Monthly Perspectives - Geopolitics - October 2016

Geopolitics
October 2016Monthly Perspectives Portfolio Advice & Investment Research
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Martha Hill, CFA, AVP, Portfolio Advice & Investment Research
In this issue
The rise of populism
A conversation with Marko Papic�� 2
Geopolitics and your portfolio
A conversation with Kevin Hebner
and Todd Mattina �� 5
Important information�� 8
With no shortage of political debates and ongoing risks associated with
geopolitical events, this month, we continue our discussion on politics
and the potential impact on financial markets. To get more insights on the
issues that are top of mind for investors, we reached out to experts for their
opinions on the political trends shaping the financial landscape.
In this issue of Monthly Perspectives, we spoke with Marko Papic, Chief
Strategist, Geopolitical Strategy, at BCA Research, who provided us with
his views on the rise of populist sentiment, the shifting sands of global
power, and current global affairs.
We continue our conversation with Kevin Hebner, Managing Director and
Global Equity Strategist at Epoch Investment Partners, and Todd Mattina,
Chief Economist at Mackenzie Investments to uncover the potential impacts
the current environment may have on investments and your portfolio.

2 Monthly Perspectives October 2016
The rise of populism
Chris Blake, CFA, Manager, North American Equities
We recently had the opportunity to speak with Marko Papic, Chief
Strategist, Geopolitical Strategy at BCA Research, about his views
on the rise of populist sentiment, the shifting sands of global power,
and the lens through which investors should view media reports on
current global affairs.
Marko, we see an apparent increase in anti-establishment
sentiment around the world; examples of this are the
rise of Donald Trump in the United States, the U.K. vote
to Brexit the European Union, and the populist movements in
South Africa and across Europe. What are the short-term and long-
term implications of this risk to global trade, and more specifically,
how will this manifest itself in North America? Are there differences
in the impact for Canada and the United States?
Global trade has been growing at a slower pace than
global growth for several years, well before the populist
trend became self-evident. Over the past two decades,
such distribution between global economic and trade growth
has only occurred amidst global recessions. As such, there is clear
evidence that trade has been impaired post-2008 by structural
factors already. Anti-establishment policymakers will reinforce this
macroeconomic trend in three ways:
1. They will overtly use protectionist policies, if they come to
power, or they will force establishment politicians to adopt
elements of protectionism in order to stay in power.
2. Success of populist politicians will encourage establishment
parties to experiment with unorthodox monetary policy,
which could lead to further currency devaluations, which may
prompt a new “competitive currency regime” to come about.
This would further impair trade.
3. Populism and jingoism go hand in hand. More aggressive foreign
policy will mean more geopolitical risk. More geopolitical risk
means more opportunities to use trade and finance as tools of
war, which means less trade.
It is highly unlikely that we will see any of the three in Canada.
However, Canada could be impacted by what the U.S. does.
Either directly—through tariffs or “renegotiation” of NAFTA—or
indirectly. For example, imagine a trade war between the U.S. and
China. On one hand, it is very likely that Canada would be forced
to choose sides in such a conflict. On the other hand, Canada
is somewhat insulated from protectionism due to the fact that
it is a major commodity producer. As we have seen with Russia,
protectionist policies rarely impact a country’s commodity sector.
We have heard you speak of an increase in “multi-
polarity” in the world. How has the world arrived at this
point and how do you see it evolving over the coming
five to ten years. Are there aspects of multi-polarity that have
investment implications?
Multi-polarity is an extremely important theme for
investors with multiple implications. Since the end of
the Cold War, geopolitics has mostly remained in the
background for investors. This is because the collapse of the Soviet
Union ushered in an era of American hegemony that lasted for
roughly two decades. During this period, the global concentration
of economic, trade, and military power increased as the U.S.
became the only true superpower (figure 1). The world entered
a period of “hegemonic stability,” an era during which regional
powers dared not pursue an independent foreign policy for fear of
U.S. retaliation and during which the “Washington consensus” of
laissez-faire capitalism and free trade was adopted by policymakers
in both developed and emerging markets.
