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SVB Asset Management | Quarterly Economic Report Q3 2015
Thoughts from the Desk 03
Overview 04
Domestic Economy 06
U.S. Federal Reserve & Monetary Policy 12
Markets & Performance 20
Global Economy 26
Portfolio Management Strategy 31
3
Volatility spread across all markets during the third quarter as global challenges such as the “Grexit” and China’s currency devaluation reverberated all the way to the U.S. in the form of paralyzed monetary policy. Heading into the quarter the Federal Reserve was poised to move away from its zero interest rate policy as the revision of first quarter GDP turned from negative to slightly positive with advance estimates of second quarter GDP to report in at 2.3 percent (third revision came in at 3.9 percent). While growth continued to improve and slack in the labor market contracts, wages did not follow suit. Wage growth was nonexistent as the Employment Cost Index (a closely watched inflation index by policy makers) increased just 0.2 percent in the second quarter, the smallest gain since the series started in 1982. Another core inflation measure, core PCE, is well below the Fed’s target of 2.0 percent, although the Fed expects inflation to head towards its target in the medium term.
An environment of slow growth, low inflation and the anticipation of interest rate lift-off added to volatility for short-term rates. For example, yields of the benchmark 2-year Treasury note traded at a range of approximately 30 basis points from peak to trough during the quarter with much of the oscillation occurring in the last 30 days. This presented entry point challenges for coupon income-seeking investors, while total return investors benefited from the volatility in the form of price gains. The investment grade (IG) sector performed well as spread volatility was contained despite record new issuances. According to Dealogic, IG issuances totaled over $800B YTD, a 22 percent increase YoY, with total corporate bond issuances surpassing $1T for the same period.
Shifting back to the U.S. economy, investors will look for further improvements in the labor market, transitory factors that are slowing inflation growth to dissipate, and strength in consumer behavior — especially as we head into the holiday season. We anticipate the consumer to continue to benefit from the improvement in employment, rise in home prices and lower gasoline prices, which in turn should fuel further spending in the fourth quarter. Business investments should also continue to improve as the latest data showed gains in construction, research and development and inventory rebuilding.
It’s certain that the Fed wants to head towards a more normalized monetary policy; however, markets will continue to debate the appropriate timing of the first move. With diminishing slack in the labor market, output growing near 4.0 percent, and reasonable confidence that inflation will march closer to the 2.0 percent target, we argue markets are ready for the Fed to remove this rate lift-off uncertainty.
Ninh Chung, Head of Investment Strategy and Portfolio Management
Thoughts from the Desk
SVB Asset Management | Quarterly Economic Report Q3 2015
4
Domestic Economy U.S. Federal Reserve & Monetary Policy
SVB Asset Management | Quarterly Economic Report Q3 2015
The third quarter brought more interest rate volatility as markets tried to gauge the Federal Reserve’s next move in the midst of a softening global economy. (p. 13) At the September FOMC meeting, the Fed delayed rate liftoff, citing “recent global economic and financial developments.” Projections released after the meeting indicated a lower path of interest rates. (p. 14-15) Key metrics show continued strength in the labor market and the general economy; however, inflation trended somewhat lower due to depressed commodity prices. (p. 16-17) Looking ahead, markets are split on whether the Fed will raise interest rates this year, or wait until the U.S. economy gains even more strength. (p. 19)
Q2 GDP expanded by 3.9 percent driven by gains in consumer and business sentiment. (p. 7) Personal consumption has strong tailwinds from improved labor market, rising home prices and lower fuel costs. (p. 7-8) The unemployment rate, which is one of the Fed’s dual mandates, appears to be on target. However, the participation rate is at an all-time low of 62.6 percent. (p. 9) The housing market has stabilized and continues to benefit from historically low mortgage rates. Household formation has improved since the financial crisis. (p. 10) Inflation continues to run below the Fed’s target and is providing the Fed with time before increasing interest rates. (p. 11)
Overview
5
Overview
Markets & Performance Global Economy
SVB Asset Management | Quarterly Economic Report Q3 2015
Inflation remains low across developed economies, supporting expansionary monetary conditions and pushing back monetary policy normalization, including interest rate hikes, in stronger economies. (p. 27) While marginally growing, economic expansion is still intact across much of the world. (p. 29)
Weaker currencies, along with idiosyncratic events, have kept inflation higher in developing economies, though price levels are expected to move lower. (p. 30) Anticipation of an interest rate hike by the Federal Reserve may have contributed to a recent decision by China to restructure the yuan’s trading range, leading to a devaluation. (p. 30)
Doubts about China reaching its 7 percent growth target in 2015 can lead to additional rate cuts in China. (p. 30)
Fixed Income securities continue to show positive total returns despite the negative price performance throughout the quarter. These products have been stable performers relative to other asset classes. (p. 21-23) Income is the primary source of fixed income returns and continues to insulate investors from market volatility. (p. 22)
Credit conditions for U.S. corporations remain healthy. (p. 24) Macroeconomic trends, such as falling energy prices, have had widely diverging impacts on corporate issuers, depending on the sector. (p. 25)
GDP
GDP and Components
7
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
SVB Asset Management | Quarterly Economic Report Q3 2015
-3.0%
-1.0%
1.0%
3.0%
5.0%
Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP
-10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%
U.S. GDP Q-o-Q Trailing 4-Quarter Average
GDP Solid Comeback
GDP grew 3.9 percent in Q2, driven by gains in consumer spending, nonresidential fixed investment and government spending.
