Currencies and Credit Questions Will Dominate Economic and Investment Directions

February 8th, 2014
in contributors

Macro Factors and Their Impact on Monetary Policy, The Economy and Financial Markets

by Jim Welsh, with David Martin and Jim O'Donnell, Forward Markets

U.S. Economy

In 2013, the reduction in federal government spending lowered gross domestic product (GDP) by about 0.5%. Since government spending will modestly increase in 2014, GDP will be lifted by at least 0.5% this year. In the third quarter of 2013, GDP rose 4.1%, which made for good headlines, but did little for the average family or worker. Through December, average weekly earnings grew just 1.5%, while personal income was up only 1.8% through November. Such weak income growth means the majority of American families barely kept up with the cost of living in 2013. In October and November, job growth improved to 200,000 and 241,000 respectively before dropping to a revised 75,000 in December.

Follow up:

We have little doubt December will be revised upward further in coming months. To smooth out monthly fluctuations, we use a 12-month exponential average of the monthly totals, which is illustrated below.

At the end of 2011, the 12-month average was 168,000, 180,000 in 2012, and 174,000 through December 2013. Even if the initial 74,000 increase in jobs in December is revised up to 150,000, the 12-month exponential moving average (EMA) would only rise to 186,000. This analysis further reveals that the high point in job creation was reached in February and March of 2012, when the EMA reached 203,000. Job growth has effectively stagnated over the last two years despite the Federal Reserve holding the federal funds rate near 0.1%, and increasing its balance sheet by more than $1 trillion. Although GDP is likely to improve in 2014, until job and income growth pick up, a sustained economic expansion will remain on the horizon.


After the European Central Bank (ECB) meeting on January 9, 2014, ECP President Mario Draghi responded to criticism of Germany's economic strength with the following comment,

"You cannot make the weak stronger by making the strong weaker."

Although erroneously attributed to Abraham Lincoln, the value of any quotation is not the author, but the timeless wisdom expressed. One of the ongoing challenges of the European Union (EU) is the disparity in productivity among its members. In the wake of the financial crisis, the least productive countries experienced a deeper and more prolonged contraction, resulting in far higher rates of unemployment that persists into 2014. Although the overall unemployment is 12.1% for the EU, it is 11% in France, 12.7% in Italy, 26.7% in Spain and 27.4% in Greece. In contrast, Germany's unemployment rate is just 5.2%, hence the friction within the EU.

Prior to the formation of the EU in 1999, the productivity gap between countries could be closed through the depreciation of an individual country versus the currency of trading partners. For instance, if Italy wanted to improve its export competitiveness, it would lower the value of the Italian lira by 5%-10% or more.

A decline in the lira would lower the cost of Italian exports and make Italian exporters more competitive with exporters around the world. Lowering the cost of exports through the depreciation of its currency, rather than cutting wages, kept Italian domestic demand stable, as a weaker currency lifted exports.

However, with the establishment of a common currency for the members of the EU, the only way to improve export competitiveness is through productivity improvements or lower labor costs, which is far more painful since lower incomes weaken domestic demand and GDP. For those countries whose productivity has lagged Germany over the last decade, the path to increased productivity will primarily be through labor market reforms. In the short run, labor market reforms will be politically unpopular in countries like France and Italy, and if enacted, will likely result in higher unemployment and slower GDP growth.

France is the second largest economy in the EU and is facing a number of economic challenges. According to an analysis by the EU, International Monetary Fund (IMF) and the Organization for Economic Development and Cooperation (OEDC), France's core problem is that wages have been growing faster than productivity for years. In 2000, the socialists in France instituted the 35-hour workweek, so French workers have been producing less in less time too. Unemployment is 11% and youth unemployment is 26%. The minimum wage is now 62% of median income, versus 38% in the U.S. Anyone who has worked more than 28 months can receive up to 75% of their old salary for 24 months. The employer payroll tax can reach 48%, which means an employee paid $1,000 a month actually costs the employer $1,480 per month.

