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David N.
Pearl
Executive
Vice President
and Co-CIO
William W.
Priest, CFA
Chief Executive
Officer
and Co-CIO
PRESENTED BY
The information contained in this presentation is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or
investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. The information contained in this presentation is accurate as of the date
submitted, but is subject to change. Any performance information referenced in this presentation represents past performance and is not indicative of future returns. Any projections, targets, or
estimates in this presentation are forward looking statements and are based on Epoch’s research, analysis, and assumptions made by Epoch. There can be no assurances that such projections,
targets, or estimates will occur and the actual results may be materially different. Other events which were not taken into account in formulating such projections, targets, or estimates may occur and
may significantly affect the returns or performance of any accounts and/or funds managed by Epoch. To the extent this presentation contains information about specific companies or securities
including whether they are profitable or not, they are being provided as a means of illustrating our investment thesis. Past references to specific companies or securities are not a complete list of
securities selected for clients and not all securities selected for clients in the past year were profitable.
Epoch’s
Quarterly
Capital Markets
Outlook
July 20, 2017 | The webinar replay will be available on our website: www.eipny.com
Kevin
Hebner, PhD
Global
Investment
Strategist
Bill
Booth
Portfolio
Manager
Financial Economy Linked to the Real Economy
Source: Crestmont Research; Epoch Investment Partners
Financial Economy Real Economy
Real GDP • Growth in work force
• Productivity
Nominal GDP • Highly correlated with
corporate earnings
P/E Ratio
EPS
Stock Market
Level
Interest Rates
Profit Margins
Inflation
Market Linkages
1
Tech is the New Macro: The Second Machine Age Has Arrived
2
First Machine Age
The Industrial Revolution, evidenced by the
invention of the steam engine which
overcame the limitations of both human and
animal muscle power.
Second Machine Age
Begins with the inflection point of digitization driven by the exponential growth rate of computing power per dollar.
* The Second Machine Age is a book by Erik Brynjolfsson and Andrew McAfee.
Exponential Growth and the Trouble with Tribbles
3
The number of tribbles exceeds 16,000
after just 15 days
Looks less scary on a log scale, but they still
need to be jettisoned
Source: Second Machine Age, Star Trek
Source: Second Machine Age, Star Trek
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Number of tribbles
1
10
100
1,000
10,000
100,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Number of tribbles
Moore's Law and the Chess Board Analogy
4
The number of grains of rice exceeds
4 billion after 33 squares
On a log scale: Still spectacular growth
Source: Second Machine Age
Source: Second Machine Age
0
500,000,000
1,000,000,000
1,500,000,000
2,000,000,000
2,500,000,000
3,000,000,000
3,500,000,000
4,000,000,000
4,500,000,000
5,000,000,000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33
Grains of rice
1
10
100
1,000
10,000
100,000
1,000,000
10,000,000
100,000,000
1,000,000,000
10,000,000,000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33
Grains of rice
Exponential Growth We entered the "Back Half" of the chess board circa 2010.
Global production of rice in 2017 will be about 3.1 x
1016 grains of rice. This is exceeded by the 56th
square. Of course, production in 13th century India
was a small fraction of this (and likely exceeded by
the 33rd square).
Why Now?
5
Moore's Law: Stated in 1965 by Gordon Moore, hit this inflection point (33 iterations) circa 2010.
Massive digitization of information.
Recombinant innovation: The ability to recombine data of all sorts.
Progress Does Not Run Out; It Accumulates
6
Digitization makes massive bodies of data relevant to almost any situation, and this information can be infinitely reproduced and reused (non-exclusivity, unlike a loaf of bread).
As a result of these two forces, the number of potentially valuable building blocks is exploding around the world and the possibilities are multiplying as never before.
These building blocks can never be eaten or used up; they increase the opportunities for future re-combinations.
Where Does The "New Macro" Manifest Itself in Corporate Finance?
7
Return on Equity Components
Technology will improve all three components
𝑃𝑟𝑜𝑓𝑖𝑡𝑠
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦 =
=
𝐑OE
𝐑𝐎𝐄
Profit Margin Asset Utilization Leverage = 𝐗 𝐗
𝐗 𝐗
𝑃𝑟𝑜𝑓𝑖𝑡𝑠
Equity
𝐑OE
Payout ratios to rise with less need for equity
to support decreasing asset base requirement
U.S. Wage and Price Inflation: Much Weaker Than in a Typical
Cyclical Recovery. This is Good News for Equity Multiples.
8
Source: Bloomberg, Epoch Investment Partners
Average of four series: Atlanta Fed, NY Fed Median, AHE, ECI
U.S. wage growth has been surprisingly
flat for the last 12 months
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
Wage indicator average (%)
Source: Bloomberg, HSBC, Epoch Investment Partners
Index tracks how inflation releases come in relative to consensus expectations.
