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Happy New Year? The Economy and Markets in 2015
20 March 2015
G. Scott Clemons, CFA Chief Investment Strategist 140 Broadway New York, NY 10005 [email protected]
@GSClemons
©2015 Brown Brothers Harriman & Co. Confidential & Proprietary. Not to be reproduced without the explicit consent of BBH & Co. "BBH" and "BBH & Co." are registered service marks of Brown Brothers Harriman & Co.
Brown Brothers Harriman Snapshot
2
BBH is a global financial institution with over 5,000 employees in 17 offices worldwide and expertise in Private
Banking, Investment Management, and Investor Services. Our Private Banking business serves both corporate
and private clients throughout the cycle of wealth creation, transition and preservation in five primary products:
Investment Advisory, Corporate Lending, Corporate Advisory, Private Equity, and Trust.
About Investment Advisory & Trust
Assets under management: $27.1 billion*
Clients we serve:
• Private business owners • Business executives • Inheritors of family wealth • Endowments • Foundations
Client minimum: $10 million
Average client size: $22 million*
Locations: New York, Boston, Charlotte, Chicago, Philadelphia, Wilmington
*As of December 31, 2014
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Roadmap of the Domestic Economy
3
Housing Market
Labor Market
Personal Consumption GDP
Wealth Effect
Income Effect
Deleveraging Savings
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The Housing Market Home Prices Rising at a 5% Annualized Pace…
4
- 20%
- 15%
- 10 %
- 5%
0%
5%
10%
15 %
20 %
$ -
$50
$100
$150
$200
$250
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: National Association of Realtors, BBH Analysis
Median Home Price (left hand scale)
Year-over-Year Change (right hand scale)
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The Housing Market … and Sales and Starts Continue to Improve as Well
5
0
1
2
3
4
5
6
7
8
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Millions of Units
Sources: U.S. Department of Commerce, National Association of Realtors
New Housing Starts (+127% from trough)
Existing Home Sales (+50% from trough)
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The Labor Market 3.2 million jobs added in the last year … bringing unemployment down to 5.5%
6
- 1%
1%
3%
5 %
7 %
9%
11%
- 1,000
- 800
- 600
- 400
- 200
0
200
400
600
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
000 s
Source: Bureau of Labor Statistics, BBH Analysis
Monthly Net Job Gains
Unemployment Rate
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The Labor Market … and Initial Claims Augur for Further Improvement
7
-
100
200
300
400
500
600
700
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
000 s
Source: Department of Labor, BBH Analysis
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The Conundrum of Wages
8
- 3%
- 2%
- 1%
0%
1%
2%
3%
4 %
5%
6%
2001 2003 2005 2007 2009 2011 2013 2015
Real Wage Growth Year Over Year
Nominal Wage Growth Year Over Year
2.1% 2.0%
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Average Weekly Hours Worked
9
32 . 70
32 . 90
33 . 10
33 . 30
33 . 50
33 . 70
33 . 90
34 . 10
34 . 30
34.50
2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bureau of Labor Statistics
Hours Worked per Week
Hours Worked per Week
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Household Debt American Households Have Deleveraged Since the Financial Crisis …
10
60 %
70 %
80 %
90%
100 %
110%
120 %
130 %
140 %
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Federal Reserve, BBH Analysis
Household Debt as a % of Disposable Income
129.7%
102.7%
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Households Savings … and Increased their Savings Rates
11
0 %
2 %
4 %
6 %
8 %
10 %
12 %
14 %
16 %
18 %
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Sources: Bureau of Economic Analysis, BBH Analysis
Trailing One Year Average
Savings as % of Disposable Income
Is a drop in the savings rate supporting personal consumption?
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Gross Domestic Product (GDP) Growth
12
- 10 %
- 8 %
- 6 %
- 4 %
- 2 %
0 %
2 %
4 %
6 %
8 %
10 %
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
S ource: Bureau of Economic Analysis, BBH Analysis
2.3% recovery average
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Gross Domestic Product Contributions to GDP Growth
13
- 2 %
- 1 %
0 %
1 %
2 %
3 %
4 %
2012 - I 2012 - II 2012 - III 2012 - IV 2013 - I 2013 - II 2013 - III 2013 - IV 2014 - I 2014 - II 2014 - III 2014 - IV
Personal Consumption
Business Spending
Net Exports
Government Spending
Source: Bureau of Economic Analysis, BBH Analysis
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Roadmap of the Domestic Economy
14
Housing Market
Labor Market
Personal Consumption GDP
Wealth Effect
Income Effect
Deleveraging Savings
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The Economy in 2015
15
• What are the implications of lower energy prices for economic activity?