Needless to say, private sector job growth has been almost nonexistent. To reduce unemployment, the government launched a new program in 2013 that will pay 75% of a new hire's salary for up to three years. The goal is to create 150,000 jobs over the next two years at a cost of $4.7 billion. The decline in productivity and high labor costs has increased France's cost of goods and hurt export sales. Until 2005, France ran a current account surplus. Since 2006, France has run a current account deficit, which was -2.2% in 2012, according to the IMF. In November, France's trade deficit of -1.3% was worse than Spain's -1.1% and Italy's -0.7%, and looks horrendous compared to Germany's trade surplus of 7.0%.

France's GDP grew a nominal 0.5% from 2009 to 2012. Welfare spending, including programs for youth, the unemployed and the elderly is set to reach 31% of GDP, the highest of the 34 OECD nations. Instead of reducing government spending, France increased spending so that government spending is now 57% of GDP, and debt as a percent of GDP jumped from 60% in 2007 to 92% in 2013. In an effort to "make the weak stronger by making the strong weaker," France has raised taxes and has a top income tax rate of 75% for those earning more than $1,000,000 euros annually.2

In early November, Standard & Poor's rating services cut France's credit rating by one notch to double AA, with this assessment,

"The French government's reforms to taxation, as well as to product, services and labor markets, will not substantially raise France's medium-term growth prospects."3

Mario Draghi has said,

"French competitiveness remains insufficient and strengthening public finances can no longer rely on tax increases."4

Whether it was the result of its credit downgrade, Draghi's comment, or recent polls which show that 74% of the French think France is on the decline and 83% view President Francois Hollande's reform policies as ineffectual, Hollande appears to have experienced an epiphany. In a speech on January 14 he said,

"How can we run a country if entrepreneurs don't hire? And how can we redistribute if there's no wealth?"5

Acknowledging that socialist redistribution does not create wealth and relies instead on entrepreneurs must have been an out-of-body experience for Hollande. Proof came when Hollande proposed cutting government spending to fund a $48 billion annual tax cut so companies won't have to pay for France's generous family welfare programs by 2017. It's unlikely that one small program will pull the French economy out of a malaise that took decades to grow.

Italy is the third largest economy in the EU, and according to the OEDC, of its 34 participating countries, Italy's output has grown the least over the last decade. This poor performance is partially due to the lack of currency flexibility, but is also due to government spending, high taxes and inflexible labor market regulations. Government spending is 50.7% of GDP and relies on high payroll taxes to fund its spending. According to the OECD, 33% of Italian salaries support Italy's pension fund, compared to 13% in the U.S.'s Social Security system. Labor costs are higher than in Spain, but Italian workers have less disposable income after taxes are deducted.

This is a bad combination since high labor costs suppress hiring, and low take-home pay mutes economic growth since workers have less money to spend. The lack of growth has resulted in chronic budget deficits, which has increased Italy's debt to GDP ratio to 130%. Within the EU, only Greece has a higher debt to GDP ratio.

Since the fourth quarter of 2011, Italy has posted eight consecutive quarters of economic contraction, with the third quarter of 2013 at -1.8%. For all of 2012, GDP was -2. 5% and will likely have only improved to around -2% in 2013. Fourth quarter GDP will be announced in late February, so there are no final 2013 figures.

The recession that has gripped Italy since the first quarter of 2012 has hurt small- and medium-sized banks especially hard. Bad loans have soared 35% since 2011, which has led to a decline in lending. According to the Italian Banking Association, bank loans declined 3.7% through October 31, 2013, after falling -1% during the same period in 2012. Italian companies rely on banks for 70% of their funding, compared to 35% in the U.S., so small companies are very dependent on a functioning banking system. With credit availability becoming harder to get, bankruptcies are at a 10-year peak, with more than 62,000 companies closing their doors as of September 30, according to research firm Cerved. Bankruptcies increased 7.3% from 2012, and are up 57% from 10 years ago. According to Morgan Stanley, Italian bank reserves covered only 41% of their bad loans as of September 30. In order to comply with Basel III regulations, Italian banks may have to raise $15 billion in new capital to meet the minimum core Tier 1 equity ratio of 8%.