Q
A
A conversation with Marko Papic, Chief Strategist, Geopolitical Strategy, BCA Research
Q
A
*As measured by the Herfindahl-Hirschman Index of three variables; GDP, imports, and military spending. Index had been adjusted to reflect the entry of new countries into the system.
Source: World Bank, SIPRI and BCA calculations. As at December 31, 2014.
Figure 1
Global Concentration of Economic, Trade, and Military Power
0.07
0.09
0.11
0.13
0.15
1960 1968 1976 1984 1992 2000 2008
Global GDP Concentration*
0.03
0.04
0.05
0.06
0.07
1960 1968 1976 1984 1992 2000 2008
Global Import Concentration*
0.13
0.15
0.17
0.19
0.21
0.23
1988 1992 1996 2000 2004 2008 2012
Global Military Expenditure Concentration*

Multi-polarity implies that the number of states powerful enough
to pursue an independent and globally relevant foreign policy is
greater than one (unipolarity) or two (bipolarity). Today, multi-
polarity is the product of America’s decaying unipolar moment.
The U.S. remains, by far, the most powerful country in the absolute
sense, but it is experiencing a relative decline as regional powers
become more capable on both the economic and geopolitical
fronts (figure 2).
Figure 2
U.S. Geopolitical Power Index (Relative to World)
77
80
83
86
89
92
95
98
1989 1993 1997 2001 2005 2009 2013
The Geopolitical Power Index measures a country's power based on a weighted aggregation
of its economic, military, political, technological, and geographical endowments.
A conversation with Marko Papic (cont’d)
Multi-polarity is not a popular theme with investors. It augurs
uncertainty, rising risk premia, and unanticipated “Black Swan”
events. We know from formal modeling in political science, and
from history, that a multi-polar world is unstable and more likely to
produce military conflict (figure 3).1
There are three reasons:
1. During periods of multi-polarity, more states can effectively
pursue foreign policies that lead to war, thus creating more
potential “conflict dyads” in the parlance of International
Relations theory.
2. Power imbalances between states are more likely if there are
more states that matter geopolitically. And power imbalances
invite conflict as they are more likely to produce a situation in
which one country’s rising capabilities threaten another.
3. The probability of miscalculation rises due to the number of
relevant states making geopolitical decisions simultaneously.
There are a number of derivatives from the multi-polarity thesis that
will be relevant for investors. For example, despite Brexit, a multi-
polar world will support European integration.2
Figure 3
National Capability Index
0
5
10
15
20
25
30
35
40
1816 1826 1836 1846 1856 1866 1876 1886 1896 1906 1916 1926 1936 1946 1956 1966 1976 1986 1996 2006
U.S. U.K. FRANCE GERMANY CHINA JAPAN RUSSIA
Source: Correlates of War Database by Singer, Bremer, and Stuckey. As at December 31, 2007. The national capability index measures the material capability of countries in the form of iron and
steel production, military expenditures and personnel, primary energy consumption, and total and urban population.
1
Mearsheimer, The Tragedy Of Great Power Politics (New York: Norton, 2001).
2
BCA Geopolitical Strategy Special Report, “After BREXIT, N-Exit?” dated July 13, 2016, and BCA The Bank Credit Analyst, “Europe’s Geopolitical Gambit: Relevance Through Integration”
dated November 2011.

How should investors view the relevance of day-to-day
news? Should they react or would they be better served
by looking at short-term news flows to help them find
opportunistic spots to invest in a more macro thematic manner?
At the end of the day, I really just read news for a living.
But to be a successful investment strategist doing so,
my team and I build geopolitical net assessments—
frameworks—through which to interpret that news flow. During
Brexit, our net assessment told us that the probability of the U.K.
exiting the European Union (EU) was much closer to 50% than the
30% implied by various betting markets. We adjusted our strategy
accordingly.
