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16 April 2013
Special Macro Topics
Global Macro Strategy | Global
The Japan View
A collaborative overview of Nomura's Japan view
Japan, the world's third largest economy, has embarked on a bold economic and political experiment. Like any experiment there is a working hypothesis; that the actions taken will re-invigorate a moribund economy and deliver sustained private-sector-led nominal GDP growth around 3%. Since the median annual nominal growth rate since 1992 has been 0.3%, the target represents a substantial shift in ambition for the country and by extension its flow of funds, balance sheets, domestic financial markets and, indeed, global markets. One way to reconcile Keynes' beauty contest and Graham's value views of investing is the concept of “reversion to the mean” where the value investor is trying to find the trending mean and the cyclical investor is trying to lean against the cyclical swings around the mean. Japan has had as much of a tradeable business cycle as any other country in the past 30 years. The problem has been the mean has been zero. We are now confronted with the possibility of a 3% change in that mean rate of expansion. Compounded forward 10 years the difference is worth in the region of JPY150trn per year, or USD1.5trn at current exchange rates. Given the prevailing asset allocation of domestic and non-domestic investors repositioning for such an outcome is not trivial. And the geopolitical implications of success are significant, if hard to pre-judge. After many failed attempts to “move the needle”, scepticism about the success (or indeed longevity) of the experiment has been high. It remains so even now. But as we discussed in A Bayesian approach to Abenomics, such scepticism becomes a target for the policymaker endowed with an informational advantage and keen to surprise. The BOJ's new leadership has duly surprised. As a firm we have produced a great deal of research on the implications of "Abenomics". Since the Bank of Japan's self-described “monetary easing on a different dimension”, interest has naturally increased in what these policies mean for international investors. This document is an “edited highlights” of our firm's recent research on the topic, with a particular focus on the post-BOJ world. It pulls together our experts‟ current thinking on the issue across market segments and geographies, including Japan itself.
16 APRIL 2013
Fixed Income Research
+44 20 7102 7800 email@example.com
+44 20 7103 0091 Muhammad.Kirdar@nomura.com This report can be accessed electronically via: www.nomura.com/research or on Bloomberg (NOMR)
Some things are immediately apparent from even a cursory reading of our Japanese team's research: 1. This is a persistent topic, and it will take some time to play out. The BOJ's actions are only one component of the whole policy picture, around which some uncertainty remains. However, the run-up to the Upper House election and the supply-side reform agenda are to take centre stage domestically. 2. We are now in a period of learning, perhaps even at the BOJ itself with regards to how the new BOJ policy will be conducted operationally. What
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16 April 2013
this means for real and nominal yields, and therefore the impetus to reallocate out of JGBs, is still an open question. 3. As such the impact on global markets is contingent on domestic government yields, FX hedging costs and foreign return opportunities, and of course whether the policy actually works. Obviously, the BOJ itself has an influence on how it flexibly conducts its operations and indeed could add further balance sheet tools if required. Set against that is the role of other countries which may have tolerated the JPY move thus far but may react from here. 4. There are several interacting dimensions as to how this may play out for markets but we see the most important as: (1) the regional and global economic demand impact of (2) net flows and return expectations of various market participants, each of which have different risk tolerances, regulatory pressures and response times, and (3) changes in asset allocation that result from shifts in the global real discount rate. 5. A key message from this note is that the direct translation of BOJ action into expectations of major sustained Japanese outflows is probably too simplistic. Instead, there is now a Kuroda put, a new high potential energy balance sheet in play where the dynamic of Japanese flow are new spread and FX trigger levels will need to be taken into account in the most directly affected markets – which we currently believe are AUD/JPY, MXN and PLN and USTs and US MBS. France and other semi-core countries along with global IG are also, on an FX-hedged carry basis, attractive at the right spread level. Given all of this, the topic is one that we will have to continually monitor and discuss. We have some overarching conclusions, however, even if we cannot offer a “golden bullet” list of trades.