Inflation surprises: Consistently to the
downside for over five years
-60
-50
-40
-30
-20
-10
0
10
US inflation surprise index Election
Tight U.S. Labor Market: Low Unemployment and Solid Jobs
Growth Should Ensure a Robust Consumption Outlook
9
Unemployment rate declined to previous cyclical
lows (true for most durations of unemployment)
Tight labor and low unemployment implies
slightly higher wage growth ahead
0.0
1.0
2.0
3.0
4.0
5.0
5-14 wks (%) 15-26 wks (%)
27+ wks (%) Previous cycle low (%)
4
5
6
7
8
9
101.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
Wage indicator average (%)
Unemployment rate (rhs, %, inverse)
Source: Bloomberg, Epoch Investment Partners
Average of four series: Atlanta Fed, NY Fed Median, AHE, ECI
Source: Bloomberg, Epoch Investment Partners
Labor Share of U.S. GDP has Declined Since 2000,
Providing a Nice Tailwind for Corporate Profits
10
Even with the cyclical recovery and tight labor market,
wages are not posing much of a challenge for profit share
Source: Bloomberg, Epoch Investment Partners
52
54
56
586
8
10
12
14
U.S. corporate profits (% GDP, lhs) Labor compensation (% GDP, inverted, rhs)
U.S. Housing Fundamentals are Constructive: Solid Income Growth,
Starts Well Below Trend and Low Mortgage Rates
11
U.S. home prices up a solid 5.7% yoy
Mortgage rates extremely low relative to history
Source: Bloomberg
Source: Bloomberg
-10
-5
0
5
10
15
20
Case-Shiller home prices, yoy (%)
2
3
4
5
6
7
8
Ave 15Y fixed mtg rate
Note: During the financial crisis the Case-Shiller Home Price Index fell briefly to 19.0 .
Household Debt Levels Remain a Concern, Especially
if Rates Rise Sharply
12
Household debt is still elevated, but down
dramatically from ten years ago
Student loan balances have soared with
delinquencies in the low double digits
Source: Bloomberg
Source: Bloomberg
50
60
70
80
90
100
110
120
HH debt (% GDP)
HH debt (% of DPI)6
7
8
9
10
11
12
0.2
0.4
0.6
0.8
1.0
1.2
1.4
Student loans ($tn, lhs)
Delinquencies, 90+ days (%, rhs)
Auto Loans are a Particular Concern, but Unlikely to be Systemic
13
Auto sales have clearly rolled over
Auto loan balances have accelerated with
delinquency rates beginning to rise
Source: Bloomberg
Source: Bloomberg
7.5
10.0
12.5
15.0
17.5
20.0
Total auto sales (mn units, saar)
Domestic auto sales
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
Consumer auto loans ($tn)
Delinquencies, 90+ days (%, rhs)
U.S. Small Business Outlook has Improved Markedly, with Only a
Marginal Pullback in Recent Months
14
Small business outlook: Big jump post-
election, and remains elevated
Small businesses plan to ramp up both
hiring and capital expenditures
Source: Bloomberg, NFIB diffusion indices
Source: Bloomberg, NFIB diffusion indices
85
90
95
100
105
110
-40
-20
0
20
40
60
Outlook (index) Optimism (index, rhs)
75
80
85
90
95
100
105
110
Hiring Plans (index) Capex plans (index)
The Production Side of the U.S. Economy Continues to Rebound:
Reflecting the Global Cyclical Recovery
15
U.S. Manufacturing ISM remains elevated,
with production beginning to catch up
Capex-related orders continue to improve
Source: Bloomberg, Epoch Investment Partners
Source: Bloomberg, Epoch Investment Partners
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
44
46
48
50
52
54
56
58
60
ISM Mfg index (lhs)
Mfg Production, yoy (rhs, %)
U.S. election-12
-8
-4
0
4
8
12
16
20
Capital goods orders, 3mma, yoy
Durable goods orders, yoy
U.S. election
Revisiting the Case For Europe: Economic Data Have Continued to Improve
and Credit Growth is Solid on Historically Low Interest Rates
16
European Commission confidence
measures have rebounded solidly,
following Germany's lead
Eurozone M3 and credit are growing at
roughly 5%, while the average interest rate
on business loans has declined to 2.3%
Source: Bloomberg
Source: Bloomberg, Epoch Investment Partners
Series indexed to 100 on 1/2005.
60
70
80
90
100
110
120
EC mfg confidence EC services confidence
German business climate
1
2
3
4
5
6
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
EZ M3 yoy (%)
EZ credit yoy (%)
EZ int rate, bus loans (%, rhs)
Company Fundamentals: Outlook Has Improved and Appears to
Have Further to Run
17
2017 is the first time in many years that
eurozone EPS has been revised up as the
year progressed
Eurozone margins are leagues below
those for the U.S., suggesting
catchup potential
Source: JP Morgan Research
Source: JP Morgan Research.
