HSBC Private Bank Strategy Matters

Investment Strategy
03 June 2008
James Butterfill Fredrik Nerbrand
james.butterfill@hsbcpb.com fredrik.nerbrand@hsbcpb.com
Summary Points Our Views on the News
Mixed performance from global Equity markets rose last week as the US government revised its GDP figures upwards
and oil prices fell the most since March 2008. The UK was the exception, however, as
equity markets, primarily driven
the FTSE was dragged down by mining and oil-related stocks. UK banks did not help, as
by economic data releases.
investor sentiment was tested by the spate of rights issues. The UK was also lower on
Inflation appears to be a key the month, by around 0.5% and European markets finished the month mixed.
investment consideration. We Latin America was amongst the best performers during May - Brazil, in particular, was up
look at which sectors historically almost 7%, to cap the biggest 2 month gain in 2 years as Brazilian government debt was
outperform at times of upgraded. The Hang Seng index proved to be the laggard, with a decline of almost equal
inflationary shocks. magnitude to Brazil's rise - down 6.5%. The S&P 500 had a monthly gain of 1% - its
second consecutive monthly gain. Technology was the strongest sector, displacing the
energy and materials groups. Japan's 3.5% rise to the highest level since January was
Market data also of note. Japan has been a relatively poor performer for a while now, but it may be
worth watching over the coming weeks. The region appears to be benefiting from a
Equity (% Value 1 week 1 year
more positive earnings outlook and the weaker tone of the yen versus dollar.
change)
Some commodities experienced a correction this week. Brent crude was down 2.5%
S&P 1391.6 0.5 -9.4 over the week to finish at $127. We believe this was due to 2 main reasons. Firstly,
NASDAQ 2508.0 1.1 -4.1 driving in the US has been recorded as less than expected. Secondly, India is said to be
DJ Euro 3737.3 0.7 -8.0 planning to scale back subsidies for oil products by 10-15%, with Taiwan, Indonesia and
FTSE 100 6057.7 0.0 -9.3 Malaysia planning to do the same. China may follow suit after the Beijing Olympics.
Topix 1407.4 2.9 -0.4 Gold followed oil with a decline of 4% to $886.
MSCIAC 553.3 1.7 9.3 However, these commodity declines failed to dispel concerns about inflation, however,
MSCI EM 1207.8 1.3 17.1 which led to bond yields rising sharply. Government bonds are at multi-month lows as
Fixed Income (bp change) the case for immediate cuts in interest rates now appears less pressing. The US 10yr
US 10 year 3.9976 8 -95 Treasury was comfortably back above 4% and briefly touched 4.14% during the week.
European 4.431 13 -3 The 10yr gilt yield climbed above 5% and the 10y bund hit a 10mth high of 4.43 %
UK 10 year 5.034 11 -26 (source: Bloomberg).
10 year JGB 3.9976 8 -95 Corporate news was relatively scarce last week but the economic calendar made up for
Currencies (vs. USD)
it. The US picture appeared quite benign overall, considering recent bad news. Aprils
durable goods orders were better than market consensus expectations, new home sales
EUR 1.545 -1.5 14.6
bounced back from the previous month and GDP growth for 1Q08 was revised up to
GBP 1.965 -0.6 -1.3
0.9% from 0.6%, suggesting that the downturn remains modest. On the other hand,
JPY 105.26 -1.0 15.7
consumer expectations fell from 50 to 45.7 their lowest since 1973.
Commodities
Economic releases are likely to remain the focus this week with the main events being
WTI 125.92 -2.3 93.5 the interest rate decisions from the European Central Bank and Bank of England on
Gold spot 883.0 -2.6 31.4 Thursday. Both are expected to remain on hold at 4% and 5% respectively.
DJ AIG 215.4 -0.6 23.8
Source: Bloomberg as at June 2nd 2008

Summary of our views

Asset Allocation
Our current asset allocation
approach is founded on our
outlook for persistent inflationary
pressures in the global economy.
Under these circumstances, we
believe it is more prudent to
focus our views over a shorter
term time frame.
We believe investors will find the
most rewarding opportunities in
hedge funds and commodities
while a healthy position in cash
should limit volatility.
Equities
Due to our moderated growth outlook
prompted by rising inflation and the
positive performance in equities over
the last month, we have reduced our
Equity rating from positive to neutral,
however our longer term view has not
changed dramatically.
Commodities
Our view towards commodities as a
whole remains positive, while our
ranking of different commodity
complexes also remains unchanged.
Our preference for agricultural
commodities continues, which we feel
is best articulated through a basket
approach.
Fixed Income
Given our increasing concerns for the
outlook for inflation around the world,
we believe it is appropriate to adjust
our fixed income view down from
neutral to negative.
In our view, selective high quality
corporate investment grade bonds are
looking more attractive.
Currencies
We expect economic weakness in the
Eurozone and UK will quickly bring
back into focus their relative
vulnerabilities, thus underpinning a
direction change for the USD.

