
02_Peugeot global sales split

Peugeot sales have been down since 2006
as weak sales in Western Europe have been only
partially offset by growth in other parts of the
world. Source: Peugeot, Credit Suisse
4,000,000
3,000,000
2,000,000
1,000,000
Reto Hess
Auto & Capital Goods Research
reto.hess@credit-suisse.com
+41 44 334 56 24
0
06
07
08
09
10
RoW China Latin America

Western Europe
11
12
Russia
13
24
Boom,
bust,
recovery
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The impressive skyline of Madrid, where the upward trend in the real estate market is indicative
of the recovery now under way in the European periphery.
01_Stylized real estate cycle

and corresponding returns of
direct real estate investments
in the UK
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20
Economic cycle
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Investors should not wait too long
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25
02_Recovery in the periphery;

Germany sound and France
potentially already in contraction
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Spain, Ireland, Hungary, the Netherlands lead the way
03_Office markets at different

stages in the real estate
recovery cycle
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Prime office vacancy rate, %
25
20
15
10
5
0
2004
2006
2008
2010
2012
2014
Madrid Barcelona Dublin Amsterdam

Rotterdam Budapest Frankfurt
04_Peripheral residential real

estate markets need more time
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House price indices (Q1 2002 = 100)

200
180
160
140
120
100
2002
UK
2004
Spain
2006
2008
France
2010
Italy
2012
2014
Germany
26
A culture
of innovation
Innovative Europe
The Global Innovation Index is published on an annual basis.
It is a composite indicator that ranks countries in terms
of their environment for innovation and their innovation outputs.
Source: The Global Innovation Index 2013 (INSEAD, WIPO, Johnson Cornell University)
Rank ( 2013 )
1
2
3
4
5
6
7
8
9
10
Country
Switzerland
Sweden
United Kingdom
Netherlands
USA
Finland
Singapore
Hong Kong
Denmark
Ireland
Rank ( 2007 )
6
12
3
9
1
13
7
10
11
21
Fostering an innovation culture is far from trivial, as success depends on a multitude of factors.
These include among other things a commitment to sustained investments in research
and development (both from the government as well as from the corporate sector), access to
a skilled/well-trained workforce, the presence of world-class universities, a dynamic investment
community and the protec tion of intellectual property. In addition, clusters of universities
and businesses that enable efficient technology transfer and interdisciplinary exchange are
clearly beneficial. At the individual company level, luck has proven to be an important element
in many cases. Whatever the reasons, success begets success, creating a virtuous circle
as it attracts top talent and further investments.
27
Global venture capital

investments 200613
Venture capital
investments by sector
Europes venture capital investments are eclipsed by the amount

spent in the USA. While they have recovered from depressed levels
in 2009, they are still somewhat below precrisis levels.
The lions share of venture capital in Europe is being invested

in sectors such as life sciences, computer and consumer electronics
as well as communications.
Source: Ernst & Young, Global Venture Capital Insights and Trends 2014
Source: OECD, Entrepreneurship at a Glance 2013
USD bn
60
21.8%
50
28.4%
40
30
12.5%
20
10
19.0%
18.2%
0
2006
USA
2007
Europe
2008
2009
China
India
2010
2011
2012
2013
Life sciences Computer and consumer electronics

Communications Industrial/energy Other
Israel
Top 10 universities by subject

While US universities clearly dominate global rankings, smaller universities should not be underestimated,
as they can be just as powerful in specialized niches.
Source: QS World University Rankings 2013/14
Engineering and technology

Rank Institution
1
Massachusetts Institute
of Technology
Stanford University
University of Cambridge
University of California, Berkeley
ETH Zurich
Imperial College London
National University of Singapore
EPF Lausanne
University of Oxford
10
California Institute of Technology
Life sciences and medicine
Location
USA
USA
UK
USA
Switzerland
UK
Singapore
Switzerland
UK
USA
Institution
Harvard University
Johns Hopkins University
Stanford University
Massachusetts Institute of Technology
University of California, San Francisco
University of California, Los Angeles
Yale University
Karolinska Institutet
Natural sciences
Location
USA
UK
UK
USA
USA
USA
USA
USA
USA
Sweden
Institution
Massachusetts Institute of Technology
University of California, Berkeley
Stanford University
Harvard University
ETH Zurich
California Institute of Technology
Imperial College London
Princeton University
Location
UK
USA
USA
USA
USA
Switzerland
USA
UK
UK
USA
3WCPVKV[XUSWCNKV[QHUEKGPVKERWDNKECVKQPU
The USA and China comfortably lead when it comes to the number of scientific publications.
More importantly, however, European publications have a high impact as measured by citations.
Source: OECD Science, Technology and Industry Scoreboard 2013
4,260
%
20
2,000
15
1,500
10
1,000
500
0
US
CN
UK
DE
JP
FR
CA
IT
Percentage of top-cited publications (l.h.s.)

Number of publications (r.h.s.)
ES
IN
AU
KR
NL
BR
RU
CH
PL
SE
TR
BE
28
Switzerland:
A pharmaceutical powerhouse
In a science -driven industry such as the pharmaceutical industry, a commitment to sustained
R&D investment is a crucial factor in order to attract the best scientists, in our view. This is not only
important to increase the success of developing drugs in-house, but also when it comes to judging
the merits of in-licensing opportunities. Switzerland has a long history of expertise in chemical/
pharmaceutical sciences and is home to two of the worlds top pharma companies.
Roche has a unique combination
of pharma and diagnostics
Roche is the worlds leader in oncology and

in vitro diagnostics. With its acquisition of
Genentech, the company has secured access
to some of the worlds leading scientists and
most promising pipeline assets. Owing to
Roches unique combination of a pharma and
a diagnostics business under one roof, it is
well-positioned in the development of targeted and personalized treatments. Here it
becomes more and more important to understand the molecular signatures of diseases in
order to stratify patients into well-defined
patient pools, thereby increasing the clarity
of the signals in clinical trials and ultimately
increasing the chances of success.
Top 10 corporate R&D spenders

Pharmaceutical companies are among the biggest spenders on R&D worldwide.
Roche and Novartis lead their peers on this metric.
Rank Short name

1
Volkswagen
Samsung
Intel
Microsoft
Roche
Novartis
Toyota
Johnson & Johnson
Google
10
Merck & Co.
Headquarters
Germany
South Korea
USA
USA
Switzerland
Switzerland
Japan
USA
USA
USA
R&D spending
(bn USD)
Industry
Automotive
13.5
Computing and electronics
13.5
Computing and electronics
10.6
Software and Internet
10.4
Healthcare
10.0
Healthcare
9.9
Automotive
9.1
Healthcare
8.2
Software and Internet
8.0
Healthcare
7.5
Novartis follows a strategy of focused

FKXGTUKECVKQP
Novartis has leading positions in all three of

its divisions. It is number two worldwide in
oncology (behind Roche) and generics (behind Teva) and, with Alcon, it owns the worlds
leading ophthalmology business. With its own
unique combination of businesses, Novartis
covers a broad spectrum of healthcare demand with innovative products, as well as
low-cost alternatives in the form of generics.
Key strengths of the company, in our view,
include the benefits of having an independent
research organization (Novartis Institutes for
BioMedical Research), as well as the complementary know-how in product innovation
(pharma) and process innovation (generics).
Top 10 pharmaceutical
companies by size of pipeline
A companys pipeline is its source of future revenue growth. Again, Roche and Novartis are
leaders in terms of number of pipeline drugs, a large proportion of which originate in-house.
Source: Citeline Pharma R&D Annual Review 2014, Bloomberg, Credit Suisse
Rank Company
1
GlaxoSmithKline
Roche
Novartis
Pfizer
AstraZeneca
Merck & Co.
Sanofi
Johnson & Johnson
Bristol-Myers Squibb
10
Takeda
Headquarters
UK
Switzerland
Switzerland
USA
UK
USA
France
USA
USA
Japan
No. of drugs
in pipeline 2014
% of originated
drugs ( 2013)
R&D expenditure
2013A (bn USD)
261
57%
6.1
248
79%
10.0
223
73%
9.9
205
67%
6.7
4.8
197
70%
186
56%
7.5
180
45%
6.3
164
52%
8.2
133
74%
3.7
132
50%
3.5
European
technology:
Small but powerful
29
ASMLs market share speaks for itself

Over the years ASML has established itself as the leading provider of
semiconductor lithography tools. This market has become a quasi-duopoly.
Source: Gartner, Credit Suisse estimates
100%
90%
Although the European technology sector trails

that of the USA by a wide range in terms of
market capitalization, it still contains companies
that are setting the bar for specific industry
trends. Long after Nokia lost its role as the
leading mobile phone producer worldwide, ARM
Holdings and ASML stepped in to fill the gap.
Nowadays, both companies have become
quasi-standards in the semiconductor industry.
80%
70%
60%
50%
40%
30%
20%
#5/.DGPGVUHTQOJKIJOCTMGVUJCTGCPFRCTVPGTUJKRRTQITCO
10%
ASML, based in Veldhoven, the Netherlands, was founded in 1984
as a joint venture between Advanced Semiconductor Materials International ( ASMI ) and Philips. The company provides lithography tools
used for the production of integrated circuits ( IC s), such as CPUs,
dynamic random access memory and flash memory. With these
machines, patterns are optically imaged onto a silicon wafer covered
with a film of light-sensitive material (photoresist). As a start-up,
ASML faced strong competition from more than ten established players. In the meantime, ASML offers the best lithography tools for the
semiconductor industry, and holds about 87% of the market. The
further development of lithography, especially the extreme -ultraviolet
( EUV ) technique used for the production of chips with a feature size
of ten nanometers and below, is crucial for the semiconductor industry to keep Moores law (i.e. that computer processor speeds will
double every two years) alive. To achieve this goal, the company
operates partnership programs with Intel, Samsung and TSMC, thus
highlighting ASMLs pivotal role in the industry. These three companies
provide additional R&D financing and own stakes (15%, 5% and 3 %,
respectively) in ASML.
0%
2000
2002
2004
2006
2008
2010
2012
Ultratech
Silicon Valley Group
Nikon
Canon
ASML
ARM inside handheld devices

The ARM chip architecture has become the driving force for the success of
handheld devices. The company is benefiting from strong growth in handheld
devices and its quasi-monopoly status. Source: ARM Holdings
2008 2009 2010

Smartphones
Low-end voice phones
Portable media players
Tablets
Digital cameras
2011 2012 2013
81%
85%
92%
89%
88%
87%
93%
93%
95%
93%
96%
95%
67%
72%
73%
82%
88%
86%
NA
NA
90%
88%
86%
84%
72%
60%
80%
86%
78%
78%
ARM architecture driving the success of handheld devices
In the 1980 s, Acorn Computers decided to design its own highperformance 32 -bit RISC (reduced instruction set computing) chip,
the ARM processor. In 1990, Cambridge -based ARM was founded
as a joint venture between Apple, Acorn and VLSI Technology, when
Apple was developing a PDA called Newton and looking for a lowpower processor to run it. Although the Newton was not a great
success, ARM decided to pursue what we now call an IP business
model. As such, the ARM processor has been licensed to many
semiconductor companies for an up-front license fee and then
royalties on production. This incentivized ARM to help its partner
access high-volume shipments as quickly as possible. ARMs IP or
architecture is now the standard used in mobile products, especially
smartphones such as the iPhone and Samsung Galaxy, and
tablets like the iPad. About 98 % of the more than two billion mobile
phones sold each year use at least one processor (chip) based on
an ARM design.
Thomas C. Kaufmann
Pharmaceuticals Research
+41 44 334 88 38
thomas.c.kaufmann@credit-suisse.com
Ulrich Kaiser
Technology & Media Research
+41 44 334 56 49
ulrich.kaiser@credit-suisse.com
30
Airports
gates to the world
In a globalized world, accessibility is a key
location factor. Airlines are one means
of transport, and airports are the gates.
According to Airports Council International
(ACI), over 1.4 billion passengers use airports
in Europe. And this figure is likely to increase
given that, as Airbuss Global Market
Forecast predicts, air transport (measured
in revenue passenger kilometers) will grow
at a rate of 4% per annum in advanced
economies between 2013 and 2032. Indeed,
ACI forecasts that airport users in Europe will almost double by 2030 to around 2.7 billion. This
ITQYVJHQTGECUVKUOCKPN[DGKPIFTKXGPD[JKIJGTGOGTIKPIOCTMGVVTCHE6JKUCUUWORVKQPEQTTG
sponds with the results of the 2014 Credit Suisse Emerging Consumer Survey, which forecasts that
international holiday traveling in emerging markets is likely to increase from its current low level
of about 10%, driven by growing household incomes. This growth creates opportunities for airports.
Reto Hess
Auto & Capital Goods Research
+41 44 334 56 24
reto.hess@credit-suisse.com
Romano Monsch
Consumer Staples Research
+41 44 332 90 59
romano.monsch@credit-suisse.com
Airports set to benefit from

rising number of air travelers
01_Split of revenues
at Paris airports
While half of Paris airport revenues still come
from the aviation business, it only earns about
12% of operating income. On the other hand,
retail and services has the highest profitability of
all businesses, earning two-thirds of the group
operating income with only 29% of sales. Retail
and services revenues grew by 5.1% in 2013
driven by retail, which increased sales by 8.7%.
Within retail, airside shops account for 70%
of revenues. Source: Aroports de Paris, Credit Suisse
9%
9%
53%
29%
Aviation Retail and services

Real estate Other
Stefanie Kluge
Consumer Discretionary & Retail & Industrials Research
+41 44 332 03 74
stefanie.kluge@credit-suisse.com
We believe that the increase in passenger traffic

offers airports the potential to diversify their
revenues away from pure aviation income toward
non-aviation income such as retail sales. Nonaviation income already contributes a significant
part of overall revenues. In the case of the Paris
airports, non-aviation sales accounted for almost
half of 2013 revenues. Retail was the secondlargest contributor, accounting for 12% of group
sales. Retail sales are likely to increase further
over the coming years due to high growth in longhaul traffic, as these passengers are the most
profitable customers for airport retailers. In addition, retail sales should benefit as airports are
expanding their commercial space. The different
shopping behavior of the broad internationally
diversified customer base is also key to increasing
income from retail activities. We expect particularly strong demand from emerging market
passengers. For example, BRIC destinations
(Brazil, Russia, India and China) only represented
4.6% of traffic at the Paris airports, but 20% of
sales per departing passenger in airside shops,
and 40% of airside shop sales growth in 2013 .
If airport providers are able to further develop
attractive and efficient retail concepts landside
and airside the retail business could become
an even more important profit driver in the future.
02_Gulf carrier share of