The bad loan problem and dearth of lending is not limited to Italy. According to PricewaterhouseCoopers (PwC), European banks are sitting on $1.7 trillion in nonperforming loans, which are loans on which no payments have been made in 90 days. In order to comply with Basel III regulations, European banks will need to increase capital by at least $240 billion to as much as $380 billion, depending on how much each bank restructures its balance sheet assets, according to PwC.

A weak economy, bad loans and looming Basel III regulations have led many banks to shrink their balance sheets and lending. The annual change in eurozone loans to nonfinancial corporations has not improved and was still negative in November at -2.3%. In early November, the ECB announced stress tests for 128 systemically important banks that should be completed by the fourth quarter of 2014.

The ECB will assume direct supervision over the largest eurozone banks in 2014. With the ECB conducting its stress tests and assuming a more active supervisory role over the largest banks, lending throughout Europe is likely to remain constrained in 2014 and well into 2015. Many banks may choose to write off bad loans before the stress test is completed so they look better, as Deutsche Bank did when it announced a fourth quarter loss of $1.35 billion. As long as credit growth is weak, economic growth is unlikely to exceed 1% in 2014.

The combined GDP of France ($2.6 trillion) and Italy ($2.0 trillion) is 35% more than Germany's GDP of $3.4 trillion, based on World Bank data. The ongoing weakness expected in France and Italy effectively offsets Germany's strength. Germany, France and Italy comprise 45% of the $17.6 trillion of the 28 countries in the EU. With the three largest members in the EU not pulling in the same direction, GDP growth is unlikely to accelerate much in 2014. With slow growth persisting in 2014, concerns about deflation are growing. According to Eurostat, the EU's statistics agency, consumer prices were up only 0.8% in December from a year ago. Core inflation, which excludes food and energy, was up just 0.7%, the lowest since records began in January 2001. Both measures of inflation are well below the ECB's 2% target.

After the ECB's last meeting on January 9, Mario Draghi said the ECB was "ready to consider all available instruments" to address low inflation.6 In terms of economic growth, he said,

"The recovery is there, but it's fragile...The risks surrounding the economic outlook for the euro area continue to be on the downside."7

Unfortunately, there are few instruments left for the ECB to use to spur growth and offset low inflation. The ECB's refinancing rate was lowered from 0.50% to 0.25% in November. The ECB can lower it further, but another 15 basis points probably won't make a big difference in spurring bank lending in the EU, or help speed up the structural reforms needed in France or Italy.

The ECB can launch another long-term refinancing operation (LTRO) program, but pushing more money into the European banking system is not likely to encourage more lending while banks are undergoing a stress test, economic growth is almost nonexistent and bad loans weigh on bank balance sheets. One step the ECB could take is lowering the value of the euro, which would improve the export competitiveness for every EU member. A cheaper euro would especially help those countries whose productivity has lagged behind Germany. Since a lower value of the euro could increase the cost of imports, like oil, which are priced in dollars, inflation may also rise.

The euro bottomed in July 2012 after Mario Draghi pledged to do "whatever it takes" to contain the EU's sovereign debt crisis.8 It has since rallied by almost 15% versus the dollar, which makes exports from EU countries more expensive and less competitive. The down- sloping trendline connecting the highs in July 2008 and May 2011 should provide resistance, and is currently near 138.5 (see chart on previous page). A close above this line would suggest a rally to near 143 was likely. The up-sloping line connecting the lows in July 2012 and lows during 2013 is near 134. A close below this line and 133.7 would suggest a decline to 128 was coming.

