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Global Investment Outlook October/November 2010

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Generated at: Thu Oct 14 10:58:47 2010

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Introduction 5Brian Feighan, Managing Director of Wealth

Global Investment Outlook 7Alan Dunne, Investment Director

Global Equity Market Outlook 9John Fahey, Investment Strategist

Irish Economic Outlook 11Simon Barry, Chief Economist Republic of Ireland

The Art of Calculating the Odds of a Double Dip 13Carl Astorri, Global Head of Economics and Asset Strategy – Coutts & Co

Commodities Outlook 15Michael Casserly, Investment Analyst

Trends in Mergers & Acquisitions and Private Equity 17Keith McGough, Investment Product Manager

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Dear clients and fellow investors,

On behalf of Ulster Bank Wealth I am delighted to present our latest Global Investment Outlook. Since our last Outlook in April, world markets have become more concerned about the sustainability of world economic recovery. The potential threat of a double dip recession, concerns over sovereign debt default and the uncertainty over whether we are headed for inflation or deflation have all combined to create an unstable global picture. Against this backdrop it is essential for investors to have an informed view of the market. This will allow investors to make sound decisions based on an understanding of what the key drivers of market performance will be in the months ahead.

In the following pages we examine the major global themes that are currently influencing market direction and performance. We start with a comprehensive overview of the global picture from our Investment Director, Alan Dunne. John Fahey, Investment Strategist, then reviews global equity market performance and the factors investors should be considering in the present climate. Chief Economist, Simon Barry, gives his views on the Irish economic outlook and the prospects for an export-led recovery. Returning to the international scene, Carl Astorrri, Head of Economics and Asset Strategy at Coutts, investigates the possibility of a double dip recession in the US. Commodities always merit our attention and Michael Casserly, Investment Analyst, reviews the prospects for Agricultural Commodities, Gold, Industrial Metals and Oil. We round off with a look at the return of activity in mergers, acquisitions and private equity from our Investment Product Manager, Keith McGough.

Notwithstanding our present economic difficulties at home, we all ultimately have a vested interest in the future performance of global asset markets and the world economy. Rarely has Ireland received so much international media and political attention as we have witnessed in recent months. One positive from this exposure is that Irish investors are becoming much more outward looking when it comes to investment selection. We are seeing a significant trend towards global diversification in our clients’ investment decisions and this is very encouraging indeed.

I hope you enjoy reading our Outlook and that it gives you some helpful insights to guide your investment decisions. As always, our wealth managers and specialists are on hand to offer you advice and guidance with your wealth management strategy. On behalf of Ulster Bank Wealth I would like to thank you for your continued support. We look forward to serving your wealth management needs for many years to come.

Best wishes

Brian FeighanManaging Director Ulster Bank Wealth

Brian FeighanManaging Director of Wealth

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Alan DunneInvestment Director

7

Global Investment OutlookWeaker growth in the major economies, a slowdown in China and a sovereign debt crisis in Europe have brought renewed volatility to financial markets. Fears of a double dip recession have resurfaced leading to speculation of further aggressive monetary measures from central banks. Investors are split in their assessment of whether deflation or inflation currently presents the greater risk and this has led to greater swings in asset markets. While the near term risks to growth have risen, we think the global economic recovery is more likely to continue than falter. In addition, the current juncture in financial markets presents good tactical opportunities in emerging market bonds and corporate bonds, and attractive longer term opportunities in equities.

The new normal: moderate economic growthThe last six months have witnessed a moderation in the economic recovery that began in mid 2009. A number of factors have contributed to this slowdown in growth: First, growth in China, an important driver of global growth, has slowed as the measures taken to cool the property market have slowed lending and investment. Second, the sovereign debt crisis in Europe, not only pushed up the cost of borrowing for some European countries, but highlighted the perils of lax fiscal policy and rising fiscal debt levels. This increased the onus on policymakers to accelerate plans to address public finance deficits by cutting spending. Third, a number of important stimulants to growth, such as the support for the housing market in the US, have run their course.

Source: Coutts

US Household Debt

50

60

70

80

90

100

110

120

130

140

59 63 67 71 75 79 83 87 91 95 99 03 07

% Disposable Income

More fundamentally, the legacy of the Great Recession of 2008/2009 is still being felt in the US economy in particular. The ongoing process of de-leveraging, from the high levels of debt built up during the boom, is impacting consumer demand. Credit constraint on the part of financial institutions and a pervasive sense of caution is also constraining business investment and hiring. Research has shown that economies burdened with higher levels of debt tend to grow more slowly, after a credit boom. This cycle looks no different and suggests that even if recovery is sustained, “normal” levels of growth going forward may be closer to 2% than the 3%-4% rates achieved for much of the last decade.

Looking ahead, however, there remain reasons to be optimistic that the recent soft patch in the data is just that; a soft patch rather than a precursor of a double dip recession and a slide into deflation. Monetary policy remains ultra accommodative as interest rates remain at historic lows. With equity markets now rising, corporate bond yields declining and financial markets continuing to thaw, the cost of capital to business has declined. The recent pick up in mergers and acquisitions activity and the growing trend of companies buying back shares, is a reflection of this lower cost of capital. Over time as confidence takes hold the hope is capital will increasingly be deployed in investment and hiring.

Furthermore, growth in many emerging economies is strong and is likely to be an important support for global growth in the coming quarters. Meanwhile in the developed world, central bankers stand ready to support growth via further liquidity injections (“quantitative easing”) should growth falter again. The recent indications from the Federal Reserve in particular suggest further support for the US economy is likely to be forthcoming in the coming months.

So while it is true that there is, as Fed Chairman Bernanke says, an “unusually high degree of uncertainty” about the macro economic outlook at the moment, the most likely scenario is that the global economy avoids a double dip recession and the economic recovery continues. Consistent with this view, our colleagues in Coutts &Co. currently forecast growth of 2% in the US economy in 2011.

Search for YieldThis scenario of moderate economic recovery is unlikely to be sufficient to erode the substantial spare capacity in developed economies and risks putting further downward pressure on core inflation levels, which are already trending down. Consequently official interest rates in the US, UK, Japan and Eurozone are likely to stay at exceptionally low levels. Over the long term there remains a strong relationship between core inflation rates and long term government bond yields. So although bond yields in the major economies are at historic lows, there remains a strong likelihood that these core bond markets will remain supported in the coming months. The likelihood of direct purchases of government bonds from quantitative easing adds further support to this case.

