China: Frying Pan or Fire?

May 4th, 2014
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Forward Markets; Macro Strategy Review for May 2014

Written by , Forward Markets


China is attempting to achieve a number of economic goals that by their nature are contradictory. On one hand, Chinese policymakers are trying to slow excessive credit growth, which has already lowered gross domestic product (GDP) growth and will continue to weigh on growth in coming quarters. On the other hand, in the last two months, China has announced plans to increase spending on railways, upgrade housing for low-income households and provide tax relief for struggling small businesses, so it can hit its 2014 growth target of 7.5%.

Follow up:

Longer term, China wants to reduce its unhealthy reliance on exports, infrastructure investment and real estate, which rose from 34% of GDP in 2000 to 48% in 2013. In order to accomplish this reduction, the size of China's middle class must grow so domestic consumer consumption can increase significantly from the 34% it represented in 2011. However, as China moves toward slowing credit growth and preventing an even larger credit bubble from forming, there will be less growth in the short run and that will likely slow the transition to a consumption-driven economy.

In addition, policymakers want to reform China's financial system by allowing market forces to play a greater role in setting the value of its currency, deposit interest rates and government guarantees of lending.

And if all this wasn't enough, China must also increase environmental regulations to improve its air quality and protect its irrigable land. In February, air quality in Beijing was 20 times more polluted than what the World Health Organization deems healthy. In mid-April, China's Ministry of Environmental Protection and Ministry of Land Resources said 16.1% of the country's soil was polluted, including 19.1% of its farmland.

In the short run, more regulation no matter how important, will hurt corporate profits and pose another drag on growth. Achievement of these somewhat contradictory goals is likely to prove extraordinarily difficult. The People's Bank of China (PBC) and the leadership of the Chinese government are attempting a balancing act that rivals the daredevil stunts of "The Flying Wallendas."

In 1928, John Ringling first saw Karl Wallenda perform with his family in Cuba and immediately signed them to appear in "The Greatest Show on Earth".  They earned their initial moniker, "The Great Wallendas", by performing without a safety net and were the headline attraction for the Ringling Brothers and the Barnum & Bailey Circus for many years. They became the the Flying Wallendas after the high wire moved unexpectedly during  a performance and four of the Wallendas fell, but were able to catch and hold on to the wire and avoid serious injury.  A reporter for the Akron, Ohio newspaper who witnessed the accident wrote, "The Wallendas fell so gracefully that it seemed as if they were flying."[1] The article was titled, "The Flying Wallendas." In 1947, Karl Wallenda created the seven-person chair pyramid, which may be the greatest, most daring high-wire act ever performed. Watching a performance of the seven-person chair pyramid is the only way to appreciate the skill, daring and teamwork needed to execute the ultimate high-wire act.

How China manages its short-term and long-term challenges, while it gradually deflates the credit bubble that has formed since 2008, will make a big difference for the Chinese people and global economy. Even if a liquidity crisis is avoided, a liquidity event that has the potential to destabilize financial markets around the world is likely to occur within the next 18 months.

Let's start with China's long-term economic goal of rebalancing its economy toward domestic consumption and away from its dependence on exports and investment. The surge in China's growth from 2000 until 2008 was the result of a significant increase in fixed investment that expanded China's infrastructure and export capacity. Cities for millions of inhabitants were built along with the power grid and power generation to keep these new cities humming. The expansion in export capacity allowed China to capitalize on its low cost of production, so it could increase its exports to Europe and the United States. As a result, fixed investment as a share of GDP rose from 34% in 2000 to 48% of GDP last year.

The good news is that fixed investment is edging lower, after peaking at 49% at the end  of 2011. Domestic consumption during the same period contracted from 46% to 34% at the end of 2011, but has modestly increased to 36% in 2013. Wages have been rising, so the size of China's middle class is growing. Since 2005, average yearly wages have soared, rising from $2,670 to $7,795 in 2013, which should lead to an increase in future consumption. The bad news is that higher wages have increased China's cost of production over the last decade. In recent years, some manufacturing has moved out of China to lower cost countries like Vietnam, Bangladesh, Cambodia and Indonesia.

Another weight on exports has come from the appreciation in the Chinese currency versus the dollar, largely in response to political pressure from the United States. From June 30, 2005, through the end of 2013, the Chinese yuan rose 26.9% in relation to the dollar. A rise in the yuan lowers the cost of imported goods into China, which increases the purchasing power of Chinese consumers.