The down-sloping and up-sloping trendlines will intersect in the next few months, which suggests the euro is approaching a crossroads. If Draghi is able to pull another rabbit out of his hat, the euro could rise above the down-sloping line. If he intimates that a cheaper euro would be helpful, or problems resurface within the EU, the euro will likely break lower. The chart indicates the possible size of the subsequent move, which is why chart analysis is essential.


After more than 20 years of deflation and weak economic growth, the three arrows of Prime Minister Shinzo Abe's economic plan were to cause GDP growth and long-term inflation to increase to 2%.

Two of the three arrows in Abe's plan, monetary stimulus and fiscal stimulus, have already achieved short-term success. Although GDP growth slipped to 1.9% in the third quarter from 3.8% in the second quarter, it was still the best stretch of growth since 1996. The improvement in Japan's economy was largely the result of a 22% decline in the yen versus the dollar in 2013, and a 26% drop against the euro, which boosted exports. As discussed in the February 2013 Macro Strategy Review (MSR), Japan produces only 16% of its energy needs, and is the world's largest importer of natural gas, second largest importer of coal and third largest importer of oil, according to the Energy Information Administration. Since these commodities are priced in dollars, we expected the decline in the yen to increase the cost of these imports, resulting in more inflation and a larger trade deficit. In November, the Consumer Price Index increased to 1.5% from a -0.9% decline in March 2013, and in November, Japan posted its largest trade deficit in decades.

Hope that "Abenomics" will prove successful in reenergizing Japan's economy and reversing deflation resulted in a 57% increase in the Nikkei 225 Index in 2013. While the return to actual GDP growth, resurrection of inflation and rebound in the Nikkei are encouraging, the long-term outcome will be determined by the "third arrow" or structural reforms of Abe's economic policy. In order to achieve his long-term goals, Abe must address the inflexibility of Japan's labor laws and open up Japan's economy. In 2013, foreign investors bought $144 key reforms will be deregulation in agriculture, construction, healthcare and medical services, tax policy and female labor force participation.

The council isn't expected to make its recommendations until June, which could pose a problem. Japan is raising its sales tax on April 1 from 5% to 8%. The sales tax increase is expected to raise $88 billion in tax revenue annually, or almost 1.5% of GDP. Demand will be pulled forward into the first quarter, as consumers buy before April 1 in order to save 3% on their purchases. First-quarter GDP will be lifted by the surge in consumer demand, only to be weakened in the second quarter by the double whammy of lower demand and higher taxes.

While global investors are waiting to hear the details of Abe's third arrow, they are likely to be pelted by discouraging second-quarter economic reports before the council's recommendations are announced in June. There is the potential that during this window doubts about Abenomics could emerge that will impact the Nikkei and yen. At a minimum, it will be important that the third arrow hits the target near the center, and that the council's suggestions are significant, realistic and credible.

Charts of the Nikkei and yen also suggest that Abenomics is likely to face its first major challenge in the first half of 2014. As shown in the chart, the correlation between the Nikkei and the yen is extraordinarily high. The Nikkei has risen when the yen has declined, and fallen whenever the yen has strengthened. The pattern of the yen suggests it is completing a decline versus the dollar which began in the fall of 2011. If correct, the yen could rise 7%-9%, and climb from 95 to 102-105. If the correlation holds as expected, a stronger yen could cause the Nikkei to decline to 13,000 or lower in the coming months.


We first discussed the potential for banking problems in China in our November 2012 MSR, and concluded that China is likely to be beset by its own banking problems in 2013 or 2014. In June 2013, we wrote,

"At some point (perhaps 2014 or 2015) China could prove vulnerable to large capital outflows that undermines its growth story, creates liquidity problems for China's state-run banking system and potentially deflates the credit bubble that has been expanding in China since 2008."

