File 707525

COUNSELLOR QUARTERLYSpring 2013

COUNSELLOR QUARTERLY 1

PRESIDENT’S MESSAGE

The past quarter has seen continued positive returns and large flows of investments into equity markets in the developed world, in spite of mixed economic signals.

In the U.S., the fiscal cliff is still not fully resolved, however, the risk has been diminished. In addition, with the U.S. housing crisis fading and employment improving, we have left our forecast for the U.S. unchanged. In Canada, lower commodity prices, a strong dollar and a weakening housing market have resulted in a continued downward trend in the economy.

In Europe, while the intensity of the crisis has been reduced, the region remains weak and we have reduced our outlook here. China and Japan, on the other hand, are showing some positive signs. China has managed a soft landing for its economy, and Japan, after many years of negative growth, is showing positive signs for growth in 2013 and 2014.

With the muted economic outlook, we expect inflation to remain subdued and, therefore, interest rates in the short term should also remain stable. The caution here is that yields are at historically low levels and we expect central banks may begin raising short-term rates in 2014. I encourage you to read a more in-depth analysis from RBC Global Asset Management (RBC GAM) Chief Investment Officer Dan Chornous and Chief Economist Eric Lascelles.

However the markets may behave, sound investment management is timeless. With this in mind, I am pleased to introduce a new investment manager. Following a rigorous investment manager search process conducted by the RBC Global Asset Management manager research team, I am pleased to announce that Guardian Capital LP (Guardian) has been appointed sub-advisor for our Canadian Growth Equity mandate. Based on the portfolio manager’s depth of knowledge and experience in Canadian stocks, and the mandate’s sound investment process, strong historical performance and ability to outperform in different market cycles, we believe that Guardian will be a complementary addition to our existing Canadian equity offering.

In recognition of our approach to investment management, our award-winning fund families were once again recognized at the 2013 Lipper Fund Awards. Combined, Phillips, Hager & North Investment Management and RBC GAM have been recognized as Best Funds Group overall for six of the past seven years and Best Bond Funds Group for the past seven years.

The greatest acknowledgment we can receive for our work, however, comes not from our peers but from our clients. In May you will receive our bi-annual client survey conducted by independent survey firm Corporate Insights. These surveys are essential in helping us to understand and exceed your expectations, and we look forward to your feedback. Your personal information and responses will remain strictly confidential.

I’d like to thank you for your continued trust and loyalty. If you have any questions when you receive your client survey, or any concerns about your relationship with RBC PH&N Investment Counsel, your Investment Counsellor will be pleased to speak with you.

Sincerely,

VIJAY PARMAR, CA

PRESIDENT

2 RBC PH&N INVESTMENT COUNSEL

CONTINUING PROGRESS TOWARD SUSTAINED RECOVERY

The global economy continues to heal and risk appetite around the world appears to be reviving. Global PMIs have swung higher and leading indicators point to decent economic prospects in the coming months. The U.S. housing crisis is now behind and employment is improving, albeit slowly.

While economic momentum has flattened out in recent weeks and the post-fiscal-cliff rebound in consumer and business confidence has been more subdued than we had hoped, investors appear to be looking past the immediate threats and focusing on the many positive developments that have occurred since the financial crisis, laying a base for sustained, balanced growth in the future. Headwinds remain and there are still many hurdles to overcome before the global economy is fully stabilized, but significant progress has been made.

HEALING CONTINUES Our basic economic thesis remains unaltered. The global economy is still destined for slower-than-normal growth, but beneath the surface, the beginning of an upward trend may be starting to form. The largest downside risks have arguably shrunk over the past year: the intensity of Europe’s crisis has eased, China has engineered a soft landing and U.S. political dysfunction has diminished somewhat. We have adjusted our economic forecasts for 2013. The Eurozone and U.K. outlooks have again shifted lower, reflecting the enduring nature of the weakness in these regions. The U.S., Canadian and emerging-markets basket of forecasts have held firm. Consensus expectations have moved in a broadly similar fashion to our own.

The theme of healing is of central importance around the world, but this is particularly true in Europe. Current-account deficits are shrinking, signalling greater self-sufficiency in Europe’s periphery. Many countries have made significant progress in reducing their budget deficits. However, public support for these initiatives has always been fragile, and the inconclusive Italian election demonstrates what can happen when austerity becomes too painful. These events have triggered a renewed sense of uncertainty in Europe. Still, while only in the early stages of rehabilitation, Europe has made measurable progress toward a sustained recovery.

The words “Japan” and “exciting” have not often gone together over the past two decades, despite the country’s status as the world’s third-largest economy. That could be about to change with the newly elected government leaders making sweeping commitments to spur Japanese growth. These actions should materially boost Japanese economic growth in 2013 and 2014. We have pushed our Japanese outlook significantly higher to reflect this new stimulus.

INFLATION REMAINS TAME

In a period of slow economic growth, few wage pressures and steady commodity prices, global inflation is unlikely to rise particularly quickly. Economic theory suggests that inflation should begin to edge up over time as economic slack is absorbed. However, we don’t think this will have an overwhelming effect in the near-term and inflation will remain subdued over the forecast horizon.

PUBLIC DEBT NOW IN FOCUS

In stark contrast to diminishing global risks and healing economies, global public-debt loads continue to rise in the developed world. Fortunately, policymakers are now turning their attention to serious debt reduction. Governments are beginning to take decisive steps to reduce their debts and this bodes well for long-term economic growth prospects. That said, debt loads will take many years to decline to more reasonable levels, and this makes nations vulnerable to economic shocks along the way.

BY DANIEL E. CHORNOUS, CFA

CHIEF INVESTMENT OFFICER

RBC GLOBAL ASSET MANAGEMENT

MARKET COMMENT


DOLLAR BOTTOM IS BROADENING

The cycle of U.S. dollar strength is unfolding as we expected. What started as safe-haven flows into the dollar due to the European crisis a couple of years ago has evolved into support for the U.S. dollar based on an economic recovery and relative monetary policies. There is tentative evidence of a gradual shift towards a positive equity/dollar correlation and it looks like the dollar base is broadening against more currencies. That’s the nature of broad currency trends – the bouncing along the bottom for the index happens as individual troughs are established. We continue to work with the base assumption that the rocky bottom will eventually resolve into a meaningful uptrend, and our 12-month forecasts reflect this.