Europe-originating seats
in 200414
Despite high air traffic demand, European
legacy carriers are under pressure from increased
capacity on international routes from Gulf carriers.
This could continue to weigh on profitability.
Source: Company data, Credit Suisse
%
20
18
16
14
12
10
8
6
4
2
0
04 05 06 07 08 09 10
11
12
13
14
31
Investments in airport efficiency likely

to increase
Competition in European airline sector

likely to remain tough
Owing to the strong growth in expected air traffic demand, additional

investments in new airport capacity will be needed to provide adequate
infrastructure. However, these investments may be prevented by regulation
and resistance from residents. Further, due to the recent downturn,
airports are planning to increase capacity by only 17% between 2012
and 2035 according to Eurocontrols 2013 Challenges of Growth survey,
and only four of the 108 airports surveyed plan to build a new runway.
This is most likely not enough to meet growing demand. Nevertheless,
we assume airports will invest more in capacity, security and efficiency
to deal with higher passenger numbers. According to Siemens, airport
pro ductivity depends on throughput time increasing flight frequencies,
higher passenger throughput, more baggage and freight. Companies
that offer solutions to improve infrastructure, information and logistics
should benefit greatly from air traffic growth, in our view.
&GURKVGVJGRQUKVKXGQWVNQQMHQTCKTVTCHEQWTQRGTCVKPIQWVNQQMHQT'WTQRGCP
airlines remains cautious. The International Air Transport Asso ciations
Financial Forecast March 2014 predicts an EBIT margin of only 1.9%
in 2014 compared to 1.1% in 2013 , mainly due to intense competition.
On the one hand, low-cost carriers have expanded their fleets. According
to the European Low Fares Airlines Associations Airline Members
Statistics, low-cost carriers transported 216 million passengers and
operated 4,526 flights in 2013 compared to 106 million and 2,331 in 2006 ,
respectively. On the other hand, competition from airlines in the Middle
East is likely to increase on international routes from Europe to Asia Pacific.
Over the next six years, we expect annual fleet growth of between 5%
and 14% for Middle Eastern airlines and that part of this higher capacity
could be used on European routes. Hence, airline competition in the
European market is most likely to remain difficult. Therefore, contrary
to airports and airport infrastructure suppliers, the outlook for European
airlines is much less attractive, in our view.
03_Passengers at Frankfurt Airport

Passenger growth at Frankfurt Airport has been strong
as airfare prices have declined and capacities have
increased. Assuming annual passenger growth of 4%
(in line with Airbuss air traffic growth forecast for
Europe) and assuming no capacity constraints,
passengers using Frankfurt Airport would grow to
over 100 million by 2032 . Source: Fraport AG, Credit Suisse
1980
17,664,171
2013
58,042,554
122,286,907
2032 (est.)
04_Average spending per departing

passenger in Frankfurt
05_European air traffic forecasts

Air passenger traffic in Europe is expected to grow
by 4% p.a. between 2013 and 2032 . This should
result in air traffic more than doubling during this time.
We think the strong growth is mainly driven by growing
demand in emerging markets, particularly in China,
due to a growing middle class. Source: Airbus, Credit Suisse
Average spending per departing passenger has increased

by 62% at Frankfurt Airport. We expect further growth
in spending from growth in air traffic, particularly driven
by emerging market long-haul traffic and an increase
in commercial space at airports. Source: Fraport AG, Credit Suisse
Intra-Western Europe
+62%
2JQVQU(NKEMT8KUKQP0Q(NWO(QVQITCG
2004 13
Western Europe USA

Western Europe Asia
Western Europe Middle East
Western Europe South America
Western Europe China
32
Future of Europe
Crisis and
convergence
Photos: https://www.ecb.europa.eu/euro/html/hires.en.html
The acute phase of the euro crisis may be passing, but European monetary union remains a
work in progress. According to Harold James, establishing an effective fiscal apparatus and
a supervisory framework for banking is yet to be achieved. In an interview, James examines these
issues as well as how to secure growth, on which the future of monetary union depends.
INTERVIEW BY OLIVER ADLER

Oliver Adler: Were here to talk about

Europes financial crisis. But as frequently
happens, geopolitical issues recently
grabbed the headlines. Could we start with
that ? Specifically, what does a financial
historian have to say about the origins of
the Ukraine crisis?
Harold James: The context is the
epochal shift in the financial history of the
recent period. After 2008 , many people
started to challenge the idea of globalization. In particular, the big powers outside
the USA began to think of alternatives.
For example, after 2008 China realized
that it needed a financial system more oriented to Chinese requirements. Internationalizing the renminbi was part of that. There
was a similar effect in Russia that didnt
get noticed so much because the general
supposition was that Russia was no longer
a big geopol itical player. But, in fact, the
2008 Georgian crisis now seems to me
to be when this idea of asserting a much
more powerful influence in Eurasia emerged
clearly as an element of Russian thinking.
Playing that out is what produced the
current crisis in Ukraine.
What has been the effect of the crisis
on the position of Europe?
Harold James: It has really highlighted
the need for a coherent European response.
In that sense, it has put some momentum
back into the European project. Polish
nationalist politicians, for instance, who
used to be very anti- EU, now recognize the
importance of a coordinated effort. And the
Ukraine question will press Europe to think
more about other aspects of integration,
in particular energy policy, which has been
badly neglected in past years.
Which brings us back to European monetary
union. German-French cooperation has
obviously been a key driver of most of
Europes steps to integration. But in the last
few years, this alliance has been pretty
fragile. Will that continue to be an issue?
Harold James: In the 1990 s, there was
a genuinely French input into the discussion
as well as German input. I think the dissatisfaction with the last three or four years
A fundamental issue in
the long term
is the question
of what kind
QHUECNTWNGU
there will be
for Europe.
HAROLD JAMES
HAROLD JAMES
*CTQNF,COGUKUQPGQHVJGHQTGOQUVPCPEKCN
historians in the world. He received his PhD
from Cambridge University in 1982 and
joined Princeton University in 1986. His most
recent book is Making the European Monetary
Union ( 2012). His awards include the
Helmut Schmidt Prize in German- American
Economic History.
33
has been the feeling that its been a one way process. Unless the German-French
relationship can be repaired, its difficult to
think of ways in which Europe can advance
coherently. I do see some signs that the
relationship is improving, not just atmospherically but also regarding basic policy
principles.
Meaning?
Harold James: A fundamental issue in
the long term is the question of what kind
of fiscal rules there will be for Europe.
So far, fiscal rules are associated very much
with Germany and budgetary austerity, and
with the export of deflation. Thats not a
concept that fits well into the French world
view. An alternative French model that has
some appeal in Italy, and in Greece and
Spain as well, envisions the state taking a
more active role. Now there may be some
convergence in approach. For example, the
fundamental idea of the much talked about
book by Thomas Piketty Capital in the
Twenty-First Century is that to address
the issue of increasing social inequality,
you need a wealth tax. That kind of concept
has already been floated in Germany in a
very different context as a way of dealing
with the debt problems of southern European
countries. I see the potential for a kind
of intellectual convergence about the desirability of what you might call Piketty-ism
between France and Germany.
Historically, the French at least thought
of the euro as a potential competitor to the
dollar and perhaps also playing a political
role. Are we back on track for the euro
to become a contender to the dollar and
then maybe in future to the renminbi ?
Harold James: Yes, I think so. I would
see the long-term impact of the 2007
2008 crisis in exactly that way. It has really
highlighted the problem of depending too
much on the USA as a major financial
center. We saw in the financial crisis how
important dollar funding was for European
banks. The Federal Reserve played a really
big part in supporting Europe through the
swap lines. Ending that dependence and
the sense that ultimately the USA is the
country where the financial markets are
deepest and most liquid is part of the vision
of how the architecture is going to evolve
in Europe, as well as in China.
How likely is it that the European Central
Bank ( ECB ) will adopt the supreme
role that the Federal Reserve or the Bank
of England have had within their domain? >
34
And how important is that for the Eurozone

and for Europe in general ?
Harold James: Its enormously important
when you have a common capital market,
a common economic area and financial
institutions that will be cross-border
and channeling flows across national
frontiers. Its key to have the supervisory
framework that goes along with that. The
point thats been often discussed is that
this is a different kind of activity than
monetary policy because theres an
inherently fiscal aspect to it. So the
demand for political accountability when
central banks get into the supervisory
or regulatory mode is much higher than it

is when they do monetary policy.
So the political system should stay out
of monetary policy ?
Harold James: Well, politics matter when
its a question of which banks will be closed
down, or how the restructuring of banks
should be managed. Those are issues that
involve fiscal resources, and demand a
great deal of political accountability. Youre
going to have to think of a governance system that treats monetary policy separately
and that has a central bank divided into
two elements, as it were: one that is truly
independent, and one that is accountable
and should present the rationale for what

its doing as its doing it.
Do you see a stronger Eurozone, with proper
institutions, as an attraction for countries
outside it ?
Harold James: The issue highlighted
in the discussions after monetary union, and
particularly after the financial crisis, seems
to indicate that the Eurozone as such needs
CUECNCRRCTCVWUUQOGMKPFQHUECNWPKQP
Its hard to see how the countries with the
opt-out, in other words, Denmark and the
UK YQWNFVKPVQVJKU#PF+HGCTVJCVQPGQH
the themes that will emerge more and more in
the lead-up to the UK referendum on Europe
United in diversity
A HISTORY OF EUROPE IN BRIEF
MARSHALL PLAN EUROPEAN
RECOVERY PROGRAM
ROBERT SCHUMAN THE ARCHITECT OF

THE EUROPEAN INTEGRATION PROJECT
In the immediate aftermath of the Second World War, European

countries were in dire straits. In 1947, in response both to deteriorating
economic conditions and to a perceived threat of communist expansion,
US Secretary of State George C. Marshall called for a massive program
to rebuild Europe. One year later, the US Congress established the
European Recovery Program known as the Marshall Plan which
provided over USD 12 billion for European reconstruction in the form
of loans and grants, as well as commodities and technical information
and assistance. For a range of political reasons, the Marshall Plan
was limited to Western Europe. During its four years of operation,
the program promoted industrialization and foreign investment in the
region. In so doing, it also helped to establish markets for American
goods. Economic historians disagree on the impact of the Marshall
Plan, but it is generally seen as a worthy humanitarian achievement.
It also provided a model for future US foreign aid programs.
6JGUVCVGUOCP4QDGTV5EJWOCPCSWCNKGFNCY[GTCPF(TGPEJHQTGKIP
minister between 1948 and 1952, is regarded as one of the drivers
of European unity. In cooperation with Jean Monnet, he drew up
the internationally renowned Schuman Plan, which he published on
9 May 1950, the date now regarded as the birth of the European Union.
He proposed joint control of coal and steel production, the most
important materials for the armaments industry. The basic idea was
that whoever did not have control over coal and steel production
YQWNFPQVDGCDNGVQIJVCYCT
Schuman giving his famous

speech on 9 May 1950,
the day that is now celebrated
as the EU s birthday.
EUROPEAN COAL AND STEEL

COMMUNITY
One of a number of posters

created by the Economic
Cooperation Administration,
an agency of the US government, to promote the Marshall
Plan in Europe, 1950 .
The brainchild of French political economist Jean

Monnet, the European Coal and Steel Community
(ECSC) was established by the Treaty of Paris in
1951 to contribute to economic expansion and
increased employment through a common market
for coal and steel. Signed by Belgium, France, West
Germany, Italy, the Netherlands and Luxembourg,
the treaty entered into force in 1952. It led to
the European Economic Community in 1958 and,
ultimately, to the EU.
is that from the European perspective, its

GCUKGTVQUQNXGVJGUECNRTQDNGOUQHVJG'W
rozone without the UK . In terms of the small
central European countries, theres not really
a doubt about it. They do and they will see
the euro as attractive. For Denmark and
Sweden, I would think a similar line of analysis would apply. But I cant see that line really
being taken for either Switzerland or the UK .
Will Europe evolve into a much closer
political union, something like a United
States of Europe? If that were to happen,
who would be part of it ?
Harold James: The EU is indeed starting
to evolve some of the aspects of a real
union notably fiscal rules but a move

that is really sustainable in the long run
would need to include some measure of
constitutionalization. In the past, getting
any consensus on such a step analogous
to the making of the US constitution in
1787 was impossible. The current triple
crisis the aftermath of the so-called euro
crisis, the crisis of legitimacy that was reflected in the high vote for anti-European
protest parties and the security crisis over
the political changes in Ukraine provide a
much greater incentive to really produce
reform and a transition to genuinely representative government. I believe that almost
35
all of the existing EU is capable of meeting

that challenge, though perhaps not the UK .
In the same vein, how likely are we to
see the domestic reforms needed to get
Europes growth motor going again?
Harold James: There is domestic
resistance, but a great deal of labor market
legislation has already been carried through,
particularly in Spain. Italy, too, is currently
initiating an impressive reform process. The
measures that we talked about for getting
an effective capital market operating are
a crucial part of that. Because without
growth, there will indeed be a backlash
CICKPUVNCDQTRQNKE[TGHQTOU
Adenauer (r.)
shaking hands
with French
President Charles
de Gaulle in 1961.
ENLARGEMENT OF THE EUROPEAN

