QIC ABN 95 942 373 762 is a statutory government owned corporation regulated by State Government legislation pertaining to government owned corporations. The Corporations Act 2001 does not apply to QIC and, therefore, QIC does not hold an Australian financial services licence and the financial product disclosure provisions in the Corporations Act 2001 do not apply to QIC. However, the Corporations Act 2001 does apply to QIC’s wholly-owned subsidiaries. Where required, QIC’s subsidiaries have obtained an Australian financial services licence. QIC and its subsidiaries and associated entities, and their directors, employees and representatives (“the QIC Parties”) do not warrant the accuracy or completeness of the information contained inthis document (“the Information”). To the extent permitted by law, the QIC Parties disclaim all responsibility and liability for any loss or damage of any nature whatsoever which may be suffered by any person directly or indirectly through relying on the Information, whether that loss or damage is caused by any fault or negligence of the QIC Parties or otherwise. The Information is not intended to constitute advice and persons should seek professional advice before relying on the Information.

Investment Markets – 2007/08Doug McTaggartAugust 2007

2

Agenda

- What I said last year (July 2006)

- Market performance over 2006/07

- Prospects going forward

- Key risks

- Conclusions

3

Conclusions – driving forces (July 2006)

- Inflation appears to be under control

• downward pressure on prices from foreign imports

• upward pressure from AUD a complication

- Interest rates will benefit from continued low inflation

• economic growth will determine cyclical pressure on rates

- As for economic growth

• long run trend growth looks good

∗ low inflation, low interest rates, high productivity

• short run cyclical downturn led by the US likely

4

Conclusions – implications for assets (July 2006)

- The environment is favourable for growth assets

• shares, property, infrastructure, private equity

- But short-run volatility likely when at turning points of cycles

- High-beta assets could suffer the most

• emerging market shares and debt

• commodities

- Expect normal return of assets – say 8.5% on shares and 5.5% on bonds – except if something happens to alter this outcome

5

Market returns – one and three years

Asset class returns to June 30

-15%

-5%

5%

15%

25%

35%

45%

Cas

h

Aus

t Fix

edIn

tere

st

Aus

t Cre

dit

Aus

t Equ

ities

Larg

e C

aps

Smal

l Cap

s

Glo

bal C

redi

t

Int'l

Fix

edIn

tere

st (U

H)

Int'l

Fix

edIn

tere

st (H

)

Prop

erty

Secu

ritie

s

Int'l

Equ

ities

(UH

)

Int'l

Equ

ities

(H)

Prop

erty

(FSW

DPI

)

Int'l

Sm

all

Com

pani

es

per c

ent p

er y

ear

FYTD 3 years

2006/07 was a repeat of the previous three years – an environment favourable to growth assets

Bonds performed less well as interest rates edged up over the latter half of the year

6

Stock markets since 1995

Relative performance of stock markets

0

50

100

150

200

250

300

350

400

30/1

2/94

30/1

2/95

30/1

2/96

30/1

2/97

30/1

2/98

30/1

2/99

30/1

2/00

30/1

2/01

30/1

2/02

30/1

2/03

30/1

2/04

30/1

2/05

30/1

2/06

Jan

1 19

95 =

100

.

S&P 500 FTSE100 ASX200

The Australian stock market didn’t “benefit” from the global equity bubble that started in 1995. And so did not suffer the severity of the subsequent crash

It has, therefore, performed equally well over the longer run

7

Sector performance of S&P/ASX

Australian market indexes

0

100

200

300

400

500

600

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan

1995

= 1

00

Banks Industrials Resources S&P/ASX 200

Banks were the best performing sector up until the early 2000s.

The resources boom on the back of a commodity price boom has seen resource stocks out-perform since 2004

8

A “typical” balanced fund – QIC Growth Fund

Balanced funds returns -- Mercer Pooled Funds Survey(net of fees and taxes)

0

2

4

6

8

10

12

14

16

18

3 months 1 year 3 years 5 years 10 years

per c

ent /

per

cen

t per

yea

r

QIC Competitor median

Funds long equities and other growth assets have done well over the last four years.