RISE IN YIELDS LIKELY TO BE GRADUAL

Central banks are probably far from tightening, and in some cases even have more stimulus to deliver. The short end of the bond market should thus remain anchored by stimulative central banks. The long end of the yield curve is always more difficult to predict. Yields remain at unsustainably low levels, and as risk appetite increases bond yields should begin to rise. However, there are distinct limits to how high bond yields can rise in the near term. In addition to the obvious

constraints of sluggish growth, moderate inflation and low central-bank rates, we must not forget that a key reason for the global recovery is the very existence of ultra-low borrowing costs. Just as rates were managed lower by central banks, we expect they will be managed higher as well.

STABLE EARNINGS GROWTH, REASONABLE VALUATIONS Equities have continued to rally in the first quarter of 2013 and we have seen large equity inflows for the first time in many quarters. It appears that the market has begun to look past the various macroeconomic headwinds and is now focusing on an economic recovery that is gaining traction. Investors are recognizing the stability of the U.S. economy and are no longer reacting solely based on concerns related to other regions. Corporate profit growth has been the main driver of index gains, as companies have proven themselves capable of stretching profit margins ever wider, even in a tough operating environment. But in an era of sluggish economic growth, further stock-market gains are now more likely to come from shifting investor behaviour than surging earnings. As the economy continues to heal, we expect valuations to gradually move higher, pulling the equity market up with it.

In Japan, the world’s third-largest economy, newly elected leaders are making sweeping commitments to boost Japanese economic growth in 2013-14.


AROUND THE WORLD IN 80 SECONDS

A = Actual, E = Estimate, F = ForecastSources: RBC Global Asset Management Inc., RBC Dominion Securities Inc., RBC Economics.

ECONOMIC & CAPITAL MARKETS FORECASTS

CHIH CHINAAH NA

Real GDP 2012A 7.80% | 2013E 8.00%ea 2 2GDP ReReal GDP 20112A 7.80% |ea 2 7 %80%

CANADA

Real GDP 2012A 2.00% | 2013E13013E 1.75%1.75%3E 1.S&P/TSX Composite February 2013 12822 | February 2014F 1301301ruaruaruruary 2013 1282822 | February 20 3000020rua2 | F3 12ry 2 Feb01USD–CAD February 2013 1.03 | February 2014F 1.00014a201 F 1.0013 1.03 | Febrbruary 2014F 1.066.06014ruar | F3 1.201 .0Fe13Overnight rate February 2013 1.00% | February 2014F 1.25%1.2ebruu 1.25%ruuary 2013 1.0000% | February 202014F 1.25%1200%013 ary 4F 10%y10-year bond February 2013 1.84% | February 2014F 2.50%F 2ebru ebuuary 2013 1.8.84% | February 2y 2014F 2.50%%y 2Fe.8401ary Fe2

UNITED KINGDOMMKINI UNITED KReal GDP 2012A 0.00% | 2013E 1.00%0%20A 0DPR DP 2012ARRe l GDP 201 AARFTSE 100 February 2013 6361 | February 2014F 6475br 116ua10 uary 2013 6361 | February 4F 6475GBP–USD February 2013 1.52 | February 2014F 1.47b 013bru–UBase rate February 2013 0.50% | February 2014F 0.50%eb 013 rue rBase %%10-year gilt February 2013 1.97% | February 2014F 2.50%| F| F 2 0%01Feyear gilt Febr 0%0

UNITED STATES TDE TEE TATATAT

Real GDP 2012A 2.20% | 2013E 2.25%%130A12 20132A 0% | 2013E 2.210 013S&P 500 Index February 2013 1515 | February 2014F 160002FuFx 1515 |Feb y 20133 1511 15USD–CAD February 2013 1.03 | February 2014F 1.064Fruy 2uru ruary 201ry 2ru 2013 1.03 3 | F| ebruru1.Fed funds rate February 2013 0.25% | February 2014F 0.25%25yuaebFe ary 2014F 0.25%eb ary 2013 0.225% | Fe% 1ry 2010-year bond February 2013 1.87% | February 2014F 2.50%0%y ryrubrruary 2013 1.87% % | Februar| 313 1.87

DOW HITS RECORDCOCORD HIGH AMIDD H D D HIG

UNDERLYING MOMENNOMMMMEEENTUMMN M

Although the growth rate was the slowest since the fi rst quarter e shee slowest since the fi rst quaquarterue twe the fi rst quart sloof 2011, consumer spending expanded at 2.1%, suggesting that ndannded at 2.1%, suggesting tg satnd d at 2.momentum in the economy continues to build. In early March, Maesses to build. In early MaMIno be ld. In early Mues tothe Dow Jones Industrial Average surpassed its previous record co dedsed its previevd ited its peeedhigh set before the fi nancial crisis in October 2007, and closed edan20 7, and close200700at a new all-time high of 14,253 – well ahead of the standard ndtandard recovery period of 78 months.

FOR ITALY, IT’S LA DOLCE FAR NIENTE

Confronted by the worst recession in their country since the 1930s, almost 25% of the Italian electorate skipped the February 2013 general elections – a post-war record.

BANK OF CANADA CAUTIOUS CANADIANS

Economic growth stagnated in the fourth quarter as GDP grew at a mere 0.6% annualized pace, with companies scaling back inventories and a decline in economic output led by manufacturers and retailers. The Bank of Canada (BoC) kept its key overnight lending rate at 1%, warning that high household debt levels are the s are thee s are thtvels aevels arelargest risk facing the country’s economy.

