Investment Research — General Market Conditions

09 July 2010

Research
Global: Growth is bound to slow – but by how much?
 Growth is bound to slow down in the second half of 2010, as the balance between
tailwinds and headwinds turns less favourable. Equity markets – from tailwind to
headwind
 The key question though is how much will growth slow. We still don’t expect 40 %
%
40
30 30
growth to go below potential growth over the coming quarters, but a pick-up in 20 S&P500 index, 2mth change 20
10 10
employment soon and no new setbacks in financial markets are key assumptions 0 0
-10 -10
behind this forecast. -20 -20
-30 -30
 Should current headwinds get stronger we will have to re-evaluate our outlook. -40 -40
-50 -50
06 07 08 09 10

Rising fears of a “double-dip” scenario Source: Reuters Ecowin

While the global recovery set off to a strong start in 2010, new headaches have appeared
for the global economy. First, the debt crisis in the Euro area has created new uncertainty
and led to sharp declines in equities and credit bonds. This has provided a new and Signs of faster slowdown in China
unexpected headwind to the global economy. Second, the labour market in the US has
Index Index
disappointed and hence is not giving as strong support to US consumers as projected. And 70 70

finally, Chinese growth appears to be slowing earlier as tightening measures may be 60 60

having a bigger effect than anticipated. These developments have raised fears of a
50 50
“double-dip” in financial markets.
40 40
We have for a long time expected some slowdown in the global economy in the second 30
China PMI, New Orders (CLSA)
30
half of 2010, but this slowdown may become stronger than expected due to the above 05 06 07 08 09 10

mentioned developments. We already see some tentative signs of this – see Global
Source: Reuters Ecowin
Business Cycle Monitor: Further declines in leading indicators. It will be crucial for
sentiment and the outlook for 2011 how much growth actually slows.

For now we will sketch some of the factors that will shape the slowdown. After the Metal prices and freight rates also
summer break we will quantify these effects more rigorously to gauge the risk of a point to slowing activity
12000 Index Index 4500
double-dip scenario more precisely.
10000 4000
LME metal price index >>
8000 3500
The balance of tailwinds and headwinds is turning 6000 3000

Judging the short-term swings in the growth rates is about estimating the changes in 4000 2500

2000 2000
short-term impulses that hit the economy (tailwinds and headwinds) and the development << Baltic Dry index
0 1500
in the inventory cycle. It is key to understand that it is the change in the tailwind that will jan maj sep jan maj sep jan maj
08 09 10
affect the change in the growth rate. This corresponds to riding a bike: A stronger
Source: Reuters Ecowin
tailwind means you can go faster. If the tailwind fades so will your speed – even though
the wind is still helping you.

Chief Analyst
Allan von Mehren
+45 4512 8055
alvo@danskebank.dk

www.danskeresearch.com
Research

The strength of the labour market and potential pent up demand/over-investment will
determine whether an economy can stay on a recovery track when tailwind factors The boost to growth from inventories
disappear. has peaked
4
US inventories,
Using this approach it seems evident that a wide range of factors point to a weakening of 3
contr. to GDP growth, q/q AR
2
growth going forward: 1
0
 The inventory cycle helped boost growth in 2009 and 2010, but there are signs -1
now that this effect has peaked and that the growth contribution from -2
-3
Grey bars mark recession periods
inventories will decline from here on. Increased uncertainty could force a -4
sharper decline of this growth contribution, as companies become wary of 00 01 02 03 04 05 06 07 08 09

restocking when the outlook is more clouded. Source: Reuters Ecowin

 Fiscal policy provided a decent tailwind in 2009 and 2010. This tailwind is
slowly fading, though, and will become a not insignificant headwind in 2011 in
both Europe and US. US fiscal policy tightening ahead in
2011
 Monetary policy has provided a substantial tailwind to the economy as rates
4 % of GDP % of GDP 4
were slashed to very low levels in 2008 and early-2009. This has led to a sharp 2 US, cyclically adjusted primary deficit 2
(Office of Management and Budget)
reduction in financing costs and thus increased disposable incomes and 0 0

corporate earnings. While low rates are still providing a tailwind for new -2 -2
-4 -4
investments and consumption the effect on incomes and earnings was a one-off -6 -6
increase and hence the growth impact will fade going forward. The tailwind is -8 -8
04 05 06 07 08 09 10 11 12
still there but it is getting smaller.
Source: Reuters Ecowin
 Emerging Markets growth provided a major boost to exports in 2009 and in
the first half of 2010 as Asia especially witnessed a sharp V-shape recovery.
Asia has been growing above its potential growth rate though and policymakers
Interest rates: Both level and change
have tightened policy to slow growth down. We are already seeing signs of this
matters
happening in China, where recent indicators such as PMI could indicate a
7 7
somewhat stronger and earlier slowdown than envisaged. Hence this strong 5
G3 3m libor rate, %
5
tailwind for the developed countries also looks bound to become smaller. 3 3
1 1
 The development in risky assets worked as a strong tailwind in 2009, as
-1 -1
equities rallied strongly and corporate yields declined substantially. This
-3 -3
reduced financing costs for companies, increased wealth for consumers and -5
G3 3m libor, y/y change, % point
-5
worked to boost overall sentiment. However, this tailwind has unexpectedly 00 02 04 06 08 10

turned into a headwind as risk markets have sold off strongly over the past 2½
Source: Reuters Ecowin
months.