Despite efforts by the People's Bank of China (PBC) to rein in credit growth in 2013, the three-month average of overall bank lending was up 27.9% through November, according to UBS. This increase includes traditional bank loans at 16.3% and nontraditional lending. The nontraditional or "shadow" banking system includes banks' off-balance-sheet lending arms, trust companies, leasing firms, insurance firms and pawn brokers. According to JPMorgan Chase & Co., between 2010 and the end of 2012, shadow lending doubled to $5.9 trillion or 69% of GDP. UBS estimates that during the same period, traditional bank lending grew by more than 18% annually.

An official audit released on December 30, showed that China's local government debt reached $2.9 trillion as of June 30, 2012, up 67% from December 31, 2010. China's debt to GDP ratio was set to reach 218% by the end of 2013, up 87% since 2008, according to Fitch Ratings, a global rating agency.

Although the debt to GDP ratio is not excessive, the rate of increase is concerning since it has occurred while economic growth decelerated. Since the end of 2010, GDP growth has slowed from 10.4% to 7.7% in 2013, which means each new dollar of debt has been contributing less and less to economic growth. Excessive credit growth in five years has proved problematic for other countries during the past 30 years as the nearby graphic illustrates.

We don't know if China's credit binge will end in a crisis, but we are confident it will result in slower growth in coming years as the PBC reduces credit availability from traditional banks and the shadow banking system. Policymakers at the PBC have been worried about credit growth and have taken modest steps to slow it. Last June, the PBC allowed the seven-day interbank rate to jump from under 4% to 11% on June 20, and again to 8.8% on December 23.  In both instances, the tightening amounted to a tap on the brakes, since the PBC quickly injected liquidity to bring rates down.

The PBC is facing a difficult balancing act in 2014. As it slows credit growth, economic growth may slow further, which is likely to reduce bank profits and cause a rise in nonperforming loans.

Not tightening monetary policy in 2014 risks a larger potentially more destabilizing credit problem in the future. Complicating their task is figuring out how to regulate the shadow banking system, which is providing an increasing share of total lending. According to the PBC, lending by the shadow banking system rose 43% in 2013.  This happened because banks knew how to circumvent existing regulations and have strongly resisted new rules.

When the China Banking Regulatory Commission (CBRC) attempted to implement Regulation 9, a new rule that would have placed rigid restrictions on banks' off-balance-sheet lending, the CBRC quickly backed off after some of the largest financial institutions complained Regulation 9 would reduce their capital levels and profits.

In December, the Chinese government's chief decision-making body, the State Council, issued document 107, which proposed a regulatory structure for managing shadow banking. One of the areas that will be addressed is banks masquerading corporate loans as bank-to-bank loans in the interbank market, which require less capital and reserves. In its third-quarter monetary report, the PBC singled out the rapid growth of such loans and called for stronger oversight.

The PBC does not want economic growth to slow below 7%, so it is likely to continue to gradually tighten policy as in 2013. This suggests there will be periodic spikes in short-term rates as the PBC taps on the brakes, followed by injections of liquidity. Our guess is that these episodes will occur with greater frequency. As the PBC attempts to increase regulation of the shadow banking system, it might allow a wealth management product to default to make a point. Although this would cause some turbulence in the financial markets, it would send a powerful message to everyone participating in China's shadow banking system.

The key takeaway is that growth is not likely to accelerate above 8% in 2014, as the PBC slows credit growth. By the end of 2014, the discussion may center on whether GDP growth will drop below 7%.

Emerging Economies

We discussed the economic fundamentals of China, Brazil, India and Indonesia in detail in the November MSR, and concluded that these emerging economies were unlikely to return to prior growth rates in 2014 and beyond. We noted that China, Brazil, India and Indonesia had provided a significant share of the increase in global growth following the financial crisis. Much of the growth, however, was fueled by an unsustainable increase in credit. We expected credit growth to slow and with it economic growth.