Source: BloombergCPICPI ex food and energy

G7 Inflation16

14

1210

8

6

4

2

0

71 74 77 80 83 86 89 92 95 98 01 04 07 10-2

% yoy

However, for long term investors current bond yields are not very attractive and investors are likely to put a premium on achieving higher yield. The pursuit of higher yield is unlikely to be indiscriminate; investors will continue to differentiate between those sovereign bond markets with strong fundamentals and

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improving credit profiles (such as many emerging markets), and those with deteriorating fundamentals (such as the peripheral European nations including Ireland). The outlook is also particularly attractive for corporate bonds at this stage of the economic cycle. With ongoing economic recovery, profit growth remains solid, and as businesses boost retained profits and cash balances their ability to meet their debt obligations improves. In this environment corporate bonds should deliver attractive risk adjusted returns.

Source: Bloomberg

US Core Inflation & Bond Yields14

12

10

8

6

4

2

0

18

12

14

16

10

8

6

4

262 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10

% yoy %

Core CPI (Lhs) 10 year government bond yield (Rhs)

Opportunities in currencies and commoditiesInterestingly in some markets it has been the opposite of this search for yield that we have witnessed in recent months. The Swiss Franc, the Japanese Yen and Gold, all assets with little or nothing in the way of yield but generally regarded as safe havens, have all appreciated. Typically these assets do well in an environment of risk aversion, so the trend is somewhat curious in the context of the sharp rally in some emerging markets over the same period. Concerns about the stability of the US Dollar, the Euro and Sterling should their respective central banks resort to further quantitative easing appear to be behind the move out of these currencies into perceived safer havens.

Looking ahead, the search for yield, and the structural trend towards investors increasing allocations to emerging market equity and debt markets, should be positive for emerging market currencies. Interest rates are generally higher in emerging economies and a number of central banks such as in India and Brazil are raising rates. This should also tend to attract capital. Although China has to date been reluctant to allow a sharp appreciation of the Renminbi, over time rising emerging market currencies should be consistent with the global economic rebalancing towards greater consumption in emerging economies. Over the medium term there appears a stronger case for having exposure to these currencies than low yielding currencies such as the Yen or Swiss Franc.

In commodity markets, while it is difficult to say that the rally in Gold is justified by fundamentals, on most measures (such as deflating Gold by the consumer prices) Gold is not yet at an historic price extreme. Given the macro economic scenario of ongoing concerns about fiat currencies in the context of further quantitative easing, there will likely continue to be further investor and speculative buying of Gold. However, for longer term investors agricultural commodities and metals may present a more attractive proposition given the demand supply imbalances in these markets.

Value in Equity MarketsThe scenario of moderate economic growth and declining inflation would not appear to be positive for equity markets. Corporate profits tend to track nominal GDP growth (the sum of real GDP growth plus inflation) over time. So far this year companies have defied weak economic growth by continuing to cut costs. Base effects have also flattered earnings growth which has been of the order of 30% year on year in both the US and Europe. That said, many investors remain sceptical towards equities, citing the weaker economic outlook and the poor performance of equities over the last decade.

Source: MSCI, Coutts

Valuations: World Trailing & Forward PE Ratio

705

10

15

20

25

30

35

40

75 80 85 90 95 00 05 10S&P 500 Trailing PELong term average

S&P 500 Forward PELong term average

However, valuation is the key driver of equity returns over the long term and the decline in equities since April has brought valuation measures back to reasonably attractive levels. The main risk in the short term is if the macro economic data weaken and deflation fears resurface, sentiment towards equities may take a hit and earnings expectations could be reduced further. While this remains a possibility over the next number of months, for long term investors many of the main blue chip companies in the US and Europe are currently priced to deliver above average long term returns.

SummaryDespite the recent weakness in the economic data a double dip recessions remains in our opinion an outlier rather than a central scenario. However, in the post boom era normal levels of growth are likely to be more muted and investors need to adjust to the new normal of lower nominal economic growth and likely lower investment returns. Investors are likely to place a premium on achieving reasonable yield with limited risk which should support fixed income markets and corporate bonds in particular. However, for longer term inventors equities should deliver the stronger returns if investors can look beyond the short term data.

Alan DunneAlan Dunne is Investment Director at Ulster Bank Wealth where he has overall responsibility for investments and pensions. He is a Director of the Ulster Bank Wealth Alternative Investment Programme and a member of the Coutts Investment Strategy Committee. He has extensive experience in global financial markets as an investment strategist. Prior to joining Ulster Bank Wealth, he was responsible for investment strategy at Allied Irish Capital Management, a commodity trading advisor (CTA). Previously he spent a number of years as a Vice President, foreign exchange strategist with Bank of America in London, Hong Kong and Singapore. He has a BA (Mod) Economics from Trinity College Dublin and an MSc in Investment Management from Hong Kong University of Science and Technology. He is a CFA charter holder.

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John FaheyInvestment Strategist

Global Equity Market OutlookThe year to date has proved testing for equity markets. Heading into 2010 it was always likely that risk appetite would be tested. The consensus view was that the first half of the year would see modest gains whilst the second half would see increased volatility as speculation over the sustainability of the economic recovery would weigh on investors minds. However the onset of the Greek debt crisis at the start of the year brought forward these uncertainties. As a result uncertainty and volatility have been the predominant feature of equity markets. While investor sentiment is an important short term factor for equity market returns, it is our view that investors have been too downbeat on the prospects for continued economic recovery. We believe that over the next 12 – 18 months, equities can achieve moderately positive returns. We base this analysis on three factors that will drive returns, namely earnings, valuations and macroeconomic fundamentals.

Equity Market Performance (Year to date, as at 30/9/2010)

Index Performance BackdropUS: S&P 500

2.34%

Concerns over a Double Dip acted as a drag, whilst positive earnings (Q1 and Q2) helped returns

Eurozone: Dow Jones Euro Stoxx 50

-7.32%

Greek debt issues developed into a Eurozone Sovereign Debt crisis, raising concerns over possible default and future of the euro

Japan: Nikkei 225

-11.16%

Hit by effects of a strong Yen, due to investor buying of the currncy as a safe haven. Political uncertainty was also a negative

EM: MSCI Emerging Markets

8.70%

Continued to outperform on stronger underlying fundamentals (economic growth rates, less deleveraging, healthier government finances)

Earnings point to a positive outlookThe latest data on corporate earnings (covering Q2) paints a positive picture with beat ratios (both revenue and earnings) at near record highs. Corporate profits have now been increasing for six consecutive quarters with previous cost cutting measures and increased efficiencies in production helping to drive margins. The latest data indicates that the increase in profits is not solely due to cost cutting and that consumer demand is increasing its role in earnings growth. 75% of companies beat estimates, with year on year earnings growth of c.48% in the second quarter. Not only are the actual earnings data encouraging, but the fact that there is an increasing number of corporations willing to issue guidance both on sales and earnings indicates a positive outlook. It shows increasing confidence on the part of corporations about future demand and the visibility on this. This is important as it will be the private sector that will drive a sustained improvement in economic performance. As this demand continues to pick up, firms will have to start hiring again to be able to meet orders, resulting in a positive impact on payrolls. As this hiring gathers momentum, so too will the economic recovery, pushing the economy into the expansionary phase of the economic cycle, increasing company earnings and driving equity market returns upwards.