• How might economic activity abroad effect the United States?
• What is the likely timing of an increase in interest rates, and what are the implications of that shift for the economy and markets?
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Sharp Decline in Oil Prices
16
West Texas Intermediate Crude Oil $/bbl
0
20
40
60
80
100
120
140
160
2007 2008 2009 2010 2011 2012 2013 2014 2015
OPEC cuts production by 15%, oil bottoms 3 days later.
OPEC maintains production target of 30 million boe per day.
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Regional Production Trends
17
-
2 , 000
4 , 000
6 , 000
8 , 000
10 , 000
12 , 000
14 , 000
1983 1988 1993 1998 2003 2008 2013
Crude Oil Production by Region (thousands of barrels per day)
Sources: U.S. Energy Information Administration, BBH Analysis
United States
Saudi Arabia
10 Year CAGR 3.5%
10 Year CAGR 1.0%
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Declining Energy Prices Boost Spending Power Economic Implications of $50 Oil
18
Economic Implication $ Impact* % of GDP*
Consumer savings from lower gasoline prices …
$65 billion 0.4%
Plus business savings from lower energy prices …
$300 billion + 1.7%
Minus cost to domestic energy producers $170 billion - 1.0%
Equals net economic benefit $195 billion = 1.1%
* annualized Rule of thumb: $10 change in the price of oil equates to an annualized economic impact of ~0.2% of GDP.
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Europe Failure to Achieve Economic Escape Velocity
19
- 12 %
- 10 %
- 8 %
- 6 %
- 4 %
- 2 %
0 %
2 %
4 %
6 %
2006 2007 2008 2009 2010 2011 2012 2013 2014
S ource: Eurostat, BBH Analysis
Eurozone Quarterly Real GDP Growth Annualized
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- 6 %
- 4 %
- 2 %
0 %
2 %
4 %
6 %
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
S ource: OECD, BBH Analysis
Europe Leading Economic Indicators Headed Down
20
Year Over Year Change in LEI Index Recessions
?
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Japan Missing the Third Arrow
21
- 20 %
- 15 %
- 10 %
- 5 %
0 %
5 %
10 %
15 %
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Japan Quarterly Real GDP Growth Annualized
1.5%
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Japan Leading Economic Indicators in Negative Territory
22
- 30 %
- 20 %
- 10 %
0 %
10 %
20 %
30 %
40 %
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Year Over Year Change in LEI Index
?
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China Cause for Concern?
23
0 %
2 %
4 %
6 %
8 %
10 %
12 %
14 %
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
7.3%
China Quarterly Real GDP Growth Annualized
Sources: National Bureau of Statistics China, BBH Analysis
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China Alternative Measures of Economic Activity
24
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China Alternative Measures of Economic Activity
25
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Monetary Policy The Beginning of the End of Easy Money …
26
• Although quantitative easing has ended, and the Fed has stopped its additional purchases of bonds, monetary policy remains very accommodative.
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Balance Sheet of the Federal Reserve
27
$ -
$ 500
$ 1 , 000
$ 1 , 500
$ 2 , 000
$ 2 , 500
$ 3 , 000
$ 3 , 500
$ 4 , 000
$ 4 , 500
$ 5 , 000
2007 2008 2009 2010 2011 2012 2013 2014
$ Billions
Source: Federal Reserve, BBH Analysis
QE 1 QE 2 QE 3
Assets on the Balance Sheet of the Federal Reserve
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Monetary Policy The Beginning of the End of Easy Money …
28
• Although quantitative easing has ended, and the Fed has stopped its additional purchases of bonds, monetary policy remains very accommodative.
• The decision to begin raising interest rates to more normal levels is a function of the strength of the economy and the threat of inflation.