But the ten year returns are about what we would expect over the long run – and going forward

9

Markets today

- Markets recently have been more volatile than has been the case

- Factors exercising the mind of market participants are:

• Repricing of risk

• A potential liquidity squeeze, on the back the US sub-prime mortgage debacle

• Contagion from the US housing market to the broader economy

• Sustainability of corporate earnings

• Strong global growth fuelling rising inflation

• Capacity constraints adding to inflationary pressures

• Unwinding of “global imbalances”

10

What determines the value of shares?

- Put simply – the value of the underlying companies determines fundamental value

- And this is determined by the value of their corporate earnings

- And this is determined, on average, by the underlying strength of the economy

- Where share prices go tomorrow depends on today’s share price relative to fundamental value

11

Stock market indexes and EPS

Earnings per share and share prices

0

200

400

600

800

1000

1200

1400

1600

1800

Jan-

79

Jan-

81

Jan-

83

Jan-

85

Jan-

87

Jan-

89

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

S&P

500

0

20

40

60

80

100

120

Earn

ings

per

sha

re

S&P 500 12m th forw ard earnings per share

Not surprisingly, therefore, there is a high correlation between measures of earnings per share (EPS) and market values

12

So, the future of stock prices depends on …

- Where∗ future real GDP growth

∗ future inflation

∗ future interest rates

all go

- and on where they are now ∗ i.e. current valuations

- Get these right and the rest is easy!!

13

Real global growth

World GDP growth(PPP and MER)

0

1

2

3

4

5

6

7

8

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

per c

ent p

er y

ear

2000 $US -- World Bank 2000 PPP -- World Bank Real PPP -- IMF Real MER -- IMF

Global growth is strong, though not a record levels

The presence of the emerging economies is finally being reflected in the data

14

The global growth engine – Anglo economies

Real GDP growth per year

-4

-2

0

2

4

6

8

10

Mar-80

Mar-82

Mar-84

Mar-86

Mar-88

Mar-90

Mar-92

Mar-94

Mar-96

Mar-98

Mar-00

Mar-02

Mar-04

Mar-06

Mar-08

% p

er y

ear

.

United States United Kingdom Canada Australia

??However, the engine of global growth remains the Anglo-economies

Of these, the US is the “locomotive

It would seem that the engine economies have passed through the trough in a typical business cycle and an expansionary phase has been entered

15

Conclusions on growth

- Global growth is strong, with emerging economies – China and India – contributing

- The Anglo business cycle is entering an expansionary phase- In the US

• Consumption is holding

• Business investment, ex housing, is recovering

• Housing remain weak (as it does in Australia)

• The labour market remains firm

• Leading indicators point to future expansion

- Europe and Japan also are adding to global growth, for a change- In Australia consumption, investment and the labour market all

appear to be robust

16

What about inflation?

Inflation

-1

0

1

1

2

2

3

3

4

4

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

per c

ent p

er q

uart

er

Headline inflation (Q)

GST spike

The recent up-tick in the June quarter inflation number was enough to cause the RBA to raise cash rates again, to 6.5%

17

But annual headline inflation is still falling

Inflation

-1

0

1

2

3

4

5

6

7

8

9

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

per c

ent p

er y

ear

Headline inflation (A)

But the previous June quarter had an even bigger up-tick so, annualised, inflation is falling!

18

Less volatile measures also within ranges

Inflation

-1

0

1

2

3

4

5

6

7

8

9

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

per c

ent p

er y

ear

Headline inflation (A) Excluding volatile items

Excluding “volatile”components sees underlying inflation more stable and within the RBA’s target zone

One could make the case that the less volatile measure is edging up

19

All volatility in inflation due the other factors

Inflation

-1

0

1

2

3

4

5

6

7

8

9

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

per c

ent p

er y

ear

Tradeable goods Non-tradeable goods

Non-traded goods inflation, while above range, is steadily falling

All the recent volatility in headline inflation is due the traded goods inflation –affected by foreign goods prices and the exchange rate – not the RBA

20

What about valuations?