Source: Coutts, Bloomberg as at 3/8/2010

Positive trend in US sales and profit growth

300 3,0002,9002,8002,7002,6002,5002,4002,3002,2002,1002,000

250

200

150

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Mar-09

Jun-09

Jun-10

Sep-09

Dec-09

Mar-10

100

50

US Equities

Net incomeSales

cost cutting periodN

et in

com

e U

S$ b

n

Sale

s US$

bn

Valuations at attractive levelsValuations for global equities have improved, making equities more attractive. This is a consequence of investors selling equities on concerns that the economic recovery was stalling, whilst at the same time corporate profits have been improving. This pessimism on the economic outlook is overdone and as a result equities have been oversold. Whilst the recovery has lost some momentum, there is still a low probability of the US recovery slipping back into recession. Valuations are now attractive both on an absolute and relative basis. On an absolute basis, forward and trailing Price Earnings (PE) ratios for US equities are below their long term average (see chart below). The current level of equity valuations on this basis are consistent with modest returns. On a relative basis, equities are cheap relative to bonds based on the equity to bond yield ratio. Whilst the valuations on emerging market equities are moving closer to developed equities, this is justified by better returns in emerging market equities. Within emerging markets, Asian equities are the most expensive, but are still trading at a discount to US equities. In summary, valuations on both an absolute and relative basis indicate that equities can achieve positive gains over the medium term.

Source: MSCI, Coutts

Valuations: World Trailing & Forward PE Ratio

705

10

15

20

25

30

35

40

75 80 85 90 95 00 05 10S&P 500 Trailing PELong term average

S&P 500 Forward PELong term average

Macroeconomic Fundamentals

Low Probability of Double Dip in USTalk of a double dip (i.e. return to recession) scenario for the US economy has become more frequent since the summer months. This is on the back of a string of disappointing macro data releases (GDP, Non Farm Payrolls), which have suggested that the recovery is losing some of its momentum. It is our view however that the US economy can avoid a double dip. The Purchasing Manager’s surveys, which are regarded as good lead indicators are still above 50 (the break even point between expansion and contraction). Our colleagues at Coutts have carried out an analysis of the likelihood of the US returning to recession (i.e. two consecutive quarters of negative growth) and their findings suggest a 30% probability that the US economy will fall back into recession. The main driver historically of US economic growth has been consumer spending. A crucial reason fuelling the uncertainty towards the US economy has been the lack of a sustained improvement in the labour market. This situation will continue to act as a drag on consumer spending. However there are some encouraging signs, with consumers still managing to spend (albeit modestly) and at the same time increasing their savings and paying down debt (de-leveraging). Overall, the outlook for the US economy is for continued growth, but the pace of growth may be slower than previously expected.

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Fiscal Austerity to act as a drag for Eurozone growth From a Eurozone perspective, the main area clouding its economic outlook is the ongoing sovereign debt issue. Those countries in the ‘periphery’ in the most precarious fiscal positions need to act promptly and aggressively to tackle their fiscal imbalances. This process of fiscal consolidation (i.e spending cuts and higher taxes) is likely to act as a drag from an economic growth perspective. The downward impact on growth will be somewhat offset by the boost to Eurozone trade from the expected continued weakness in the euro. Therefore economies with an export orientated characteristic and who have significant trade to emerging market economies will benefit from international trade. Those economies with a greater reliance on domestic demand and implementing the toughest austerity measures could experience periods of contraction. Overall, the Eurozone as a whole has the potential to sustain growth, but with increasing divergence in economic performance amongst ‘core’ and ‘periphery’ economies.

Emerging Market economies will continue to lead the way Emerging Market economies are continuing to set the pace in terms of economic performance. China registered GDP growth of 10.3% y/y in Q2, whilst India’s economy in Q2 expanded by 8.8%, its fastest pace of expansion in over two years. This compares with growth of 3% in the US and 1% in the Eurozone over the same period. The strong performance from emerging economies is helping to sustain growth in the global economy. There has been ongoing concerns of ‘overheating’ in the Chinese economy and the Chinese authorities have implemented measures to try and ease upward pressures on prices. These measures have included official guidance to banks to curb lending. The macro data over the last number of months suggests that the Chinese government is succeeding in slowing the pace of economic growth. While equity market reaction to this macro data has been negative, on a longer term basis a slowdown from its current high growth rates is desirable as it is not sustainable for China to keep growing at such a rapid pace. A Chinese slowdown will impact other emerging economies that trade with China, however its growth rates will still be substantially higher compared to developed economies. Therefore the outlook for emerging economies is one of continued outperformance over developed economies.

Equity Strategy ImplicationsTherefore a backdrop of moderate economic growth for developed economies, continued outperformance of emerging economies, and a benign inflationary environment in developed economies implies the following implications for equity market returns and investment strategies:

(1) Equity markets have the potential to achieve gains over the next 12 – 18 months, however given the more sluggish nature of the economic recovery and the short term impact that investor sentiment can have on returns these will be moderately positive. Equity valuations are currently consistent with modest rather than spectacular returns.

(2) The fact that domestic demand in the Eurozone will be negatively impacted by austerity measures, the region will still rely heavily on exports to drive economic performance. This means that domestic companies with a strong export focus outside the region have strong growth potential. This highlights the relevance of investing in European equities (and other western equities) with a strong sales exposure to emerging market consumers.

(3) Emerging market economies will continue to lead the way in terms of performance and growth levels. These economies are not facing the same headwinds as developed economies. There is no widespread de-leveraging, consumers are not as indebted compared to their developed neighbours and government finances are in much healthier state. Merger and acquisition activity is now greater in Asia than in Europe. Given these compelling fundamentals, direct equity exposure to emerging markets offers potential for strong returns. Investment flows into these markets will increase as investors seek out the higher potential returns and these increased flows will add further upward momentum to equity returns.

(4) A macroeconomic scenario of sluggish economic growth and continued downward pressure on prices is an environment where income stocks tend to outperform growth stocks. The dividend payout from a stock will be worth more each year if the price levels fall. Therefore income stocks will get upward support from investors who are hedging against deflation.

SummaryEquity market performance is currently following a ‘risk on, risk off’ pattern, where negative news is prompting risk aversion and a sell off in equities. This trend is likely to continue in the short term, as investors remain to be convinced on the sustainability of the economic recovery. Whilst the recovery has lost some momentum, we still believe that there is a low probability of a double dip scenario in the US economy. Therefore on a 12 – 18 month basis equities can continue to make gains, however the magnitude of these gains will be modest. Given the more sluggish nature of the recovery in developed economies, exposure to emerging markets either through direct exposure or via companies in developed markets with a strong sales exposure to emerging market consumers offers the potential for stronger returns from equities. A macro backdrop of continued downward pressure on prices offers the opportunity for income stocks to outperform.