Overview of “quantitative and qualitative monetary easing”
Shuichi Obata and Tomo Kinoshita summarise the specifics of the policy changes, which were approved with only one dissenting vote, as follows: 1) The Bank will change the operational target for its monetary market operations from the unsecured overnight call rate to the monetary base. Specifically, it will carry out money market operations so that the monetary base increases by around ¥60–70trn a year (thereby raising the total amount outstanding from around ¥138trn at end-2012 to ¥200trn at end-2013, and around ¥270trn at end-2014). 2) Purchases of long-term JGBs are to be increased, with longer maturities also becoming eligible for purchase:
Outstanding balance of long-term JGBs is to be increased by ¥50trn a year (more or less doubling gross average monthly purchases to just over ¥7trn). JGBs of all maturities including 40-year instruments will become eligible for purchase. The average remaining maturity on BOJ purchases will be raised from almost three years to around seven years.
3) ETF and REIT purchases are to be increased (with the following targets)
ETFs: annual increase of ¥1trn REITs: annual increase of about ¥30bn
4) Purchase of CP and corporate bonds is to continue until outstanding balances reach ¥2.2trn and ¥3.2trn, respectively (by end-2013), after which outstanding balances will be maintained at those levels.
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5) The asset purchase programme is to be ended and the banknote rule to be temporarily suspended: The asset purchase programme and rinban operations will effectively be combined. 6) Fund-supplying support for financial institutions in quake-affected areas will be extended by one year. See BOJ policy board meeting – Qualitative and quantitative easing announced (4 April 2013)
The flow landscape
Jens Nordvig, Yujiro Goto and Ankit Sahni of the G10 FX strategy team provide a thorough analysis of the pressures and institutional constraints and behaviours of the insurance, pension, banking and retail investor communities in Japan. They conclude that the effect of QE on foreign fixed income substitutes will depend on the size and speed of the programme and reflect:
The home bias of domestic JGB holders. The size of the programme is smaller than the Fed's ongoing QE ($700bn vs $1.02 per year). The purchases at the >10yr sector (relevant for lifers and pension funds) are smaller than the Fed or BoE's QE both in absolute terms and relative to issuance in the sector. Notwithstanding these considerations, they think it likely that net outflows will occur but perhaps, all else equal, not at the pace that some commentators and market participants are expecting.
See: Global FX Insights: Where will Kuroda‟s Money Go? (8 April 2013)
Tomo Kinoshita (Chief Economist Japan) and his team increased their growth and inflation forecasts for fiscal and calendar years 2013 and 2014. They now expect the economy to expand at 2.4% for FY 2013 and 1.4% for FY 2014. These are both above-trend rates of expansion, and FY 2013 is projected to be the highest growth rate since FY 1996 (excluding the 2010 rebound). One key aspect is that domestic demand is expected to take over from Asian demand as the key driver of expansion. While headline inflation and the GDP deflator are set to hit 2%, accounting for the consumption tax hike leaves underlying inflation below 1%. See: Japan: FY12-14 economic outlook revisions: Aggressive BOJ monetary policy likely to boost real economy (12 April 2013)
Naka Matsuzawa (Chief Japan Rates Strategist) believes JGBs are moving back to a range-bound market. He thinks a sustained JGB sell-off is unlikely unless there is a prevailing view that: (1) the BOJ is done with easing in the current cycle; and (2) the global monetary easing phase has ended. He thinks the first condition has been met, but does not expect the second to take place until the Fed moves closer to ending QE3, probably in JulySeptember. In the near term, he thinks the JGB will find a new equilibrium point after a few rounds of BOJ purchase operations and JGB auctions, and trade within the new ranges. In this environment, he provisionally estimates that the equilibrium points will be near 0.45% and 1.10% for 10s and 20s, respectively, with the lows on 5 April (10s at 0.315% and 20s at 0.845%) likely serving as the lower ends of their respective trading ranges. Lacking support from “further BOJ easing”,
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which previously had been the primary driver of JGB rallies, the market could react to relatively minor factors, bullish and bearish. Accordingly, he recommends shifting focus from long trades on bull flattening in the superlong zone and look for opportunities to dip-buy cash bonds in tenors that offer relatively high carry and roll, which he thinks should perform better in a range-bound environment. See: Japan Navigator (No. 514) (8 April 2013)
Foreign exchange strategy