US Forward PE

5

10

15

20

25

30

Jan-79 Jan-84 Jan-89 Jan-94 Jan-99 Jan-04 Jan-09

RAW FWD PE Trend FWD PE

US PEs are back at long run averages following the equity bubble impacts from 1995 to 2003

Trend PEs above raw PEs indicate a downgrading of future earnings forecasts

21

What about valuations?

US BY/EY

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-79 Jan-84 Jan-89 Jan-94 Jan-99 Jan-04 Jan-09

BY/EY LR average 2 sd

Equities do not look expensive relative to bonds

22

What about valuations?

Australia Forward PE

5

10

15

20

Dec-86 Dec-89 Dec-92 Dec-95 Dec-98 Dec-01 Dec-04 Dec-07

RAW FWD PE Trend FWD PE

A similar story for Australia, although valuations based on past earnings growth look more stretched here

23

What about valuations?

Australia BY/EY

0.5

1.0

1.5

2.0

Dec-86 Dec-89 Dec-92 Dec-95 Dec-98 Dec-01 Dec-04 Dec-07

BY/EY LR average 2 sd

Equities look more expensive relative to bonds in Australia

24

What can we conclude?

- Global growth, US growth and local growth all look like holding up, even improving as the Anglo-economies enter into a normal expansionary phase of the business cycle

- Inflation in Australia, and elsewhere looks like it is under control, notwithstanding the pre-emptive moves by the RBA

- Valuations do not look stretched, although equities in Australia may be more fully valued than elsewhere

- All things considered, it remains a good environment for growth assets

25

What about the risks

- US housing and sub-prime markets

- Are current earnings sustainable?

- Collapse of commodity boom

- Australian housing market and housing affordability

- Other risks

26

US house price growth collapse

Price growth for existing houses

-4

-2

0

2

4

6

8

10

12

14

16

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

per c

ent p

er y

ear

.

United States

The collapse in the growth of house prices has been the trigger for all kinds of concerns, including chatter about the US economy falling into recession

27

But …. put in a broader context

Price growth for existing houses

-20

-10

0

10

20

30

40

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

per c

ent p

er y

ear

.

United States United Kingdom Australia

The recent US experience is not unusual in a broader context

Australia and the UK went through much bigger house price booms than did the US without the necessity of it “all ending in tears”

We need to find other causes to draw the bow of US recession

28

Delinquencies not beyond expectation

US Mortgage delinquencies

0

2

4

6

8

10

12

14

16

18

Q1 98

Q3 98

Q1 99

Q3 99

Q1 00

Q3 00

Q1 01

Q3 01

Q1 02

Q3 02

Q1 03

Q3 03

Q1 04

Q3 04

Q1 05

Q3 05

Q1 06

Q3 06

Q1 07

Q3 07

Q1 08

per c

ent

Sub-prime Prime

The collapse of US house price growth has certainly focussed attention back on the riskier end of the market

But the sub-prime market is about 15% of the US mortgage market which is about 40% of US bond markets

Roughly 15% of sub-prime mortgages are expected to fail

29

Credit spreads

The concern is that the sub-prime market problems will cause a broader liquidity crunch ringing about a collapse in spending, putting us on the vicious downward spiral into recession

History of US Investment Grade Spreads(on the run index)

20

30

40

50

60

70

80

90

100

110

Oct

-03

Dec

-03

Feb-

04

Apr-

04

Jun-

04

Aug-

04

Oct

-04

Dec

-04

Feb-

05

Apr-

05

Jun-

05

Aug-

05

Oct

-05

Dec

-05

Feb-

06

Apr-

06

Jun-

06

Aug-

06

Oct

-06

Dec

-06

Feb-

07

Apr-

07

Jun-

07

bp s

prea

d to

sw

ap

30

Credit spreads

The concern is that the sub-prime market problems will cause a broader liquidity crunch ringing about a collapse in spending, putting us on the vicious downward spiral into recession

But all we see at the moment is the repricing of risk back to something approaching normal levels

US High Yield Credit Spreads to Treasuries

0

2

4

6

8

10

12

Nov

-85

Nov

-87

Nov

-89

Nov

-91

Nov

-93

Nov

-95

Nov

-97

Nov

-99

Nov

-01

Nov

-03

Nov

-05

(%)