UNION A TIMELINE
From its genesis in 1952, with six original members, the European
Union followed more or less a slow and gradual approach toward
enlargement over the next five decades. In 2004, EU membership
accelerated when ten nations joined the fold, bringing the total
to 25. Croatia is the most recent addition (2013), with six nations
currently listed as candidates to join. Source: European Union
Croatia
KONRAD ADENAUER
A PRAGMATIC DEMOCRAT
AND TIRELESS UNIFIER
Romania
Cyprus
Czech Republic
Estonia
Hungary
Latvia
Lithuania
Malta
Photos: Art Archive / images.de, The LIFE Picture Collection / Getty Images, Keystone, European Union
6JGTUV%JCPEGNNQTQHVJG(GFGTCN4GRWDNKE
of Germany, who stood at the head of the
newly-formed state from 1949 63, changed
the face of post-war German and European
history more than any other individual. Like
many politicians of his generation, Adenauer
had already realized following the First World
War that lasting peace could only be achieved
through a united Europe. His experiences
during the Third Reich (he was removed from
QHEGCUVJG/C[QTQH%QNQIPGD[VJG0C\KU)
UGTXGFVQEQPTOVJKUQRKPKQP+PVJGUKZ[GCTU
from 194955 Adenauer realized far-reaching
foreign policy goals to bind Germanys future
with the western alliance: membership of
the Council of Europe (1951), founding the
European Coal and Steel Community (1952),
and Germanys entry into NATO (1955).
A cornerstone of Adenauers foreign policy
was reconciliation with France. Together
with French President Charles de Gaulle,
a historic turning point was achieved: in
1963 the once arch-enemies Germany and
France signed a treaty of friendship, which
became one of the milestones on the road to
European integration.
Bulgaria
Poland
Slovakia
Slovenia
Austria
Finland
Sweden
Portugal
Spain
Greece
Denmark
Ireland
United Kingdom
Belgium
France
(West) Germany
Italy
Luxembourg
Netherlands
0
10
20
30
Period of being a member state in years
40
50
60
36
Corporates to loosen
Y
O
L
P
E
D SH
CA
M&A
Benefit
INVEST
Improve efficiency /
productivity and /or
raise capacity
RE
I
U
Q
AC
t her
iring o
Acqu otentially a
ring
e s s, p
busin or, or ente
it
NF
t
G
e
comp DWUKPGUU

Y
G
P
C
IMPROVE
Immediate revenue
gains, potential
market share gains,
market consolidation could improve
pricing power
CONSOLIDATE
RAISE
Dividends
Distributing
a portion of
recurring earnings
to shareholders
B UYING
SHARE S
Share
buybacks
DOWN DEBT
Increase
financial
flexibility
Drawback
Capex
Description
In
e i ve s
t
h
ex e t i n g
pa r t
nd o m in p
c a a in la n
pa t a t a
ci t in nd
y cu e
to r r qu
m en ip
ee t c m
t g a p en
r o a c t,
wi it y
ng o
de r
m
an
Corporate
action
Improving economic trends are likely

to lead to a distinct increase in corporate
activity. What might be good for equity
valuations may be less so for corporate
credit quality trends.
Paying
down debt /
raising cash
holdings
Bu ying the
companys own
sha res , loweri ng
the equity count
Raising dividends
sends a confident
message to investors;
can continue to raise
management capital
discipline
EXPAN SIONARY
CAPEX REQUIRES
GROWING DEMAND
TO UTILIZE
INTEGRATION RISK,
MANAGEMENT
RETENTION,
BUSINESS DISRUPTION,
HIGH GOODWILL
COMPONENT
INVESTORS APPRECIATE
STABLE / INCREASING
DIVIDENDS, SO SUBSEQUENTLY LOWERING
DIVIDENDS IS DIFFICULT
RAISE
Automatically
raises EPS ; generally supportive of
the share price
Lowers financial /
default risk; lower
cost of debt boosts
income statement
RISK
CAN SIGNAL A
POTENTIAL LACK OF
GROWTH / INVESTMENT
OPPORTUNITIES IN ITS
OWN BUSINESS
IF IT LEADS TO A
SUB OPTIMAL CAPITAL
STRUCTURE (TOO
LITTLE DEBT) IT CAN RAISE
THE FIRMS OVERALL
COST OF CAPITAL
37
their purse strings

the common currency experienced an existential threat. Now, as
forward visibility improves, companies may be more willing
to engage in corporate actions to pursue growth opportunities.
This could include raising capital expenditure, entering into
mergers and acquisitions, or returning cash to shareholders via
dividends or share buybacks. In reality, it is likely that we will see
a combination of all these measures.
For the most part, we believe todays corporate sector is resilient

and we think it is better positioned to weather an unexpected
credit shock. Many corporates have used the prevailing low
interest rate environment and strong demand for credit to
UVTGPIVJGPNKSWKFKV[RQUKVKQPUCPFGZVGPFFGDVOCVWTKV[RTQNGU
European economic recovery means better economic visibility
or at least more certainty. During the height of the Eurozone
crisis, management had to formulate contingency plans in case
MORE
Priority
IF
IF
Maintenance capex needs to

occur regularly to replace
equipment wastage and avoid
GHEKGPE[NQUUGZRCPUKQPCT[
capex is necessary if running
up against full capacity
Examples
Airbus and Boein g
Civil aerospace
are having to add capac ity
and jet engine suppli ers
to meet Asian / Middle Easter n deman d
Autom ation/
General industrial
ciaries ABB ,
Robot ics applic ations with benefi
Kuka, Fanuc
Oil & Gas equipment to sustain
Potential to consolidate
a market, eliminate a
competitor, improve
market share; enter new
business field
VID
bsta
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f
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av s o e i r
e
s h cord g th clud
m
r
e sin s in
i
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f
l,
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ve t r a c r m p s , r a
S e h e d r l y i n E x a n a l d LO
lis ula ds . c D o s on, tria
g
re iden n, M ohn e, Al
div ev ro n & J o c h
Ch hnso is, R
J o var t
No
is currently very much

in focus. Firms such as Medtronic,
AbbVie, Novartis, Pfizer and others
are looking to improve scale,
strengthen R&D pipelines and in
some cases access overseas
cash via tax inversions
EN
IF
Healthcare
DI
Increase if supported
by earnings improvement
and sufficient financial
flexibility
the boom in US shale gas
DS
IF
IF
Undertake if substantial
PCPEKCNGZKDKNKV[CPF
management perceives
current share price
to be low
Economic uncertainty is
increasing, or if temporarily
elevated due to prior M&A,
for example
Cash-rich
sectors such
as technology,
energy and
healthcare
have stepped
up share buyback programs, e.g. Apple,
Microsoft, ExxonMobil, Novartis,
but also General Electric, Philip Morris,
Nestl
European cement
majors are still restoring financial flexibility
to support credit
ratings. European utility
and telecoms sectors
both have prioritized
debt reduction in recent years to try to
stabilize credit ratings
38
Corporates have many choices available

A step up in capex needs tighter capacity
utilization rates
Conditions look ripe for increased

M&A activity
and may lead to deteriorating corporate

credit quality
The European economic recovery may not be

so vigorous as to require a material expansion
in aggregate capital stock. Companies typically only add to their productive capacity once
utilization rates rise toward full capacity and
to avoid ceding market share to competitors.
A weak growth environment may make raising
capacity relatively uneconomical.
Instead, companies may seek to deliver the

growth in revenues and ultimately the earnings per share that the equity market is looking for via mergers and acquisitions. And
since the low inflationary environment has
also left its mark on producer pricing, firms
may well benefit from M&A activity if it consolidates the market and improves industry
discipline in the process. Competition authorities will probably be reluctant to allow
mergers that reduce competition and raise
pricing, which explains why companies will
never openly mention this as the motivation
for M&A . Elaborate cost synergies will often
be presented, even if the true rationale underlying M&A activity often involves improving
market dynamics.
We are seeing a marked step-up in M&A activity. So far, many transactions have been
financed with a substantial equity component,
which limits the potential negative credit
impact. Nonetheless, the current cheap and
plentiful financing available in the corporate
bond market may well encourage corporates
to increasingly use debt in their funding mix,
ultimately leading to an increase in leverage.
It seems likely that we are in the early stages
of an increase in corporate leverage that will
ultimately feed through to pressure on credit
ratings. Sectors likely to see the most M&A
activity include healthcare, telecommunications and materials, although in reality we
think conditions are ripe for widespread activity across the board.
01_Corporate cash piles remain high
02_Corporate confidence is improving
Corporate cash holdings look ample compared to recent decades and

are complemented by easy access to bond markets. This provides plenty
of fire power for a material increase in corporate actions.
The CEO Confidence index is a survey conducted by the Conference Board

and PwC that measures CEO s assessment of current economic conditions.
A reading above 50 indicates more positive responses than negative and that
CEO s expect economic conditions to improve. Source: DataStream, Credit Suisse / IDC
Source: DataStream, Credit Suisse / IDC
in %
in %
5.5
80
5.0
4.5
70
4.0
60
3.5
50
3.0
40
2.5
30
2.0
20
1.5
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Mar 76 Mar 80 Mar 84 Mar 88 Mar 92 Mar 96 Mar 00 Mar 04 Mar 08 Mar 12
Non-financial corporate sector: cash/total assets
US CEO business confidence
Average
39
for deploying excess cash

Shareholder distributions are also
set to rise
but too much at once will cause

credit quality to deteriorate
Corporate cash piles remain high
Returning cash to shareholders either via

dividends or share buybacks is often seen as
an alternative to investing in the business. In
the extreme case, it could be interpreted as
management not being able to identify any
attractive investment opportunities in its business. On its own, shareholder distribution of
excessive free cash flow (whether via dividends or buybacks) is seldom a problem from
a credit perspective.
If higher shareholder distributions coincide

with an increase in capex or opportunistic
M&A that together result in a material releveraging of the company, then credit deterioration will likely occur. We see little evidence of this currently, but improving CEO
confidence on the back of better economic
visibility and the continued easy and cheap
access to debt capital markets may well result
in more aggressive corporate actions. Improving CEO confidence will invariably lead
management to pursue growth initiatives in
an effort to generate revenues and the higher earnings per share that the equity market
needs to justify current valuations. How
it impacts corporate credit quality is less
straight forward. However, if corporate actions
rise to the extent that they cause material
releveraging of corporate balance sheets, it
is likely to usher in the next down- cycle in
corporate credit quality.
Company balance sheets are for the most

part in good shape. However, we believe management was in many instances traumatized
during the stressed funding environment following on from the Lehman collapse. This was
a period during which access to funding was
severely curtailed, and those able to borrow
were forced to accept very unfavorable terms.
In our view, this has contributed to a shift in
funding preferences in favor of holding a more
ample liquidity position. This likely partly explains the high cash holdings currently sitting
on corporate balance sheets, though we
would also point out that a large share of the
cash is actually held by cash-rich sectors such
CUVGEJPQNQI[JGCNVJECTGCPFGPGTI[
Michael Weber
Auto & Building Materials & Chemicals Research
+41 44 333 54 25
michael.weber@credit-suisse.com
03_US corporates have financial flexibility
04_European corporates a little less
US corporates look to have begun releveraging off of the post-Lehman low,

but still remain below the 25 -year average. Source: DataStream, Credit Suisse
Leverage as measured by net debt / EBITDA is slightly above the 25 -year

average. As a result, European corporates have a little less financial
flexibility compared to their US peers. Source: DataStream, Credit Suisse
times
times
2.2
2.0
3.0
1.8
2.5
1.6
2.0
1.4
1.5
1.2
1.0
1.0
0.5
Jan 90
Jan 94
Jan 98
Jan 02
US net debt to EBITDA, non-financials
Jan 06
Average
Jan 10
Jan 14
Jan 90
Jan 94
Jan 98
Jan 02
Europe net debt to EBITDA, non-financials
Jan 06
Jan 10
Average
Jan 14
40
JOE PR ENDERGA ST chats

with the single European currency
about its birth, existence and
the future of Economic and
Monetary Union (EMU).
J P: It has been said that the euro project

YCUHCVCNN[CYGFCPF[QWCTGFGUVKPGFHQT
failure, as the Eurozone is not an optimal
currency area and your creators did
not anticipate the challenges you would
inevitably face. Is this fair ?
EU RO: It is undeniable that the euro
area is not wholly an optimal single currency
area, but I dont see this as a critical issue.
Is the United Kingdom an optimal currency
area, or was Italy ? The so-called NorthSouth divides are not particular to me.
There were, and still are, missing vital components, of course, but I disagree that this
was not foreseen. At the time of my birth,
I was seen as a step on a journey toward a
fully integrated Europe. The then European
Commission President, Romano Prodi, in an
interview shortly before my notes and coins
were introduced in January 2002 , accepted
that many necessary instruments for
success were missing, but that some day
there will be a crisis, and new instruments
will be added. 1 I dont feel like a failure.
Money talks
In conversation with the euro
J P: That may be seen as a cynical