However, the benefit to Chinese consumers from a stronger yuan is outweighed by the economic burden it has placed on exporters, since Chinese consumers don't buy as much as Chinese companies export. In order to compete with countries with a lower cost of production and protect market share, Chinese exporters have resorted to cutting prices and profit margins. In 2012 and 2013, industrial profits were the worst since the Asian financial crisis in 1997, so the strength in the yuan has been a problem. In January, the PBC moved to weaken the yuan, and as of April 18, the yuan was down 2.7% from where it traded at the end of December. Although this will only provide modest relief for Chinese exporters, it suggests that policymakers feel they need to prop up their economy any way they can.

The PBC-yuan intervention had a secondary goal of chastising the flow of "hot money" into the yuan. Since it was almost a sure thing that the yuan would rise about 3% every year, buying the yuan became a "take it to bank" trade. International traders could borrow money for less than 1% and leverage their purchases of the yuan.

Employing leverage of 10 to 1 would lift the annual return from 3% to 20% or 25%, after subtracting the cost of borrowed funds. In 2013, a total of $244 billion flowed into China. Of that total, UBS estimated that hot-money inflows amounted to $150 billion. Needless to say, the fall in the yuan has not been appreciated by U.S. manufacturers or politicians. American manufacturers have long complained that China has manipulated the yuan to give  China an unfair trade advantage. Some U.S. politicians have backed legislation targeting China as a currency manipulator. Although the volume on this complaint is likely to be turned up during an election year, it is unlikely China will listen. Targeting hot-money inflows is a legitimate concern for China, especially since yuan strength was largely due to prior pressure from the U.S.

Exports have been a major pillar of China's stunning growth since 2000. With demand weak, heavy debt loads and widespread excess capacity, a growing number of export-oriented sectors (i.e., cement, steel and solar panels) have seen profit margins narrow considerably. For others, a threatening squeeze on cash flow has already resulted in a number of defaults and is increasing stress on the Chinese financial system as companies struggle to repay bank loans.

If the stress on the Chinese financial system was limited to just the export sector, there would be no looming liquidity event. In the aftermath of the 2008 global financial crisis, local governments have relied on land sales to developers for almost 40% of their revenue. Initially, the revenue from developers allowed local governments to cover up their budget shortfalls. Over time, the cozy relationship between local governments, developers and bankers boosted land values and spurred growth as developers launched massive construction projects. It also made it possible for local governments to take on more debt. From the end of 2010, local government debt has increased 67.3% to $2.9 trillion, as of June 30, 2013. If property values fall, local governments could face lower collateral values backing the mountain of debt they have assumed and less revenue from future land sales.

Unsold residential space nationwide has grown to 342 million square meters, equal to 42% of all residential space built in 2013. According to the China's National Bureau of Statistics, 2.0 billion square meters of apartments were built in 2013, even though sales of apartment space were 1.25 billion square meters, an excess of 35%. According to real estate research firm CLSA, the rate of construction in third- and fourth-tier cities needs to fall by half between 2014 and 2020 to get supply and demand back into balance. Roughly 200 cities with populations of 500,000 to several million account for 70% of property sales. In many cities, developers have slashed prices 20-40% to work off unsold property. In 100 cities tracked by Nomura Holdings, 42% experienced price declines in March from February. The downward pressure on property values will continue, especially in third- and fourth-tier cities where overbuilding is epidemic.

The construction, sale and furnishing of apartments accounted for 23% of China's GDP in 2013, up from just 10% in 2006, according to Moody Analytics. Nomura calculates that in 2013, real estate accounted for 26% of new loans and contributed 39% to government revenue. Between 2002 and 2012, property values in major cities, like Beijing and Shanghai, rose almost 500%. According to economist Li Gan of Texas A&M University, real estate represents about two-thirds of Chinese household wealth. At the peak of the housing bubble in the United States, real estate only represented one-third of household wealth.