EUROPEAN UNI E EURUROPEEAN UUEU N UNIONNIONN NN

Real GDP 2012A (0.50%) | 2013E (0.75%)RReall GDDP 2012A 0.50%Real A 0.50 ) | 2013E (0.75%0 50 | 2013E (0.775%00 0.7MSCI Europe February 2013 1483 | February 2014F 1650MSCI uro e Fe ruar 2ope F r Europe February 2012013 1483 | Februur 2013 1483 Feeb13 Fe ruEuro–USD February 2013 1.31 | February 2014F 1.20uro US Feb uary 01uro–USDUS February 2013 1.3131 | February 20U 13 311 | bruu ry 2US 3 1 u 20Eurozone policy rate February 2013 0.75% | February 2014F 0.50%E oz e p icy FFebcy rate February 202013 0.75% | Fecy e F uary 013 75% | FFeb 0 |Germany 10-year bund February 2013 1.45% | February 2014F 2.00%G ma 10- Fyearr bub nd February 202013 1.45% | Fr b d Fe ary 13 45% | Far bun 20 %

JAPANJAPAN

Real GDP 2012A 1.90% | 2012E 1.75%a 01 0%0% 20012A 1.90 201% | 20120Nikkei February 2013 11529 | February 2014F 12250ik ru 01Nikkei Feb 13 11USD–JPY February 2013 92.53 | February 2014F 95.00US F uarP FFeebruruOvernight call rate February 2013 0.10% | February 2014F 0.10%O ghOvern ght ca10-year bond February 2013 0.66% | February 2014F 1.25%100

.

YEAR OF THE SNAKE STARTS OFF SLUGGISH YEAR OF TTHE SNAKE STTARTS OFF SSLUGGISHAR S ST OF U SHKE STAR UGG

Shanghai fell 1.0% ahead of key economic data releases. Factory growth S s FFs. Fhanghai fell 1l 1.0% ahead of keeyy economic ddaata releasesfe e e c el sghai fell 1.0% ahea data slowed to multi-month lows as sluggish domestic demand was added to s manl maowed toto multi-month lows s aas sluggish domomestic demm th slu o c ish do mman already depressed foreign demand. The Nikkei closed up 0.3% after a seseedednn alalready depressed foreigeign demand. Thhe Nikkei clod fo m e idemand i cloparing gains in reaction to the Bank of Japan’s decision not to pursue p c onec n aring gains in reactionn to the Bank of JaJapan’s decisionns on an a ceactionon to th s dec nnfurthefffurthrther easing at thiiss point.in pother easing t


GLOBAL ECONOMY

REVIVING RISK APPETITE

In contrast to the economic improvements celebrated in the previous edition of Counsellor Quarterly, the past quarter was more mixed. Economic momentum has flattened out, and it is inescapable that output in the world’s major developed nations declined in the final quarter of 2012. The post-fiscal-cliff rebound in U.S. consumer and business confidence is proceeding, but more gingerly than hoped given higher taxes, rising gasoline prices and several remaining policy hurdles.

To be sure, there is still much that is going right. Japan is

implementing bold policy remedies that might just awaken it

from two decades of economic slumber. The decline in existential

risks is spurring a revival of risk appetite, and the much-feared

U.S. fiscal cliff was mostly deflected at year-end. Leading

indicators point to decent economic prospects for the coming

months, and the stock market has given its clear approval.

As a result, our basic thesis remains unaltered. The global

economy is still destined for slower-than-normal growth,

mainly because fiscal authorities are trying to disentangle their

countries from large deficits. But beneath this, the beginning

of an upward trend may be starting to form. The U.S. economy

is healing and is now capable of generating additional growth.

Europe, while only in the early stages of rehabilitation, has

made measurable progress. Risk appetite is reviving, with

positive consequences for growth and markets.

BY ERIC LASCELLES CHIEF ECONOMIST

RBC GLOBAL ASSET MANAGEMENT

RECONCILING CONTRADICTIONS

The first order of business is to reconcile the apparent

contradiction between leading indicators that point to decent

economic growth with fourth-quarter GDP that shrank in the

Eurozone, the U.K., Japan and – most surprisingly – left U.S.

output basically flat.

Normally we would be inclined to take GDP as the better arbiter

of economic health, but in this case leading indicators appear

more trustworthy. Certainly, the Eurozone is in recession, and its

economic figures are a fair reflection of that. But the U.K. and

Japan – for all of their flirtations with recession – are probably on

a trajectory of slow growth once the quarterly wiggles have been

smoothed out (and as prophesied by leading indicators).

The fourth-quarter U.S. GDP figure was the big surprise.

However, it is likely an outlier. Revisions have turned what was

initially a slight negative into a slight positive. Moreover, much

of the remaining weakness was temporary. Inventories exerted a

drag, likely because of the dampening effect of Hurricane Sandy

on production. This should shortly turn into a tailwind as those

effects reverse. Military procurement was exceptionally weak,

and while some part of that may persist as the U.S. winds down

its overseas military commitments, the extent of the drop was

unusually sharp. The U.S. economy is almost certain to rebound

when the next quarterly figure is published.

DIMINISHED SEASONALITY TO COME?Seasonal trends have played an unusually large role in economic

statistics over the past three years, with economic data stronger

in the winter and weaker in the summer. Explanations for this

include distortions to the seasonal adjustment factors arising

from the economic collapse of 2008-2009 and/or a subsequent

pattern of warm winters and sweltering summers that tilted

construction toward the winter months.

We anticipate a diminished seasonal trend this year for four

reasons. First, these patterns are simply not supposed to exist

and could vanish just as mysteriously as they appeared. Second


(and relatedly), lingering seasonal trends are absorbed by the

model over time, eventually snuffing out any visible pattern.

Third, this winter has not been as warm as last year’s. Fourth,

initial readings for 2013 have already adhered less closely to

the usual seasonal trend.

To be clear, we still suspect that this spring and summer will

exhibit weaker activity than the winter, and this could induce

a temporary dip in confidence and perhaps even markets.

Economic momentum has already flattened out. But the

subsequent softening may be less obvious than in past years,

and it is important to keep in mind that growth has always

subsequently returned (Exhibit 1).