Yujiro Goto, Yunosuke Ikeda and Jens Nordvig recently increased their USD/JPY target, reflecting the impact of monetary easing under new BOJ Governor Haruhiko Kuroda. Their new target is USD/JPY of 100 at end-June 2013, 102 at end-2013, and 106 at end-2014. During Q2, as asset allocations peak, they believe overshooting towards 105 is possible. They have already entered JPY short positions in the form of long AUDJPY immediately after the BOJ decision, and recommend retaining the position. The team believes the currency's weakness since the Lower House was dissolved on 14 November partly reflects fundamentals such as the trade deficit, and partly reflects speculative yen shorting by overseas investors in anticipation of aggressive monetary easing. They judge that monetary easing under the leadership of Governor Kuroda will encourage offshore investors to remain aggressively short on the yen as part of a long-term yen depreciation trend. In fact, they see potential to increase position and use JPY for funding purposes. See: G10 FX Insights: Raising USD/JPY target (9 April 2013) Jens Nordvig, Yujiro Goto and Ankit Sahni of the G10 FX strategy team target AUD/JPY and some EM currencies such as MXN and PLN as direct beneficiaries. In addition, they think retail flows into BRL and TRY should pick up, and given likely low hedging ratios these EM currencies could benefit more than the majors. See: Global FX Insights: Where will Kuroda‟s Money Go? (8 April 2013) Craig Chan and the Asia FX team expect limited inflows into non-Japan Asia (NJA) assets from the BOJ's new monetary policy. Not only has toshin allocation into NJA been relatively small historically, but even if Japan lifers were to invest in foreign bond markets and reference to global bond indices, they judge NJA would broadly see limited inflows (largest recipients could be Korea, Malaysia and Singapore). Overall, their bias remains to be short KRW and TWD, noting that Korea is the most exposed country to third market competition with Japan. They retain their view about the benefits of being short the S$NEER while acknowledging how the sharpness of the JPY move has hit the recommendation. They also remain long THB and PHP, believing that being part of Japan's supply chain just adds to the attractiveness of these crosses. See: Asia Insights: Gauging Japan's competition with the rest of Asia (7 March 2013)
US fixed income strategy
George Goncalves and his team expect the intermediate sector of the US yield curve to benefit the most from the BOJ's balance sheet expansion. They derive this conclusion from considering both the investment requirements and characteristics of the Japanese fixed income investors most directly affected and their behaviour when buying foreign debt – in particular the dominance of carry and roll-down characteristics as investment
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metrics. Taken together they feel this suggests the belly of the US curve is most attractive and the long end steepening as a result. They also note that life insurance companies in Japan are running foreign asset positions at around 25% of total assets versus a cap of 30% and calculate the difference equates to around USD90bn – about the same amount that our Japanese strategy team thinks lifers need to buy in longdated JGBs. As lifers appear to run shorter duration risk in their overseas portfolios than at home, the team judges the belly of the US curve is the “sweet spot”. The team estimates in the region of USD80-USD110bn of total flow per year. See US rates: Global Rates Insights: BoJ QE-driven Spill-Over into USTs (10 April 2013) Ohmsatya Ravi and the MBS team perform a similar analysis for the MBS market, concluding that, all else equal, the BOJ's announcement adds USD45-53bn to annual net demand for agency MBS for a total flow from Japan of USD61-69bn. They expect most of the net demand to be directed towards GNMA MBS and lower coupon GNMAs (GN 2.5s-3.5s). Given likely issuance of USD 100bn this year, the Japanese and Fed demand should overwhelm supply. Our Japan and global FX strategy teams concur, pointing out that the GNMA MBS FX-hedged yield spread to 20yr JGBs is high relative to recent history. They think this sector is likely to be one of the key beneficiaries of the portfolio rebalancing by Japanese investors. See US MBS: Impact of BOJ Announcement on Demand for Agency MBS (10 April 2013) and Global FX Insights: Where will Kuroda‟s Money Go? (8 April 2013)
European fixed income strategy
