Economic & Market Outlook 2013-14

1. Economic & Market Outlook 2013-14 Warren Jestin, Chief Economist Camilla Sutton, Chief Currency Strategist Vincent Delisle, Investment Strategist

2. 2013-14 Economic Outlook New World Rising Warren Jestin Senior Vice-President & Chief Economist

3. Gains In Global Growth Will Be Moderate & Uneven China and other emerging market powerhouses will increasingly drive global activity, maintaining a wide growth lead over traditional developed nations. If the U.S. avoids a turn-of-the-year fiscal cliff, it should edge out Canada as the top G7 growth performer. It’s not a hard race to win.

4. Developed Nations Confront Big Headwinds Sluggish growth and ongoing fiscal drag will temper job creation, confidence levels and spending trends, particularly in Europe.

5. Europe Battles Long-term Challenges Europe’s debt crisis is far from over, with severe austerity measures undermining growth prospects well beyond mid-decade. A number of debt-heavy nations, locked in recession, are experiencing substantial social and political fallout from sky-high youth unemployment rates.

6. Emerging Markets Increasingly Drive Global Growth … Robust growth in China and a number of other emerging markets will provide important support to global trade flows & commodity prices.

7. … Supported By Rising Income & Financial Resources Domestic demand is underpinning growth in China and other emerging markets, supported by rapid income gains and large financial resources.

8. Monetary Policies Remain Geared To Reviving Growth Slow growth, low inflation & fiscal austerity point to a continuation of pedal-to-the-metal monetary stimulus in many developed economies.

9. The Loonie Will Continue Flying High The Canadian dollar is supported by strong commodity earnings, rising foreign investor interest and relatively favourable fiscal and financial fundamentals.

10. Fiscal & Financial Strains Less Intense In Canada The U.S. housing market is beginning to revive, but a return to more balanced conditions is still years away. Canada’s fiscal advantage provides a competitive edge as the U.S. and other nations confront the need to substantially boost taxes & scale back spending on key programs.

11. U.S. Begins To Play Catch-up In Employment … Despite recent U.S. job gains, over 4 million jobs are still needed to return to pre-recession peaks. Canadian employment is setting new records, with skilled labour shortages putting upward pressure on wage trends.

12. … And Big-Ticket Purchases Jobs gains, improving confidence & years of deleveraging are putting U.S. households in a mood to increase their spending. With home ownership at record highs, tighter mortgage rules and high household debt levels are cooling home sales in Vancouver and Toronto.

13. Non-Res Construction Much Stronger In Canada Canadian non-residential construction continues to benefit from big resource projects, infrastructure development and more balanced commercial markets.

14. Resource Sector Drives Job & Income Gains Canada’s resource-rich provinces will continue to lead in job and income gains.

15. 2013-14 Foreign Exchange Outlook Making Progress Camilla Sutton Chief Currency Strategist

16. 2012 Forecast vs Performance SCOTIABANK FORECASTS VS ACTUAL RETURNS (2012) FORECASTING ACCURACY SUMMARY FROM 2012 (to November 29) CAD – direction and magnitude JPY – direction and magnitude GBP – direction and magnitude AUD – direction but over estimated rise EUR – failed on both direction and estimate; as we had forecasted weakness & EUR is flat

17. Scotiabank’s Forecast

18. FX Themes – Year-to-Date • Main themes in 2012: • Europe • Global growth outlook • Central bank policy response • Main themes in 2013 • Global growth outlook • Europe • The US backdrop • Central bank policy • Politics: new leadership in China; Elections in Italy, Japan, Germany, etc.

19. THEME 1: Growth – US & China vs EU & Japan • Can growth in China and the US offset weakness in Europe and Japan? • A soft landing in China with 2013 GDP of 8.0%.

20. THEME 1: Growth – European Recession Ends • Europe exits recession; headlines should improve. • Growth remains moderate at best and complicated by demographics.