CPFUGNUJXKGYIKXGPVJGUGXGTGGEQPQOKE
consequences of the crisis.
EU RO: Perhaps, but without EMU
there would also be crises and recessions,
just as there were before me. It is of
course also my view that further European
integration is desirable and ultimately
U VCDKNK\KPICPFUQVJGDGPGVUOWUVCNUQ
be considered.
J P: Despite the crisis of recent years,
your growth seems to be an unstoppable
force in Europe. You now cover 18 countries
and a population of over 330 million. How
far do you think your reach will expand ?
EU RO: Politically, we are reaching
the boundaries of what seems feasible
for the next decade or so. Smaller former
Eastern bloc countries that have built a
record of stability have been absorbed
without any problems. But further expansion to larger EU member countries in
Photo: Pando Hall/Getty Images
this region may take considerably more time

and preparation. The growth of the EU toward the boundaries of the Commonwealth
of Independent States has an increasingly
political as opposed to monetary dimension
and has been one source of rising territorial
tension in the region.
J P: For the existing countries,
do you think the framework now in place
KUUWHEKGPVVQMGGRVJGGWTQCTGCQPC
stable path?
EU RO: Not quite. Against the background of the current debt crisis, important
measures to improve the economic governance in the EU and my area in particular
have been taken. EU member states have
strengthened the Stability and Growth Pact,
introduced a new mechanism to prevent or
correct macroeconomic imbalances, and are
increasingly coordinating structural policies.
But is all this enough to avoid another crisis
at some point ? It may not be. Key structural
reforms are still missing, the euro area
economy is in a weakened state, and many
countries are burdened with excessive
debts. Another global cyclical downswing,
for example, would risk another challenge
to my stability.
J P: Do you have a view on your own
value, say versus the US dollar ?
EU RO: For me the most important
issues of value are the internal ones most
particularly that one euro equals one euro
equals one euro, no matter in which member state I am issued. The notion of the
GWTQCTGCHTCIOGPVKPIQTQHO[FGPKVKQP
being dissolved or diluted may be theoretically possible, but it is not practically so.
I have read a lot of market views on this
topic through the crisis, and I have to say
I like the line of Credit Suisses William
Porter on this: the milk is in the coffee and
it cannot now be practically separated.
External value is a secondary issue, which
HTCPMN[DCHGUOG+NGCXGVJCVVQVJG
experts what do you think ?
J P: Currencies are inherently unpredictable, I agree, but I believe we can make
strong statements about their relative valuaVKQPVJGOCLQTE[ENKECNCPFQYHQTEGUVJCV
drive them, and we know currencies tend to
VTGPFHQTUKIPKECPVRGTKQFUQHVKOG+VJKPM
your recent resilience is understandable in
this context, as the European growth outNQQMJCUKORTQXGFUKIPKECPVN[CPFVJGTKUM
premium associated with EMU and your
existential crisis has faded dramatically. This
has resulted in a large resurgence of capital
KPQYUCVVJGUCOGVKOGVJCVVJGGWTQCTGC
is running a large current account surplus. I
also believe euro area banks cross-border
deleveraging of balance sheets, much of
which is USFQNNCTUJCUIGPGTCVGFUKIPKECPVPGVQYDCEMVQGWTQ$WV+DGNKGXGVJKU
UWTIGKPPGVKPQYUNGCXGU[QWOQFGTCVGN[
overvalued.
EU RO: If that is all true, it sounds like
I could stay overvalued for some time. I am
not sure Mario would approve.
J P: I think it wont last. A trend change
is likely before long, most probably driven by
anticipation of a trend rise in US short-term
interest rates, while euro area key rates stay
very low. In the meantime, as there was remarkably little evidence of large -scale capiVCNQWVQYHTQOVJGGWTQCTGCFWTKPIVJG
crisis, there should be a limit to the current
reversal; and cross-border bank balance
sheet reduction is well advanced. The large
external surplus is likely to persist, but as
this is driven more by an import decline than
an export boom, it will probably prove at
NGCUVFKUKPCVKQPCT[5Q+CITGG'WTQRGCP
Central Bank President Mario Draghi may
not approve and this will continue to maniHGUVKVUGNHKPCTGCVKQPCT[DKCUVQECB monetary policy even as the Fed moves toward
an exit from its unconventional easing program. But we seem to be changing roles
here, so let me pose another question
J P: The European Parliament elections
in 2014 saw a near-doubling of representation of the extreme right and left. Should
we see this as representing an increasingly
popular anti-euro view in Europe?
EU RO: The 2014 European elections
YGTGVJGTUVUKPEGVJGGWTQETKUKUWPHQNFGF
and have understandably shown a large
swing away from the European political center since 2009. Perhaps the most surprising
outcome is how dominant that center remains, for now. If it is to stay that way, the
message of the people must be heard, and
policymakers must react. But, in a currency
union of sovereign states, the largest political risks to me will come from the member
states parliamentary elections, not the
European Parliaments. The single greatest
potential hurdle on this front was the
German elections last year, during which my
name was barely mentioned. More deeply,
at the heart of the political debate lies the
question of what it means to be anti-euro
or anti- EMU. It is not clear, at least to me,
that there are credible policy alternatives
being tabled by anyone on the right or left
41
that offer a better and brighter future for

any individual country, or indeed Europe
collectively.
J P: You mentioned earlier that we cant
rule out a further crisis, say due to a cyclical
economic downswing. Has Europe simply
DGGPRWUJKPIVJGPCNFC[QHTGEMQPKPIHQT
EMU forward ?
EU RO: I really dont think so, but this
is critically dependent upon policymakers
integrating further and, in particular, pursuing both domestic and EMU -wide reforms
more aggressively. And, most importantly,
as and when a true test of commitment to
European integration comes, its vital that all
participants behave reasonably rationally.
These two are really the critical points.
The increasing powers of the European
Parliament and the pragmatic evolution of
ECB policy show that as a vested common
interest grows, so too does the force to
build a much deeper integration in Europe.
This has been a trend since the beginnings
of European integration, with the demise
of the European Monetary System, for
example, leading more rapidly to EMU,
rather than more slowly. In this sense, so
HCTO[ETKUGUQPN[OCMGOGUVTQPIGT
1 Quote from interview with Romano Prodi, December 2001
(cited in the Financial Times, 20 October 2008).
The euro: Not feeling

or looking like a failure
Despite the existential crisis of recent years,
the euro has held in the upper end of its lifetime
range of approximately USD 0.80 and 1.60.
A large euro area current account surplus,
a surge of post-crisis capital inflows, and low
US interest rates have been drivers of the most
recent appreciation. Source: Datastream, Credit Suisse/IDC
USD per euro
1.60
1.50
1.40
1.30
1.20
1.10
1.00
0.90
0.80
1999 2001 2003 2005 2007 2009 2011 2013
Joe Prendergast
Head of Financial Markets Analysis
+41 44 332 83 18
joe.prendergast@credit-suisse.com
42
Has Spanish
competitiveness
become more
German?
01_Harmonized competitiveness
indicators
The ECB (European Central Bank) publishes
competitiveness indicators (the lower the value,
the better). Germany has improved its competitiveness since the Hartz reforms of 2005 .
Spains competitiveness has worsened since
joining the Eurozone, but improved since the
recession and following the reform. Since then,
the country has been regaining ground
vis--vis Germany. Source: ECB, Datastream, Credit Suisse
+PFGZ3
120
110
100
90
80
1999 2001 2003 2005 2007 2009 2011 2013
Spain
+|
n the late 1990 s, the German economy

showed little of the dynamism that
characterizes it today. Unemployment
rose fairly steadily after reunification in
1990, despite comparatively robust GDP
growth during that decade. An ambitious reform program termed Agenda 2010 (a.k.a.
the Hartz reforms), announced in 2003 , tried
to address certain shortcomings of the labor
market. The Agenda 2010 legislation, most of
which had become law by 2005, modernized
the system of public employment agencies,
reduced regulation of certain forms of employment (temporary employment, labor leasing), lowered barriers to layoffs and tied welfare benefits more closely to efforts to find
employment.
Labor market developments since re form
implementation have been impressive: the
number of employed individuals rose to an
all-time high of 42.1 million from 39 million by
the end of 2005, while the unemployment
rate declined from 12.1% to a post-reunification low of 6.7 % by May 2014 . Although
these numbers are indeed impressive, critics
of the reforms argue that the quality of the
new jobs created has been rather weak
focused to a large extent on manual and
low-paid jobs. There may well be some truth
to this claim. For example, the number of employees of so-called labor-leasing agencies
has increased substantially since the market
was opened up.
In response to these criticisms, the German government is currently stepping back
somewhat from the spirit of the Agenda
2010 reforms, e. g. through the introduction
of a federal minimum wage and discussions
Germany
France
about lowering the retirement age for certain

types of employees.
02_Unemployment rates
in Germany and Spain
The 2012 Spanish labor market reform
Since 2005, the unemployment rate in Germany

has nearly halved, also supported by the Hartz
labor market reforms. Following the global
financial crisis, the Spanish unemployment rate
has shot up to levels beyond 25 %, well above
the previous peak in 1994 . Encouragingly,
there have been early signs of improvement
in recent months. Source: Datastream, Credit Suisse
While it took Germany several years to agree

on reforming the labor market, the euro crisis
forced Spain to follow a comparable path
within a much shorter period of time. One of
the key initiatives in this regard was the Spanish labor market reform announced in February 2012. It had a significant impact on labor
costs. Indeed, the OECD estimates that more
than half of the 3.9 % decline in unit labor
costs between Q4 2011 and Q2 2013 can be
attributed to the labor market reform. Among
the key adjustments were improvements in
incentives for firms to hire as well as for individuals to look for work, e. g. by reducing
severance payments and granting firms more
flexibility in adjusting the size of their workforce. However, the reform fell short of (high)
expectations. We view the labor market reform as an important step in the right direction, but we would like to see further progress
on this issue. Still, the OECD estimates that
the undertaking is responsible for the hiring
of 25,000 employees with permanent contracts each month, especially among smalland mid-cap firms. We portray two Spanish
small caps on page 44.
%
30
25
20
15
10
5
0
1992
1997
Spain
2002
2007
2012
Germany
03_WEF competitiveness
ranking puts Germany close
to the top, with Spain still
below its precrisis highs
Germany has been assessed as a very competitive economy over the last eight years, without
any substantial variability in its ranking. Spains
competitive ranking has declined compared
with pre crisis levels, but the 2012 reform and
the improved macroeconomic stability should
lift its ranking back up again. Source: WEF, Credit Suisse
Rank (out of 148)
Bjrn Eberhardt
Global Macro Research
+41 44 333 57 43
bjoern.eberhardt@credit-suisse.com
Javier J. Lodeiro
Banking & Insurance Research
+41 44 334 56 44
javier.j.lodeiro@credit-suisse.com
22
29
22
29
22
29
23
23
23
23
24
42
36
36
35
33
50
2007 2008 2009 2010 2011 2012 2013 2014
Spain
Germany
Eurozone average

1
2
12
11
04_Other factors matter too
10
Apart from an efficient labor market, many other factors also contribute to a countrys overall compet itiveness, among
them openness to constant change and the readiness to work hard to maintain an innovative edge. The World Economic
Forum (WEF ) has ranked countries according to their competitiveness for over a decade, looking at 12 factors to
determine the overall competitive position. 5QWTEG9'()NQDCN%QORGVKVKXGPGUU4GRQTV s%TGFKV5WKUUG
6
7
+PPQXCVKQPFTKXGPGEQPQOKGU
Overall competitive
ranking
1
Institutions
Infrastructure
10
11
12
Macroeconomic
environment
Health and primary

education
Higher education
and training
Goods market
efficiency
Labor market
efficiency
Financial market
Technological
readiness
Market size
Business
sophistication
Innovation
Germany
4th
Ranked
overall. Strong and consistently high
competitive ranking, with even a further improvement in the
most recent ranking.
VJ
Ranked
overall, with a score broadly in line with
similar innovation-driven economies. The burden of government
regulation (tax and labor markets) is cited as being somewhat
problematic. Another area for improvement could be the strength
of investor protection.
TF
Ranked
overall, very strong positioning and above the
average of similar innovation-driven economies. The only weak
rankings in this category relate to quality of the electricity supply
and mobile phone penetration compared with similar economies.
27th
Ranked
overall, better than similar innovation-driven
economies. The ranking in this category is negatively impacted by
the currently elevated level of government debt as a percentage
of GDP.
21st
Ranked
overall, in line with similar innovation-driven
economies, with high scores for quality of primary education and
life expectancy.
TF
Ranked
overall, better than other innovation-driven
economies. High scores for availability of research and training
services as well as the extent of staff training.
21st
Ranked
overall, similar to innovation-driven eco nomies. The taxation and the incentives to invest (including the
process for starting a business) are perceived as areas where
the economy could become even more competitive.
41st
Ranked
overall, similar to innovation-driven eco nomies. To improve the overall competitive positioning of
the country, more flexible wage determination, as well as more
flexible hiring and firing policies, including a reduction of
redundancy costs, would be needed.
29th
Ranked
overall, similar to other innovation-driven
economies. The report claims that more financing flexibility
(loan access, venture capital) and a sounder banking system
could support the overall competitive positioning of Germany.
14th
Ranked
overall, similar to other innovation-driven
economies, with room for improvement in the area of foreign
direct investment and technology transfer.
VJ
Ranked
overall, above the average of other innovationdriven economies.
TF
Ranked
overall, also substantially above the average
of other innovation-driven economies.
4th
Ranked
overall, above the average of other innovationdriven economies, with some bottlenecks apparently existing in
the availability of scientists and engineers.
Spain
VJ
Ranked
overall, still below the pre crisis level of 29,
but above the 2011 low of 42.
VJ
Ranked
overall. Further progress in the overall
competitive ranking might be triggered by more efficient use
of government spending, reducing the burden of government
regulation, and enhancing the protection of minority
shareholders interests.
10th
Ranked
overall, very strong positioning as well,
and above the average of innovation-driven economies. A further
increase in the penetration rate of mobile phone subscriptions
would support overall competitive positioning.
116th
Ranked
overall. Certainly the result of the recession
in Spain, and could improve this ranking to some extent once
cyclical economic headwinds recede. A much better overall competitive positioning would materialize if the central government
budget and debt could be reduced structurally.
VJ
Ranked
overall. Improving the quality of primary
education would enhance the overall competitive positioning.
26th
Ranked
overall. The overall competitive rank could
be improved by more closely aligning the educational system and
the needs of the economy. Notably, a higher-quality educa tional
system in general terms, and in terms of mathematics and
science education, could raise overall competitive rankings.
TF
Ranked
overall. Improvements in the overall competitive ranking could materialize if more efficient antimonopoly
policies were implemented, the process for starting a new business was shortened and taxes were reduced.
VJ
Ranked
overall. The labor reform of 2012 may
improve this overall ranking to some extent. But more must
be done to retain and attract professional talent, for example.
This is definitely an area where the country needs to show
further progress.
97th
Ranked
overall. This overall ranking may improve
to some extent with the cyclical recovery of the banking sector.
In our view, a more normal economic environment is needed
to properly assess this criterion.
26th
Ranked
overall. The overall competitive positioning
could be improved if firms could be incentivized to absorb more
technology.
14th
Ranked
overall, also above the average of other
innovation-driven economies. Further increases in exports as
a share of GDP could raise the ranking.
TF
Ranked
overall. The country ranking could be
improved by higher rankings in categories such as willingness
to delegate.
VJ
Ranked
overall. Research and development is an
area in which the country still needs to improve, as well as the
area of government procurement of advanced tech products.
44
SME 1 AVANZARE
Employees: 35
Export: 40 countries
Export quantities: 50% of total production
Region: La Rioja
City: Navarrete, Logroo
Years active: 10 (since 2004)
SME 2 IMPLASER
Employees: 40
Export: 20 countries
Export quantities: 17% of total production
Region: Aragn
City: Alfajarn, Zaragoza
Years active: 16 (since 1998)
Spains
new businesses:
Small, but erce
Spains SME s are seeing definite signs of economic recovery. Two successful companies
describe their formula for maintaining a going concern. Aside from sheer hard work, inspiration
and expertise (no surprise there), other key factors are innovation and exports.
TEXT AVELINA FRAS