EPS indexed to 100 at start of each year.
83
85
87
89
91
93
95
97
99
101
103
MSCI Eurozone '13 EPS
14 EPS
15 EPS
16 EPS
17e EPS15%
16%
17%
18%
19%
20%
21%
S&P500 EBITDA margin (ex fin) MSCI Eurozone
Eurozone's Equity Performance Relative to the U.S. Appears
to have Bottomed
18
Eurozone vs. U.S. equities:
Underperformance has largely reflected
relative weak EPS
This cycle has been a difficult one
for European equities, but it hasn't
always been thus
Source: Bloomberg, Epoch Investment Partners
Source: Bloomberg, Epoch Investment Partners
50
70
90
110
Relative performance Relative fwd EPS
70
80
90
100
110
120
130
140
150
Relative performance, Europe vs. US
"In Line" with U.S.
74%
outperformance
41% under-
performance
Eurozone Valuations: Not Obviously Cheap
19
Europe's PE relative to the World : Bang on 15Y median
Source: JP Morgan Research
0.70
0.75
0.80
0.85
0.90
0.95
1.00
EZ sector neutral fwd PE vs MSCI World Median +1 Stdev -1 Stdev
European Financials: Stock Performance Remains a Yield Call
20
If Bund yields continue to climb, then
banks are likely to keep outperforming
The recovery in eurozone credit
growth is a positive for bank RoE
Source: Bloomberg, Epoch Investment Partners
Source: Bloomberg, Epoch Investment Partners
-2
0
2
4
6
8
10
12
14
16
18
20
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
EZ credit yoy (lhs, %)
EZ Bank fwd ROE (rhs, %, last 12m)
EZ Bank RoE (rhs, %)
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
75
80
85
90
95
100
105
Eurozone Banks relative (index)
German 10Y Bund yield (rhs, %)
Eurozone Economic and Market Outlook: Conclusions
21
Economic data: Have continued to improve. Company fundamentals: Appear to have bottomed and the outlook is improving. Relative performance: Has been better recently, but still poor in a longer-term context. Valuations: In the aggregate, and when adjusted for sector differences, are closer to "fair" than
"cheap." Election outcomes: Have generally been positive and supportive for the European project. Italy
remains the key wildcard and risk (see below). Investing perspective: Focus on bottom-up opportunities within Europe. Recent developments may
argue for a preference for domestic Europe over domestic U.K.
Elections: So Far, So Good France (+): Le Pen was defeated and Emmanuel Macron won a majority in the National Assembly. UK (?): Early election backfired on PM May. Increased chance of a "soft" Brexit. Germany (+): Polls show Angela Merkel's support improving. Martin Schulz not a bad alternative (at least for the EU project). Both can work well with France's Macron to lead Europe forward. Italy (?): Wildcard and biggest known risk. Election timing in limbo (possibly 1Q18).
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Summary
1. Equity multiples unlikely to increase further: Multiples expanded on QE, but the period of looser
monetary policy is now well behind us. Consequently, equity return drivers are likely to shift from broad
multiple expansion to earnings growth.
2. Tech is the new macro: Technology is positive for all three return on equity (ROE) components — profit
margins, asset utilization, and leverage. Among other things, this implies corporate margins can remain
high for a prolonged period and don't necessarily need to revert.
3. Muted wage and price inflation: Much weaker than in a typical cycle, likely due to technology. Still, given
the global cyclical recovery, we expect moderate reflation and slightly higher bond yields.
4. Robust U.S. outlook: Regardless of policy (which doesn't appear to be moving the needle, one way or
another), domestic demand is solid and the production side of the economy is picking up. This provides
a robust backdrop for earnings growth over coming quarters. Risks include excessive household debt
and declining auto sales.
5. European growth continues to improve, but political risks loom: Corporate fundamentals appear solid,
earnings growth is picking up and valuations are "fair." Further, election outcomes have generally been
supportive, but Italy remains a wildcard. Overall, we are focused on bottom-up opportunities within
Europe.
6. Investment approach: As a result of the above points, we believe it is ever more important to favor
companies with a demonstrated ability to produce free cash flow and allocate that cash flow wisely
between return of capital options and reinvestment/acquisition opportunities.
22
23
A replay of our quarterly webinar is available on our website
www.eipny.com
Conclusion
RECENT PUBLICATIONS, WHITE PAPERS AND INSIGHTS
"The Impact of Passive
Investing on Market
Efficiency"
Winning at Active
Management
"Trump and Trade:
What are the Risks?"
"Tech is the New
Macro: Impacting All
Three Components of
Return on Equity"