The opportunities for investors in politics and geopolitics come
when the daily news flow drives investors. In those situations,
themedianarrativetakesoverandthemarketpricesrisksaccordingto
theconventionalwisdomdujour.Butmediadoesnotrepresentreality,
only one interpretation of reality. And investors who focus on doing
their own fundamental political and geopolitical analysis—based on
an analysis of objective constraints facing policymakers—can find
opportunities in those moments when the daily news flow drives
the market.
With geopolitical uncertainty rising in Europe’s neighbourhood—
particularly in the Middle East—and with Russia reasserting itself,
Europe’s core countries will not follow down the “exit” path that
the U.K. pursued. However, the geopolitical disequilibrium in East
Asia is deepening, with China’s pursuit of a sphere of influence in
the South and East China Seas likely to continue to raise tensions
in the region.
But the overarching concern for investors should be how multi-
polarity impacts the global economy. Global macroeconomic
imbalances—such as the current combination of insufficient
demand and excessive capacity—can be overcome either by
unilateral policy from the hegemon or through coordination among
the major economic and political powers. A multi-polar world,
however, lacks such coordination.
Globalization is therefore at risk from multi-polarity.3
Not only
are regional powers pursuing spheres of influence, which is by
definition incompatible with a globalized world, but the world lacks
the hegemon that normally provides the expensive, and hard to
come by, global public goods: namely economic coordination and
geopolitical stability.
The investment implications of multi-polarity center on three broad
themes:
Apex of globalization
Going forward, the world is going to be less, not more, globalized.
This will favour domestic over global sectors and consumer-oriented
economies over the export-oriented ones. Globalization is also a
major deflationary force, which would suggest that, on the margin,
a world that is less globalized should be more inflationary.
Developed markets over emerging markets
Multi-polarity is more likely to produce a number of conflicts, some
of which lay dormant throughout the Cold War and subsequent era
of American hegemony. These conflicts tend to be in emerging or
frontier markets.
Safe havens
With the frequency of geopolitical conflict on the rise, safe haven
assets like U.S. Treasuries, the U.S. dollar, gold, and Swiss and
Japanese government bonds, should continue to hold an important
place in investors’ asset allocation.
A conversation with Marko Papic (cont’d)
Q
A
3
BCA Geopolitical Strategy Special Report, “The Apex Of Globalization: All Downhill From
Here,” dated November 12, 2014.
See Marko Papic on MoneyTalk
Tune in to see Marko on MoneyTalk
October 19, 2016
7:00 p.m.
Marko Papic is Chief Strategist for Geopolitical Strategy at BCA
Research. Marko has been a guest on MoneyTalk with Kim
Parlee, which can be seen Wednesdays at 7 p.m. ET on BNN
and Saturdays at 3:30 p.m. ET on CTV.
with Kim Parlee

We are living in a period of heightened geopolitical risks across the
globe, which have been exemplified by events such as the Brexit
vote and the rise of populist movements in different regions in
the world. In order to get some perspective on how the current
environment could impact your investments, we spoke with
Kevin Hebner, Managing Director and Global Equity Strategist at
Epoch Investment Partners, and Todd Mattina, Chief Economist at
Mackenzie Investments. Below is a summary of their views:
Do these events represent investable themes or just short-
term noise?
Todd Mattina: Geopolitical risks, ranging from the
impact of Brexit to the U.S. presidential race, remain top of
mind for investors. However, forecasting the outcome of
political events and their highly uncertain impact on market returns
does not usually serve investors well in the long run. For example,
forecasters failed to predict the outcome of the Brexit referendum
or its immediate economic impact. Diversification across asset
classes, geographies and equity factors provides the best defense,
especially for investors with longer time horizons. Strategic use of
currency hedging can also be important to reduce portfolio risk.
What are the specific catalysts that are likely to move
internationally-focused investments?
Mattina: While many factors drive the returns of
internationally focused funds, three potential catalysts
worth monitoring include long-run shifts in the Canadian
dollar, the global mix between monetary and fiscal policies and the
emerging markets (EM) market rally following a multi-year bear
market.