John FaheyJohn Fahey is Investment Strategist at Ulster Bank Wealth where he is responsible for macroeconomic and investment strategy analysis. Prior to this role, John was Head of the Financial Planning Unit within Wealth. Before joining Ulster Bank, John worked in the Economics Department at National University of Ireland (NUI) Galway, where he taught courses in economics. He has a BA in Economics, Sociology, Political Science and an MA in Economics from NUI Galway.

90002744 8 14/10/2010 10:52


Simon BarryChief Economist Republic of Ireland

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Irish Economic OutlookExternal demand is always a key driving force in the early stages of a cyclical pick-up in a small, open economy such as Ireland and sure enough, the dominant factor in the return to positive GDP growth in the first quarter was a stronger than expected 7.1% quarterly surge in export growth – the strongest quarterly performance in three years.

Total exports continued to grow in Q2, albeit at a less exceptional pace of 1.6% q/q, but a pick-up in imports meant that net trade was a drag on Q2 GDP growth which returned to negative territory at –1.2%. The latest data on goods trade indicate further expansion of merchandise exports in Q3 (the value of July exports were up 7.4% on the Q2 average), a signal that is corroborated by the strength of industrial production which is running 8.7% ahead of the Q2 average on the latest numbers.

However, it would be wrong to assume that the recovery will be plain sailing from here. Indications of a slowing global economy lately are a troubling development, notably in the US where a series of recent data points have disappointed to the downside. At this stage it is difficult to know whether what is unfolding here is some softening in momentum following an early-cycle snap-back in growth or whether the global recovery is headed for a premature end.

There have also been some signs of a stalling in the more positive trends in some domestic indicators lately. Notably, the monthly profile of core retail sales has softened in recent months following a run of consecutive monthly gains earlier in the year, linked to signs of a weakening in consumer confidence. There has also been a softening in the manufacturing and services PMIs, with the headline index in both dipping below the key fifty mark for the first time in several months in September. While we never read too much into one month’s data, a continuation of the recent downtrend here would be a cause of some concern as the trajectory for GDP growth has closely followed the signal from the trends in the much more timely composite PMI index (available to September).

Irish GDP and Composite PMI

3035404550556065

Q4 00Q3 01

Q2 02Q1 0

3Q4 03

Q3 04Q2 05

Q1 06

Q4 06Q3 07

Q2 08Q1 0

9Q4 09

Q3 10–10

–5

0

5

10

GDP % y/y (RHS)

Source: CSO, Market Economics

Latest readings:GDP: Q2 '10PMI: Sep '10

Composite PMI of Manufacturing, Services and Construction (LHS)

The signs of a slowing global economy, combined with the recent loss in momentum in some key indicators of domestic economic activity and the likelihood of tighter-than-previously anticipated budgetary policy have prompted us to revise down our growth forecasts. Following a 7.6% plunge in real GDP in 2009, we now envisage average annual GDP growth of around 0.5% this year (previously 1.0%). GNP is somewhat weaker at –1.0%, (previously –0.5%) partly reflecting the strength of multinational corporations’ profit outflows. For next year we now expect GDP growth of the order of +2.5% (+3.0% previously) – lower than the latest consensus forecast of +2.8%.

The economy also continues to face a number of structural headwinds, most notably from the property correction which, while well-advanced , has not yet fully run its course. On the jobs front, the labour market is set to weaken further in the short term: employment probably has further to fall, though at a reduced pace compared with heretofore, while the unemployment rate is set to peak between 13.5 and 14% later this year, from 13.2% in Q2.

Turning to the public finances, the correction here has entered its third year and the considerable progress to date means that in our view the Irish government has established itself as a “credible deficit reducer”. Targets for the underlying budget situation are broadly on track which should result in a reduction of the underlying deficit from a peak of 12.1% last year to 11.5-12% this year and to around 10% in 2011.

The government recently reaffirmed its commitment to get the deficit back to 3% by 2014, indicating that a larger than previously signalled budgetary package would be delivered in December and that a detailed multi-annual fiscal programme would be spelt out next month in advance of Budget Day (December 7th). While the strong commitment to deficit-reduction is appropriate given the need to demonstrate to markets that the public finances will be restored to a sustainable path, it does mean that fiscal policy will continue to weigh on domestic demand for several years to come.

Whatever about underlying budget targets remaining broadly on track, the considerable uncertainty about what the true final cost of recapitalising the banking sector will ultimately amount to has been weighing heavily on investor sentiment in Irish government bond markets. 10-year spreads relative to Germany have widened dramatically since late July and hit new crisis highs of close to 4.5% at end-September. But the 30th September announcements from the authorities on the banking sector represent an important development in terms of plausibly quantifying the true and final burden from recap requirements on the public finances. The shockingly large costs involved will likely result in an extremely ugly, though one-off, spike in this year’s headline budget deficit to around 32% of GDP, of which some 20% of GDP is directly attributable to the non-recurring recap costs (including a revised total gross cost for Anglo of €29bn).

Such costs will result in a General Government Debt (EU measure) to GDP ratio of around 99% for 2010. However, this is a gross measure and does not reflect the very substantial assets held in the National Pension Reserve Fund (€24bn at end-June), or the substantial cash balances held by the NTMA (over €20bn in June). On a net debt basis, the debt/GDP ratio would be just over 70 per cent of GDP this year. The sizeable liquidity buffer means the state is pre-funded until Q2 of next year and has enabled the NTMA to avoid having to raise funds in the market at extremely unattractive levels (around 6.5% for 10-year cash). It has put its debt-issuance programme on hold until early next year, pending an expected normalisation of sovereign debt market conditions – an expectation that is dependent on a favourable market assessment of the credibility of the forthcoming fiscal plan and its implementation, beginning in the December budget.

For now, our central scenario envisages a continuation of the global recovery, albeit at only a moderate pace. In support of this we note the strength of US corporate profitability, the ongoing process of financial sector healing, the apparent resilience to date of the euro area and UK economies, the large amounts of stimulus (especially of the monetary variety) still in the system and the apparent willingness of central bankers in the US and UK to do more if necessary to secure recovery.

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Irish Exports: Performance & Prospects

-7-5-3-11357

Sep-01Jun-0

2

Mar-03

Dec-03

Sep-04Jun-0

5

Mar-06

Dec-06

Sep-07Jun-0

8

Mar-09

Dec-09

Sep-10Jun-1

1-10

-5

0

5

10

15

RoI External Demand Proxy* LHSRoI Export Volumes % yoy RHS

Source: CSO, UB, * Trade Weighted GDP Growth (actual and projected) for US, UK, Eurozone. Source: UB

FORECAST

This is an environment that should foster further expansion of Irish exports, the performance of which is also underpinned by improvement in Irish competitiveness, as reflected in declines in domestic costs and prices, in both absolute and relative terms, as well as a somewhat weaker euro against the dollar and sterling. A continuation of the export-led recovery should promote improved domestic confidence and ultimately provide the platform for a recovery in domestic demand, beginning next year.