Business investment was strong with gains in construction, research and development and inventories.
Spending on intellectual property increased by 8.6 percent, the largest advance since 2007. Consumers are poised to benefit from improvements in employment, rising home prices and cheaper fuel costs. Inventories have accumulated and could cause headwinds in Q4 2015.
0.0%
50.0%
100.0%
150.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
Personal Consumption (LHS) Personal Savings (LHS) Household Debt to Disposable Income Ratio (RHS)
Consumption Overview
Retail & Food Service Sales
8
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
SVB Asset Management | Quarterly Economic Report Q3 2015
Consumption Strong Tailwinds
Personal consumption has strong tailwinds from improved labor market, rising home prices and lower fuel costs. Retail sales have been improving and should contribute positively to consumer spending. Consumer sentiment and the financial markets grew unsettled in Q3 in the wake of economic turmoil in China. As markets stabilize, consumer sentiment is expected to improve as the holiday season approaches.
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
$500.0
Vehi
cle
Sal
es (M
illio
ns)
Ret
ail &
Foo
d S
ervi
ces
Sal
es
(Bill
ions
)
Ex Autos Vehicle Sales
Consumer Sentiment – University of Michigan
40.0 50.0 60.0 70.0 80.0 90.0
100.0 110.0 120.0
Average
1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0%
Job Hire Rate Job Quit Rate
Employment Landscape
Hires and Quits
9
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
SVB Asset Management | Quarterly Economic Report Q3 2015
Employment Steady Improvement
The U.S. has added an average 200,000 jobs per month year to date. The unemployment rate is at a healthy level of 5.1 percent. While the unemployment rate is on target, the participation rate is at an all-
time low 62.6 percent. The hire and quit rates are steady.
Labor Force Participation Rate
-15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)
62.0%
63.0%
64.0%
65.0%
66.0%
67.0%
68.0%
Labour Force Participation Rate (LHS)
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
3.0 4.0 5.0 6.0 7.0 8.0 9.0
Hom
e S
uppl
y (m
onth
s)
Hom
e S
ales
(Mill
ions
)
Total Sales (new & existing) Existing Home Supply
Home Sales & Supply
Housing Affordability
10
Source: Bloomberg and SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q3 2015
U.S. Housing Stable Home Prices - Indexed to 100
Household Formation
90
140
190
240
290
Case Schiller 20 City FHFA Purchase Median Home Price
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
0.0
50.0
100.0
150.0
200.0
250.0
Affo
rdab
ility
Inde
x
Housing Affordability 30 Year Fixed Mortgage Rates
-3000
-2000
-1000
0
1000
2000
3000
4000
Thou
sand
s
30-Year Fixed Mortgage Rates
Core PCE - % Change from Prior Year
Univ. of Michigan Survey of Inflation Expectations
11
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
SVB Asset Management | Quarterly Economic Report Q3 2015
Inflation Below Target
Core PCE continues to hold at 1.3 percent. The low Core PCE gives the Fed room to keep interest rates low. Wage inflation is expected to pick up leading to 2016, which can add to inflation pressures. Gas and oil prices have dropped since the start of the year and the downward pressure is expected to continue during the global slowdown.