Andy Chaytor, Guy Mandy and team think French bonds (OATs) are likely to see inflows: given the positive spread to both USTs and bunds, as well as a near-zero FX hedge cost, OAT yields look attractive relative to USTs, Germany, the UK and Canada for Japanese investors. And recent flow trends suggest that Japanese investors view France as a safe investment – Japanese buyers have accumulated more than EUR50bn of French bonds since January 2012 (after selling EUR5bn in 2011). See European Rates Insights: Post-BOJ/ECB thoughts on euro sovereigns (4 April 2013) They also point out that European government bonds have been very popular with Japanese accounts over the past year, most notably France, Netherlands and, more recently, Spain. With FX-hedging costs effectively at zero, the “full” amount of yield from these countries gets accrued to Japanese investors, and they believe this will ensure this segment of nonJPY investable assets remains popular. However, these markets may have got ahead of themselves – French 10yr spreads to JGBs have fallen ~40bp since before the BOJ announcement and are now at historical lows (back to 1990). They would, however, be wary of trying to fade the move at the very long-end. Such is the lack of liquidity in long-dated EGB paper these days that relatively modest flows, if and when seen, have the potential to rile the market. Thus they would look at some combination of decompression (semicore underperformance to Germany) trades in the belly of the curve mixed with long-dated flatteners in semi-core as the best big picture risk-reward going into the long-lasting, but uncertain, Japanese flow environment. The significant richening of semi-core sovereigns should increase the attractiveness of SSAs on a relative basis, and the relative spread and volatility metrics leave KFW vs. France looking attractive in the 5-9yr
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segment of the curve. They would not expect major flows in the UK on the back of the BOJ actions. It has been three years since Japanese investors bought Gilts in any meaningful way, and when viewed through a Japanese lens, FX-hedged UK yields are flat to Germany. No bid is likely come from that kind of valuation. See: European Rates Insights: Time to take stock on EGB moves (9 April 2013) They add that Europe still lacks a large-scale buyer of last resort to help replace the large number of investors who have exited the government bond market. If the European crisis remains non-systemic, the flows resulting from the BOJ action may be sufficient to mask the increasing credit differentiation across European sovereign markets. However, there may come a point where an assigned buyer of risk may be required if European conditions deteriorate further. As such they would avoid buying longer-dated Italy or Spanish debt given the rich valuations and favour a more defensive portfolio. See: European Rates Strategy: Trade Portfolio (12 April 2013)
Dollar bloc fixed Income strategy
Martin Whetton, our Sydney-based rates strategist, sees a positive effect on the Australian fixed income market as it is the highest-yielding G10 rates market that the Japan accounts are already familiar with. On the basis of historical actions, he believes the accumulation of AUD assets will commence in the current quarter and will take place on an unhedged basis (but given the size of unhedged activity lifers usually do, all else being equal this indirectly limits how large the flow can be into AUD rates). Utilising a similar mode of analysis to our US team and comparing the carry and roll dynamics of Australian government bonds, he favours the longer end of the Australian government bond curve. This suggests an ongoing flattening. In terms of spread products, both semi-government and SSAs demonstrate higher yields and should perform well on an ASW basis. Due to demand for liquidity, he expects the spread market to only marginally outperform the government curve. His SSA preference is for Washington/Nordic/Canada names over Europe, in line with Nomura‟s economic view for softness in the eurozone economies in 2013. His semigovernment preferences are NSWTC and TCV for liquidity, while he judges QTC should attract the more yield-sensitive buyers. All in all, the view should manifest itself in a higher AUD/JPY exchange rate, a flattening of the curve and a small outperformance of spread product against the government curve. See: Asia Insights: Australia Special Topic – Implications of BOJ Easing (11 April 2013)
Tony Volpon and George Lei estimate that the changes in monetary policy in Japan will lead to an increase of retail toshin inflows that may reach USD10bn this year, helping to boost BRL. They also believe that the indirect effect through lower global yields will likely lower rates in Brazil, though recent market movements may have already fairly priced in this impact. See: EM FX Insights: Brazil: Mr. Kuroda and BRL (11 April 2013) More generally the FX team notes that most developed markets bonds look rich relative to their history (aside from France) on a JPY FX-hedged basis. Thus, the search for carry is likely to push Japanese institutional and retail investors into emerging market bonds to a greater degree. They think investment into EM currencies by Japanese institutional investors will likely