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 HSBC Private Bank Strategy Matters
Investment Strategy
03 June 2008
Statistic of the Week Strategy Matters
What can we expect from the markets in an inflationary environment? It is difficult to
compare inflation in the 1970s to today primarily due to the changes in the composition
of world economic activity in developed and developing countries. However, we have
constructed a model that identifies inflationary shock periods relative to the prevailing
economic conditions preceding them, Figure 1 highlights the key periods of inflationary
shocks according to our analysis.
17 months Figure 1: Inf lationary shock periods

Inf lationary shock periods World Y oY inf lation

35

30

The average length of high inflationary 25

periods since 1970. Source: Thomson
20
DataStream and HSBC Private Bank, June
2nd 2008. 15

10

0
Jan-70 Jan-75 Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05

Source: Thomson DataStream as at June 2nd 2008.

The first inflationary shock to be highlighted in our analysis (dating back to 1970)
occurred in 1973 and was prompted primarily by the actions of OPEC cutting oil
deliveries to nations that supported Israel in its conflict with Syria and Egypt, following
the incidents at the Munich Olympics. The 1978 event was most likely caused by the
Iran hostage crisis prompting an extended period of inflation lasting 24 months. During
both these periods, particularly in the UK and European economies, industry unionisation
is also deemed likely to have placed further upward pressure on prices through wages.
In 1989 the savings and loans crisis caused a 17 month hiatus of higher inflation, most
likely extended by the fall of the Berlin wall. Whilst in 1994 there did not appear to be
any particular coincident event to trace inflationary pressures back to, however the Iraq
war and looser than necessary monetary policy are likely to have contributed. The policy
responses to the Long Term Capital Management Crisis (LTCM) prompting the Russian
Rouble collapse did have an effect on inflation but was not significant enough to be
highlighted by our model.

Chart of the week Figure 2: Commodities performance during inflationary shock periods versus the
market average performance
Following periods of inflationary
Inf lationary shock periods A verage (1970 - March 2008)
shocks, most commodities tend to
outperform their longer term 10%
average price level, according to our 9%
analysis. The exception appears to
8%
be the Oil and Gas complex, which
7%
may best be viewed as the reversal
of their leading price rises which 6%
frequently cause higher inflationary 5%
periods in the first place. 4%
3%
2%
1%
0%
Oil & Gas Foodstuf f s Livestock Metals Fats & Oils Raw Textiles
Industrials

Source: Thomson DataStream and HSBC Private Bank as at June 2nd 2008.
Note: past performance is no guarantee for future performance.
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 HSBC Private Bank Strategy Matters
Investment Strategy
03 June 2008

Quote of the week
Inflation is when you pay
fifteen dollars for the ten-dollar
haircut you used to get for five
dollars when you had hair.
American writer, Sam Ewing
The general trends of these events are oil shocks and banking crises (and subsequent
monetary easing by policy makers). Our economic data suggests that the current
inflationary shock period started September 2007 and as at end-March 2008, it still
continues. At present we have the sub-prime crisis as well as oil and other commodity
price shocks, driven by high demand from Emerging Markets and investor speculation.
Using our model, we have identified how different commodity complexes and industry
sectors increase (or decrease) in price six months after the start of an inflationary shock
period, versus their average price performance from 1970 to date.
Figure 2 shows how various commodity classes have performed during these periods.
Oil & Gas commodities tend to underperform six months after the start of an inflationary
period suggesting a decline or flattening of prices whilst Foodstuffs, Livestock and Fats
& Oils tend to significantly outperform. This suggests that inflationary shocks that may
originally have been triggered by oil price rises do tend to filter through to the prices of
other commodities, due to the increased energy input costs in their cultivation and/or
production. It is interesting to note that by the time these higher energy costs appear to
have fed through to other commodity prices, oil prices themselves have generally fallen.
We continue to monitor the oil price closely to see whether this pattern re-emerges.
Figure 3: Industry sector performance during inflationary shock periods

Inf lationary shock periods A verage (1970 - March 2008)

6%
5%
4%
3%
2%
1%
0%
-1%
-2%
-3%
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Source: Thomson DataStream and HSBC Private Bank as at June 2nd 2008.
Note: past performance is no guarantee for future performance.
Industry sectors all show underperformance relative to non-inflationary shock periods
but there are some sectors that appear to outperform relative to the whole market:
Healthcare (well protected by world events), Oil & Gas (a delayed effect due to
previous high oil prices inflating company earnings) and Basic materials, where it is
likely that production costs can be more easily passed on to the consumer.
From this analysis, we believe an investors attention may beneficially be turned to
those areas where performance may be more reliable during times of inflationary
shocks. This is, of course, predicated on investors sharing our view that persistent
inflationary pressures have entered the global economic system.