Crude Oil and Gasoline Prices
1.5%
2.5%
3.5%
4.5%
5.5%
1 Year Ahead 5-10 Year Ahead
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
% C
hang
e fro
m P
rior Y
ear
Core PCE Fed Target Monetary Policy Threshold
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$0.0
$50.0
$100.0
$150.0
Pric
e pe
r bar
rel
Crude Oil (LHS) Daily National Average of Gasoline Prices (RHS)
5-10 Years Ahead
13
Historical Interest Rates Rising, Yet Volatile
SVB Asset Management | Quarterly Economic Report Q3 2015
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
2 Year Treasury Yield 1 Year Treasury Yield
Q4 2014 Q1 2015 Q2 2015 Q3 2015
The IMF cuts world growth estimates as there is a greater likelihood of a Eurozone area slowdown.
The ECB announces a bond purchase program, and central banks across the globe announce further easing measures.
U.S. economic data reveals some softness as Q1 GDP contracts 0.2 percent.
Anxieties over Greece dissipate early in the quarter, but then concerns over China’s growth and currency devaluation take the spotlight.
The Fed QE program ends with a consensus for a mid-2015 rate hike. The Fed will “be patient” with policy normalization.
U.S. job growth continues to be robust, although a strengthening dollar weighs on growth expectations.
Headlines center on a potential “Grexit” with a standoff between Greece and its creditors.
The U.S. economic landscape continues to improve: Unemployment drops to 5.1 percent, Q2 GDP expands 3.9 percent and inflation holds at 1.3 percent.
Oil prices plummet to a five-year low. Market consensus is for a Fed Funds rate liftoff in September of this year.
Fed hints at rate hike this year, but a gradual path to normalization.
The Fed delayed rate liftoff, citing “recent global economic and financial developments.”
Source: Bloomberg and SVB Asset Management. Data as of 9/18/2015.
2-Year Treasury Yield 1-Year Treasury Yield
14
Central Bank Economic Projections Focus on the Global Economy
SVB Asset Management | Quarterly Economic Report Q3 2015
2015 2016 2017 2018 Longer Run
Economic Projections: United States
Change in Real GDP 2.1% 2.3% 2.2% 2.0% 2.0%
Unemployment Rate 5.0% 4.8% 4.8% 4.8% 4.9%
Core PCE Inflation 1.4% 1.7% 1.9% 2.0%
Interest Rate Projections: United States
Federal Funds Target Rate 0.375% 1.375% 2.625% 3.375% 3.5%
Economic Projections: Eurozone
Change in Real GDP 1.4% 1.7% 1.8%
CPI Inflation 0.1% 1.1% 1.7%
Unemployment Rate 11.1% 10.6% 10.0%
Economic Projections: China
Change in Real GDP 7.0%
CPI Inflation 3.0%
Unemployment Rate 4.5%
Economic Projects: Japan
Change in Real GDP 1.7% 1.5% 0.2%
CPI Inflation 0.7% 1.9% 1.8%
Source: Federal Reserve, European Central Bank, National People’s Congress of the People’s Republic of China, Bank of Japan. Federal Reserve projections are median figures. Data as of 9/18/2015. Forecasts are not available for all periods.
15 SVB Asset Management | Quarterly Economic Report Q3 2015
Federal Reserve Rate Projections Gradual Path Ahead
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Hun
dred
s
September 2015 Median 0.375% 1.375% 2.625% 3.375% 3.50%
June 2015 Median 0.625% 1.625% 2.875% 3.75%
March 2015 Median 0.625% 1.875% 3.125% 3.75%
Source: Federal Reserve data as of September 17, 2015. Percentages below the chart reference the median forecasted rate at the end of each period
16
Yellen’s Dashboard Slow Improvement
SVB Asset Management | Quarterly Economic Report Q3 2015
Source: Bloomberg and SVB Asset Management. Data as of 9/9/2015.
Pre-recession Level (2004-2007 Average)
Worst Level Since 2008 Current Level
Layoffs/Discharges Rate 1.4% 2.0% 1.1%
Job Openings Rate 3.0% 1.6% 3.9%
Nonfarm Payrolls (3-month average) 161.8K -826.0K 221K
Unemployment Rate 5.0% 10.0% 5.1%
Hires Rate 3.8% 2.8% 3.5%
Quits Rate 2.1% 1.3% 1.9%
U-6 Underemployment Rate 8.8% 17.2% 10.3%
Long-term Unemployed Share 19.1% 45.3% 27.7%
Labor Force Participation Rate 66.1% 62.7% 62.6%
Target Threshold Current Level
Inflation (Core PCE) 2.0% 2.5% 1.2%
The Federal Reserve has a dual mandate to promote “maximum employment” and to keep prices stable. Below are the factors the Fed is considering to determine the best time to embark on normalization of monetary policy.