PHOTOGRAPHY ROBERTO CASTELLI
One of the great lessons of the economic crisis for small and mediumsized enterprises ( SME s) in Spain is that market rules are no longer
what they once were. In todays ever-changing and complex world,
staying afloat in the market and remaining competitive in the medium
and long term means that businesses must maintain a global vision
and a flexible approach toward research, development and innovation.
Two of Spains best SME s, based within very different sectors, agree
that the basic formula for economic recovery has two main components:
export and innovation. These components are interdependent. The
first is focused on development within the company, and the second
is geared toward fostering international expansion. In orienting both
of these approaches toward achieving the same goal, these companies have been able to successfully seize windows of opportunity
despite the economic crisis.
45
SME 1
AVANZARE
Our objective is a double

expansion to increase national
sales by 20%, and international
sales by 80%. Export of our
products will continue to be the
main focus for us.
JULIO GMEZ, CEO AVANZARE
46
paniards would find it hard to believe that,

for an SME with only 35 employees, the
economic crisis is already a thing of the
past. This young company has only ten
years of market experience, yet the signs
of economic recovery are becoming increasingly more evident. So far this year,
Avanzare has increased sales and production levels over
those of the same time last year, and hopes to end 2014 with
a further increase of 50%. Exporting the companys products
and continuously investing in innovation have been key to
achieving these results.
Avanzare is considered one of the five most innovative
SME s within Spain and is among the top few in Europe in its
sector. The companys principal activity is the distribution of
graphene (a versatile form of carbon), as well as the fabrication of nanomaterials, nanocomposites and nanoparticles.
These nanoparticles are used to create chemically modified materials that are then employed in the further elaboration of final products used in everyday life, such as those
produced by the automotive, aeronautical, textile, wood, paper, plastics, rubber, construction and packaging industries.
In this way Avanzare acts as a nanointermediary and is
able to maintain a competitive edge within the global market.
Julio Gmez, Avanzares CEO, explains that the companys
activity is similar to that of intermediaries in the pharmaceutical industry, which supply the goods and materials that go
into medicinal drugs.
Avanzare is an obvious example of how exporting national goods and products has helped to dampen the effects
of the economic crisis in Spain. In 2009, when the crisis was
at its peak, 99.5% of the companys market lay outside the
country, which is why Avanzare began to develop its products
mainly for export.
Thanks to an export and investment program offered by
ICEX (the Institute for Foreign Commerce, a government body
that promotes the internationalization of Spanish companies),
Avanzare was able to present industrial-scale use of graphene at international fairs for the first time. The company
subsequently expanded its reach to more than 40 countries,
first within the USA and later within Northern Europe and
Asia.
The increase in export sales in 2013 in turn enabled
Avanzare to expand its employee base by 20%. The Spanish
governments labor reforms made it more flexible for companies to adjust the workforce. The new employment incentives for businesses across the board were also beneficial
for Avanzare, and allowed them to offer new jobs to young
investigators and researchers.
As is typical of the pharmaceutical industry, 35% of
Avanzares budget goes toward research and development.
This is key to remaining competitive on a global level, as well
as to gaining a larger sector of the market. Up until now, the
market has been dominated by big chemical companies with
upward of 50,000GORNQ[GGU
1 Some 35% of Avanzares budget goes toward research and development. 2 Avanzare,
CUCpPCPQKPVGTOGFKCT[qEQORCP[ETGCVGUEJGOKECNN[OQFKGFOCVGTKCNUYKVJPCPQRCTVKENGU
YJKEJCTGVJGPGORNQ[GFKPVJGHWTVJGTFGXGNQROGPVQHPCNRTQFWEVUWUGFKPGXGT[FC[NKHG
3 An increase in international sales in 2013 enabled Avanzare to create new jobs within
the company. 4 Graphene is a form of pure carbon that conducts heat and electricity with
ITGCVGHEKGPE[+VKUTGOCTMCDN[UVTQPICPFNKIJVYGKIJV
100 times stronger than steel).
5 The company exports to more than 40 countries.
47
48
SME 2
IMPLASER
We cant assume that within

the next ten years we are going
to be doing the same thing as
we are now. The world is
moving fast, and if you stop,
trying to get back on can be
quite complicated.
JAVIER ARILLA, QUALITY AND PRODUCTION MANAGER
I
1
1+ORNCUGTRTKPVUVGZVKOCIGUCPFKNNWUVTCVKQPUQPVQOGVCNUCPFCVRNCUVKE
materials, and also manufactures photoluminescent products. 2 The
business is comprised of 2,000 m2 of plant, facilities and storehouse
space. They have invested heavily in preparing their products for the
international market.
49
mplaser was founded in 1998 in Zaragoza. Ever since,

this SME has strived to be a big company, not liter ally
in size, but rather in its approach toward business
challenges.
Acting responsibly and maintaining a long-term
vision are two principles that have helped Implaser to
weather the effects of the economic crisis in Spain. In
the process, the company has innovated and transformed
from the inside out.
Implaser is one of Spains leading silk-screen printing
companies. It prints text, images and illustrations onto metals and flat plastic materials, and also manufactures photoluminescent products. In developing and applying these
photoluminescent products, Implaser has reaped major rewards within the competitive global market.
The company uses photoluminescent LED (light-emitting
diode) hybrid technology to produce individual emergency
and security signage, as well as entire systems of more sophisticated and extensive installations in buildings, industrial
plants, and train and highway tunnels.
The development of these products launched Implaser
on its journey toward exporting, a process that began in
2005 through the PIPE 2000 program, offered by ICEX.
Implaser describes the early days of its expansion as
arduous, long and costly, as it coincided with the peak of
the economic crisis in 2009. Now, however, the company
can see its efforts beginning to bear fruit.
Javier Arilla, quality and production manager, says that
currently 17% of Implasers total turnover comes from the
international market. The company is anticipating a further
20% increase for 2014 .
In the last five years, Implaser has managed to expand
and export to 20 countries on five continents, with Northern
Europe, Asia and Latin America being the companys
main markets.
According to Arilla, facing the economic crisis with a more
dynamic approach was a decisive element for the company.
Implaser invested heavily in preparing its products for the
international market. The company has also used alternative
strategies to better work with the unstable national market,
such as creating parallel lines of business, and investing in
new technologies and research.
These strategies have enabled the company to continue
to create new jobs, primarily for women and young people.
Implaser has progressed from being a company of 34 people
in 2009 to one of 40 in 2014 .
The economic recovery is in sight for this small big enterprise. And although the good news comes mainly from
foreign markets, it is clear to Implaser that this would not
have been possible without the companys dynamic management vision for change from within.
50
3 Photoluminescence is a chemical effect whereby an object absorbs light from the visible spectrum and later
emits it, or glows, for some period of time, in total darkness. 4 The export process requires very careful resource
planning and management from beginning to end. 5 To better face the challenges of innovation, Implaser
has created new jobs for specialized technical employees. 6 6JG[JCXGCGZKDNGYQTMUEJGFWNGCPF60% of
the employees are women. These are some of the keys to an excellent management policy at Implaser.
51
Reference herein to any specific commercial products, process or service does not constitute or imply its endorsement, recommendation or favoring by Credit Suisse or
any of its employees. Neither Credit Suisse nor any of its employees make any warranty, expressed or implied, or assume any legal liability or responsibility for the accuracy,
completeness, usefulness or any information, product or process disclosed.
52
The scope of energy

security in Europe
Energy dependence has long been a known risk: Europe imports more than half of its total energy
needs. Moreover, close to one-third of the regions crude oil imports and two-fifths of its natural gas
imports come from a single trading partner Russia. What are the alternatives, and how viable are they?
NOR
5.8%
64.5%
2014
AM
2.9%
NA
SWE
8.0%
51.0%
RE
ISL
ST
EU28
NO
RD
6.4%
14.1%
P
P
DNK
7.5%
26.0%
2014
P
IRL
NLD
GBR
6.1%
4.5%
POL
BEL
North American
energy exports
DEU
6.1%
6.8%
2015
6.5%
12.4%
CZE
6.7%
11.2%
LUX
5.9%
3.1%
Given its success in shale gas exploration,

expectations were high that the 75# would
contribute to energy security in Europe.
However, although recently debated, 75 exports
of crude oil are still largely prohibited. Aspiring
GZRQTVGTUQHNKSWGGFPCVWTCNICU
.0) still
have to gain approval from the Department
of Energy through a lengthy process, and the
export infrastructure is still in its infancy.
AUT
Gas pipeline routes

Existing
2NCPPGF
Interconnectors
GZKUVKPI
+PVGTEQPPGEVQTU
RNCPPGF
Southern Corridor
Shale gas
extraction 2013
Shale gas basins
$CPPGF/moratorium
Allowed
Allowed and permits issued
Dependency on Russian gas
(as a % of total consumption)
0%: None
120%: Small
2050%: Medium
50100%: High
N/A%
32.1%
HUN
CHE
5.0%
9.6%
NA
21.0%
SVN
8.5%
20.2%
P
FRA
6.4%
13.4%
HRV
6.2%
16.8%
2017
LNG terminal
Import terminal
operational
Import terminal
under construction
5.2%
11.0%
6.1%
4.2%
O PA
6.3%
7.2%
ITA
Oil-drilling zones
Oil-drilling zones in Europe
6.4%
13.5%
PRT
6.6%
24.6%
Political risk in North Africa

Number of events related
VQRQNKVKECNXKQNGPEG
DCVVNGU
civilian killings, riots,
protests and recruitment
CEVKXKVKGU201013.
ESP
7.6%
14.3%
COUNTRY
599
Energy savings potential
CUC % of consumption
in 2016
Share of renewables
CUC % of total energy

EQPUWORVKQP
1,001
34
24
54
72
47
169
25
4
2
54
26
860
120
13
6
MLT
8.2%
1.4%
5
16
432
Crude oil and natural gas

imports of origin country
as a % of total imports, 2013
Energy import dependence

for Europe, 2012
Dependence is high across energy assets.
Given limited tradability, gas is most sensitive
to supply disruption.
Russia is the most dominant trading partner

for both crude oil and natural gas. However,
gas imports are far more concentrated on a small
number of suppliers.
Source: Eurostat
imports as a % of total energy consumption
Source: European Commission, Eurostat
100
L
BR
OT
HE
RH
LIBYA
KAZAKHSTAN
5.9%
35.8%
P
2014
Moscow
LTU
8%
SAUDI ARABIA
ALGERIA
NORWAY
RUSSIA
STREA
NIGERIA
9%
6.5%
21.7%
QATAR
SVK
4.3%
10.4%
SOY
UZ
OTHER
11%
BLUE
ROU
STREA
OUTH
NORWAY
11%
4.5%
22.9%
RUSSIA
32%
BGR
6.0%
16.3%
Tbilisi
Ankara
HER
OUT
R
N CO
RIDO
Baku
TRA NS-C ASP IAN
P
P
GRC
6.3%
13.8%
CYP
5.2%
6.8%
88
14
2,857
390
5QWTEG'PGTI[+PHQTOCVKQP#FOKPKUVTCVKQP+PVGTPCVKQPCN'PGTI[#UUQEKCVKQP)&(5WG\1'%&#TOGF%QPKEV.QECVKQP'XGPV&CVC2TQLGEV
#%.'&'WTQRGCP7PKQP$2%TGFKV5WKUUG
LVA
4%
YA
AZERBAIJAN
D
OO
4%
EST
4.7%
25.8%
12%
Solid fuels
14%
Total energy
6%
Gas
6%
Petroleum
products
NIGERIA
30%
ALGERIA
St. Petersburg
IRAQ
OTHER
36%
3%
20
3%
42
40
4%
53
4%
ANGOLA
OTHER EUROPEAN
COUNTRIES
66
60
5.4%
34.3%
3%
86
80
FIN
53
54
s Europe reconsiders its relationship with Russia amid the crisis in

Ukraine, the issue of energy security and asymmetric dependence
on Russia is now the center of attention. At
a point where the European recovery is still
fragile, the future of energy was high on the
agenda even before tensions rose: the advent
of shale gas in the USA has significantly lowered the relative price of US natural gas vis-vis the rest of the world. The renaissance
of US manufacturing has persuaded some
that the decrease in European competitiveness, paired with the overall effect of higher
energy prices faced by European producers
and consumers, would pose a serious threat
to the European recovery. But how can dependency be reduced ?
New sources of supply: Pipeline illusions
01_Cumulative installed solar capacity (in gigawatts)

Solar installations are predicted to grow at a high rate until 2020 .
Source: European Photovoltaic Industry Association
36.01 80
Germany
Italy
17.61 42
Spain
4.71 18
France
4.70 30
Belgium
2.98 7
UK
2.74 22
Greece
2.59 8
Czech Republic
2.13 4
Romania
Bulgaria
Austria
An obvious solution for Europes dependence

on natural gas imports would be to exploit the
supposedly vast shale gas resources on its
own soil. According to the US Energy Information Administration (EIA), Europe is sitting on
shale resources of 18.1 trillion cubic meters
2011 2020E
Netherlands
Nuclear
26%
2%
22%
25%
Coal
0.69 4
Oil
0.67 8
Gas
0.54 3
Denmark
0.53 1
Portugal
0.28 3
Wind
5%
Slovenia
0.25 1.50
Solar
1%
Other renewables
19%
Poland
05
Sweden
22%
1%
19%
23%
10%
3%
22%
0.04 1
Hungary
0.02 2
0
10
2013
20
30
40
50
60
70
80
2020E
02_Nuclear capacity in Europe (in megawatts)

While nuclear energy remains politically unpopular in Europe, new capacity is being added
in emerging markets. Source: World Nuclear Association
63,130 1,720 1,720 66,570
France
12,003 0 0 12,003
Germany
UK
10,038 0 6,680 16,718
Sweden
9,508 0 0 9,508
Spain
Europe
168,241
139,029
22,240
6,762
7,002 0 0 7,002
Belgium
5,943 0 0 5,943
Czech Republic
3,766 0 2,400 6,166
Switzerland
3,252 0 0 3,252
Finland
2,741 1,700 0 4,441
Bulgaria
1,906 0 0 1,906
Hungary
1,889 0 2,400 4,289
Slovakia
The elusive potential of European shale gas
Source: IEA
1.02 3
Slovakia
A network of pipelines circumventing Russia,

the Southern Corridor, has been proposed in
2008 and is seen by some in Western Europe
as providing diversification of supply. But this
is a complex project and it is unclear that
it will be built soon. One of the key Southern
Corridor projects, the Nabucco pipeline, intended to connect Europe to Caspian gas
assets, was terminated in 2013 . Meanwhile,
South Stream, though not free of issues, is
at a relatively advanced stage and still seems
likely to proceed. Hence, an extended system
of pipelines is unlikely to resolve energy insecurity. In addition, many of the potential partnerships identified by the European Union are
subject to a broad array of uncertainty risk.
Africa, which has major energy assets, is subject to severe political risk (see map). Central
Asia, which holds equal amounts of resources, can easily look eastward to China and the
rest of Asia, where demand will increase
strongly in the coming years. Hopes are high
that the lack of liquidity in the European gas
market will be compensated over time by
the creation of a global infrastructure for tradable liquefied natural gas (LNG). Several
import terminals are currently being built in
Europe (see map), but global export capacity,
including future supplies from the USA , has
yet to evolve.
Electricity generation by source
1.02 5
1,816 942 0 2,758
Romania
World
640,904
374,611
188,755
77,538
1,310 0 0 1,310
Slovenia
696 0 0 696
Netherlands
485 0 0 485
0 0 6,000 6,000
Poland
0 0 1,350 1,350
Lithuania
10,000
Operational
20,000
30,000
Under construction
40,000
2NCPPGF 6QVCN
50,000
60,000
70,000
03_New routes to the

international gas trade
The increase in gas demand, driven by China
and Europe, must be matched by incremental
increases in exports from five key regions:
the USA , Australia /New Zealand, Russia,
Africa and Central Asia. Source: Eurostat
Incremental change
in natural gas trade,
2015 20 (billion cubic meters)
160
Middle East ex. Iran
Latin America
140
Iran
Non- OECD Europe
Europe is not the USA
India
120
or about 10% of global shale gas reserves.