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Inflation … Or the Lack Thereof
29
0 . 0 %
0 . 5 %
1 . 0 %
1 . 5 %
2 . 0 %
2 . 5 %
3.0%
3 . 5 %
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bureau of Labor Statistics, BBH Analysis
% Change Year - over - Year
Core PCE
CPI Inflation ex Food and Energy
1.6%
1.3%
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Inflation Expectations of Disinflation
30
- 0 . 5 %
0 . 0 %
0 . 5 %
1 . 0 %
1.5%
2 . 0 %
2.5%
3 . 0 %
3 . 5 %
2008 2009 2010 2011 2012 2013 2014 2015
Sources: Bloomberg, BBH Analysis
5 Year-5 Year Forward
10 Year Breakeven Spread
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Monetary Policy The Beginning of the End of Easy Money …
31
• Although quantitative easing has ended, and the Fed has stopped its additional purchases of bonds, monetary policy remains very accommodative.
• The decision to begin raising interest rates to more normal levels is a function of the strength of the economy and the threat of inflation.
• With inflation no real and present danger, the Fed can afford to be patient in raising interest rates.
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Monetary Policy Interest Rates Expected to Normalize at a Slow Pace
32
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Monetary Policy Longer Rates Down as Inflation Fears Wane
33
%
%
0 . 01 0 . 01 % 0 . 09 %
0 . 70 %
1 . 66 % 2 . 20
2 . 81 %
%
0 . 05 % 0 . 05 % 0 . 08 %
0 . 37 %
1 . 64
2 . 79 %
3 . 72 %
- 1 %
0 %
1 %
2 %
3 %
4 %
5 %
1 Month 3 Month 6 Month 2 Year 5 Year 10 Year 30 Year
Source: Bloomberg, BBH Analysis
7 March 2014
9 March 2015
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Equity Markets The S&P 500 Has Tripled From the Trough of the Crisis …
34
600
800
1 , 000
1 , 200
1 , 400
1 , 600
1 , 800
2 , 000
2 , 200
2008 2009 2010 2011 2012 2013 2014 2015
Source: Bloomberg, BBH Analysis
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Corporate Earnings Growth
35
- 60 %
- 40 %
- 20 %
0 %
20 %
40 %
60 %
80 %
100 %
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Standard and Poor's, BBH Analysis
% Change Year - over - Year
2015 consensus
4Q2014 Earnings
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Operating Profit Margins
36
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Market Valuations
37
25.4x
0
5
10
15
20
25
30
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Sources: Standard and Poor's, Robert Shiller, BBH Analysis
+ 2 standard deviations
+ 1 standard deviation
- 2 standard deviations
- 1 standard deviation
Average
20.4x
18.6x
15.4x
10.4x
5.4x
S&P 500 Trailing PE Ratio
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The Market Formula in 2014
38
Price = Earnings x P E
The S&P 500 Index rose 11.4% in 2014 (13.7% including dividends).
S&P 500 earnings were up 5% year over year …
… so higher valuations accounted for about half the market move.
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Market Conclusions
39
• It’s all about the earnings …
• The option value of cash remains appealing, as it provides the opportunity to take advantage of market corrections to redeploy cash into more
productive assets.
• … and the earnings are all about the revenues. With profit margins at such high levels, earnings growth from continued cost cutting or margin
expansion will be hard to come by.
• As interest rates rise, we will at some point put assets back to work in more traditional fixed income, but only when we believe that investors are being
adequately compensated for inflation and price risk.
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Economic Conclusions
40
• Sustained gains in the housing and labor markets bode well for continued improvement in the U.S. economy.
• In order to support this moderate expansion, and in the absence of inflationary pressures, the Federal Reserve is likely to take its time in
restoring more normal monetary policy.
• Focus on the health of Personal Consumption: as goes the consumer, so goes the economy.
• The fall in energy prices, if sustained, could have a meaningful effect on economic growth in 2015, increasing GDP growth by a full percentage point.
©2015 Brown Brothers Harriman & Co. Confidential & Proprietary. Not to be reproduced without the explicit consent of BBH & C5. “BBH” and “BBH & Co.” are registered service marks of Brown Brothers Harriman & Co.
Happy New Year? The Economy and Markets in 2015
20 March 2015
G. Scott Clemons, CFA Chief Investment Strategist 140 Broadway New York, NY 10005 [email protected]
@GSClemons