MIXED BAG OF FORECASTS

In response to these developments, we have adjusted our

economic forecasts for 2013 (Exhibit 2). The Eurozone and

U.K. outlooks have again shifted lower, reflecting the enduring

nature of the weakness in these regions. The U.S., Canadian and

emerging-market basket of forecasts have held firm. Meanwhile,

we have pushed the Japanese outlook significantly higher to

reflect new stimulus.

Consensus expectations have moved in a broadly similar fashion

to our own. Relative to the consensus, we nonetheless look for a

stronger U.S. and Japan, and relative weakness in the Eurozone

and emerging markets.

This report marks the introduction of our 2014 forecasts.

Most estimates are informed by our knowledge of long-term

sustainable growth rates, overlaid with the expectation that

growth will begin to rebound given ongoing healing and the

eventual abating of fiscal drag. Supporting this narrative of

moderate improvement, financial conditions have become

favourable, and excess liquidity signals further growth.

EXISTENTIAL RISKS HAVE SHRUNK

The identification of tail risks is no less important than the

generation of base-case economic forecasts. The largest

downside risks have arguably shrunk over the past year: the

intensity of Europe’s debt crisis has eased; China has engineered

a soft landing; and U.S. political dysfunction has diminished

somewhat. Each is being bled of its venom while simultaneously

becoming less likely to bite.

Of course, there are always new risks. A steady drip of elections

over 2013 brings an element of uncertainty, especially in a

beleaguered Europe where the need for political consistency

is greatest. Unfortunately, the deadlocked Italian election has

triggered a renewed sense of uncertainty in Europe. Social

unrest is significant across Europe, the Middle East and North

Africa. Separatist movements are on the march in Catalonia and

Scotland. Geopolitical risk percolates in Syria and Egypt, and

elevated frictions exist between Iran and the West, Israelis and

Palestinians, and China and Japan. A nuclear test in North Korea

and accusations of Chinese cyber-sleuthing add to the clamour.

Natural disasters constitute a perpetual unknown. These sorts

of developments rarely exert a tangible presence on the global

economy or markets, but they could.

Exhibit 1: 2013 U.S. Quarterly Profile

Source: RBC GAM

POLICY UNCERTAINTY

SANDY REBOUND

SEASONALITY Q1 Q2 Q3 Q4

REBOUNDFROM Q4 GDP

Exhibit 2: RBC GAM GDP Forecast for Developed Markets

Source: RBC GAM

2.25%

1.75% 1.75%

1.0%

-0.75%

2.75%

2.0%

1.25%1.5%

0.5%

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

U.S. Canada Japan U.K. Eurozone

Ann

ual G

DP

Gro

wth

(%)

2013 2014


REVIVING RISK APPETITE

Risk appetite appears to be reviving around the world given

declining perceptions of risk. This can be seen in narrowing

credit spreads and lower expected volatility in financial markets.

It also shows up in declining correlations across asset classes

and between individual stocks.

The revival of risk appetite is an important development.

In an era of sluggish economic growth, stock-market gains

(and bond-market losses) are more likely to come from shifting

investor behaviour than surging earnings. Already, investors

are beginning to show a greater thirst for equities. Continued

improvement in risk appetites will be critical in determining

the performance of financial markets over the coming year.

HEALING CONTINUES

The theme of healing remains of central importance. In an

era when sluggish economic growth casts a sickly pallor, it

is important to acknowledge the mending of bones occurring

beneath the surface.

The U.S. housing market continues to surge, and appears to

have additional upside left in it. Credit is flowing again, and

even hiring has pushed higher in workmanlike fashion. These

three variables are particularly important: the first was the root

of the financial crisis, and pullbacks in the latter two had the

most devastating consequences.

Europe, too, can now begin to claim some healing after

policymakers took a scalpel to the gangrenous debt that afflicts

the continent’s periphery. The restorative effects are best

demonstrated by the remarkable decline in Spanish bond yields.

Competitiveness is rebounding, albeit with some distance to go.

Current-account deficits are shrinking, signalling greater self-

sufficiency in Europe’s periphery. Many countries have made

significant progress in shrinking their budget deficits (Exhibit 3).

Even the run on Greek and Spanish banks seems to have faded.

However, public support for these initiatives has always been

fragile, and the February 25 Italian election demonstrates the

gridlock that can result when austerity becomes too painful.

The Cypriot election reassures that pro-Europe candidates

still have at least a chance at the polls, though it also reminds

us that the era of bailouts is not quite over.

EUROZONE RECESSION PERSISTS

One must distinguish between the progression of the Eurozone’s

debt crisis and the erosion of the region’s economy. Whereas the

debt crisis has ebbed, the economy is still shrinking. In fact, the

rate of GDP decline in the fourth quarter of 2012 was the worst

since 2009 (Exhibit 4).

This gulf can be reconciled in two ways. First and most

importantly, the economy has tended to lag developments

in the sovereign-debt crisis. For instance, it took a year for the

Eurozone to descend into recession after the debt crisis struck.

Exhibit 3: Significant Fiscal Tightening Done, but More to Go

Note: Numbers shown are reductions in budget deficits during the time periods.

Structural balances from 2012 to 2017 are IMF forecasts. Source: International Monetary Fund, Haver Analytics, RBC GAM

3.0

14.1

5.2

4.9

3.6

1.9

0.6

4.0

2.3

4.0

3.1

3.2

Italy

Greece

Portugal

Ireland

Spain

France

Change in Government Structural Balance as % of GDP

2009-2012 2012-2017


Similarly, the debt crisis has abated in part because banks

are recapitalizing nicely and governments have cut spending.

These very actions mean less economic growth in the short run.

The big question for the Eurozone is whether the economy will

finally begin rebounding in 2013. We suspect the answer is

unfortunately “no.” Whereas Eurozone GDP shrank by around

0.5% in 2012, we forecast an even larger decline of 0.75% in

2013. Happily, growth is expected to return in 2014, when we

forecast a 0.5% expansion, and the outlook may soon begin

improving if leading indicators are to be believed (Exhibit 5).

