II December 2013 GEM Equity Strategy Outlook 2014 China likely to be a more negative driver for GEM in 2014 Sentiment towards the Chinese economy and financial assets has once again swung wildly over 2013, because of the relative lack of transparency in terms of the underlying drivers of both the economy and the corporate sector, but the overall influence of China on the rest of the asset class has been relatively neutral. We believe that there is a significant chance of a decisive break in a negative direction in 2014, due to the increasing pressure from the build-up of debt through much of the corporate sector and local government, which raises the risk of a debt trap (Figure 34 and Figure 35) as nominal rates of sales and GDP growth slow. Most investors are ending the year with a relatively positive view of China following the perceived success of the CP Plenum in presenting an agenda for reform. The Plenum represents a strong statement of intent, but did not really lay down a template for implementation in the area which matters most, namely the dysfunctional fiscal relationship between local government and Beijing, which is the underlying cause of rising debt and falling productivity in the broader economy. We do not believe that the authorities in Beijing have sufficient time to implement the policy shifts laid out in the post-Plenum document, and that at some point over the course of 2014, borrowers and investors will begin to lose confidence in their ability to pursue what we see as the irreconcilable objectives of 7%+ growth and financial stability. We therefore see the potential for deterioration in growth expectations for China to influence the rest of GEM in terms of trade, fund flows and commodity prices. Unresolved structural issues and polarised valuations imply negative returns Overall, we do not feel that the outlook for absolute returns has changed very much since we made a tentative forecast of a negative return of 10.15