21. THEME 2: Europe – Making Progress

22. THEME 3: The US Backdrop Source: Bloomberg & Scotia FX Strategy • The fundamental USD story is not a strong one. • US economy needs a weak USD; just like Eurozone needs a weak EUR.

23. THEME 3: The US Lacks A Fiscal Plan FORECASTED US FISCAL DRAG US FISCAL & DEBT FORECAST As % of GDP • US fundamentals are typically those associated with a weak currency • Short-term: fiscal cliff uncertainty lays foundation for temporary USD strength • 2013 fiscal drag is expected to be between 1 and 2% -- assumes agreement • Medium term: lack of credible fiscal plan should create USD weakness

24. THEME 4: Central Bank Response – FX Impact • Positive CAD – BoC has one of few hawkish central bank bias in advanced economies. • Negative USD – QE3, rates on hold until mid 2015 & threat of QE3 expansion.

25. THEME 4: Central Bank Response – QE • Difficult to measure exact impact of QE programs. • Fed: QE1 decreased 10-year bond yields by 40 to 110bpts; • while QE2 decreased them by 15 to 45bpts. • Expect QE3 to be expanded in December to include Treasurys.

26. THEME 4: Central Banks – The Fed’s Timeline Source: Scotiabank FX Strategy & Economics

27. THEME 4: Central Banks – Global Timelines Source: Scotiabank FX Strategy & Economics

28. CAD Drivers & Outlook Source: Bloomberg & Scotia FX Strategy

29. Scotiabank’s Forecast

30. Major Risks MAJOR RISKS TO FORECAST • Fiscal cliff – no compromise – major global growth consequences • Global growth – China fails to engineer soft landing • Inflation – central bank policy stems significant inflationary pressures • Oil – geopolitical tensions rise; oil rallies and threatens global economy • Europe – Escalates beyond current expectations

31. 2013-14 Equity Market Outlook Bottom Line Trumps Headlines Vincent Delisle Investment Strategist, Portfolio Strategy Group

32. Revisiting 2012: Equities Surviving Policy Fears • Equities edging bonds in 2012; U.S., Mexico, Germany leading. • Canada lagging; Brazil & China bucking trend with losses.

33. Revisiting 2012: Earnings Leadership Rules • Positive earnings revisions in the U.S. and Germany… • …negative trends in China, Brazil, and Canada.

34. Revisiting 2012: TSX Lag Due to Resources • Mining, Golds, and Energy hurt… • non-resources + dividend payers shine.

35. Revisiting 2012: P/E Expansion Provides Lift • Valuations improved in 2012, Mexico premium jumps. • Ex-Mexico, P/E multiples still below historical averages.

36. Stronger U.S. & China Momentum in 1H13 • Manufacturing surveys bottomed in Q3-12, expect recovery in 1H13. • U.S. and China growing, Eurozone still negative.

37. Post-China Easing supports TSX Gains • Positive reversal from a year ago. • TSX and Latam (Brazil) hurt when China is tightening.

38. TSX versus S&P500 Return Recovering • TSX coming back from extreme underperformance versus S&P500.

39. Sub-9% China GDP = Muted CRB Gains • Commodity upside limited by moderate China recovery… • …will challenge TSX and EM leadership.

40. Positive Reversal for Global Earnings • Recovering manufacturing positive for earnings outlook... • …should support risk appetite in 1H13. Global earnings growth YoY

41. Sporadic Risk-On/Risk-Off Leadership to Continue • Market environment remains volatile, challenging for buy-and-hold.

42. U.S. Housing/Employment Recovery • Stay constructive on S&P500/equities as long as U.S. housing and payrolls improve.

43. Recommended Asset Mix • Modest Equity over Bond bias extended through 1H13. • TSX and Latam could have strong start, but S&P500 should be among leaders again in 2013.

44. Canadian Index - Sector Strategy • Global over domestic focus to kick off the year. • Base Metals, Forest Products, Energy, Industrials, Insurance focus.

45. Disclaimer TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. This report has been prepared by Scotiabank Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank nor its affiliates accepts any liability whatsoever for any loss arising from any use of this report or its contents.