After only experiencing the wonder of ever-increasing property prices, the new experience of lower prices has been upsetting. After cutting prices in the first quarter, developers have experienced protests from those who had purchased homes before the price reductions, demanding refunds. With the glut of property for sale in many cities, this experience will become more common. As one policeman told an irate protester, "You bought a private home. Prices will go up or down. It's just like investing in the stock market."[2]

The risk to the Chinese economy from falling property values could be significant. The property glut will likely result in less building in the coming years, which may also weigh on the country's future GDP growth. If the price declines now evident in third- and fourth- tier cities spreads to the larger cities, the market psychology that has driven the real estate market for so long could shift and cause demand to weaken broadly. There are signs that this may already be occurring. According to Standard Chartered Bank, unsold property inventory in second-tier cities has swelled from its long-term average of 16 months to 25 months.

With so much wealth tied up in illiquid real estate, falling real estate prices could dampen consumer spending, weakening economic growth further. In March, Zhejiang Xingrun Real Estate Co. announced it was unable to repay $400 million in bank loans. This probably will not be the last developer to default on bank loans. Since 2000, the total debt of real estate firms has soared from 20% of GDP to 55.9% in 2013, according to CEIC Data.

In 2013, the three-month average of overall bank lending was up 27.9%, according to UBS, even though GDP grew just 7.7%. A portion of lending in 2013 was from banks rolling over loans to sectors that are struggling with excess capacity, vanishing profit margins and insufficient cash flow to support their debt loads. Corporate debt as a percentage of GDP has soared from 92% in 2008 to 151% at the end of 2013, the highest ratio in the world. With economic growth slowing, the squeeze on cash flow is only intensifying. In the first quarter, GDP slowed to 7.4% from 7.7% in the fourth quarter. However, the "official" reported level of GDP may have overstated actual growth. According to macroeconomic research company Capital Economics, based on electricity demand, shipping activity and real estate, GDP slowed to around 6% from the first quarter in 2013.

Since 2008, bank assets have exploded 150%, rising from $10 trillion to more than $25 trillion at the end of 2013. Despite this increase and the slowdown in China's GDP growth, nonperforming loans are still under 1%. Rather than acknowledging the cash flow struggles many corporations are experiencing, banks are simply rolling over loans. In 2013, the five biggest state-owned banks wrote off just $10.5 billion in nonperforming loans. Chinese banks have begun using a questionable tactic to unload soured loans that would not be allowed under Western accounting standards. Here's how it works. A bank sells a bad loan to its investment bank at above market prices, so the bank's loss is much less. Under Chinese accounting rules, the bank can book the much smaller loss and get the bad loan off its books. The rationale behind this tactic is that the investment bank will have more time to work out the bad loan and ultimately get more than if the banks just wrote off the loan.

The PBC has been gradually tightening monetary policy and increasing short-term interest rates. In March, the broadly measured money supply was up 9.6% from a year ago, the smallest increase since comparable record keeping began in 1997. As you can see from the chart nearby, the deceleration in the rate of money-supply growth has been highly correlated with the slowdown in industrial production over the last six years. Borrowing costs, as measured by seven-day interbank rates, have averaged more than 4.0% so far this year through mid-April, up from 3.2% last year.

In the first quarter of this year, China experienced its first ever corporate bond default, when Shanghai Chaori Solar Energy Science & Technology Co., Ltd. failed to make a $14.7 million interest payment. Although the amount was small, this event sent ripples through the Chinese bond market. More than 30 Chinese companies have scrapped plans to sell debt after the default because of weak demand and domestic credit-rating companies downgrading 10 firms due to sharp declines in revenues and profits. Chinese investors are waking up to the fact that the Chinese government will allow risky borrowers to fail. To compensate for the increased perception of risk, investors are demanding higher returns. In the long run, allowing the credit market to price risk is a good thing, since cheap capital will flow to companies that have earned it through performance rather than companies with government connections. In the short run, it means companies that have routinely had access to cheap credit, irrespective of their financial health, must now improve their business model, pay more for credit or face failure. Companies that previously had access to credit through trust companies' wealth management products are also scrambling after two wealth management products were allowed to renege on promises. This has slowed the indiscriminate flow of credit into wealth management products from private investors looking for better returns.

The liquidity squeeze we have discussed periodically over the past year is intensifying, as cash-strapped companies lose access to additional credit from banks, the credit market and the shadow banking system. A whole host of companies and investors are learning what it means to operate without the safety net of implied government guarantees. A good number of companies are not going to be able to maintain their balance on the high wire of debt they have accumulated, which could negatively impact China's highly levered banks and economic growth. The question is how many companies will policymakers allow to fail before they revert to backstopping bad loans and announcing new infrastructure spending programs. The risk is that by the time they act it will be too late. History shows that once a liquidity crisis takes hold, events often take on a life of their own.