Although the Fed's decision to postpone tapering at their mid-September meeting provided a respite, we expected countries with current account deficits (for instance, Brazil, India, Indonesia, Turkey and Mexico) would experience another test once the Fed decided to scale back its quantitative easing (QE3) purchases. The lead financial story in 2014 has been the upheaval in emerging market currencies, especially those with current account deficits.

Large declines in a country's currency have consequences. Often the central bank will increase interest rates in an effort to stem the tide of money flowing out of a country. Higher interest rates depress domestic economic growth, which can lead to additional weakness in the country's currency. If a country has sizeable imports, inflation usually follows a large currency decline, as Japan has experienced over the last year. For those countries that import energy and food staples like rice, it can be politically unstable, since the rising cost of imports increases the current account deficit.

In the past, some countries have been forced to reduce its subsidies for energy and food, potentially leading to riots. Higher inflation erodes the purchasing power of workers, so their incomes don't buy as much. It is not uncommon in developing countries for this vicious cycle to culminate in the fall of governments. Turkey, Thailand and Argentina come to mind as countries currently facing serious political instability. In 2013, central banks in Brazil, India and Indonesia increased interest rates, which we expected to weigh on growth in 2014. As we recommended last November, investors in emerging markets will need to be nimble in coming months and should favor those emerging economies with a current account surplus.

In addition to financial institutions being too big to fail in 2008, another component of the financial crisis was the lack of transparency of derivative holdings. No one knew how much each bank or insurance company was holding or who the counterparties were. The impact of this lack of transparency caused financial institutions to stop lending or trading with each other, which contributed to the liquidity crisis that ensued.

More than five years after the financial crisis, what progress has been made to address the drivers of the 2008 financial crisis? Not much. The banks that were too big to fail in 2008 are even larger today, and the $650 trillion in derivative holdings are as opaque today as they were in 2008.

We have advocated that all derivative contracts be traded through a clearinghouse so market participants know how much each institution is holding and their counterparty risk. The volatility experienced in the currencies of a number of emerging economies has the potential to spill over into the global economy, since no one knows if there is one or more large institution holding leveraged derivative contracts in the most affected emerging economy currencies. This lack of transparency and knowledge is likely to make whatever disruption occurs worse.

Those strategists who have been bullish on emerging markets in recent months have compared the relative value of emerging markets (EM) to the S & P 500 Index as one reason why investors should increase exposure to EM. Let's put this into context. If a woman, whose height is 6 feet 3 inches, stands next to a man who is 5 feet 9 inches, she looks tall. But if she stands next to an elephant, she will look small. Based on Shiller's cyclically adjusted price-earnings (CAPE) method of valuation, Tobin's Q Ratio and the U.S. market capitalization as a percentage of GDP, the valuation of the S & P 500 is far more expensive than indicated by its price-to-earnings (P/E) ratio.

Comparing the valuation of EM to the S & P 500's valuation may not be a great idea, given how expensive U.S. equities appear. In addition, the MSCI Emerging Market Index had a P/E ratio of 3.5 in the late 1990s, versus its current multiple of 11.3 times earnings. Investors in emerging markets should favor those countries with current account surpluses and use technical chart analysis to manage risk.


In last month's MSR, we noted that the high level of bullish sentiment, valuation and the length of time of the current bull market suggested the stock market could be approaching a significant top in coming months. We also discussed that since 1980, the average intrayear decline has been -14.7%, according to J.P. Morgan Asset Management.

According to financial information provider S & P Capital IQ, the average duration between 10% corrections since 1945 has been 18 months. It has now been 27 months since the last 10% correction ended in October 2011, so history suggests the market is overdue for a 10% correction.

However, as we have stressed for many months, markets do not go down just because investors are too bullish, time or valuation levels. Markets go down when investors are confronted with data that does not support their positive outlook and thus provides a reason to sell. Large corrections in the stock market are frequently preceded by a loss of upside momentum, which is followed by a major average like the S & P 500 falling below a prior low. We have remained constructive about the stock market since momentum has been strong and the S & P 500 has continued to make higher highs and higher lows, which is the technical definition of a bull market.