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have even lower hedge ratios than for AUD, and will thus be concentrated in large and liquid markets covered by sovereign bond indices – for example the Citigroup World Government Bond Index includes Malaysia, Mexico, Poland, Singapore and South Africa. Additionally, since this flow involves even lower FX hedge ratios, it has potential to be more important for FX markets in these countries. Based on past trends, and the size and liquidity of markets, they think the largest destinations of institutional funds are Mexico and Poland. In particular, they think MXN is a likely destination for a large portion of the EM flows, also due to improving growth and a better political backdrop. See: Global FX Insights: Where will Kuroda‟s Money Go? (8 April 2013)
Olgay Buyukkayali, Peter Attard Montalto and James Burton note that, within EEMEA, the biggest beneficiary should be TRY for retail flows and PLN for institutional flows. As per South Africa, Japanese investors have recently started to focus elsewhere, such as Turkey and Mexico. They judge that trend will probably prevail for now. Hence, for EEMEA, they expect Poland to capture most of institutional inflows bolstered by strong fundamentals, better growth and fiscal than core Europe, similar volatility and higher yields than core Europe. Similarly, Turkey, for which they expect multi-upgrades, should be a target for retail investors and for some institutional investors. They recommend owning long-end bonds in Turkey and Poland. There is also another market Japanese investors are starting to look at – Russia. It has not been a traditional uridashi market, but it has one of the highest yields in EM these days and reasonably strong growth/balance sheet dynamics. They do not expect flows to be comparable to those in BRL, MXN or TRY at this stage, but think there will probably be inflows which can potentially benefit 2-5 years of rate curves and to some extent the currency. They continue to recommend receiving 2yr RUB swaps. See: ZAR: Japanese investors focused elsewhere, for now (15 March 2013), Which one would you buy: Polgbs or Bunds? (15 February 2013), If the economy is not “hot”, time to buy TURKGB 8.5% Sep 22) (28 February 2013) and Adding to RUB 2y cross currency swaps (11 April 2013)
Hiromichi Tamura, Hisao Matsuura and Jun Yunoki have revised their domestic equity index return forecast for end-2013 targets for the Nikkei Average from 14,500, to 16,000, and for the TOPIX from 1,200, to 1,350 as they view the BOJ‟s monetary easing in a “different dimension” is at a level that investors had not anticipated. Our mainstream Japanese equities investment strategy is to focus on sectors that stand to benefit from reflationary policies and Abenomics, such as real estate/financials for the former and retail/machinery for the latter. See: Japanese equities investment strategy (12 April 2013)
Ken Takamiya takes a positive view of the quantitative and qualitative easing (QQE) announced by the Bank of Japan on 4 April in terms of how he expects it to affect the valuations of major Japanese banks and their BPS (by increasing unrealised gains on equity holdings). They present their views on the likely shape of investment activity by banks following the introduction of QQE. The two conclusions drawn are: (1) deposits at the BOJ look likely to increase; and (2) investment in foreign bonds using foreign currency is likely to rise but probably along the trend line seen to date. See Major banks‟ securities investments (16 April 2013)
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Michael Kurtz notes that, in the ex-Japan equity space, the implications of aggressive Japanese reflation can be segregated into flow-driven and fundamental effects. He upgraded Japan to an Overweight in the global context on 3 December (2012), a change funded out of Europe by reducing his previous Overweight UK equity recommendation to Neutral. Indeed, benchmarked global funds themselves seem to have arrived at similar allocation decisions, as survey-based data from EPFR show global funds having increased Japan (and US) exposure since late-2012 largely at the expense of Developed Europe. Within the Asia-Pacific region, increased Japan positions appear largely to have been funded via reduction of China and/or Korea exposure – the latter largely reflecting concerns over zero-sum competitiveness losses driven by yen depreciation relative to the won and the substantial degree of competitive overlap between the two economies. In terms of the potential for Japanese cross-border flows in an environment of expanding yen liquidity, Kurtz notes that the story for now appears mostly a fixed-income phenomenon. Even considering the relative rise of other currencies vs. the (falling) yen, the combined [equity + currency] returns in Asia ex-Japan, for example, have failed to match Japan-local equity returns (underperforming by roughly 12% YTD). Indeed, Japanese Finance Ministry data show December-February domestic Japanese equity net-repatriation – suggesting Japanese equity investors, at least, have been more “enticed home” by the reflation of domestic ROEs than put off by the yen's sliding value. Admittedly, March data for Japanese overseas toshin investment funds show a switch to a