 Housing market incentives in the US provided a strong tailwind to the housing

market boosting home sales over the past year and giving support to house Important that the job growth picks up
prices. As these incentives have expired this tailwind is disappearing.
Mn Monthly chng, '000
117 300
While most of these effects were anticipated and already discounted in current forecasts, 115 100
the development in risky assets and the early warnings of a sharper decline in the 113 -100
111 -300
contribution from the inventory cycle are new. << US private payrolls, level
109 -500
There are also stabilising forces pulling in the other direction though. Bond yields are 107 -700
US private payrolls, chng >>
lower than expected and oil prices have also seen a setback, which increases purchasing 105 -900
05 06 07 08 09 10
power somewhat. But it is questionable whether these are strong enough to compensate
for the new headwinds. Source: Reuters Ecowin

Employment and pent-up demand all the more important now

With the growth impulses turning more negative than expected it is all the more important
that the labour market shows improvement and provides support to consumer incomes.
While this has actually happened we have to say that the improvement has disappointed
lately – at least in the US where employment growth slowed again in May and June after
showing stronger-than-expected gains in March and April.

2| 09 July 2010
www.danskeresearch.com
Research

It is paramount that we see stronger job growth in the US soon. If economic growth slows
Scenarios for ISM depending on
too much before job gains have picked up the momentum in the labour market could fade
financial market developments
again by the end of the year, leaving little support for the economy. We still expect this to
65 Index 65
Before shock Index
come through, but the recent data has of course raised some uncertainty in this area. 60 60
55 55
ISM
Lean corporate sector means increased resilience 50
45
Global crisis
50
45
40 Current shock 40
On a positive note, the corporate sector is in much better shape this time, compared with (no improvement)
35 35
2008, for example. The crisis led to enormous cutbacks in employment, investment and 30 30
07 08 09 10 11
inventories. The corporate sector is therefore extremely lean now and inventories are at a
very low level. Should global growth slow more strongly, there is no extra layer of fat Source: Reuters Ecowin
that will need to be cut away this time. This in itself would put a limit on any new decline
in growth rates.

Conclusion: Rising risks, but too early to call for a double-dip

While downside risks have increased and growth is bound to slow, we believe it is too
early to call for a double-dip in which growth gets stuck below trend growth. Our current
forecasts, however, are based on the expectation that job gains pick up soon and equity
and credit markets stabilise and recover. Should these factors fail to come through in the
coming months we will have to re-evaluate the outlook.

For more on the effects of the euro crisis see also Research US: Euro crisis could speed
up manufacturing slowdown, where we look at different scenarios for the US
manufacturing sector depending on the development in financial markets.

3| 09 July 2010
www.danskeresearch.com
Research

Disclosure
This research report has been prepared by Danske Research, which is part of Danske Markets, a division of
Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The author of
this report is Allan von Mehren, Chief Analyst.

Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high
quality research based on research objectivity and independence. These procedures are documented in the Danske
Bank Research Policy. Employees within the Danske Bank Research Departments have been instructed that any
request that might impair the objectivity and independence of research shall be referred to Research Management
and to the Compliance Officer. Danske Bank Research departments are organised independently from and do not
report to other Danske Bank business areas. Research analysts are remunerated in part based on the overall
profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other
remuneration linked to specific corporate finance or debt capital transactions.

Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals’
Ethical rules and the Recommendations of the Danish Securities Dealers Association.

Financial models and/or methodology used in this research report

Calculations and presentations in this research report are based on standard econometric tools and methodology
as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be
obtained from the authors upon request.

Risk warning
Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis
of relevant assumptions, are stated throughout the text.

First date of publication

Please see the front page of this research report for the first date of publication. Price-related data is calculated
using the closing price from the day before publication.

Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It has been prepared
independently, solely from publicly available information and does not take into account the views of Danske
Bank’s internal credit department. It is not an offer or solicitation of any offer to purchase or sell any financial
instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no
representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from
reliance on it. Danske Bank, its affiliates or staff may perform services for, solicit business from, hold long or
short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned
herein. The Equity and Corporate Bonds analysts are not permitted to invest in securities under coverage in their
research sector. This publication is not intended for retail customers in the UK or any person in the US. Danske
Markets is a division of Danske Bank A/S. Danske Bank A/S is authorized by the Danish Financial Supervisory
Authority and is subject to provisions of relevant regulators in all other jurisdictions where Danske Bank A/S
conducts operations. Moreover Danske Bank A/S is subject to limited regulation by the Financial Services
Authority (UK). Details on the extent of our regulation by the Financial Services Authority are available from us
on request. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and
may not be reproduced in whole or in part without permission.

This publication has been prepared by the correspondent of Auerbach Grayson & Company Incorporated
(“AGC”) named above on the date listed above.

We are distributing this publication in the U.S. and any U.S. person receiving this report and wishing to effect
transactions in any security discussed herein, should do so only with a representative of Auerbach Grayson &
Company Incorporated. Additional information on recommended securities is available on request.

4| 09 July 2010
www.danskeresearch.com