In our January Macro Market Update webcast, we suggested that the Shanghai Stock Exchange Composite Index would make a trading low if it traded under 2,000. This view was based on the technical pattern in the Shanghai Composite and not the fundamentals of the Chinese economy. In early March, the composite did trade under 2,000, and has since rallied. If it can trade above 2,140, a rally to 2,240 will likely follow. Although we still believe any liquidity event may not become a factor until later this year or in 2015, a decline below 1,975 would reflect a serious deterioration of liquidity in the Chinese financial system. Conversely, a rally above 2,450 would likely indicate that Chinese policymakers had accomplished a feat similar to Karl Wallenda's seven-person chair pyramid.

U.S. Economy

After the extreme weather in January and February depressed economic activity, the economy has rebounded as we expected. So far, the recovery appears to be nothing more than a snapback and not a true acceleration. GDP growth may climb above 3% in the second quarter, but after averaging growth of around 1% in the first quarter, first half growth will remain stuck in the 2.0-2.5% range of the past three years. Strength in the second quarter may lead some economists to increase their second-half GDP forecasts; however, income and job growth don't support that optimism in our view.

Nonfarm jobs reached 116.09 million in March, finally surpassing the prior peak of 115.98 million in January 2008. Although private jobs achieved a new milestone, total jobs are still almost 500,000 below their prior peak, since federal, state and local employment  is down by 535,000 jobs from December 2007. If private payrolls were adjusted for population growth and the current labor market participation rate, another seven million jobs would be needed. With the 192,000 jobs created in March, the 12-month average of job creation is stuck in the range it has been in since March 2012. Average weekly earnings were up 2.1% from March 2013, which means most workers are barely keeping up with the cost of living. The U-6 rate rose to 12.7% from 12.6% in February, as the number of workers working part time, but preferring a full-time job, rose from 7.17 million to 7.40 million. Of the 10.50 million Americans officially unemployed, 3.70 million have been out of work for more than six months. Consumer spending represents 70% of GDP, so job and income growth will need to accelerate significantly, before an increase in GDP growth above 3% can reasonably be expected.

On a positive note, the economy may get a lift before year-end from an increase in business investment spending, which represents about 14% of GDP. Capacity utilization has been creeping higher over the last three years and reached 79.2% in March. As it edges closer to 80.0%, companies may feel it necessary to invest in new equipment and plants to meet future demand. Bank lending to businesses increased in the first quarter, as the six largest banks increased commercial loans by 8.3%. These loans may indicate that companies are finally ready to invest in their businesses, rather than just buying their stocks.

Consumer confidence improved in March, rising to 82.3 from 78.3 in February. The Present Situation Index, a subcomponent of the Consumer Confidence Index, actually dipped from 81.0 to 80.4 in March, while its counterpart, the Expectations Index jumped to 83.5 from 76.5 in February. Two factors likely lifted consumer spirits. Tax refunds were processed much faster this year than in 2013 when they were delayed by the fiscal cliff standoff. Since the increase in confidence was completely due to the large improvement in the Expectations Index, consumers were clearly looking forward to the arrival of spring, warmer temperatures and the end of the worst winter in recent memory. Steady growth in coming months is the ideal backdrop for the Federal Reserve to maintain its pace of quantitative easing (QE) tapering.


After the European Central Bank's (ECB) meeting on April 3, President Mario Draghi stated that the ECB's 24-member board was "unanimous in its commitment to deploy unconventional instruments" if inflation stays too low for too long.[3] Although  the inflation rate fell to 0.5% in March, Draghi noted that Easter occurred during March of last year, and with Easter taking place in April this year, the inflation rate is expected to rebound. Even if inflation ticks up to 0.6% or 0.7%, it still will be well below the ECB's target of 2.0%.

As we discussed in the April Macro Strategy Review, the simplest way for the ECB to lift inflation and further support growth would be to communicate a desire for the euro to decline. International currency traders would be more than happy to sell the euro short, knowing they had the ECB's blessing. The ECB has estimated that the 15% rise in the euro over the last 18 months has shaved 0.4% off eurozone inflation. Since imported goods will cost more and add to inflation, a weaker euro should alleviate some of the downward pressure on inflation. A weaker euro would also make exports from every country in the European Union (EU) cheaper for the rest of the world to buy, which will likely lead to an increase in exports and GDP growth for the EU. A cheaper euro would especially help Italy, Spain and France, which have higher labor  and production costs than Germany. Talking the euro down may not cost the ECB a single euro, since international currency traders will do most, if not all, of the "heavy" selling. And the unintended consequences of the euro devaluation strategy seem far less than the other options under consideration.