ML High Yield Master less Treasury Master

US Investment Grade Credit Spreads to Treasuries

0

0.5

1

1.5

2

2.5

3

Nov

-85

Nov

-87

Nov

-89

Nov

-91

Nov

-93

Nov

-95

Nov

-97

Nov

-99

Nov

-01

Nov

-03

Nov

-05

(%)

ML Corporate Master less Treasury Master

31

Impacts of re-pricing risk

- Moderately tighter credit conditions – effectively a monetary policy tightening

- A pull-back from financial innovation and financial engineering of financial products, and wash-out of high risk borrowing

- A halt in M&A activity based on leveraging corporate balance sheets – a pullback in private equity activity

- A return to yield and “quality” earnings in stock markets, reversing the drift to value stocks on the hope of public to private buyouts

- Potentially real spending effects as households and corporatesface higher borrowing and debt servicing costs:

• Although the impact of this should be minimal based on the underlying strength of household and corporate balance sheets, coupled with the underlying strength in the labour market

32

Are past earnings growth rates sustainable?

Growth rates of earnings per share

0

20

40

60

80

100

120

Jan-

79

Jan-

81

Jan-

83

Jan-

85

Jan-

87

Jan-

89

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Jan-

09

cent

s pe

r sha

re

Forward EPS 6.25% per year growth rate

This gets to the question about current equity valuations, which on the surface look good.

But are they based on unsustainable forecasts of earnings going forward?

On some historical measures, yes.

33

Are past earnings growth rates sustainable?

Growth rates of earnings per share

0

20

40

60

80

100

120

Jan-

79

Jan-

81

Jan-

83

Jan-

85

Jan-

87

Jan-

89

Jan-

91

Jan-

93

Jan-

95

Jan-

97

Jan-

99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Jan-

09

cent

s pe

r sha

re

Forward EPS 6.25% per year growth rate 8% per year growth rate

But, earnings growth potential also depends on the economic environment of the day

We live in a very good environment which, I think, is here to stay for w while

However, the experience of the past four years is unsustainable

34

What about the commodities boom?

Te rm s of tra de

60

70

80

90

100

110

120

130

Mar

-60

Mar

-63

Mar

-66

Mar

-69

Mar

-72

Mar

-75

Mar

-78

Mar

-81

Mar

-84

Mar

-87

Mar

-90

Mar

-93

Mar

-96

Mar

-99

Mar

-02

Mar

-05

Mar

-08

2004

/05

= 10

The commodities boom is really a price boom, fuelled by lagging global supply against growing global demand, as reflected in the very high TOT

35

Causing a problem for trade balance

Tra de ba la nce a s a sha re of GDP

-6

-4

-2

0

2

4

6

Mar

-60

Mar

-62

Mar

-64

Mar

-66

Mar

-68

Mar

-70

Mar

-72

Mar

-74

Mar

-76

Mar

-78

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

per c

ent

But it is a two-edged sword

The trade balance has collapsed because of the currently overvalued exchange rate

36

This used to be known as the “Dutch disease”

Tra de ba la nce a nd te rm s of tra de

60

70

80

90

100

110

120

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

2004

/05

= 10

0

-5.0

-3.0

-1.0

1.0

3.0

5.0

7.0

per c

ent

T e r m s o f trade (LHS) Tr ade balance as a s hare o f GDP (RHS inve r te d )

Every time the TOT improve, the trade balance worsens

This is counterintuitive when one thinks of a commodity boom leading to improved export performance

In fact, the very opposite happens

37

Creating a “two-speed” economy

Growth rates of State and Domestic Final Demand

0

2

4

6

8

10

12

WA QLD AUS VIC SA NSW

per c

ent p

er y

ear

The Dutch disease has created a two-speed economy

A further complication for monetary policy management

38

Is the AUD still a commodity currency?