Overall, the Irish economy is still very weak: the level of GDP is still 12% lower than pre-recession levels; the improvements in some areas are tentative at this stage; while there are other sectors, notably construction, for which recovery remains elusive. However, the Irish economy made some important early progress in a number of key areas (e.g. GDP, exports, the PMIs, industrial production and car sales) over the first half of the year in establishing a more favourable growth dynamic. Nonetheless, the downside risks facing the international outlook have risen and the weakness across the very latest (September) domestic measures of both business and consumer confidence was noteworthy and suggests the balance of risks to the Irish outlook is tilted to the downside. In particular, global economic momentum will require very careful watching as without the critical support from external demand, it is very difficult to see the Irish recovery staying on track, especially given the likelihood of tighter than-previously-signalled domestic fiscal policy.

Simon BarrySimon Barry is Chief Economist, Republic of Ireland at Ulster Bank Capital Markets. His areas of responsibility include coverage of the Irish economy as well as the major international economies and related interest rate and foreign exchange rate markets. Before joining Ulster Bank, Simon spent almost 7 years as Senior Economist with Bank of Ireland Global Markets. Prior to that, he worked as a senior consultant with Goodbody Economic Consultants having also worked as a lecturer in economics in Waterford Institute of Technology. He holds B.Comm. and M.Econ.Sc. degrees from University College Dublin.

90002744 10 14/10/2010 10:53


Carl AstorriGlobal Head of Economics and Asset Strategy – Coutts & Co

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The Art of Calculating the Odds of a Double DipHopes for a “V-shaped” US recovery have given way to fears of a ‘double dip’ as US growth has lurched from 5% at the end of last year to just 1.6% in the latest quarter. We’ve looked at the leading indicators that have historically had the most success in predicting future recessions, and our analysis suggests a current 30% probability that the US economy dips back into recession. However, these quantitative models cannot capture policy changes, which could significantly alter the probability in either direction by either by becoming more expansionary or more restrictive in the coming months. We believe a return to recession will ultimately be avoided, but markets will continue to price it in as a significant threat.

25

68 71 74 77 80 83 86 89 92 95 98 91 04 07 10

20151050-5-10-15-20-25

1086420-2-4-6

% yoy

ECRI (Lhs, 2q adv.)

% yoy ECRI called the bottom right

Source: Datastream, Coutts. As at 9/9/2010

GDP (Rhs)

Our analysis of a wide range of leading indicators found that the ECRI and the Conference Board leading indicators conveyed the most valuable information about the future growth of US GDP. For example, they both turned positive in April 2009, about two quarters before the US economy started recovering, but one month after the trough in the S&P 500.

What are leading indicators signalling?So what probability of a new recession in six months time are these leading indicators currently suggesting? We define a recession as two quarters of negative GDP growth and use a series of models to analyse these indicators and capture the probability of a double dip in six months time. The indices signal significantly different probability of a recession by the end of the year. The ECRI, which recently fell significantly, points to around a 30% chance, while the Conference Board to less than 10%. To reconcile this discrepancy we look more closely at the constituents of the Conference Board leading indicator, as no information on the calculation of the ECRI is provided.

The Conference Board index is a composite of 10 macroeconomic indicators, one of which is the difference between the yield on US 10-year Treasuries and the Federal Reserve’s Fed Funds rate for overnight lending between banks. Research has shown that this indicator has been a very good predictor of future recessions; a downward slopping curve, whereby longer term rates are lower than short term rates, usually indicates an upcoming economic slowdown. Indeed, many analysts argue that the current very steep upward slope of the yield curve indicates an almost zero probability of recession in the following months.

We believe this is an invalid argument. The Fed has cut its target rate to an historically low level and used a series of unconventional measures to ease monetary policy further. This has kept the yield curve artificially steep and obscured its value as an economic indicator. Considering that there will probably be no rate hikes for the foreseeable future, in order for the yield curve to invert and predict a recession, 10-year Treasury yields would have to fall to an extremely low level that could only be justified if we were already in a deep depression.

-0.5

-1.0

-1.50706 08 09 10

Leading indicator

momchanges

Stripping the yield curve from the indicator


Leading indicator ex rates

1.5

1.0

0.5

0.0

Excluding the impact of the yield curveExcluding the impact from the yield curve sub-component, the re-calculated Conference Board indicator suggests a 30% probability of the US economy going back into recession in the next six months, very close to what the ECRI predicts.

Probabilities of recession in six months100

32%29%

908070605040302010061 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09

Recession Conference board lending indicator ex curve ECRI

%


Economic theory also suggests that the yield curve may be irrelevant at the moment in determining the future path of the US recovery. A modern capitalist economy has three main participants; the government, households or private consumers and private corporations. In the past, the correction of large imbalances in the private sector preceded an economic recession. For example, before the 2001 recession corporations had invested heavily in new equipment using their cash reserves. When rates and cost of capital started increasing in 1999 they had to correct this over-capacity, putting downward pressure on growth. This “deleveraging” process usually finishes when debt comes back to “normal” levels and companies start spending again to support new expansion.

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14

A steep yield curve is generally accommodative for corporations, as they can borrow more cheaply at the short end of the curve to finance their investment plans. However, currently US corporations have accumulated record high cash reserves and do not need to borrow to finance their expansion. Expensive cost of capital is not the reason that capex expenditure is currently low. Therefore, a steep yield curve will probably not trigger the usual resumption of investments that supports a strong recovery.

Source: Datastream. As at 9/09/10

US corporate cash to asset ratio10.5109.59

8.58

7.57

6.5680 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

%

Parallel to the above, a steep yield curve has historically been very beneficial for the banking sector. Banks tend to finance their operations with short term debt and invest in longer term assets. We should therefore expect banks to report strong earnings, supporting the US recovery. However, the opposite was the case with investment banking profits declining in the last quarter. The reason is that deleveraging is a much stronger force. This time, banks have accumulated a large amount of assets – e.g. real estate – and are now in the process of disposing them, sometimes at sale prices lower than the initial cost. As this deleveraging process continues, banking profits are expected to be below historical norms.

Like banks, households were heavily exposed to falling house prices and have historically high debt burdens. The downward trend in savings that started in the 70s was abruptly reversed by the 2008 recession. Private consumers, comprising 70% of the economy, increased their ratio of savings to income from 2% in 2007 to around 6% currently. The trend seems to have stabilised, but the higher level of savings, which translates to lower consumption, will be a drag on the economy in the coming quarters.