small net-outflow to foreign equities, but at ¥60bn (or US$630mn) the amount is negligible. Moreover, he notes that toshin equity exposure is essentially too small to be consequential in any market where they are active. Toshins' largest exposure as a percentage of local market-cap in any single market is in Vietnam (still at just 0.37%). However, for yield-seeking Japan outflows, in the equities space, AsiaPacific REITs do offer a logical incremental step out the risk curve from highquality, liquid fixed-income yield – and thus may receive substantial flows. The key Asia-Pacific REIT markets are: Australia (accounting for 53% of regional market-cap in the space); Singapore (25%); and Hong Kong (13%). Fundamental equity impacts flow primarily from currency effects, as many regional firms (notably Taiwanese) still have substantial Japan-sourced component costs, allowing them to benefit from cheaper inputs. Similarly, Japanese JV operations listed in China, India and elsewhere derive cost benefits from cheaper Japanese-sourced parts. By contrast, German and Korean stocks seem the closest to zero-sum victims of yen depreciation, but even for Korea, Kurtz notes that expanding export demand historically has been more decisive a determinant of KOSPI performance than the won-yen or won-dollar exchange rate. For example, despite the almost continuous 33% appreciation of the won vs. the yen during 2004-07, the KOSPI considerably outperformed both the MSCI Asia-Pac ex-Japan benchmark in US$ terms (by more than 27% cumulative) and the Nikkei. Moreover, the policy stance in Seoul appears to have shifted in recent weeks, and Korean officials are now responding to JPY depreciation with KRW depreciation of their own, suggesting far less incremental FX competitive loss for Korean exporters going forward in any case. Lastly, still underappreciated, he believes, are the potential benefits for Asia ex-Japan equity markets from the reflation of Japanese domestic demand. Not only could the world's third-largest economy finally “doing the right thing” after two decades of monetary policy error arguably remove a key “background risk” from equity markets, but Japan stands as a key potential new incremental source of final demand as a driver of corporate top-line
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earnings. Of note, for example, YTD our economists have upgraded their Japanese nominal GDP forecast for full-year 2013 by an incremental US$66bn – more than offsetting the US$49bn incremental downgrade in our Chinese 2013 nominal GDP forecast since then. See: Global Equity Strategy Monthly - Pushback Mountain (6 February 2013)
Quantitative equity strategy
Inigo Fraser Jenkins notes that the BOJ announcement coincided with a change in equity factor dynamics. During Q1 the principal cross-sectional determinant of stock returns had been exposure to risk factors such as return and earnings volatility, with low-risk or high-quality stocks outperforming. Since 4 April and the announcement by the BOJ there has been a new phase of factor leadership that has not simply been a reversal of the prior trend. Highly geared stocks have outperformed, and this has been accompanied by an outperformance of high risk stocks. He is most intrigued by the performance of yield, however. One would have thought that if there was any impact within equities from the BOJ‟s announcement, it would increase investors' demand for higher yielding assets. However, the opposite has been true. The yield factor had already been underperforming in Q1 in Japan even as the proposed scale of BOJ intervention was discussed, but the factor had been outperforming in every other region. Since 4 April the slide in high yield stocks in Japan has continued and their outperformance in the rest of the world has gone into reverse. He sees two driving factors as influencing the performance of high yield companies. On the one hand they benefit from investor appetite for yield – as seen clearly in the US over the past year. Yet such companies are also defensive, so they will underperform if investor sentiment switches to a more risk-on frame of mind. Investors in equity markets have decided that the latter is a more important driver in the current environment. In the medium to long term he thinks that the mean-reversion of factor valuations is the key driver. Given the wide spread of factor valuations that exist at present, he expects risk and value to outperform and quality to underperform. This is further reinforced by the convergence in analyst sentiment on the stocks that underlie these strategies. See NMRA page on Bloomberg for regional equity factor indices. See: Global Quantitative Research Monthly (19 March 2013)
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Disclosure Appendix A-1
We, Kevin Gaynor and Muhammad Kirdar, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
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Nomura | Special Macro Topics
16 April 2013
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