This amount would cover more than 35 years
of Europes current natural gas demand. Despite the groundbreaking results of the shale
revolution in North America, which provided
the necessary technology and know-how,
considerable obstacles stand in the way of
similar success in Europe. To date, broadbased development has been prevented mainly
by environmental concerns over hydraulic
fracturing, the predominant extraction method.
Apart from early shale exploration in Poland
and Romania, the UK is the only European
country where shale resources recently received added support from the government,
including tax advantages for exploration and
planned licensing of shale acreage.
Central Asia
Japan
100
Africa
Other Asia
80
Russia
60
Europe
Australia/NZ
40
20
It has yet to be shown whether European geology is actually viable for commercial shale
extraction and how much of this resource is
ultimately recoverable at a reasonable cost.
In comparison with the USA , Europes much
higher population density, lower level of transportation and processing infrastructure, and
different land ownership structures are further
challenges to be taken into account. While
supply concerns could prompt other countries
to follow the UKs example and rethink their
strategies toward unconventional shale resources, commercial development will take
time and is unlikely to materialize before the
end of this decade.
ambitious, but the alternatives are clearly

too few for policymakers not to take them
seriously.
The case for policy coordination
We have argued that Europe cannot solely

rely on new sources of supply. It should focus
on areas that are in its control. First of all,
policymakers should address the inefficiencies in their fragmented energy network, and
they must be prepared to invest in the infrastructure for pan-European energy flows and
storage. Second, measures toward increased
energy efficiency are central to energy security and should be taken seriously. For years,
energy consumption forecasts have been
factoring in efficiency gains, and Europe
cannot risk falling behind. In the absence of
genuine policy coordination, European member states will continue to be vulnerable to
short-term disruptions in energy markets and
JGPEGJKIJGTGPGTI[RTKEGU
Renewables will continue to play a role

USA
China
Incremental demand
Incremental supply
04_European natural gas

supply breakdown
LNG imports will likely remain a small fraction
of pipeline imports. However, they could prove
pivotal in the event of supply disruptions.
Source: Eurogas, Wood Mackenzie
in million tons of oil equivalent

600
400
200
0
2010
2015E
2020E
LNG net imports Pipeline imports

Indigenous sources
Investors often complain about the degree of

policy uncertainty over different forms of alternative energy. In fact, policymakers have
found it difficult to voice their support for wind
and solar given the short-term benefits of
natural gas and even coal. However, prices for
solar have been falling constantly, and they are
close to becoming cost-competitive in terms
of their levelized cost of energy (the price that
offers a minimum return required to undertake
a project). In addition, nuclear energy which
has historically played a large part in European power generation (see Figure 2) is still
considered unpopular, and new projects face
enormous financing challenges. Hence, renewables are likely to remain an integral part
of the EUs strategy to cope with energy
insecurity and emissions. It has pledged to
increase the share of renewables in total energy consumption from 14.2% today to 20%
by 2020, and plans to increase it further to
27% by 2030 . These targets are certainly
55
Markus Stierli
Head of Fundamental Micro Themes Research
+41 44 334 88 57
markus.stierli@credit-suisse.com
Matthias Mller
Energy Research
+41 44 332 87 20
matthias.mueller.3@credit-suisse.com
Nikhil Gupta
Fundamental Micro Research
+91 22 6607 3707
nikhil.gupta.4@credit-suisse.com
56
European telecom
sector ready
to deploy cash
Light regulation and the EUs single market initiative aim to promote
consolidation and investment in Europes telecom infrastructure.
USA
20
TELECOM PROVIDERS
EUROPE
70
TELECOM PROVIDERS
Currently, more than 70 telecom companies offer their services in 28 European countries.
This compares to less than 20 telecom companies operating in the USA . This fragmented and fiercely
competitive environment has prevented companies from investing in future technologies,
leaving some business models vulnerable to new, disruptive technology.
n environment of globally cheap

PCPEKPIEQUVUCPFITQYKPIEQPdence in economic recovery, along
YKVJURGEKEUVTWEVWTCNHQTEGUGPcouraging consolidation, suggests that the
European telecom mergers and acquisitions
(M&A) DQQOYKNNEQPVKPWG6JGGPXKTQPOGPVKU
an incentive for companies to deploy cash
and improve their return on investment, and
M&A U CTG QPG YC[ QH CEJKGXKPI VJKU +P VJG
year to date, telecommunications has been
one of the most active industries globally,
YKVJQXGTUSD 220 billion in deals. This does
not include one of the biggest transactions
in history, Vodafones 2013 USD 130 billion
sale of its stake in Verizon Wireless. Beyond
the factors driving global M&AXQNWOGUYG
see an additional driver for telecom sector
consolidation in Europe. We believe the
EUoU pUKPING OCTMGVq KPKVKCVKXG YKNN UVKOWNCVG
consolidation and investment in the sector.
We would
like to have
more BMWs
than Fiats in
the European
telecom
sector.
NEELIE KROES
EU Commissioner for the Digital Agenda
EU telecom sector in need of consolidation
Currently, more than 70 telecom companies

offer their services in 28 European countries,
EQORCTGFYKVJNGUUVJCP20 telecom companies operating in the USA . This fiercely com-
57
petitive environment in the EU telecom sector

has prevented companies from investing in
future technologies, leaving some business
OQFGNUXWNPGTCDNGVQPGYFKUTWRVKXGVGEJPQNogy. Since the launch of the iPhone in 2007,
YJKEJ WUJGTGF KP C PGY GTC QH UOCTVRJQPG
penetration and the mobile Internet, free cash
HNQY IGPGTCVKQP KP VJG UGEVQT JCU FGENKPGF
from EUR 55 billion to EUR 32 billion at the
end of 2013 . The market capitalization of the
nine largest EU VGNGEQO EQORCPKGU
YJKEJ
reflects 87% of total EU telecom market
capitalization) has decreased by EUR 220 billion, during the same period as Apple gained
EUR 320 billion of market value. High-margin
voice and SMS sales have been displaced by
mobile Internet apps such as WhatsApp. In
CFFKVKQPVQVJGUVTWEVWTCNEJCPIGUVJGYGCM
economic environment, fierce competition
and regulatory impacts (e.g. mobile terminaVKQP CPF TQCOKPI VCTKHH EWVU YGTG CNUQ C
JGCFYKPFVQGCTPKPIUCPFEQPVTKDWVGFVQVJG
decline.
EU moves trigger M&A s and investments
The EU telecom authorities launched the

single market initiative in March 2013 . >
01_Market value of European telecom operators hurt by smartphones

and the mobile Internet
The launch of the iPhone ushered in the age of the smartphone displacing traditional sources of revenue
and significantly decreasing the value of the EU telecom market. Recent EU initiatives have helped the sectors
valuation to recover. Source: Datastream, Credit Suisse
2007:
in USD bn
USD 320 bn
iPhone
launch
800
in %
Apple gains
70
in market cap
60
700
600
50
500
40
400
30
300
Photos: Apple, Wikimedia Commons
20
EU telecoms lose
USD 220 bn
200
in market cap
10
100
0
2006
2007
Apples market cap
2008
2009
2010
Aggregate market cap of five European incumbents
2011
2012
European Smartphone penetration (r.h.s.)
2013
2014
58
02_European M&A activity

driven mainly by telecoms
Global M&A activity in 2014 features a number
of big headline deals and multiyear highs for
total deal volumes. The recovery in European
deal volumes is particularly pronounced.
M&A activity on the rise
(in USD bn)
2,500
600
500
2,000
400
1,500
300
1,000
200
500
100
0
06.02
06.08
06.14
Western Europe volume (r.h.s.)

Western Europe deal count
03_FCF generation in the

European telecom sector
in EUR bn
The initiative highlighted the need to strengthGPVJGVGNGEQOUGEVQTYJKEJRNC[UCPKORQTtant role in the economy, and needs investment to maintain its competitive position and
state -of-the -art communications infrastructure for Europe. A so-called light regulatory
CRRTQCEJ HQT VJG YKTG NKPG DWUKPGUU KU KPtended to stimulate investment in broadband
KPHTCUVTWEVWTG CPF IKXG ITGCVGT NGGYC[ VQ
consolidation among European telecom markets. The regulations have had an immediate
KORCEVYKVJ CNOQUV CNN 'WTQRGCP VGNGEQO
operators increasing their capital expenditure
guidance. This increase reflects the confidence of companies that investments in future technology should result in higher returns
on invested capital. While some have expressed fears about rising prices for consumGTUYGDGNKGXGVJGRQNKVKECNYKNNVQKPEGPVKXK\G
HWVWTGVGEJPQNQI[KPXGUVOGPVUYKNNJGNRURWT
the European recovery and could lead to a
gradual re -rating of European telecom sector
stocks over the next five years.
Recovery could yield over EUR 60 billion
Based on the nine largest EU telecom operators,

representing 87% of EU telecom market value
The decline in free cash flow generation has

prompted politicians to act. State -of-the -art
communications and high-speed Internet access
are key components of a competitive European
landscape. Source: Company data, Credit Suisse
While a number of uncertainties remain, including discussions over roaming tariff cuts
CPF PGVYQTM PGWVTCNKV[ EU telecoms have
already begun to position themselves for a

more business-friendly environment. M&A
activity has risen materially, and domestic
consolidation has already taken place in
Austria, Ireland and France. At the time of
YTKVKPIVJGOGTIGTQHE -Plus and Telefnica
&GWVUEJNCPF JCU PQV DGGP CRRTQXGF YJKNG
consolidation is still expected in Spain, Italy
and other European countries. Cable operators are also engaged in the consolidation
trend. Vodafone, for example, recently acSWKTGFVYQECDNGEQORCPKGU-CDGN&GWVUEJland and Ono, thus improving its converged
offering in Germany and Spain. Based on our
estimates, the total cost synergies and value
creation from consolidation could exceed
EUR 60DKNNKQPHQTVJGOCTMGV
Uwe Neumann
Technology & Telecom Research
+41 44 334 56 45
WYGPGWOCPP"ETGFKVUWKUUGEQO
Dan Scott
Investment Strategy & Research
+41 44 334 56 33
FCPUEQVV"ETGFKVUWKUUGEQO
FCF continues to decline

60
58
50
56
47
49
40
44
37
30
32
30
13A
14E
20
10
0
07
08
09
10
11
12
05_European wireless equipment market to outgrow

Asia and the USA
European telecom companies have increased capex significantly. Investment in the quality
QHPGVYQTMUKUGZRGEVGFVQRC[QHHKPCNGUUTGIWNCVGFCPFOQTG EQPUQNKFCVGFOCTMGV
FCF generation in the EU telecom sector

in EUR bn
Source: Company data, Credit Suisse
in %
04_Potential value of market

recovery in EUR bn
20
19 %
18
Market recovery value through domestic

consolidation is a function of potentially rising
RTKEGUJKIJGTUCNGUCPFEQUVU[PGTIKGUYJKEJ
affect EBITDA and FCF generation positively.
Source: Arthur D. Little, Credit Suisse
16
14
10
EU market recovery values
16
13 %
12
12 %
13 %
11%
10 %
10 %
7%
6%
6
12
4
8
3%
0%
1%
2011
FR
DE
IT
ES
UK
NL
BE
SE
DK
AT
US
2012
Asia Pacific
Western Europe
2013
2014E
59
Investor know-how
Ratings
and risks
Valuation is not an exact science and there is no single approach that can accurately assess whether
an asset is fairly priced without making assumptions. Sometimes markets are driven more by liquidity
and sentiment rather than fundamentals, but it is in such cases when well-researched valuation analysis
can prove most useful in helping investors identify opportunities and avoid risk.
VALUATION
What is a fair price for an asset ? This question

has spurred the creation of a multibillion dollar industry that tries to identify the intrinsic
value of assets and benefit from possible
mispricings. There are numerous valuation
methodologies, of which discounted cash flow
and relative valuation are the most commonly used. All methodologies share some principles, but they can yield very different results.
The most commonly used method is relative valuation, whereby the market price of a
security is compared to the price of other assets. Security prices are standardized using
one or more variables, such as earnings or
book value. Metrics like earnings are relatively volatile, which is why some practitioners
prefer to use averages or forecasts. The
Shiller price -earnings (P/E) ratio, for example,

uses real earnings averaged over 10 years.
Valuation multiples are often compared to
their own history or those of comparable
secu rities, but the time horizon used can
provide conflicting results. For example, at
the time of writing, the 12 -month forward P/E
ratio of the S&P500 is well above its 10 -year
average, but is in line with its 20 -year average.
While this type of analysis is intuitive and
simple to use, it has significant limitations as
it assumes that fundamental conditions do
not change over time and/or that other assets
are fairly valued. In addition, there is no guarantee that valuations will immediately revert
to their mean: the Shiller P/E ratio has been
above its 144 -year average value 96% of the
time in the last 20 years. Comparable assets
are not always easy to find, different multiples
ECPRTQFWEGEQPKEVKPITGUWNVUYJKNGVJGTGKU
UKIPKECPVUWDLGEVKXKV[QXGTYJGVJGTCUGEWTKV[
should trade at a premium or discount.
Another common valuation methodology
is the discounted cash flow model, which
estimates an assets intrinsic value by
F KUEQWPVKPI KVU RTQLGEVGF ECUJ HNQYU +VU
advantage is that it is very versatile and
can be tailored to different types of assets
(e.g. non-public assets), market conditions