Savings ratio and household net worth

13 400

450

500

550

600

650

119

7

5

31

-159 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10

% Income

Personal Saving/Disposable Income (LHS)Household NetWorth/Disposable Income (RHS, Inv’td)

% Income

Fiscal policy – an uncertain variableThe third component of an economic system is the government, and here economic models are unable to predict policy changes. Obama’s administration has recently announced their intention to extend or introduce a new fiscal stimulus package. The implementation of this plan will depend on the result of mid-term elections, but if it is put in place it will significantly lower the probability of a double dip.

On the other hand, contrary to past experience, governments of advanced economies have accumulated significant amounts of external debt that they now have to start paying back. Indeed, many European countries have already put in place ambitious fiscal consolidation plans. If the US decides to cut spending, or is forced to by bond investors, then the probability of a double dip increases above the current 30%.

SummarySince the start of the year, our view has been that there is a distinct possibility for a quarter of very weak growth in the coming months. However, we consider it unlikely that the US economy would experience two consecutive quarters of declining output. Despite the significant slowdown envisaged, the probability of a double dip remains less than 50%.

Carl Astorri Carl Astorri joined Coutts & Co in January 2006 to head the Investment Strategy Team, and is responsible for leading and managing asset allocation strategy. Carl has fifteen years experience as a strategist and economist, having previously worked at Barclays, ISIS Asset Management and the Bank of England. Carl holds a Masters degree in Economics and Finance from Bristol University and is an associate member of the UKSIP.

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Michael CasserlyInvestment Analyst

15

Commodities OutlookOne of the key reasons for investing in commodities is the growing demand and constrained supply associated with this asset class. There is only a finite supply of commodities with the exception being agricultural commodities that face a time lag to rebalance discrepancies between supply and demand that occur in the short term. This should mean that investing in commodities is rather straight forward as entering the market now should result in good investment returns over time. However like many things, investing in commodities is rarely as simple or as straight forward as this. The stage of the economic cycle is a key determining factor in the demand for commodities and this relationship has been consistent over the long term. Similar to other risk assets such as equities, returns during the recovery stage of the economic cycle tend to be more modest after the rebound seen in 2009.

Economic Outlook2010 saw commodity assets under management breach $300 billion for the first time according to data complied by Barclays Capital. However, given the stop start nature of the global economic recovery and the outlier possibility of a double dip recession investors have become more cautious to the asset class in recent months. August saw the first large outflow of funds from commodities as investors reassessed their view of the strength of the economic recovery as disappointing macro data showed that the pace of recovery was slowing. Nevertheless, there are still a number of investment opportunities within specific commodities as many are influenced and benefit from either weak economic data/financial uncertainty or factors that fall outside the normal supply and demand fundamentals.

Agricultural CommoditiesAgricultural commodities had a rather subdued start to the year however since June there has been a sharp increase in a broad spectrum of soft commodities.

The weather phenomenon La Nina, which can bring above-average rain to Australia, parts of Asia and drier weather to the southern US, has strengthened and may persist at least into early 2011 according to the Australian Bureau of Meteorology. The effects of these weather events have been numerous in recent months, with Pakistan suffering from severe flooding, parts of Australia experiencing the wettest July since 1986 and parts of China being exposed to its worst flooding in more than a decade.

Russia, the third largest wheat producer, experienced its worst drought in over 50 years which drove wheat prices to their highest levels since 2008. This disruption to supply resulted in Russia imposing an export ban initially until the end of the 2010 and subsequently extended into 2011. Corn was the main beneficiary to the disruption in the wheat supply, as consumers shifted to corn as an alternative which often occurs when an individual commodity suffer a tightness in supply.

News of Russia’s export ban caused the re-emergence of concerns over global food supplies and prices. The United Nation’s Global Food Price Index increased to 176 last month, the highest level since September 2008. However, this market ‘noise’ has overlooked the fact the world wheat stockpiles remain in a healthy state, particularly in the major exporting countries of Europe and the US.

Source: Bloomberg/UB Wealth

Key Agricultural Commodity Futures150140

Pric

e Re

base

d

Apr-10

May-10Jun-10

Jul-10

Aug-10Sep-10

1301201101009080

Wheat Cotton Corn Sugar

The recent rally in agricultural commodities may offer further upside from their current position in Q4 and Q1 2011. We may experience a short term pull back as there is the potential that investors such as hedge funds may unwind positions that captured the recent price appreciation and as the concerns surrounding food security begin to moderate. Another factor that may limit short term upside is the ability of agricultural producers to respond to supply shortfalls in key commodity markets by increasing the acreage being planted. However, this may ultimately have a knock on affect on the supply of an alternative commodity come next harvest. We maintain our medium/long term view that agricultural commodities offer good potential for growth based on underlying fundamentals of economic and population growth, supply constraints and investor demand.

GoldGold has continued to benefit from the elevated levels of risk aversion experienced to date in 2010. Gold hit an all time end of day high of $1,309.05/oz in late September as macro data from developed economies continued to disappoint adding to fears of a potential double dip recession. News that the US Federal Reserve stands ready to provide ‘additional accommodation’ if needed to support the economic recovery and to return inflation to levels consistent with its mandate (i.e. stable prices), would suggest that a second round of Quantitative Easing (QE) is now almost certain. This has provided Gold with a significant boost based on the realisation that interest rates are likely to remain lower for a more extended period. This is good news for non yielding assets as the opportunity cost of holding Gold is much diminished. Gold’s role as a safe haven and currency of last resort in periods of financial dislocation has been the key driver in 2010, and in recent weeks the long term inverse relationship between the US Dollar and Gold has resumed. When adjusted for inflation, Gold prices are still a long way off their high of over $2,300/oz set back in 1980 and therefore it is likely that Gold will continue to be added to investors’ portfolios over the short term.

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16

Gold has resumed its inverse relationship with the US Dollar

1400

12001300

10001100

800900

600700

400500

200

95

90

85

80

75

70

65

Gold US$/oz (LHS)

Sep-05

Nov-05

Jan-06

Mar-06

May-06Jul-0

6

Sep-06

Nov-06Jan-07

Mar-07

May-07Jul-0

7

Sep-07

Nov-07

Jan-08

Mar-08

May-08Jul-0

8

Sep-08

Nov-08Jan-09

Mar-09

May-09Jul-0

9

Sep-09

Nov-09Jan-10

Mar-10

May-10Jul-10

Sep-10

US Dollar (RHS)

300


Investment demand continues to plug the gap left by the drop off in jewellery demand. Data from the World Gold Council shows that investment demand bounced back in Q2 2010 to the second highest quarterly investment flow recorded, the highest being Q1 2009. Jewellery demand has been constrained by higher prices, however, we are now entering the traditional physical buying season for Gold which coincides with the Diwali, the Indian wedding season, Christmas and the Chinese New Year in February. Therefore this combined with continued demand from investors is likely that this will act as a strong support and driver of prices in the near term.