At the recent highs, our proprietary Major Trend Indicator suggested that corrections were likely to be in the 4% to 7% range. The last pivot low in the S & P 500 was 1,768, the intraday low on December 18. As indicated last month, as long as the S & P 500 holds above 1,768, the intermediate trend is up.


As discussed last month, the 10-year Treasury yield bottomed in July 2012 at 1.39%, and we thought the initial yield increase would top out near 3.15-3.20%. After this peak in yield, our guess was that yields would come down, possibly to 2.5-2.7%. The yield on the 10-year Treasury bond peaked at 3.036%, and then fell to 2.717% on January 27. If the S & P 500 falls below 1,768, the 10-year yield could dip to 2.46%-2.63%. The longer-term target is 3.50-3.75%, which was the February 2011 yield high.


1.The New York Times, "European Central Bank Set to Do Whatever It Takes to Bolster Recovery," January 9, 2014.


3.CNBC, "UPDATE 2-S & P lowers France credit rating, cites slow reform pace," November 8, 2013.

4.The Wall Street Journal, "The French Disconnection," December 5, 2013.

5.The Wall Street Journal, "Hollande Courts Business With Economic Revival Plan," January 14, 2014.

6.The New York Times, "European Central Bank Set to Do Whatever It Takes to Bolster Recovery," January 9, 2014.


8.Financial Times, "ECB 'ready to do whatever it takes'," July 26, 2012.


Definitions of Terms

10-yearTreasuryis a debt obligation issued by the U.S. Treasury that has a term of more than one year, but not more than 10 years.

BaselIIIis a comprehensive set of reform measures designed to improve the regulation, supervision and risk management within the banking sector.

BPS(basispoint)is a unit that is equal to 1/100th of 1%, used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.

Correlationrefers to the statistical measure of how two securities move in relation to each other and is computed as the correlation coefficient, with ranges from -1 to +1.

Cyclicallyadjustedprice-earnings(CAPE)ratiois the ratio of stock prices to the moving average of the previous 10 years' earnings, deflated by the Consumer Price Index.

Derivativeis a security whose price is dependent upon or derived from one or more underlying assets.

The eurois the official currency of the European Union.

Federalfundsrateis the interest rate at which a depository institution lends immediately available funds to another depository institution overnight.

Grossdomesticproduct(GDP)is the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP of a country is one of the ways of measuring the size of its economy.

Liquidityis the degree to which an asset or security can be bought or sold in the market without affecting the asset's price.

MSCIEmergingMarketsIndexis a free float-adjusted market capitalization index designed to measure equity market performance in the global emerging markets.

Price-to-earnings(P/E)ratioof a stock is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income.

Q ratio is a ratio devised by Nobel Laureate James Tobin that suggests that the combined market value of all the companies in the stock market should be about equal to their replacement costs.

Quantitativeeasing(QE)refers to a form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero.

S & P500Indexis an unmanaged index of 500 common stocks chosen to reflect the industries in the U.S. economy.

Tier1 capital is the core measure of a bank's financial strength from a regulator's point of view.

Valuationis the process of determining the value of an asset or company based on earnings and the market value of assets.One cannot invest directly in an index.


Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.

This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.

The new direction of investing

The world has changed, leading investors to seek new strategies that better fit an evolving global climate. Forward's investment solutions are built around the outcomes we believe investors need to be pursuing-non-correlated return, investment income, global exposure and diversification. With a propensity for unbounded thinking, we focus especially on developing innovative alternative strategies that may help investors build all-weather portfolios. An independent, privately held firm founded in 1998, Forward (Forward Management, LLC) is the advisor to the Forward Funds. As of December 31, 2013, we manage $5.2 billion in a diverse product set offered to individual investors, financial advisors and institutions.

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