The 25% decline in the Canadian-U.S. dollar exchange rate during
2014-2015 contributed to the over-performance of many unhedged
internationally focused funds. Over the longer run, Canada’s slow
and uneven rebalancing from resource- to manufacturing-led
growth suggests a weaker loonie may still be needed, supporting
international funds with unhedged foreign currency exposure.
The diminishing effectiveness of ultra-loose central bank policies
to boost economic growth, especially in the euro zone and Japan,
could lead to a shift towards greater fiscal stimulus by already
indebted governments with potentially negative implications for
longer duration interest rates.
Weak EM markets in recent years reflected the prospect of U.S.
Federal Reserve (Fed) rate tightening, falling commodity prices and
slower Chinese growth. Looking ahead, the expected glacial pace of
Fed rate tightening and the stabilizing outlook for commodity prices
and China’s economy suggest the EM market rally can continue.
Kevin Hebner: The three long-term themes that could
have an outsized impact on the investment landscape for
years to come are 1) secular stagnation, 2) the importance
of technology as a driver of productivity growth and profit margins
and 3) the rebalancing of China's economy.
Secular stagnation
Epoch believes the U.S. economy is consigned to a secular 2%
growth rate. This century, when the U.S. has grown faster than
2%, as it did in 2003-2007, it has come alongside a dangerous
level of borrowing, which is not likely to be repeated, because the
prior episode contributed to a housing bubble. Noted economist,
Larry Summers, has popularized the decades old term “secular
stagnation,” which stems from excess savings over investment
acting as a drag on demand, growth, inflation, and real interest
rates. The causes of secular stagnation include an aging population
that saves more and consumes less, deleveraging on the part of
households and governments, and muted capital spending by
businesses in light of new technologies and a more service-oriented
economy. Since 2011, the International Monetary Fund (IMF) has
repeatedly lowered their growth estimates. The IMF is currently
forecasting 1.8% growth in developed countries for 2016 and
2017. Regarding inflation, 30 of 35 Organization for Economic
Cooperation and Development (OECD) countries currently have
2% or less inflation rates. The investment considerations of secular
stagnation include a lower ceiling on earnings growth than might
otherwise be the case and worried central bankers that err on
the side of policy accommodation to thwart the potential risks of
deflation. While the economic impact of quantitative easing (QE)
and negative interest-rate policies (NIRP) can be debated, such
measures have been shown to support risky asset prices.
The importance of technology
Technology is enabling firms to operate with higher returns on
equity (ROE). First, technology has allowed firms to operate with
lower labour costs as an input to sales, leading to improved profit
margins. The World Economic Forum (WEF) surmises that office
and administrative jobs have been most at risk of being replaced
by disruptive technologies and more robot substitution should take
place where robots are already in use, such as in manufacturing
and production. Second, technology has made it possible to
produce sales with less investment in property, plant, equipment,
and inventories, leading to better asset utilization. It is becoming
increasingly common for firms to carry low or zero inventories,
due to advances in supply chain management. A by-product
of lower inventories is reduced possession and facility costs.
Third, technology’s impact on supply and demand has contributed
to low interest rates. Low interest rates have encouraged many
companies to increase their leverage.
A
Geopolitics and your portfolio
A conversation with Kevin Hebner, Managing Director and Global Equity Strategist at Epoch Investment Partners,
and Todd Mattina, Chief Economist at Mackenzie Investments
Darim Abdullah, CFA, Senior Analyst, Managed Investments
Q
A
Q
A

China’s rebalancing should provide a meaningful tailwind for
companies catering to domestic consumption and services.
Conversely, this rebalancing could represent a headwind for
commodities and capital spending in the decade ahead. China's
over-capacity and high leverage is a key element of secular
stagnation. We agree and conclude that Chinese deleveraging and
rebalancing has several important consequences: Excess capacity
has resulted in China exporting goods price deflation to the rest of
the world. Less investment in China has driven lower commodity
prices (e.g., iron ore, steel, coal and copper).
Mr.Mattina,canyoucommentonMackenzieInvestments'
views on the imbalances in China?