(e.g. liquidity), contexts (e.g. corporate mergers) and investment horizons.
The cash flows of some assets like Treasury bills and bonds are relatively certain, but
this is not the case for most assets like equiVKGU+PVJGNCVVGTECUGKPXGUVQTURTQLGEVECUJ
flows by making assumptions that can vary in
complexity and depth. Alternatively, it is also
possible to apply a constant growth rate to
future cash flows, a method commonly used
HQTRTQLGEVKQPUCVVJGCUUGVENCUUNGXGNQTHQT
cash flows that are far into the future.
The second component of the discounted
cash flow is the discount rate, which is at the
heart of finance theory and represents the
expected rate of return on the asset, given
its risk. Discounting reflects two key assumptions: cash flows become less valuable as
time passes, and investors prefer safer over
riskier cash flows. Estimating this has become
somewhat of a Holy Grail in the financial industry, as no single model provides a definitive answer as to what the rate should be. The
Capital Asset Pricing Model is the most
popular approach to evaluating assets and
won its originators the Nobel Memorial Prize
in Economic Sciences. It postulates that >
60
01_US real equity returns

A popular way of assessing valuation is to compare the market level to its long-term trend, which is associated with potential growth. A buy or sell signal
is triggered when equities have deviated significantly from their trend. Markets can remain at such levels for long periods, so momentum can also
be factored in. Wars and economic depressions may have permanent negative effects on a markets potential level, meaning that it is not always correct
to extrapolate the past. Source: Datastream, CS Global Strategy/IDC
Index level (log scale)
Trend = 6.2%
Standard deviation = 33.9%
16
Secular bull
24 yrs
Aftermath
12 yrs
Reflation
13 yrs
Inflation/war
14 yrs
Bubble Deflation/war
9 yrs
14 yrs
Secular bull
27 yrs
Stagflation
14 yrs
Secular bull
16 yrs
11.1%
8.3%
2.9%
8.3%
1.3%
22.4%
2.5%
9.5%
2.8%
12
10
Aftermath
13.6%
14
Panic
8 yrs
1869
1849
1889
1909
1929
1949
1969
1989
2009
US long-term real equity returns (log level index returns per annum)
02_US discount rate (January 1976 June 2014)

6JGKORNKGFFKUEQWPVTCVGEQODKPGUTGNCVKXGXCNWCVKQPYKVJECUJHNQYCPCN[UKUCUKVGORNQ[UECUJHNQYRTQLGEVKQPUVQFGTKXGVJGKORNKGFEQUVQHECRKVCN
The Credit Suisse HOLT discount rate also factors in inflation and differences in accounting standards, which makes it a powerful valuation tool.
Source: Credit Suisse HOLT
US discount rate (%)
8
7
6
Tech bubble bursts
4WUUKCPFGHCWNV.6%/HCKNU
10
1998
2000
Current DR: 4.3

90th percentile: 7.6
Median: 5.7
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
Note: Excludes financials and regulated utilities
US discount rate
10th percentile VJRGTEGPVKNG /GFKCP 75th percentile
90th percentile
1996
2002
European debt crisis
Credit crisis
9/11 attacks
/GZKECPRGUQETKUKU
Kuwait invasion
$NCEM/QPFC[
/GZKEQFGHCWNVU
1981 recession
Energy crisis
1980 recession
Enron, WorldCom
2004
2006
2008
2010
2012
2014
the expected return of an asset is a function

of the risk-free rate, the risk premium of a
diversified (market) portfolio and how much
risk the asset contributes to this portfolio
(also known as beta).
In practice, the risk premium is often inferred from history. According to the Credit
Suisse Investment Returns Yearbook, which
provides estimates of risk premia for different
asset classes since the start of the 20 th century, global equities have generated a return
of 4.3% in excess of the risk-free rate (the
US Treasury bill), while the excess returns on
US equities have been 5.5%. Practitioners
often compare asset returns or yields to the
long-term trends in order to understand the
impact that positive and negative economic
shocks can have on valuations. At the time of
writing, US equities are slightly above their
trend since 1849, but not excessively so. As
Figure 1 suggests, equities can spend entire
decades above or below trend.
Some valuation methodologies estimate
the discount rate by reversing the problem of
asset pricing: instead of estimating the fair
price of an asset, they estimate the rate that
makes discounted cash flows equal the market price for the asset class (see Figure 2). This
ECPVJGPDGCRRNKGFYKVJUQOGCFLWUVOGPVU
at the single security level (a method used by
Credit Suisse HOLT ). Alternatively, it can be
compared to its own history, as well as other
financial variables like implied volatility and
credit yields to gauge whether an asset is
fairly valued and to conduct scenario analyses
(a method favored by Credit Suisse strategists). HOLTs implied discount rate methodology indicates that equities are currently
trading at a premium relative to their historic
average but at a discount relative to government bonds.
Choosing between competing methodoloIKGU TGSWKTGU C FGITGG QH LWFIOGPV CPF KU
often determined by data availability. No
valuation methodology is ironclad as they all
TGSWKTGCUUWORVKQPUVJCVCTGUWDLGEVKXG;GV
they are extremely useful for investors who
use them properly and are able to understand
VJGKTNKOKVCVKQPU
61
BOND SPREADS
TEXT JAMES GAVIN

Sovereign bond spreads are the difference
between yields issued by governments with
high and low credit ratings. Bonds that have
a lower rating for example in an emerging
market carry a higher yield due to the perception of additional risk involved in buying
the debt. Widening or narrowing spreads can
reflect perceived differences in central bank
policies as well as economic growth prospects. Bond spreads are therefore used to
compare risk between markets.
A bond yield mainly has two components
interest rate risk and credit risk (plus a bit of
liquidity risk). Some investors are happy to
carry all the risk, but when interest rates are
expected to rise, bond prices fall, leading to
capital loss. Consequently, investors may
try and strip out the interest rate risk by
hedging or doing long-short trades on bonds
(or combinations of bond and credit default
swaps). Thus they get exposed only to

credit risk.
There are several techniques for measuring spreads. One is by yield differential, i.e.
calculating the difference between equivalent sovereign notes. The second is by the
so-called credit default swap (CDS) differential. The first method is based on traded
prices, for example, 10 -year government
bonds are physically traded in the market,
providing a physical price signal. The second
is a derivative.
The sovereign CDSOCTMGVKUPQYCOCLQT
component of capital markets, providing a
means for estimating individual sovereign
risk by taking out insurance against default:
the buyer pays a default swap premium,
usually expressed in terms of basis points.
Typically, CDS trading volumes are much
higher, react more rapidly, and at times are >
The role of rating agencies: Chicken or egg?

The narrowing of bond spreads in 2014 bears a relation to the trajectory of the European
economic recovery, with growing belief that the worst is over. The yield story says much
about investor sentiment and the urgency with which many are looking for yield including
KPGEQPQOKGUVJCVTGOCKPKPCEJCNNGPIGFUECNUKVWCVKQP
That bullish sentiment, though, is based at least in part on signals provided by the
KPVGTPCVKQPCNETGFKVTCVKPICIGPEKGU/QQF[oU5VCPFCTF2QQToUCPF(KVEJ%TGFKVTCVKPIUJCXG
CENGCTKPWGPEGQPDQPFURTGCFURCTVKEWNCTN[QXGTVJGNQPIVGTO
Sovereign investment grade status is often associated with lower spreads in international
markets. In a study of 35 emerging markets between 1997 and 2010, the International
/QPGVCT[(WPF
+/( found that investment-grade status reduces spreads by 36%, above and
beyond what is implied by macroeconomic fundamentals.
The decline in European periphery yields follows positive ratings assessments, such as
Fitch Ratings increasing its risk rating for sovereign debt in Greece and Spain and announcing
an improvement in its outlook for Ireland, Cyprus, Italy and Portugal.
Investors rebalance their portfolios across markets to reduce exposure to riskier borrowers,
and they factor in the rating agencies assessments. But there is a chicken-and-egg situation.
In general, credit ratings tend to be slow and reactive, and spread movements lead to rating
Antonios Koutsoukis
Fundamental Micro Themes Research
+44 20 7883 66 47
antonios.koutsoukis@credit-suisse.com
changes, rather than the other way round. So spread changes can become a leading indicator
of fundamental improvement signals in an economy, which ultimately leads to rating changes.
62
a better reflection of market sentiment and

market pricing. Bonds, on the other hand, can
become illiquid under certain conditions.
Spreads track Eurozone fall and rise
The contraction in sovereign bond spreads

seen in some early months of 2014 between
states of the European periphery Portugal,
Spain, Greece, Italy and Ireland and core
Eurozone economies like Germany has highlighted positive investor reaction to signs of a
recovery under way in formerly struggling
economies such as Portugal and Ireland.
Portugal, which entered a bailout program
in 2011, has experienced a sharp fall in sovereign bond yields, which dropped from 6.2%
at the end of 2013 to 5.3% in January 2014 ,
to 3.5% in early May. Even Greece, in its first
sortie into the debt capital market, managed
to raise EUR 3 billion in five -year bonds in
April, with a yield below 5%.
Investors have moved into Eurozone
periphery bonds, helping bring yields down
to levels not seen for more than a decade. In
DIFFERENCE IN YIELD
DEFINES SPREAD
The difference in yield among variously
TCVGFIQXGTPOGPVDQPFUFGPGU
VJGURTGCF(QTGZCORNGQP/C[)GTOCP
yields were 1.47%, whereas the equivalent
Italian yield was 3.02%. This 155-basispoint difference represents the desired
premium or spread that investors
ask to hold for the perceived higher-risk
Italian sovereign paper, as compared
to the better-rated German bunds.
early May, yields on 10 -year Italian government bonds fell to near 3%, the lowest on
record. Spains 10 -year bond coupon dropped
below the 3% mark, but Irelands yields
have declined the most, reaching 2.74% in
early May.
The way spreads have contracted shows
that investors now require less yield to hold
the debt of European periphery states. The
spread in early May that investors demanded
for Spains 10 -year bonds, compared to
equivalent-tenor German debt, shrank as
much as 6 basis points to 146 basis points
the narrowest since August 2010.
Sentiment is clearly playing a role in driving this process, with investors taking a cue
from signals of an ongoing economic revival
and reduced volatility. On 5 May, Portugal
announced it was ready to exit its three -year
bailout program, an indication of its slow
emergence from the financial crisis. Many
investors who were put off from investing in
lower-rated European sovereign paper have
found reassurance in the commitment of the
European Central Bank ( ECB) to support
these economies come what may.
A mixture of more favorable fundamentals
and reviving investor sentiment has combined
to shift allocations toward the likes of Portugal and Italy. Investors hunger for yield is
clearly pushing them back to these markets,
given the lack of adequate returns elsewhere.
For example, Germanys benchmark 10 -year
yield stood at 1.46% in early May, a level
offering too little reward for the risk.
Investors also see an environment where
there is a higher risk of deflation than inflation. The decline in bond yields witnessed in
How shifts in the investor base affect spreads

5JKHVUKPVJGNQECNKPXGUVQTDCUGOC[CNUQDGKPWGPEKPIVJGFGENKPGKPDQPF[KGNFU#EEQTFKPI
to an +/(UVWF[HTQO(GDTWCT[HQTGKIPKPQYUVQVJGUSA , UK and core euro area countries
CRRNKGFFQYPYCTFRTGUUWTGQPUQXGTGKIPDQPF[KGNFUFWTKPIVJGPCPEKCNETKUKUYJKNGHQTGKIP
QWVQYUTGUWNVGFKPWRYCTFRTGUUWTGKPVJGRGTKRJGT[GWTQCTGCEQWPVTKGU#TKUKPIHQTGKIPUJCTG
QHIQXGTPOGPVFGDVJQNFKPIUKUCUUQEKCVGFYKVJCUVCVKUVKECNN[CPFGEQPQOKECNN[UKIPKECPV
decline in long-term sovereign bond yields.
The +/(PQVGUVJCVVJGKPETGCUGKPHQTGKIPKPXGUVQTUKPVJGCHVGTOCVJQHVJGINQDCNPCPEKCN
crisis contributed to a decline in the long-term sovereign bond yields in the USA , UK and
) GTOCP[QH s sCPF s DCUKURQKPVUTGURGEVKXGN[+PEQPVTCUVVJGQWVQYQH
foreign investors contributed to an increase in long-term sovereign bond yields in Spain and Italy
of 110 180 and 40 70 basis points, respectively. The +/( study suggests that normalization
QHOCETQGEQPQOKEOQPGVCT[CPFUECNRQNKE[FGVGTOKPCPVUQHDQPF[KGNFUOC[DGKPUWHEKGPV
to bring long-term rates back to their precrisis level unless this is accompanied by a similar
normalization of the foreign investor base.
CREDIT DEFAULT SWAPS