With the recession well underway, we are now in a position to

evaluate the severity of the Eurozone’s downturn. Officially, it

has been a shallow recession. However, it has often felt much

worse than that. Why? One reason is that some countries have

suffered greatly, while others have sailed through (Exhibit 6).

The situation also depends on which aspect of the economy is

being discussed. Exports have held up fairly well, leaving the

impression that the economic decline was much milder than

in 2009. But to domestic households and businesses, the hit

has been nearly as bad as 2009 – pretty brutal stuff.

Eurozone inflation has been unusually high for a number of

years as sales-tax hikes took effect. With the tax hikes now mostly

completed and falling out of the equation, inflation should run

at a more subdued 1.75% in 2013 and 1.25% in 2014. Faced

with this, the European Central Bank (ECB) may be forced to

reconsider its stubborn policy stance, potentially delivering a

further rate cut to trigger a softer euro. Quantitative easing would

be good medicine, but seems unlikely given current attitudes.

Some countries fared better than others during the Eurozone downturn. Estonia’s experience was notably better than in economies like Greece, Portugal or Cyprus.

Exhibit 4: Eurozone in Enduring Recession

Source: Haver Analytics, RBC GAM

1.9

4.1

1.6 1.4

2.6

0.90.4

-1.4

-0.1-0.7

-0.3

-2.3-3

-2

-1

0

1

2

3

4

5

GD

P G

row

th (Q

oQ %

Ann

ualiz

ed)

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12


U.S. PRIVATE DELEVERAGING OVER

The U.S. economy appears to be outperforming most of its

developed peers for two reasons. First, it enjoys a higher GDP

speed limit than other nations due to a combination of superior

demographics, a culture of innovation and entrepreneurship,

and better competitiveness.

Second, the U.S. was more forthright in acknowledging losses

after the global financial crisis, which permitted more rapid

deleveraging. Our calculations suggest the U.S. private sector is

in fact now fully deleveraged. Illustrating this, household debt

has now declined by more than the value of household assets.

All the same, there remains one last cinch on U.S. growth.

Fiscal tightening is set to subtract between 1.5% and 2.0% from

GDP growth in 2013. There is still some uncertainty around

the precise drag owing to several decisions that remain in the

hands of American politicians. Most prominently, the sequester’s

March 1 deadline has now passed, meaning that $85 billion

of spending cuts scheduled for 2013 are commencing. But there

are still opportunities for politicians to halt the cuts, including

toward the end of March when a budget deal must be struck,

or as the debt ceiling is hit over this summer.

In this context, it is frankly remarkable that the U.S. is still on

track for something near 2.25% growth this year. As fiscal

austerity subsides later in the year and risk appetite continues to

revive, we look for growth to accelerate to 2.75% in 2014. Inflation

looks set for slightly below 2% in 2013, and around 2% in 2014.

The U.S. Federal Reserve (Fed) was very busy over the final few

months of 2012, first instituting a new round of quantitative

easing in September, and then expanding it in December. Recent

comments from Fed members reveal a schism on the committee

regarding when these asset purchases should end. A number of

members favoured an early conclusion while several others –

presumably including Chairman Bernanke – preferred to continue

pressing ahead. If we have learned anything over the past several

years, it is that policymakers are likely to deliver more stimulus,

not less. Despite this, the U.S. dollar may find itself wafting higher

as other countries get in on the currency-depreciation game.

CANADA SPUTTERS

The Canadian economy sputtered through the second half

of 2012 and ended the year with a face full of soot. There are

several reasons for this. The Canadian dollar is still arguably

stronger than it should be. Western Canadian oil producers are

being forced to accept deeply discounted prices due to pipeline-

capacity problems, while consumers in the rest of the country

are paying a premium for imported crude. The gap between

the two is problematic. Lastly, and perhaps most importantly,

the Canadian housing market is cooling.

Despite all of this, we still expect the Canadian economy to

muddle through. The Bank of Canada’s Business Outlook Survey

still shows that companies plan to continue with hiring and

capital investments (Exhibit 7). Canada is ramming through

less fiscal austerity than most of its peers. Even if the housing

market does correct substantially, some offset would come

from a weaker Canadian dollar, and perhaps from fiscal or

monetary stimulus, where policymakers have some leeway.

Most importantly, it is far from clear how much or how quickly

housing activity and prices will actually decline.

Exhibit 5: Eurozone Economy Shrinking Less Quickly

Note: PMI refers to Puchasing Managers Index, a measure of economic activities.

Source: Markit, Haver Analytics, RBC GAM

30

35

40

45

50

55

60

65

2006 2007 2008 2009 2010 2011 2012 2013

Man

ufac

turi

ng P

MI

Expansion

Contraction

Exhibit 6: Varying Economic Experiences in Europe

Source: Haver Analytics, RBC GAM

-8 -6 -4 -2 0 2 4

EstoniaSlovakia

AustriaGermany

FranceBelgium

EurozoneNetherlands

FinlandSpain

ItalyCyprus

PortugalGreece

Q4 2012 GDP YoY % Change

Notably worse

Notably better

Average


While residential construction represents an unusually high

share of GDP, the sector’s share actually looks quite pedestrian

in inflation-adjusted terms. And while tighter mortgage rules

introduced in July 2012 have indeed cooled the Canadian

market, their effect usually wanes after two to three quarters –

around now. Affordability is still fairly good given current

interest rates, though this will deteriorate when interest rates

do eventually rise. We look for the Bank of Canada to tighten

policy at the beginning of 2014 at the earliest.