Mattina: China’s unbalanced growth and rapid credit
growth set the stage for a difficult macroeconomic
adjustment. Years of credit-financed investment resulted
in excess productive capacity, high debt, low profits and low
producer prices. In fact, China’s total debt increased by about
80% of GDP since 2008 to reach almost 2.5 times the size of the
economy. At the same time, rapid credit growth has delivered an
increasingly smaller kick with economic growth falling from double
digits in the mid-2000s to about 6.7% today. Such a rapid increase
in credit with slower growth seldom occurs without a financial
The rebalancing of China's economy
China’s economy is slowly and gradually rotating away from
investment and heavy industries and towards consumer spending
and services (figure 4). In the decade ahead, consumption should
pass the 50% of GDP threshold for the first time ever. By way
of comparison, consumption is typically 65% to 75% of GDP in
developed economies. Likewise, investment as a share of GDP
should contract.
crisis. Fortunately, China’s reserves of about $3.2 trillion provide
sizable buffers to absorb financial shocks or currency pressure.
The greatest risk for China is getting stuck in a “middle income
trap” of prolonged sluggish productivity due to misallocated capital
and troubled loans.
The European Commission recently hit Apple Inc.
(AAPL-Q) with a €13 billion clawback of unpaid taxes in
Ireland. Do you believe that such action by the European
Commission could undermine foreign investments in the region,
specifically by American multi-national companies?
Mattina: Many core European Union (EU) states,
supported by the Organization for Economic Co-operation
and Development (OECD) and other international
organizations, have warned about a race to the bottom in setting
corporate tax rates, threatening government revenues in all
countries. According to reports, Ireland’s generous tax concessions
to Apple implied an effective tax rate of just 0.005% in 2014.
Ireland’s spectacular growth in recent decades depended on strong
foreign investment, motivated in part by access to the EU common
market at very low tax rates. Other EU countries suspect investments
in their economies may have suffered because of perceived “unfair”
tax policies. In this way, the EU decision reflects a broader policy
debate between EU countries rather than a targeting of successful
U.S. multinationals. However, the implication is that multinationals
face increased risk from the uncertain political and regulatory
environment, which threatens to hold back new investment.
One of the key themes discussed nowadays is the high
degree of cross-asset correlation where various asset
classes seem to be moving together. Many have attributed
this to all markets being focused on Central Banks' policies.
To what extent do you believe global asset prices have been driven
by Central Banks' policies versus fundamentals?
Mattina: Central banks played an important role in
boosting asset prices after the Great Recession through
unprecedented low interest rates and asset purchases,
dampening market volatility. However, today’s continuing low
rates and high asset prices reflect three key longer run macro
forces that have lowered the discount rate for asset pricing.
First, population aging and low productivity slow the supply-side
growth engine of the economy. Second, a legacy of high debt means
the days of credit-financed spending are behind us. Finally, a glut
of global savings keeps downward pressure on real interest rates.
These macro headwinds imply that trend economic growth,
inflation and real interest rates will remain below average, keeping
downward pressure on discount rates and supporting high asset
prices.
Q
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Q
A
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A conversation with Kevin Hebner and Todd Mattina (cont’d)
Figure 4
Changing Composition of China’s GDP
Source: McKinsey, March 2016.
Q
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0
10
20
30
40
50
60
Consumption Investment Government Net Trade
2000 - 2010 2010 - 2020 2020 - 2030
%

Hebner: The U.S. stock market has recently recorded
new all-time highs. Since 2012, a significant portion
of the total return has been attributed to higher price-
to-earnings ratios, rather than earnings growth or dividends.
This unusual contribution to returns through expanding market
multiples is largely the result of very accommodative monetary
policies and “lower for longer” discount rates. During this period,
an appetite among investors for companies with a demonstrated
track record of producing cash flow and returning it to shareholders
has contributed to defensive stocks outperforming cyclical ones.
While this may have created a limited number of opportunities
in cyclical sectors, investors need to be wary of potential “value
traps,” especially in the global materials and industrials sectors.