Before the 200INQDCNPCPEKCNETKUKU
sovereign CDS markets were not
EQPUKFGTGFUWHEKGPVN[NKSWKFVQRTQXKFG
an accurate measure of developed
GEQPQOKGUoUQXGTGKIPTKUM
The post-Lehman environment changed that,
with an increase in CDS trading volumes.
According to data from the Bank of
+PVGTPCVKQPCN5GVVNGOGPVUKPVJGTUVJCNH
of 2010 sovereign CDSs accounted for
13% of total CDSs, whereas at the beginning
QHVJGETKUKUVJKUIWTGUVQQFCVQPN[6%.
Sovereign CDS premiums rose most
sharply in the European periphery
economies most affected by the crisis.
year-to-date 2014 reflects in part the fact

that investors are betting that the ECB will
begin printing money, after comments from
President Mario Draghi that unconventional
measures might be considered to stop inflation falling further.
However, there is some evidence of
greater appetite from European periphery
investors for sovereign paper in their own
markets. There are reports that insurers in the
Eurozone periphery, which rely on sovereign
bonds to match their liabilities, have been
KPXGUVKPIJGCXKN[KPDQPFUKPVJQUGOCTMGVU
63
Photos: Martin Stollenwerk
Authors
Michael Ghler
Thomas C. Kaufmann
Co-Head Global Equity & Credit Research ..................

michael.gaehler@credit-suisse.com ...........................
+ 41 44 333 51 84 ....................................................
Pharmaceuticals Research ........................................

thomas.c.kaufmann@credit-suisse.com .....................
+ 41 44 334 88 38 ...................................................
Michael Ghler is Co-Head of Global Equity & Credit

Research at Credit Suisse Private Banking and Wealth
Management, covering European Utilities. Previously,
he was Head of Global Infrastructure Credit & Equity
Research, having joined Credit Suisse in 2004 .
He holds a Master of Business Administration and
Economics from the University of Zurich, Switzerland,
and is a CFA charterholder. > Pages 15 17
Thomas C. Kaufmann joined Credit Suisse Private

Banking in 2006 as an equity analyst for nanotechnology in the healthcare sector. He is now senior
research analyst for the global pharmaceuticals sector
and is also in charge of research on the megatrend
topic of Innovation. He holds a Master of Science in
Biochemistry and a PhD in Biophysics, both from the
University of Basel, Switzerland. > Pages 26 29
Oliver Adler
Nikhil Gupta
Ulrich Kaiser
Head of Economic Research .....................................

oliver.adler@credit-suisse.com ..................................
+41 44 333 09 61 ....................................................
Fundamental Micro Research ....................................

nikhil.gupta.4@credit-suisse.com ..............................
+91 22 6607 3707 ..................................................
Technology & Media Research ....................................

ulrich.kaiser@credit-suisse.com ................................
+ 41 44 334 56 49....................................................
Oliver Adler is Head of Economic Research at Credit

Suisse Private Banking and Wealth Management.
He has a Bachelors degree from the London School of
Economics as well as a Master of International Affairs
and a PhD in Economics from Columbia University
in New York, USA . > Pages 04 10, 1214, 32 35
Nikhil Gupta joined Credit Suisse Private Banking

and Wealth Management in 2011, and is currently part
of the thematic research team. He has six years of
experience, which encompasses consulting and
financial research. He is a postgraduate from the Indian
School of Business, Hyderabad. > Pages 52 55
Ulrich Kaiser is a senior research analyst in the Global

Equity and Credit Research team at Credit Suisse
Private Banking and Wealth Management, covering the
IT services and software, hardware and media sectors.
He joined Credit Suisse in 1993 , initially working in
Japanese Equity Research. He is a CEFA charterholder
and holds a Master of Economics from the University
of Constance in Germany. > Pages 26 29
Bjrn Eberhardt
Reto Hess
Stefanie Kluge
Global Macro Research .............................................

bjoern.eberhardt@credit-suisse.com ..........................
+ 41 44 333 57 43 ....................................................
Auto & Capital Goods Research ..................................

reto.hess@credit-suisse.com ....................................
+ 41 44 334 56 24 ....................................................
Consumer Discretionary & Retail & Industrials Research

stefanie.kluge@credit-suisse.com .............................
+ 41 44 332 03 74 ....................................................
Bjrn Eberhardt is Head of Global Macro Research

at Credit Suisse Private Banking and Wealth
Management. He joined Credit Suisse Group in 2011
after working as a financial markets analyst and
mutual fund manager at Luzerner Kantonalbank.
He holds a PhD in Economics from the University of
Wisconsin-Milwaukee and a Diploma in Economics
from the University of Potsdam, Germany, and he is
a CFA charterholder. > Pages 04 10, 42 43
Reto Hess is a senior research analyst at Credit Suisse

Private Banking and Wealth Management, covering
the European, North American and Japanese automotive and capital goods sectors. He is a CFA and CAIA
charterholder and has a Master of Science from the
University of Zurich, Switzerland. > Pages 2223, 30 31
Stefanie Kluge joined the Global Equity and Credit

Research team at Credit Suisse Private Banking and
Wealth Management in 2014 . Prior to this, she worked
in the Institutional Clients department as a junior
consultant. She holds a Master of Science in Banking
and Finance from the University of Applied Sciences
in Winterthur, Switzerland. > Pages 30 31
Dominik Garcia
Philippe Kaufmann
Antonios Koutsoukis
Real Estate & Emerging Markets Research ..................

dominik.garcia@credit-suisse.com .............................
+ 41 44 334 25 38....................................................
Global Real Estate Research .....................................

philippe.kaufmann. 2@credit-suisse.com ....................
+ 41 44 334 32 89 ...................................................
Fundamental Micro Themes Research ........................

antonios.koutsoukis@credit-suisse.com .....................
+ 44 20 7883 66 47 .................................................
Dominik Garcia is a research analyst in Global Equity

and Credit Research at Credit Suisse Private Banking
and Wealth Management, focusing on global real estate
and emerging market financials. Before joining Credit
Suisse in 2010, he worked as an analyst in product
management at the largest Swiss life insurance company.
He holds a Master of Banking and Finance from
the University of Zurich, Switzerland. > Pages 24 25
Philippe Kaufmann is Head of Global Real Estate

Management, where he also worked for Swiss Real
Estate Research for six years. Before joining Credit
Suisse in 2007, he worked for a policy consulting firm
and an economic research company. He holds a
Master of Economics from the University of Fribourg,
Switzerland. > Pages 24 25
Antonios Koutsoukis is a research analyst in Fundamental Micro Themes Research. His areas of responsibility include thematic strategy and megatrends
research. Antonios Koutsoukis holds an MS c in Finance
from Cass Business School and a BS c in Economics
and Economic History from the London School of
Economics, United Kingdom. > Pages 59 61
64
Javier J. Lodeiro
Roman Ochsner
Markus Stierli
Banking & Insurance Research ...................................

javier.j.lodeiro@credit-suisse.com ..............................
+ 41 44 334 56 44 ...................................................
Junior Research Analyst ...........................................

roman.ochsner@credit-suisse.com ............................
+ 41 44 332 03 72 ....................................................
Head of Fundamental Micro Themes Research ...........

markus.stierli@credit-suisse.com ..............................
+ 41 44 334 88 57 ....................................................
Javier J. Lodeiro joined Credit Suisse in 2010 as

research analyst responsible for the global insurance
sector and US banks, and now heads the Global
Research Financials team. He has 18 years of
experience as a buy- and sell-side analyst. He holds
a Master of Economics from the University of Bern,
Switzerland, and is a CFA and FRM charterholder.
> Pages 42 43
Roman Ochsner joined the Global Equity and Credit

Research team at Credit Suisse Private Banking
and Wealth Management as a Career Starter in 2013 .
He covers European asset managers and banks.
Before joining as a Career Starter, Roman interned
with UBS IB and Credit Suisse Investor Services.
He is a graduate of the University of St. Gallen,
Markus Stierli is Head of Fundamental Micro Themes

Management. His team focuses on long-term investment
strategies, including sustainable investment and global
megatrends. Before joining the bank in 2010, he taught
at the University of Zurich. He earlier worked at UBS
Investment Bank. He holds a PhD in International
Relations from the University of Zurich. > Pages 52 55
Romano Monsch
Joe Prendergast
Michael Weber
Consumer Staples Research .....................................

romano.monsch@credit-suisse.com ...........................
+ 41 44 332 90 59....................................................
Head of Financial Markets Analysis ...........................

joe.prendergast@credit-suisse.com ...........................
+ 41 44 332 83 18 ....................................................
Auto & Building Materials & Chemicals Research ..........

michael.weber@credit-suisse.com .............................
+ 41 44 333 54 25....................................................
Romano Monsch joined the Global Equity and Credit

Research team at Credit Suisse Private Banking and
Wealth Management in 2013 and covers the consumer
staples sector. He holds a Master of Science in Sustainable Development with a Major in Economics from
the University of Basel, Switzerland. Before joining
Credit Suisse, he was a sustainability analyst for different companies in the financial industry. > Pages 30 31
Joe Prendergast is Head of Financial Markets Analysis

at Credit Suisse Private Banking and Wealth Management and also a member of the Credit Suisse Investment
Committee and the Global Economics and Strategy
Group. He holds a BA in Pure Economics from University College, Dublin, Ireland, and a Master of Science
in Economics from the London School of Economics
in the United Kingdom. > Pages 40 41
Misha Weber is a senior research analyst at Credit

Suisse Private Banking and Wealth Management,
responsible for covering various cyclical sectors.
He holds a Bachelor of Commerce from the University
of New South Wales, Sydney, Australia, as well as a
Graduate Diploma in Applied Finance & Investment
from the Financials Services Institute of Australasia.
Matthias Mller
Dan Scott
Energy Research .....................................................

matthias.mueller.3@credit-suisse.com .......................
+ 41 44 332 87 20 ...................................................
Investment Strategy & Research ................................

dan.scott@credit-suisse.com ....................................
+ 41 44 334 56 33 ...................................................
Matthias Mller is a research analyst in the Global

Equity and Credit Research team at Credit Suisse
Private Banking and Wealth Management, responsible
for covering the energy sector. He joined Credit Suisse
in 2007, initially working in the Investment Fund
department. He holds a Master of Science in Banking,
Finance and Controlling from the University of Basel,
Dan Scott is a research analyst with over ten years

of capital market experience. Dan Scott is in charge of
key Investment Strategy & Research initiatives including
the Credit Suisse Top Investment Ideas, Dividend
Strategies, the Top 30 (a managed portfolio that reflects
Credit Suisses equity strategy), the M&A15 (a list of
equities set to benefit from M&A activity), and is the
metals and mining sector specialist. > Pages 56 58
Uwe Neumann
Christine Schmid
Technology & Telecom Research ................................

uwe.neumann@credit-suisse.com..............................
+ 41 44 334 56 45 ...................................................
Co-Head Global Equity & Credit Research ..................

christine.schmid@credit-suisse.com ..........................
+ 41 44 334 56 43 ...................................................
Uwe Neumann is a senior research analyst in the Global

Equity and Credit Research team at Credit Suisse Private Banking and Wealth Management, covering the
telecom and technology sector. He joined Credit Suisse
Private Banking in 2000 and has 28 years of experience in the securities and banking business, including
18 years in research. He holds a Master of Economics
from the University of Constance, Germany, and is a
CEFA charterholder. > Pages 56 58
Christine Schmid is Co-Head of Global Equity &

Credit Research at Credit Suisse Private Banking and
Wealth Management, covering financials. She has
covered financials for 15 years and coordinates the
global financial view. She joined Credit Suisse in 1993
in accounting, and later portfolio management. She
holds a Master of Economics from the University
of Zurich, Switzerland, and is a CFA charterholder.
> Pages 18 21
> Pages 36 39
Risk disclosure
Investors should consider this report as only a single factor in making their investment
decision. For a discussion of the risks of investing in the securities mentioned in this report,
please refer to the following Internet link:
https://research.credit-suisse.com/riskdisclosure
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Global Investor 1.

14, August 2014

From crisis to opportunity

Oliver Adler Charting a sustainable path to European reform and recovery.

The milk is in the coffee and cannot now be practically separated.

Important disclosures are found in the Disclosure appendix.

Photos: Martin Stollenwerk, Chou Chiang

GLOBAL INVESTOR 1.14

Responsible for coordinating the focus

GLOBAL INVESTOR 1.14

Toward a less imperfect

TEXT OLIVER ADLER

GLOBAL INVESTOR 1.14

The crisis in the Eurozone is often regarded as

Source: EU Commission, Datastream, Credit Suisse

Source: Datastream, Credit Suisse

2QTVWICN +VCN[ Greece

With devaluation and currency risk apparently

UGG(KIWTG  Accelerating import growth

Real estate bubbles,

Current account balances of selected Eurozone members

but rather a balance of payments crisis

Debt less than

Greek blowup. Private funds dried up as fears

Economic boom, falling interest rates, easy lending

Source: Bloomberg, Datastream, Credit Suisse

GLOBAL INVESTOR 1.14

Mario Draghi, 26 July 2012

Source: Bloomberg, Credit Suisse

GLOBAL INVESTOR 1.14

Jos Manuel Barroso, 7 January 201

GLOBAL INVESTOR 1.14

ADJUSTMENT REFORM AND RECOVERY

UGG(KIWTG . In the less cyclical (but far larger) services sectors,

been enormously accentuated by the crisis. Even though most

Source: Datastream, Credit Suisse

The ECBs new building in Frankfurt is currently under construction.

GLOBAL INVESTOR 1.14

subjected to such a formal program

reforms, we have devised a reform

balance and the retirement age.

Photos: Helmut Vogler/Fotolia, petra b./Fotolia

9KVJXGT[NKOKVGFUECNWPKQPVJGECB will remain the central anchor of stability

Taxes, be they assessed on income or

also imply substantial transfers between

GLOBAL INVESTOR 1.14

How much growth ahead?

Source: Datastream, Credit Suisse

Pronouncing the verdict on the European Stability Mechanism, 2014 .

refinancing operations, i.e. preferential loans to banks to boost their

FROM CRISIS TO OPPORTUNITY

Photo: Kai Pfaffenbach/Reuters

GLOBAL INVESTOR 1.14

Doing what it takes

Europe has strengthened after every crisis.

The gradual macroeconomic recovery

The banking sector was hit hard by the

German cars in top gear

Audi, BMW and Mercedes-Benz are on a

Boom, bust, recovery

Dominik Garcia and Philip Kaufmann

According to Thomas C. Kaufmann and

Airports gates to the world

UGG(KIWTG Accelerating import growth

Jos Manuel Barroso, 7 January 201

UGG(KIWTG. In the less cyclical (but far larger) services sectors,

9KVJXGT[NKOKVGFUECNWPKQPVJGECB will remain the central anchor of stability