The latest national statistics show a clear slowdown in housing

starts and building permits. Growth in household credit is

slowing and home prices are also stalling. Our analysis suggests

some further moderate drag is likely from housing, mainly

because of the overbuilding evident in certain regions and

segments of the market. This points to a leaner year or two for

the Canadian economy and marks one of the few times since

the financial crisis that Canada’s economy has underperformed

Exhibit 7: Canadian Businesses Expect to Increase Investment and Hiring

Source: Haver Analytics, Bank of Canada, RBC GAM

-25

-15

-5

5

15

25

35

45

1998 2000 2002 2004 2006 2008 2010 2012

Bus

ines

s O

utlo

ok S

urve

y(%

Bal

ance

)

Future Investment and Employment

Despite slowing growth in household credit and a cooling housing market, the Canadian economy is still expected to muddle through. The Bank of Canada may tighten policy in early 2014.


the U.S. But the timing is highly imprecise, systemic risks are

low, the banking sector is fairly well insulated and the largest

risks confronting Canada are still global in origin.

PUBLIC DEBT’S LONG JOURNEY

In stark contrast to diminishing global risks and healing

economies, global public-debt loads continue to rise in the

developed world. This is normal in the sense that public debt

usually declines with a lag, ceding priority to the private sector

to unwind its excesses first.

Fortunately, policymakers are now turning their attention to

serious debt reduction and they have many options available

to them. The most likely fix is a combination of budget surpluses

and repressed interest rates, combined with a smidgen of

additional inflation and economic growth. However, even with

all of these contributors pulling in the same direction, public-

debt reduction efforts will take an excruciatingly long time.

By our calculations, many countries will be locked in debt-

reduction mode for decades if they wish to return to normal

debt levels. (Exhibit 8).

Governments are beginning to take decisive steps to reduce

their debts, and this bodes well for long-term economic growth

prospects. The economic pain associated with falling debt loads

is very much front-loaded (Exhibit 9). However, the very fact that

debt loads will take many years to decline to more reasonable

levels makes nations vulnerable to economic shocks.

EMERGING MARKETS STABILIZE

With few exceptions, emerging markets do not suffer from the

same public debt problems as the developed world. They

learned their lesson during a series of financial crises in the

1990s (Asian financial crisis, Mexico’s “Tequila” crisis), and

subsequently constructed a protective shell of low debt loads,

current-account surpluses and large foreign-exchange reserves

to ward off the risk of recurrence.

Emerging-market economies have lately rebounded nicely after

swooning in mid-2012. We suspect the rebound itself is peaking,

and most emerging economies are unlikely to fully return to

the growth rates achieved over the prior several years. But the

current rate of growth can probably be maintained, allowing our

six-nation basket of emerging markets to achieve solid growth

of around 6.0% in both 2013 and 2014, while inflation holds in

the 4.5% range. As usual, China looks set to outperform the rest,

as its economy expands 8.0% in 2013 and 7.5% in 2014.

INFLATION REMAINS TAME

In a period of slow economic growth, few wage pressures and

steady commodity prices, global inflation is unlikely to rise

particularly quickly, as confirmed by current copacetic levels.

There are certainly national exceptions to this prognosis – the

U.K. is clearly one, while Japan is (hopefully) another – but

most are well in line with these levels.

Exhibit 8: Target Achievement of Public Debt Goal

Note: “Public Debt Goal” defined as easier of 60% debt-to-GDP ratio or pre-crisis (2007) debt-to-GDP ratio. Source: IMF, RBC GAM

Year Necessary Debt Reduction (ppt)Netherlands 2016 8Germany 2017 18Canada 2018 21France 2021 26Italy 2021 23U.K. 2025 29Spain 2027 31U.S. 2028 40Japan 2035 54Portugal 2036 51Ireland 2037 58Greece >2050 63


China’s economy expanded over 15% from 2013-2014s, and it looks set to outperform the rest of the emerging-market economies in the months ahead.

YIELDS TO RISE SLOWLY

We have already discussed each major central bank separately.

Together, the common theme is that central banks are probably

far from tightening, and in some cases even have more stimulus

to deliver. This is an easy call for Japan, but may also prove true

for the Bank of England, the ECB and even the Fed. The short

end of the bond market should thus remain anchored by

stimulative central banks.

The long end of the yield curve is always more difficult to

predict. Our models suggest that yields are unsustainably low,

as they have for many months. Yields have primarily been held

down by two drivers: risk aversion and central-bank stimulus.

Together these forces have pushed real yields far below

equilibrium, and to the point where investors are seeing

negative returns after the effects of inflation. Risk appetite is

now beginning to pick up, which should allow yields to drift

higher. More of a risk to bond holders is central bank policy.

As the economy continues to leave the burden of the financial

crisis behind and unorthodox monetary policies that are

currently suppressing yields become less desirable, real rates

will begin to move back toward historic norms dragging

nominal yields with them.

Exhibit 9: Pain Is Front-Loaded

Source: RBC GAM

Budget Balance

as % of GDP

+_

Rising deficit

Steady deficit

Shrinking deficit

Rising surplus

Steady surplus

GROWTH

DEBT

Boosts growth Growth neutral

Rising debt

Hurts growth

Stabilizing debt

Growth neutral

Falling debtRising debt

Current Phase Next Phase

Economic theory suggests that inflation should begin to edge

up over time as economic slack is absorbed. There is even the

chance of a bit more inflation than usual – several years down

the line – given the way that central banks have shifted their

focus toward economic growth, and given fears of premature

tightening and temptations to inflate away government debt.

But this is highly speculative, and unlikely to have an

overwhelming effect through the forecast horizon.


traction. According to our fair-value models, equity markets in

most regions remain undervalued, indicating the potential for

further gains.

THE GREAT ROTATION

Since the beginning of 2013, the media has been focused on the

theme of “The Great Rotation.” This refers to the point at which

investors decisively move their assets from bonds and other safe

havens into the stock market. Since the first week of January, we

have seen large equity inflows. In the past two months, $21 billion

of assets has flowed into equities, close to the amount that has

flowed to equities in the past two years combined! That said,

bond inflows have been strong as well, indicating that investors

are simply moving cash into both the equity and bond markets.