The Dollar & Oil
The Labor Market
17
Source: Bloomberg and SVB Asset Management. Data as of 9/18/2015.
SVB Asset Management | Quarterly Economic Report Q3 2015
Tracking Key Indicators Some Stabilization Inflation
Wage Growth
0.0 20.0 40.0 60.0 80.0 100.0 120.0
70.0 75.0 80.0 85.0 90.0 95.0
100.0 105.0
DXY Index (LHS) Brent Crude Index (RHS)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Core PCE YoY Fed Target
60.0% 61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Nonfarm Payrolls (LHS) Labor Force Participation Rate (RHS)
0.0%
1.0%
2.0%
3.0%
4.0%
Average Hourly Earnings YoY % Chg Average Hourly Earnings YoY % Change
18 SVB Asset Management | Quarterly Economic Report Q3 2015
Federal Funds Target Rate
Previous Tightening Cycles Not Far Off
Today the unemployment rate stands at 5.1 percent, inflation is 1.3 percent and Real GDP YOY was 3.9 percent in the second quarter. The Federal Reserve has implemented three interest rate tightening policies since 1990. Below is a historical perspective showing key metrics during each of those cycles.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
1994 tightening - Unemployment Rate: 6.5% - Inflation: 2.46% - Real GDP YoY: 5.4%
1999 tightening - Unemployment Rate: 4.3% - Inflation: 1.23% - Real GDP YoY: 3.3%
2004 tightening - Unemployment Rate: 5.6% - Inflation: 1.87% - Real GDP YoY: 3.0%
Source: Implied probabilities of Fed Funds Futures, compiled by Bloomberg.
Earlier in the year, markets were highly optimistic about a rate hike in 2015 given strengthening economic data. Following the June FOMC meeting, investors interpreted the Fed's "dot plot" as there would be two rate hikes before the end of the year with a gradual path to normalization. The second and third quarters were dominated with headlines over a potential "Grexit" and concerns over global growth with softness reported in China's economy. As a result, the probability of lift-off was pushed back from September to December and even 2016.
19
Probability of Move Shifting Back
SVB Asset Management | Quarterly Economic Report Q3 2015
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Sept FOMC Oct FOMC Dec FOMC Jan FOMC
Historical Probabilities of an Interest Rate Hike at each FOMC Meeting
21
Fixed Income Returns Overview
SVB Asset Management | Quarterly Economic Report Q3 2015
Spread is based on Option Adjusted Spread. Duration is based on Modified Duration. Data as of September 29, 2015. Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management.
Basic Statistics Spread Change Total Return % Excess Return %
Spread Yield Duration QTD YTD QTD YTD QTD YTD
1-3yr Treasuries 0.00 0.61 1.79 -- -- 0.31 0.98 -- --
1-3yr Agencies 6.00 0.70 1.73 -3.00 2.00 0.37 1.08 0.07 0.07
0-3yr MBS 61.00 1.57 1.99 17.00 42.00 0.30 0.68 -0.19 -0.42
1-3yr ABS 70.00 1.17 1.28 4.00 17.00 0.40 1.11 0.17 0.40
1-3yr IG Corporates 114.00 1.81 1.92 23.00 26.00 0.16 1.12 -0.22 0.01
3-5yr IG Corporates 138.00 2.56 3.60 25.00 27.00 0.54 1.99 -0.59 -0.23
5-10yr IG Corporates 192.00 3.69 6.23 37.00 37.00 0.38 1.24 -2.02 -1.90
1-5yr High Yield 783.00 8.99 2.76 188.00 205.00 -4.94 -2.69 -5.61 -4.20
1-3yr Corporates By Rating
AAA 37.00 1.04 2.00 0.00 15.00 0.52 1.14 0.12 -0.04
AA 61.00 1.27 1.92 6.00 19.00 0.44 1.20 0.06 0.09
A 91.00 1.58 1.93 12.00 27.00 0.34 1.22 -0.04 0.10
BBB 172.00 2.41 1.90 44.00 28.00 -0.24 0.93 -0.60 -0.16
1-3yr Corporates By Sector
Financial 109.00 1.75 1.91 14.00 21.00 0.31 1.29 -0.05 0.21
Industrials 118.00 1.84 1.93 31.00 30.00 0.04 1.02 -0.34 -0.10
Utility/Energy 117.00 1.84 1.95 15.00 35.00 0.05 0.67 -0.32 -0.48
Source: Bloomberg, BoAML and SVB Asset Management. Data as of September 29, 2015. YTD Return based on BoAML sector index performance, as of September 29, 2015. Prices and returns on individual securities and holdings will vary and are not a guarantee of future results.