The ECB pays no interest to banks that have funds on deposit with the ECB. If the ECB charged banks a negative deposit rate (i.e., banks would pay the ECB 0.1% for funds on deposit), banks might pull  their deposits, and hopefully, lend more to small- and mid-sized companies that have been struggling for access to credit. One of  the problems with negative deposit rates is that no central bank  has ever done it, so there is no prior experience to learn from and no assurance it will have a meaningful impact.

The ECB is also studying QE, which would be more difficult for  the ECB than it was for the Federal Reserve. Banks provide 80% of credit in the EU, versus 35% in the United States. Firms in the U.S. rely much more on issuing bonds in the U.S. credit market than on banks for credit. This means the eurozone bond market is much smaller, so there are far fewer bonds available for the ECB to buy. In addition, there are 18 countries with 18 bond markets for the ECB to navigate, which could prove a fertile playground for political infighting. Bond yields throughout the eurozone are already historically low, so QE may not make that much of a difference. On April 10, Greece sold $4.2 billion of bonds, with a yield of 4.8% on the five-year bond and less than 6.0% on the 10-year bond. In 2012, the yield on Greece's 10-year bond exceeded 30.0%. From a macro point of view, Greece being able to peddle $4.2 billion of bonds at such low yields must be recognized as an event. Possibly a bookend to Draghi's comment in July 2012 that the ECB would do "whatever it takes," from which point sovereign debt yields fell significantly in every country.

One of the biggest threats to the eurozone's recovery is the lack of credit flowing to small- and medium-sized businesses. As discussed last month, lending is still contracting and the ECB's stress testing of the 128 largest banks is likely to keep most banks reluctant to increase lending anytime soon. The lending crunch is so severe that a number of U.S. nonbank investment firms began taking advantage of the opportunity by lending directly to small European firms last year. According to financial advisory firm Deloitte LLP, the number of loans by nonbank lenders increased from 18 in the first quarter of 2013 to 56 in the fourth quarter. While helpful, the volume of this lending is too small to make a large impact.

The ECB has long argued that the securitization of mortgages, business loans and other loans should be revived since it would provide an additional funding source for the eurozone economy. An April 11 report by the ECB and Bank of England noted that the default rate of European securitized loans between July 2007 and September 2013 was just 1.5%, versus a default rate of 18.4% for U.S. securitizations for the same period. Despite the superior performance, the securitized loan market in the EU is $2.1 trillion, compared to $8.0 trillion in the U.S. The report cited regulatory treatment as one of the top reasons the market for securitized loans in Europe has not grown. Reviving the securitized loan market would involve modifying regulations, take a fair amount of time to implement and in the end, would not likely lift inflation or boost growth in the short term.

Of the options on the table to lift EU inflation and growth, talking down the euro's value seems the easiest choice compared to negative deposit rates, QE and the revival of the securitization market. Ironically, all of the options may result in a decline in the euro. Shorting the euro has the potential to result in a profitable trade over the next year.


From recent highs, the Russell 2000 Index corrected -9.67% and  the NASDAQ 100 Index fell -8.67% while the S&P 500 Index slipped only -4.37%. The wide disparity between the depth of the S&P 500's decline and the other indices indicates that as some stocks were being sold, others were being purchased. Investors sold the big winners from 2013 so they could rotate into cyclical stocks that are presumed to offer more value. Since there is consensus that economic growth will improve in the second half of this year, investors are positioning their portfolios to benefit from better growth. A rotational correction is normally less severe than one  in which investors sell all stocks. Although rotational corrections are more benign, they can still inflict damage on the market's underpinnings, as the recent correction demonstrated.

Our proprietary Major Trend Indicator has continued to weaken, even though the S&P 500 is within 1% of a new all-time high, as of April 25. Another sign that the overall market's participation is lessening can be seen in the contraction in the number of stocks making a new 52-week high. On April 23, just 140 stocks made a new high on the NYSE versus the 536 stocks that did so last May, even though the S&P 500 is 12% higher. The Russell 2000 and the NASDAQ 100 are not likely to confirm any modest new highs with the S&P 500, which would represent a technical warning for the overall market. Although the S&P 500 is hovering within 1% of a new high, the market is weaker than it looks on the surface, based on momentum and the market's internal technical strength.