Although a “great rotation” isn’t evident in the flow data – at

least not yet – the new attention to equities may be a positive

sign for near-term performance. Since equity outflows

troughed in December 2012, the market has increased 11% and

outflows are currently around $1.5 billion. Continued healing

in the global economy and increasing investor risk appetite

may eventually push equity mutual-fund flows into positive

territory, providing fuel for stocks to move even higher.

The global economy continues to heal. Risks remain, but the

market appears to be looking past immediate hurdles and

focusing on positive developments taking place.

We are already beginning to see yields tentatively rise. Reflecting

all of this, our forecast for the next 12 months is for an increase in

10-year yields across the developed world on the order of 50 to 70

basis points. Aside from the U.K., most countries over the forecast

period are likely to see negative total returns to sovereign debt.

Looking out further, based on a return to equilibrium, total

returns could be low or negative for an extended period.

However, there are distinct limits to how much bond yields

can rise in the near term. In addition to the obvious constraints

of sluggish growth, moderate inflation and low central-bank

rates, we must not forget that a key reason for the global

recovery is the very existence of ultra-low borrowing costs.

For policymakers to allow a significant increase in rates would

be to betray the very recovery on which the low bond yields have

been based. Just as rates were managed lower by central banks,

we expect they will be managed higher as well, moving gradually

towards our forecasts and, ultimately, equilibrium.

STOCK MARKETS CONTINUE TO PUSH HIGHER

Stock markets got off to a quick start in 2013 with global

equities, as measured by the MSCI World Index, up almost 5%

year-to-date. While the U.S. fiscal debate is on-going and the

crisis in Europe continues to evolve, it appears that investors

have begun to look past the macroeconomic headwinds and

are now focusing on an economic recovery that is gaining


PLANNING STRATEGIES FOR COUPLES

Couples in a long-term relationship or considering one now need to be more aware than ever of the financial and legal ramifications of a love that lasts and, equally, where it may not.

Whether due to the increasing tendency to marry at an older

age, live longer or the increased prevalence of divorce,

Canadian marriages are now facing increasing financial

responsibilities, likely not considered in generations past.

On top of this, there may be even more mouths to feed at

the Canadian couple’s financial table – whether with the

increase in “blended families” (children from previous

marriages) or those in the “sandwich generation” (couples

caring for aging parents in addition to children). Exploring

the following issues can contribute to the likelihood of a

loving and stable relationship well suited to meet life’s

challenges over time.

Whether you have been married for 50 years or considering

marriage, the following are the key areas of tax, estate, and

financial planning consideration for couples (including

common-law partners).

1. CREATE A FINANCIAL PLAN

Deciding together how to best allocate and prioritize expenses

will not only save headaches, but build valuable habits and

save money. A financial plan may also identify a number of tax

planning strategies for couples (for example, “income

splitting”). One example of income splitting for couples is to

have the higher-earning spouse pay living expenses for the

family as well as the family’s tax liabilities, so the lower income

spouse can invest their own income which will be taxed at the

lower-income spouse’s tax rate.

Another effective income splitting strategy is a spousal RRSP,

which is an RRSP to which one spouse makes contributions

WEALTH MANAGEMENT

Couples need to be more aware than ever of financial and legal planning considerations – whether they have been married for 50 years or are considering marriage.


(the contributor), but is opened in the name of the other

spouse, who is the annuitant (or owner) of the RRSP. Spousal

RRSPs provide a simple way to split retirement income

between spouses in an effort to equalize the retirement income

and minimize the couple’s income taxes.

2. USE YOUR PRINCIPAL RESIDENCE EXEMPTION WISELY WHEN OWNING TWO HOMES

An exemption on the capital gain only applies to your principal

residence, and now that you are a couple, only one exemption is

available per family unit per year (for each year prior to 1982,

each member of the family unit may designate a separate home

as their principal residence). This means if you and your partner

both own a house (or a house and a cottage), only one exemption

is available for the years that you are considered common-law or

married. Be sure to consult your tax professional to determine the

best use of the exemption where there is more than one home.

3. DETERMINE THE BEST OWNERSHIP OF ASSETS FOR YOU AND YOUR PARTNER AND THE ACHIEVEMENT OF YOUR GOALS Do you wish to own them jointly or in your own names? Ensure

that you understand the advantages, but most importantly, the

legal and tax results and how they will be distributed if you die

(or break up). You should obtain independent legal advice from

a qualified family law lawyer as every province has its own

unique rules.

4. FOR THOSE WHO HAVE BEEN MARRIED BEFORE Consider obligations you may have with a former spouse,

children or elder parents. You will need to consider how your

assets are going to be shared both during your lifetime and

later, through your estate plan.

5. MAKE A PRACTICE OF REVIEWING AND UPDATING BENEFICIARY DESIGNATIONS ON YOUR REGISTERED PLANS AND LIFE INSURANCE TO ENSURE THAT THEY ALIGN WITH YOUR CURRENT WISHES This is particularly important if you now have a RRIF

(beneficiary designations are not automatically carried over

from your RRSP) or have remarried.

6. CONSIDER YOUR WILL SOONER RATHER THAN LATER

Be sure it is up to date, and if recently married or re-married,

whether it has been automatically revoked on marriage. This

will depend on the provincial laws where you reside. You will

also need to decide how your partner/spouse will benefit

under your Will.

7. UPDATE YOUR POWERS OF ATTORNEY

So that if you are unable to make health care or financial

decisions, the right people have the authority to make them

for you.

8. SOMETHING TO THINK ABOUT FOR THOSE CONTEMPLATING MARRIAGE OR LIVING TOGETHER

Consider a marriage or cohabitation agreement that sets out

your financial expectations concerning the relationship to

help avoid conflicts later (including legal hassles) should the

relationship end. In most jurisdictions in Canada, legislation

is encouraging use of these agreements by giving certainty

that they will be upheld except where they are found to be

unreasonable. You can also agree on certain matters relating to

the children, including their educational or religious upbringing

and custody and access issues (however, in many jurisdictions

these provisions may be disregarded by a Court if it is felt to

be in the best interests of the children). However, do not leave

the marriage contract to the last minute. It is probably wise to

consult your respective lawyers well in advance of the proposed

nuptial date or even the “Save the Date” cards being sent to

allow for adequate consideration and negotiation. The

implementation of a marriage or cohabitation agreement will

generally require that you make full financial disclosure to your

partner. Full financial disclosure may include providing details

of your assets, income, debts and liabilities to your future

common law partner/spouse. As part of this process, you may

need to obtain professional valuations for various assets,

including business and real estate interests.