22 SVB Asset Management | Quarterly Economic Report Q3 2015
-0.88
-0.86
-1.36
-0.27
-0.92
-0.57
0.01
-0.57
-2.18
-2.30
-1.77
-0.71
-1.84
-0.77
-1.05
-0.65
-0.38
-1.13
-0.97
-0.75
1.26
1.54
2.31
1.25
1.92
1.64
1.11
1.70
3.31
3.46
2.93
1.91
3.05
2.00
2.28
1.89
1.63
2.39
2.28
2.40
0.39
0.68
0.95
0.98
1.00
1.07
1.11
1.13
1.13
1.16
1.16
1.20
1.21
1.23
1.23
1.24
1.25
1.26
1.31
1.65
Automotive
MBS
Insurance
US Treasury
Basic Industry
US Agency
ABS
Technology
CMBS
Services
Media
Healthcare
Utility
Consumer Goods
Capital Goods
Telecommunications
Energy
Real Estate
Banking
Financial Services
YTD Sector Returns %
Total Return % YTD Income Return % YTD Price Return % YTD
U.S. Agency
U.S. Treasury
Fixed income spreads continue to widen under pressure of heavy new issue volumes, uncertain central bank policy and sharp increases in corporate leverage. As a result, negative price returns persist as risk premiums increase. However, income returns cushion the effect of price decreases in bonds and are the primary contributors of positive total returns.
Sector Returns Cushioning Market Volatility
23
All returns above are on total return basis. YTD 2015 returns are on an annualized basis up to September 29, 2015 for FI Credit and Treasury and September 22, 2015 for the other asset classes. FI Credit refers to Barclays 1-3 year US Investment Grade Fixed Income portfolio; Treasury refers to Barclays 1-3 year US Treasury portfolio; Gold refers to S&P GSCI Gold Spot; WTI refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index. Source: Thomson Reuters, Barclays Live and SVB Asset Management.
Ass
et C
lass
Ret
urns
SVB Asset Management | Quarterly Economic Report Q3 2015
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD 2015
WTI 40.82%
REIT 34.18%
WTI 57.68%
US Treasury 6.67%
WTI 78.00%
Gold 29.67%
Gold 10.23%
REIT 16.47%
Wilshire 33.06%
REIT 28.24%
FI Credit 0.82%
Gold 18.36%
Gold 22.95%
Gold 31.35%
Gold 5.53%
Wilshire 28.29%
REIT 26.97%
WTI 8.15%
Wilshire 16.05%
S&P 500 32.39%
S&P 500 13.69%
US Treasury 0.68%
Wilshire 6.38%
S&P 500 15.79%
US Treasury 7.31%
FI Credit 0.30%
S&P 500 26.46%
Wilshire 17.18%
REIT 7.48%
S&P 500 16.00%
WTI 7.32%
Wilshire 12.70%
Wilshire -4.00%
S&P 500 4.91%
Wilshire 15.78%
FI Credit 5.96%
S&P 500 -37.00%
REIT 26.27%
WTI 15.10%
S&P 500 2.11%
Gold 6.96%
FI Credit 1.45%
FI Credit 1.12%
S&P 500 -4.20%
FI Credit 1.89%
FI Credit 4.66%
Wilshire 5.61%
Wilshire -37.23%
Gold 23.96%
S&P 500 15.06%
FI Credit 1.75%
FI Credit 3.69%
REIT 1.26%
US Treasury 0.63%
Gold -5.00%
US Treasury 1.62%
US Treasury 3.93%
S&P 500 5.49%
REIT -39.05%
FI Credit 11.59%
FI Credit 4.15%
US Treasury 1.55%
US Treasury 0.43%
US Treasury 0.36%
Gold -1.51%
REIT -5.40%
WTI -0.34%
REIT -17.84%
WTI -53.52%
US Treasury 0.80%
US Treasury 2.40%
Wilshire 0.98%
WTI -7.08%
Gold -28.26%
WTI -45.76%
WTI -13.60%
Total Return Comparisons Stability in Bonds
24 SVB Asset Management | Quarterly Economic Report Q3 2015
S&P 500 Index Fundamentals
Credit Cycle Healthier Corporate Credit Conditions Remain Corporate credit conditions remain healthy, as operating margins have stayed elevated and debt levels are near the lows of this century.