Amazingly, 21 out of 21 equity strategists expect the S&P 500 to end 2014 above 1,850, according to Credit Suisse. With such an optimistic outlook, few are likely to sell unless they are provided a good reason or data that challenges their sanguine view. Investors have accepted the winding down of QE as a good trade for the better growth they expect later this year. If growth does not accelerate as forecasted, investors might have a reason to  do some selling, but that may not be known until around Labor Day. Obviously, if civil war erupts in Ukraine, investors could very quickly have a reason to be concerned. Over the next month or  so, corrections are likely to be limited to a range of 4-7%, since investors are unlikely to be presented with an economic reason to sell all stocks.

Comparing current valuations to the dot-com bubble levels of 2000 seems silly, since it is unlikely those extremes will be seen again by anyone alive today. Current valuations are in the top three of the highest valuations over the past 140 years, based on Shiller's CAPE Ratio, Tobin's Q-Ratio and the market's capitalization as a percent of GDP. Until a good reason to sell appears, the market can become more expensive. However, the portfolio risk from the current level of valuation suggests it may be time to reduce the allocation of buy-and-hold investments and instead pursue investments with a tactical approach. The best time to consider an allocation change is before a reason to sell appears, not after.

Treasury Bonds

The pattern of the 10-year Treasury yield suggests that it is likely to fall below 2.58% and approach 2.46%. Although we expect the Federal Reserve to continue paring its purchases of Treasury bonds and mortgage-backed securities, we don't expect economic growth to accelerate much. If our ECB assessment is correct, a weaker euro and stronger dollar could bring nondollar investment flows back into Treasury bonds.


  1. The Flying Wallendas website, "Wallenda's history."
  2. The Wall Street Journal, "China Holds Its Breath As Property Balloon Deflates," April 21, 2014.
  3. The Wall Street Journal, "Bundesbank's Dombret: ECB Has Necessary Instruments to Counter Low Inflation," April 8, 2014.


Definition of Terms

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

Capacity utilization rate measures the rate at which potential output levels are being met.

Consumer Confidence Index (CCI) is a measure of U.S. consumer confidence, defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending.

Consumer Price Index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. The percent change in the CPI is a measure of inflation.

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

Debt-to-GDP ratio is a measure of a country's federal debt in relation to its gross domestic product (GDP). By comparing what a country owes to what it produces, the debt-to-GDP ratio indicates the country's ability to pay back its debt.

Devaluation is a reduction in the value of a currency with respect to other monetary units.

European Central Bank (ECB) is one of the world's most important central banks, responsible for monetary policy covering the 18 member countries  of the eurozone. The ECB, established by the European Union (EU) in 1998, is headquartered in Frankfurt, Germany.

Expectations Index is a subindex that measures overall consumer sentiments toward the short-term (6-month) future economic situation.

Gross domestic product (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.

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

A mortgage-backed security (MBS) is an asset-backed security whose  cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are typically made monthly over the lifetime of the underlying loans.

NASDAQ 100 Stock Index is a modified capitalization-weighted index that includes the largest nonfinancial U.S. and non-U.S. companies listed on the NASDAQ stock market across a variety of industry groups, such as retail, healthcare, telecommunications, wholesale trade, biotechnology and technology.

Present Situation Index is a subindex that measures overall consumer sentiments toward the present economic situation.

Q ratio was devised by James Tobin of Yale University, Nobel laureate in economics, who hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm's assets.

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

Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 3000 Index represents approximately 98% of the investable U.S. equity market.

Shanghai Stock Exchange (SSE) Composite Index is an index of all stocks (A shares and B shares) traded on the Shanghai Stock Exchange. It includes the values of 50 Chinese companies.

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

Sovereign debt is the total amount owed to the holders of the sovereign bonds (bonds issued by a national government).

U-6 unemployment rate includes the total amount of people unemployed and those marginally attached to the labor force, plus total employed part time for economic reasons.

Valuation is 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 March 31, 2014, we manage $5.2 billion in a diverse product set offered to individual investors, financial advisors and institutions.

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