Important Notice
HSBC Private Bank (UK) Limited has issued this document for information purposes only. If you require investment advice or wish to discuss the
suitability of any investment decision, you should contact your Relationship Manager or you should seek such financial, legal or tax advice from
your professional advisers as appropriate.
This document is not and should not be construed as an offer to sell or solicitation of an offer to purchase or subscribe for any investment.
Members of the HSBC Group and/or their officers, directors and employees may have positions in any securities mentioned in this document (or
any related investment) and may from time to time add to or dispose of any such securities (or investment). Members of HSBC Group may act as
the only market maker and may have assumed an underwriting commitment in the securities of companies mentioned in this document (or any
related investment), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment
banking or underwriting services for or relating to those companies.

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 HSBC Private Bank Strategy Matters
Investment Strategy
03 June 2008
Past performance should not be seen as an indication of future performance. The time periods to which the past performance information within
this financial promotion relates may not be current. Please contact your Relationship Manager should you require up to date past performance
information. The value of investments and the income from them may go down as well as up and you may not get back the full amount invested.
No investor should invest unless they are prepared to accept a degree of risk. The rules and regulations made under the Financial Services Markets
Act 2000 for the protection of investors, including the protections of the Financial Services Compensation Scheme, do not apply to investment
business undertaken with the non UK offices of HSBC Group. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, on any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of
HSBC Private Bank (UK) Limited. This document may not be distributed to the United States or any other country in which its distribution is
unlawful.
HSBC Private Bank (UK) Limited, 78 St Jamess Street, London SW1A 1JB, is authorised and regulated in the United Kingdom by the Financial
Services Authority.

Glossary of Terms
Absolute Return - The nominal return on an investment irrespective of any given specific benchmark
Asset Allocation - The apportioning of investment assets among categories such as stocks, bonds, cash, real estate, etc.
Asset Class - Assets suitable for the proposed portfolio are aggregated into classes that share similar characteristics. Asset classes include
Equity, Fixed Income, Liquid Assets and Alternative
Benchmark - An unmanaged group of securities whose overall performance is used as a standard measure of investment performance
Cautious in relation to an asset class, market or indicator suggests a lower than expected or lower than trend level or rate of growth; in relation to
an investment decision suggests Hold or Underweight rather than Overweight
Credit Risk - Can occur where the issuer or counterparty to an investment suffers from a reduced credit rating or fails to deliver cash or
investments up to the pre-agreed amount
Derivatives - Futures, options and swaps are instruments that derive their value from the movement in the price of an underlying asset
Diversification - The process of spreading a portfolios holdings over a range of securities in order to reduce investment risk
Hedge - A transaction made with the intent of reducing investment risk, using with the use of options or forwards
Hedge Fund - A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to
unit and investment trusts. Hedge funds are exempt from many of the rules and regulations governing other plain vanilla funds, which allows them
to accomplish aggressive investing goals. Usually falls within the Alternative asset class
High Conviction an investment recommendation that is very strongly supported by market indicators and economic rationale
High Yield - Investments that can provide a very high return in a short period, but usually imply high risk
Hold maintain a current level of investment in a particular asset class, market, sector, security, or investment vehicle. If a portfolio does not have
exposure to a particular asset class, market, sector, security, or investment vehicle that is rated as a Hold, an initial investment should not be
undertaken at that time
Long Term a time horizon of 12 to 24 months or greater
Market Capitalisation - Refers to the total value of a company or stock exchange. Usually calculated by multiplying the number of shares
outstanding for a company or a stock exchange by the value of a single share
Medium Term a time horizon of between 6 to 12 months
Negative - in relation to an asset class, market or indicator suggests a much lower than expected or much lower than trend level or rate of growth;
in relation to an investment decision suggests Underweight rather than Overweight or Hold
Neutral no strong indication or economic rationale to expect under or over performance of an asset class, market, sector, security, or investment
vehicle to a specified time horizon.
Neutral / Positive neutral but with an anticipation of over performance if more supportive information becoming available
Overweight - increase a current level of investment in a particular asset class, market, sector, security, or investment vehicle, relative to a
benchmark. If a portfolio does not have exposure to a particular asset class, market, sector, security, or investment vehicle that is rated as
Overweight, an initial investment is recommended
Short term a time horizon of between 3 to 6 months
Strategic defined as 12 to 24 months
Strategic Asset Allocation - A long term portfolio Strategy that involves periodically rebalancing the portfolio in order to maintain a long term
goal for asset allocation
Tactical Asset Allocation - An active management strategy that deviates from the long term strategic asset allocation in order to take advantage of
current market views
Tactical defined as 3 6 months
Underweight - decrease a current level of investment in a particular asset class, market, sector, security, or investment vehicle, relative to a
benchmark. If a portfolio does not have exposure to a particular asset class, market, sector, security, or investment vehicle that is rated as
Underweight, an initial investment is not recommended
Copyright. HSBC Private Bank (UK) Limited 2008 ALL RIGHTS RESERVED
PBGB/564/06/2008

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