Now may be a good time to review your planning. For

more information on planning strategies for couples, please

consult with your RBC advisor and your tax or legal advisor,

as applicable.

Together with our RBC Partners, we can assist with any of the

following recommendations, in conjunction with your tax or

legal advisors. You should obtain professional advice from a

qualified tax advisor before acting on any of the information in

this article. This will ensure that your own circumstances have

been considered properly and that action is taken on the latest

information available.


Three years ago, I wrote to you about bringing together the two firms of PH&N Investment Management (PH&N) and RBC Phillips, Hager & North Investment Counsel (RBC PH&N IC), making a significant investment in technology and continuing to build on our investment solutions. Much has happened since that time, and I wanted to update you on our progress.

At the outset, we were determined to continue to exceed your

expectations of us. In fact, we wanted our highly valued clients

to benefit from the integration of both firms. Some of these

benefits are already in place, and some will come to fruition

over the next few months, including:

First, we have expanded our award-winning investment

offering to provide you with even more choices for fixed-

income, equity and alternative investments. With the

acquisition of BlueBay Investment Management we can

now extend more fixed-income choices, and we have also

expanded our equity offering with new dividend-oriented

investments, hedge funds and private equity options.

To make it easier for you and your Investment Counsellor

team to stay in touch, and to provide additional functionality,

we are investing in our business technology to provide more

comprehensive reporting and communications. Over the

next six months, we will be implementing new portfolio

management and contact management systems, culminating

with the transfer of all RBC GAM (former PH&N) client

accounts on to this platform.

Amid ongoing global economic change, we wanted solutions

to be available for you to protect the wealth you’ve earned,

minimize the taxes you pay and prepare your estate to

transition to the next generation. To do so, and based on

client feedback, we have expanded our resources in the

areas of tax, financial, insurance and estate planning. We

have also grown our team of specialists and brought on

experts in business succession to help manage, protect and

transition the wealth in your business.

We will be communicating regularly with you over the coming

year on the progress of these changes. By always remaining

committed to you, our clients, we can continue to provide the

industry-leading investment solutions, wealth management,

service and reporting that, we hope, will continue to exceed

your expectations.

VIJAY PARMAR, CA

PRESIDENT

INVESTING IN OUR BUSINESS, AND OUR CLIENTS

THE LAST WORD

Past performance is not indicative of future results. Counsellor Quarterly has been prepared for use by RBC Phillips, Hager & North Investment Counsel Inc. and RBC Global Asset Management Inc. as an exclusive service for Discretionary Investment Management clients. The information in this document is based on data that we believe is accurate, but we do not represent that it is accurate or complete and it should not be relied upon as such. Persons or publications quoted do not necessarily represent the corporate opinion of RBC Phillips, Hager & North Investment Counsel Inc. or RBC Global Asset Management Inc. This information is not investment advice and should only be used in conjunction with a discussion with your RBC Phillips, Hager & North Investment Counsel Inc. or RBC Global Asset Management Inc. Investment Counsellor, as applicable. This will ensure that your own circumstances have been considered properly and that action is taken on the latest information available. Neither RBC Phillips, Hager & North Investment Counsel Inc., RBC Global Asset Management Inc. nor any of its affi liates, nor any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. This document is for information purposes only and should not be construed as offering tax or legal advice. Individuals should consult with qualifi ed tax and legal advisors before taking any action based upon the information contained in this document. Some of the products or services mentioned may not be available from RBC Phillips, Hager & North Investment Counsel Inc.; however, they may be offered through RBC partners. Contact your Investment Counsellor if you would like a referral to one of our RBC partners that offers the products or services discussed. RBC Phillips, Hager & North Investment Counsel Inc., RBC Private Counsel (USA) Inc., RBC Global Asset Management Inc., Royal Trust Corporation of Canada, The Royal Trust Company, RBC Asset Management Inc., RBC Dominion Securities Inc. and Royal Bank of Canada are all separate corporate entities that are affi liated. Members of the RBC Wealth Management Services Team are employees of RBC Dominion Securities Inc. RBC PH&N IC and RBC GAM are member companies of RBC Wealth Management, a business segment of Royal Bank of Canada. The brand name RBC Wealth Management – PH&N Investment Counsel is used by RBC PH&N IC and the private client division of RBC GAM. ® / ™ Trademark(s) of Royal Bank of Canada. RBC, RBC Wealth Management and RBC Dominion Securities are registered trademarks of Royal Bank of Canada. Used under licence. © RBC Phillips, Hager & North Investment Counsel Inc. 2013. All rights reserved. VPS82362 94632 (04/2013)


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WINNER ANNOUNCED FOR 2013 CHARLES TAYLOR PRIZE FOR LITERARY NON-FICTION

Andrew Preston has been named the winner of The 2013 Charles Taylor Prize for Literary Non-Fiction for his book Sword of the Spirit, Shield of Faith: Religion in American War and Diplomacy, published by Knopf Canada.

Noreen Taylor, chair of the Charles Taylor Foundation, announced the winner’s name before a packed audience of guests, publishers and media at the King Edward Hotel in Toronto in March 2013, and presented him with a cheque for $25,000 and a specially commissioned crystal award.

This is the 12th awarding of the prestigious prize, which recognizes excellence in Canadian literary non-fiction. First presented as a biennial award in 2000, and made annual in 2004, the Charles Taylor Prize for Literary Non-Fiction is presented to a Canadian author whose book best demonstrates a superb command of the English language, an elegance of style and a subtlety of thought and perception. RBC Wealth Management is the presenting sponsor for the prize.

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