Central Banks, whom in the past were net sellers of Gold, in the first half of the year were net purchasers of Gold, purchasing approximately 90 tonnes. This is a bullish sign and in addition the fact that many Gold producing companies have de-hedged significant proportions from their forward sales indicates that many believe that high prices are here to stay.

However, potential risks do exist. Investment demand (ETF’s, speculative investment and retail investment) has been a key driver to Gold’s recent price surge. For example, retail/identifiable investment has grown from 5% of total Gold demand in 2000 to over 40% of total gold demand in 2009, clearly if there is a slowdown in investment demand, a downward price correction can be expected. In addition, central banks could potentially use some of their annual sales quota to improve their balance sheets which would bring new supply to the market, however it may now be that central banks will remain net purchasers rather than sellers going forward.

Considering the above it is likely that Gold will continue the bull run it commenced almost a decade ago. Investor behaviour on the back of continued uncertainty surrounding the global economy and financial markets is likely to push Gold higher over the next 12 months as investor seek safe havens. Any fall back in prices in the near term can be viewed as attractive buying opportunities for investors.

Industrial MetalsIndustrial metals have experienced an indifferent year to date when compared to the excellent performance seen in 2009. In Q2 of this year, industrials sold off sharply as the demand for base metals in China tapered off as Chinese authorities took steps to cool its property market. However, data since July shows signs that China is stabilising in terms of demand and is likely to offer continued support in Q4 which seasonally tends to be a strong quarter for industrial metals. The outlook for Copper continues to be bullish as it is likely to go into supply deficit in 2011. This is based on the limited pipeline for new mines, supply constraints at existing mines and China’s reliance on copper imports. Copper recently hit a five month high as inventories declined for the 31st week in a row mainly on the back of continued demand from Asia. On the other side of the coin both Aluminium and Zinc see supply continue to outstrip demand and a price correction may be due. Aluminium is a multi purpose metal used in a variety of applications and is very susceptible to the uneven nature of the global economic recovery, therefore it is likely to come under pressure unless production levels are cut to address the imbalance. However the longer term outlook

for Aluminium is positive and a pick up in global economic growth will see a strong increase in demand. Zinc, the worst performing base metal in 2010, continues to be in excess supply and inventory levels at the London Metals Exchange (LME) are currently at their highest levels since 2005.

OilAs the demand for oil is closely linked to GDP growth it is not surprising that oil has struggled in recent months. Oil inventories remain troublesome and show little signs of falling back to levels seen in 2007 in the near term, while production continues to exceed demand meaning it is likely that oil prices are to remain in a depressed state. OPEC continues to play a significant role in the equilibrium of the oil market, and any sharp decline in the price of oil is likely to result in OPEC members slashing production in an effort to support prices.

Crude Oil Prices vs. US Oil Inventories

US Oil Investories (‘000’s barrels) LHS Crude Oil Price $ RHS


380000 90

80

70

60

50

40

30

370000

360000

350000

340000

330000

320000

310000

300000

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Over the longer term there are still many reasons to believe that oil demand fundamentals will improve. The International Energy Agency (IEA) announced in July that China had assumed the role of the world’s largest consumer of energy overtaking the US. This is a far cry from 10 years ago when China’s energy consumption was half that of the US. Energy consumption in the OECD countries fell by 5% last year, while at the same time consumption rose by 2.7% in non OECD countries. This indicates that while we are currently in a market lull for oil, once economic growth recovers to a more solid footing in developed markets, demand and the upward trend in oil prices is likely to return. However in the near term it is the excess supply fundamentals that are likely to hold back any significant rally in oil prices and a price correction from current levels can not be ruled out.

OutlookFor the remainder of 2010, we favour Gold, copper and a number of key agricultural commodities that face tightness in supply (in particular sugar and cotton). In the medium term industrial metals and agricultural commodities are likely to continue to benefit from the emerging countries demand and the return of growth in developed nations. Direct exposure to commodity markets may be achieved through investing in commodity futures, an alternative method would be to purchase stocks in the mining, food, agribusiness and fertiliser markets. These stocks have exposure to the underlying trends in commodity prices and therefore can benefit directly from an increase in prices of the raw commodity that feed into company earnings.

Michael CasserlyMichael Casserly is Investment Analyst at Ulster Bank Wealth where he is responsible for thematic research and analysis. He holds a Bachelor in Agricultural Science from University College Dublin, a Graduate Diploma in Business Studies and a MBS in Finance both from the UCD Michael Smurfit Graduate Business School.

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Trends in Mergers & Acquisitions and Private EquityThe global economic downturn softened the appetite for corporate takeovers last year. More recently deal activity has picked up substantially. There are a number of trends emerging in the Mergers & Acquisitions (M&A) markets this year. These include:

• Takeoveractivityhasincreasedinthepast12 months

• Dealpremiumsaretrendingupwards

• EmergingmarketsM&Avolumesareincreasing,andaresurpassing some developed markets

• PrivateEquitybackedM&Adealsareattheirlowestlevelsin more than a decade, but volumes, as a percentage of total M&A activity, are increasing

• IncreasedinvestorinterestinthePrivateEquity Secondary Market

Takeover Activity has increasedThe total value of announced M&A activity in 2009 was $1.76 trillion, which was less than half of the value of $4 trillion M&A deals announced in 2007, according to Bloomberg. During the downturn, most companies sought to repair their balance sheets and were reluctant to spend their precious cash as corporate strategy shifted from growth to survival. As a direct result of this conservative approach, Bloomberg estimates that global companies are now sitting on $3 trillion in cash.

Shareholders expect companies to either put capital to work or to give cash back through dividends, and companies are once again putting cash to work as the global economy recovers. Some companies are using cash to buy back their own shares. This reduces the amount of shares in the market and improves earnings per share for investors. Other companies are seeking growth opportunities through M&A. The president of Fujitsu Ltd, the Japanese computer and IT company, recently commented that the company is very actively looking for acquisitions to spur global growth. The trend is that companies that have cash are now starting to spend it.

At the mid point in 2010, there were almost 12,000 announced M&A deals with an average price of $150m according to Bloomberg. At the time of writing, the volume had increased to 17,350 deals and the average price paid in Q3 to date was $190m. This represents a 30% increase in the average price of $146 million across the 21,000 deals announced in all of 2009. The trend that is emerging is a growing number of deals, at an increasing average price. We are also seeing an increasing number of hostile bids, which tends to be a lead indicator of the start of an M&A cycle. The percentage of M&A deals that were hostile has doubled so far this year relative to 2009. The largest takeover deal announced so far this year, BHP Billitons $43 billion bid for Potash Corporation, was a hostile bid.