Many of these companies could fall short on generating sustainable
cash flow growth.
The SP 500 Index second-quarter earnings season is completed
now, and although profits are down slightly versus the same period
a year ago, forward estimates are no longer being revised lower.
This means the worst for earnings has largely concluded, and a more
predictable earnings environment should ensue. Going forward,
companies that allocate capital wisely and can consistently produce
earnings and cash flow growth should be in an enviable position.
The aftermath of the June 23 Brexit vote was the latest reminder
that central banks will loosen their policies to combat unwanted
risks and volatility. In this low-yield environment, it is important to
remember that the dividend yield on developed market equities
exceeds that on government bonds. And, the dividend yield does
not include other aspects of shareholder yield, such as cash returned
to shareholders in the form of stock buybacks.
Going forward, returns are expected to come from profits and
cash flow growth, as well as dividends. Firms that make smart
capital allocation choices, while returning cash to shareholders
via dividends, share purchases, and debt reduction should occupy
the commanding heights in a slow-growth environment with low
interest rates.
Where do you see the most attractive opportunities
looking out over the next 6-12 months and which areas
might you be avoiding?
Mattina: Mackenzie’s Asset Allocation team expects
tactical opportunities in three areas: the asset mix
between stocks and bonds, relative equity markets and
currencies.
We currently favour stocks relative to bonds because of exceptionally
stretched bond valuations. Despite a recent bottom in high-quality
government bond yields, fixed income markets remain highly
overvalued even as inflation shows tentative signs of gradually
returning to normal.
Across global stock markets, we remain overweight in British and
EM stocks and underweight in the relatively overvalued U.S. and
Japanese stock markets. Our bearish view of U.S. stocks reflects
the more advanced stage of the U.S. business cycle and tighter
monetary policy. Our bullish view of EM stocks reflects attractive
valuations following a multi-year bear market and strong market
sentiment following a sharp rebound. U.K. stocks benefit from the
weaker pound as about three quarters of foreign earnings of FTSE
100 companies originate from overseas.
In currencies, we remain bearish of the British pound given highly
negative market sentiment and unattractive macroeconomic
conditions that may demand additional rate cuts by the Bank of
England.
Hebner: To summarize, our view on capital markets over
the next 12 months is as follows:
Fixed income: There is not much upside to holding bonds.
Commodities: A V-shaped recovery is unlikely given the tepid global
growth outlook and headwinds facing investment spending.
Equities: A tough environment for top-line growth. Consequently,
we prefer a diversified collection of high quality companies with
strong track records regarding cash flow generation, shareholder
distributions and capital allocation policies where returns on
invested capital are greater than cost of capital.
A
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A conversation with Kevin Hebner and Todd Mattina (cont’d)

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Debt Capital Markets Inc. and/or its licensors. Neither FTSE TMX Global Debt Capital Markets
Inc. nor its licensors accept any liability for any errors or omissions in such indices and / or
ratings or underlying data. No further distribution of FTSE TMX Global Debt Capital Markets
Inc.’s data is permitted without FTSE TMX Global Debt Capital Markets Inc.’s express written
consent.
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Percentage of subject companies under
each rating category—BUY (covering
Action List BUY, BUY and Spec. BUY
ratings), HOLD and REDUCE (covering
TENDER and REDUCE ratings).
As at October 3, 2016.
Distribution of Research Ratings
0%
10%
20%
30%
40%
50%
60%
70%
80%
BUY HOLD REDUCE
REDUCE
2.9%
BUY
56.3%
HOLD
40.8%
61.42%
37.06%
1.52%
Percentage of subject companies
within each of the three categories
(BUY, HOLD and REDUCE) for which
TD Securities Inc. has provided
investment banking services within the
last 12 months.
As at October 3, 2016.
Investment Services Provided
0%
10%
20%
30%
40%
50%
60%
70%
80%
BUY HOLD REDUCE
61.42%
37.06%
1.52%

Monthly Perspectives - Geopolitics - October 2016

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