Commodity prices and the exchange rate

50

70

90

110

130

150

170

190

210

230

Jan-83

Jan-85

Jan-87

Jan-89

Jan-91

Jan-93

Jan-95

Jan-97

Jan-99

Jan-01

Jan-03

Jan-05

Jan-07

2001

/02

= 10

0

0.3

0.5

0.7

0.9

1.1

1.3

USD

per

AU

D

USD commodity price index (LHS) USD/AUD exchange rate (RHS)

When the TOT collapse under the weight of increased global commodity supply, the exchange rate should depreciate, restoring competitiveness to the rest of the Australian economy at the expense of the resource sector

39

And house prices?

Price grow th -- e sta blishe d hom e s

-20

-10

0

10

20

30

40

50

60

Jun-

86

Jun-

87

Jun-

88

Jun-

89

Jun-

90

Jun-

91

Jun-

92

Jun-

93

Jun-

94

Jun-

95

Jun-

96

Jun-

97

Jun-

98

Jun-

99

Jun-

00

Jun-

01

Jun-

02

Jun-

03

Jun-

04

Jun-

05

Jun-

06

Jun-

07

Jun-

08

per c

enr p

er y

ear

Sydne y M e lbourne Br is bane

We have been through an extended house price boom, although nowhere near as strong as in 1987-89

House price growth appears to be recovering and will be further stimulated if equity markets continue to weaken or show increased volatility

40

The average punter is a long-run arbitrager

House and share price indexes

0

100

200

300

400

500

600

Jun-

86

Jun-

87

Jun-

88

Jun-

89

Jun-

90

Jun-

91

Jun-

92

Jun-

93

Jun-

94

Jun-

95

Jun-

96

Jun-

97

Jun-

98

Jun-

99

Jun-

00

Jun-

01

Jun-

02

Jun-

03

Jun-

04

Jun-

05

Jun-

06

Jun-

07

Jun-

08

June

198

6 =

100

Sydney Melbourne Brisbane ASX200

Rotation out of shares into houses

Convergence

Convergence

Rotation out of shares into houses

Investors very sensibly rotate between asset classes as condition in markets varies

41

Housing affordability – been there before!

Housing affordability

80

100

120

140

160

180

200

Mar

-80

Mar

-81

Mar

-82

Mar

-83

Mar

-84

Mar

-85

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Inde

x

15

17

19

21

23

25

27

29

31

Rat

io

Housing affordability index (LHS) Repayment to income ratio (RHS)

Current conditions are the same as following the 1987-89 house price boom

Markets equilibrium conditions will change

42

Other risks

- There are many, too many to mention them all:

- Geopolitical risk

- Oil prices

- Capacity constraints

- China falling over

- Global inflation exported from emerging economies

- Unwinding of global “structural imbalance” – US budget deficit and current account deficit

- US dollar depreciation

- Global household indebtedness

- ……

43

Conclusions

- Global growth is expected to remain firm, or even pick up over the next few years

- Global inflation remain firmly under control, not because central banks are doing a good job but because of the globalisation of the workforce and product markets

- The interest rate cycle will enter an up phase on the back of strong real growth

- All in all, it remains a good environment for growth assets

- However, it is inconceivable that the equity performance of the last four years can be repeated one more year

- The re-pricing of risk will see quality come to the fore

- Nonetheless, there is still the “weight of money” driven by an ageing society looking for assets to own and hold

QIC ABN 95 942 373 762 is a statutory government owned corporation regulated by State Government legislation pertaining to government owned corporations. The Corporations Act 2001 does not apply to QIC and, therefore, QIC does not hold an Australian financial services licence and the financial product disclosure provisions in the Corporations Act 2001 do not apply to QIC. However, the Corporations Act 2001 does apply to QIC’s wholly-owned subsidiaries. Where required, QIC’s subsidiaries have obtained an Australian financial services licence. QIC and its subsidiaries and associated entities, and their directors, employees and representatives (“the QIC Parties”) do not warrant the accuracy or completeness of the information contained inthis document (“the Information”). To the extent permitted by law, the QIC Parties disclaim all responsibility and liability for any loss or damage of any nature whatsoever which may be suffered by any person directly or indirectly through relying on the Information, whether that loss or damage is caused by any fault or negligence of the QIC Parties or otherwise. The Information is not intended to constitute advice and persons should seek professional advice before relying on the Information.

Investment Markets – 2007/08Doug McTaggartAugust 2007