M&A activity is supportive of equity markets. As news of mergers and acquisitions filters through, it tells the market that companies are looking to expand their businesses by utilising large cash balances or historically low cost borrowings. The expected growth in earnings at an acquiring company, as a result of the expansion, translates into an increase in share price.

Deal premiums are lower than 2009 but are trending upwards againAcquisition prices typically incorporate a premium. This premium reflects the difference between the prevailing market price of a target company and price the acquirer is prepared to pay. Data available from Bloomberg indicates that the premiums paid so far this year are 22%, compared with 25% in 2009. However, the trend is moving upwards; as the average premium for Q3 to date is 25%, up from 23% in Q2 and 19% in Q1 2010. The higher premiums are being caused by the larger amount of hostile takeovers, as mentioned above, as more dollars are chasing fewer good deals. The graph below illustrates the increase in the volume of global M&A activity in recent months coupled with the increasing average premium.

Source: Bloomberg

M&A Activity (Volume & Average Premium)40%

35%

30%

25%

20%

15%

10%

5%

0%

300

250

200

150

100

50

0

Volume (RHS)

Sep-08

Oct-08

Nov-08

Dec-08Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09Jul-0

9

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09Jan-10

Feb-10

Mar-10Apr-1

0

May-10Jun-10

Jul-10

Aug-10

Average Premium (LHS)

Growing interest in Emerging Markets M&AIn our Global Investment themes 2010 publication we discussed the opportunities that were arising in emerging markets as a result of global rebalancing. The commentary went on to describe decoupling as the phenomenon whereby emerging economies managed to post growth even in the face of economic contraction in the developed world. Global companies are increasingly seeking opportunities to participate in the fast growing countries like Brazil and China. M&A activity in emerging markets is up on last year and now accounts for 30% of global M&A activity.

The four BRIC countries, Brazil, Russia, India and China, now account for more than half of emerging markets M&A activity. The majority of M&A activity amongst the BRIC countries is focused on China, with $86 billion in activity so far this year based on Bloomberg data. While China is the clear favourite target, volumes in the other three BRIC countries have already passed their 2009 volumes. Emerging markets M&A volumes have now surpassed the developed European M&A volumes.

Private Equity deal activity low, but increasingThe $2.5 trillion private equity industry saw a significant decline in deal flow during 2009. Data from Bloomberg shows that private equity deals accounted for only 4.6% of all M&A deals in 2009, compared to almost 8% in 2008 and 18% in 2007, when M&A volumes were also much higher.

Keith McGoughInvestment Product Manager

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18

As a result of the slowdown in deal activity in 2009, it is estimated that somewhere between $500 billion and $1 trillion of Private Equity Funds under management have yet to be deployed and are still available for investment. Many company valuations are hovering at record lows and are seen to be undervalued. Private Equity managers currently have an opportunity to acquire attractive companies at very good prices, relative to prior years. Blackstone Group for example, the world’s largest buy out firm, recently agreed to acquire Dynergy Inc., the US energy company, for a total acquisition value of $4.7 billion making it the largest private equity backed deal this year. The target company share price was trading at an eight year low, and was even two thirds off it’s 52 week high at the time of the deal.

A number of positive trends have emerged during 2010, with an encouraging rise in deal volumes and sizes. Private equity has accounted for almost 8% of all M&A so far this year and the upward trend is being driven by a returning appetite for larger deals coupled with an increased availability of debt. If private equity managers succeed in adding value to acquired companies by finding efficiencies and increasing corporate earnings, private equity fund valuations should continue their upward trend going forward, providing good news for investors.

Global M&A Activity

$483.9$516.0$572.5

$438.1$353.7

$59.2$39.7$22.8$30.5$20.2

$0$100$200$300$400$500$600$700

Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010

Volume of deals, in billions Private Equity Volume

Source: Bloomberg

Private Equity Secondary Market Broadly speaking, there are two types of Private Equity Secondary markets. The first type refers to the buying and selling of pre-existing investor commitments to private equity funds. Typically, the participants in this market are distressed investors hoping to offload their funding obligations. Not only are the investors selling on their existing interest in a private equity fund, they are also selling on their unfunded commitments.

The other type is the institutional investor or private equity firm looking to exit or rebalance their portfolio. An institutional secondary transaction may involve the spin off of a single company, a portfolio of direct investments or an interest in an underlying private equity limited partnership. Buyout firms need to demonstrate to investors that they can exit investments at a profit. Banks are more likely to provide debt finance for investments with stable cash flows and these companies are becoming more likely to be spun off in a secondary transaction. According to Dealogic, the M&A data provider, 35% of private equity purchases in the first half of 2010 were secondary buyouts, where one private equity firm sold to another.

The motivation for selling an existing investment in private equity is either to increase liquidity or avail of a profitable exit opportunity. The motivation to pursue a secondary purchase is the opportunity for a buyout firm to acquire a private equity exposure at a potential discount, while simultaneously diversifying the make up and vintage of an existing private equity portfolio. Sellers are unwilling to dispose of their assets at heavily discounted prices and the market will ultimately be driven by the ability of buyers and seller to agree a fair price.

Summary Cash rich companies are seeking growth opportunities through acquisitions and are picking up companies at a relative discount. The increasing premiums paid for acquisitions are indicating that companies are prepared to spend the cash that they’ve accumulated in recent years. The growth dynamics in emerging markets are attracting an ever increasing amount of investment from companies seeking growth opportunities. Private equity deal flow activity is recovering and there is an increasing appetite for deal size coupled with the increasing availability of debt. The private equity secondary market is providing an attractive opportunity for investors to gain access to an existing portfolio at a discount.

Keith McGoughKeith McGough is Investment Product Manager at Ulster Bank Wealth where he is responsible for close-ended equity finance investments. He has worked in financial services for 14 years, having first joined Ulster Bank in 1996. He has worked in Ulster Bank Wealth for six years and prior to that he worked in Bank of Ireland Private Banking. He is a Qualified Financial Advisor and has a Diploma in Wealth Management.

This document is issued for information purposes only, and does not constitute an offer or invitation to invest. The information contained herein should not be construed as advice, and is not intended to be construed as such.

90002744 16 14/10/2010 10:53


For further information please contact your Wealth Manager in your local Business Centre. Wealth Manager contact details can be found on our website www.ulsterbank.ie/wealth

Alternatively please contact 01 608 5279 if you require further assistance.

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www.ulsterbank.ie/wealth

Ulster Bank Wealth. An unlimited company having a share capital. Registered in Republic of Ireland. Registered No 149869. Registered Office: Ulster Bank Group Centre, George’s Quay, Dublin 2. Member of The Royal Bank of Scotland Group. Ulster Bank Wealth is regulated by the Financial Regulator. Calls may be recorded. ULST672 October 2010

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global investment outlook · trends in mergers & acquisitions and private equity 17 keith...

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