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
Operating Margin (RHS) Total Debt to Total Asset (LHS)
Source: Standard & Poor’s S&P 500 Index
S&P 500 Energy Sector Index
S&P 500 Utility Sector Index
25
Source: Standard & Poor’s, Bloomberg and SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q3 2015
Credit Cycle Focus Divergent Impact of Falling Oil Prices
Since the beginning of 2014, crude oil prices have fallen by almost 50%, squeezing the operating margins of the higher fixed cost energy sector. At the same time, falling energy prices have boosted disposable income for consumers, contributing to a steady increase in consumer confidence. This in turn has expanded operating margins for companies within the consumer discretionary sector. The utility sector has also benefitted, as operating margins rose steadily over the same period due to the lower price environment. Rising interest rates will magnify the sector-specific impact of macroeconomic and exogenous factors, making sector selection critical.
S&P 500 Consumer Discretionary Sector Index
30
50
70
90
110
0.0%
3.0%
6.0%
9.0%
12.0%
Operating Margin Crude Oil Price
75
80
85
90
95
100
10.2%
10.3%
10.4%
10.5%
10.6%
10.7%
Operating Margin Consumer Confidence
20
40
60
80
100
120
16.0%
17.0%
18.0%
19.0%
20.0%
Operating Margin Crude Oil Price
27
Sources: Federal Reserve, European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, Bloomberg and SVB Asset Management.
United States United Kingdom Eurozone China Japan
Central Bank Federal Reserve Bank of England European Central Bank
People's Bank of China Bank of Japan
Benchmark Rate 0-0.25% 0.5% 0.05% 4.60% 0.1%
Current Policy
Weakening emerging economies and sub-target inflation foiling a rate hike.
Rising wages not enough to boost overall inflation, preventing an interest rate rise.
Softer prices and export demand may spur QE expansion.
Interest rate and reserve ratio has been cut 4 times year to date.
Reiterated current Quantitative & Qualitative program, as some prices begin to perk.
Inflation
Unemployment 5.1% 5.5% 10.9% 4.0% 3.3%
Analysis
Expectations now are split over whether there will be a rate hike in 2015.
Rate hike delayed until Q1 2016 by uncertain inflation path.
ECB will maintain its current QE program through 2016, as scheduled.
Further rate cuts ahead to support growth target.
Further easing possible in 2016 if fiscal stimulus fails to generate faster inflation.
SVB Asset Management | Quarterly Economic Report Q3 2015
1.2%
0.0% 1.0% 2.0%
1.0%
0.0% 1.0% 2.0%
0.9%
0.0% 1.0% 2.0%
2.0%
0.0% 1.0% 2.0% 3.0%
0.6%
0.0% 1.0% 2.0%
Source: Federal Reserve, European Central Bank, Bank of England, The People’s Bank of China, Bank of Japan, Bloomberg, SVB Asset Management.
Stable Stable
Easing
Easing
Easing
Central Banks Wait A Minute
Economic Activity
Monetary Conditions
28
Source: National Bureau of Statistics of China, China Automotive Information Net, The People’s Bank of China, Bloomberg, SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q3 2015
China Controlled Deceleration
China's policy and stimulus measures are intended to counter their economic slowdown. High corporate debt and weaker aggregate demand could undermine the effectiveness of stimulative policies. Underlying transformation to a domestic-based economy will require government's delicate balancing act to achieve stability in short term during longer-term transitions.
Consumer Status
0.0% 5.0%
10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%
Cha
nge,
Yea
r ove
r Yea
r
GDP Real Estate Investment (3 Month Average) Retail Sales
-40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% 120.0% 140.0%
85 90 95
100 105 110 115
Cha
nge,
Yea
r Ove
r Yea
r
Inde
x (D
ecem
ber 1
997
= 10
0)
Consumer Confidence (LHS) Auto Sales (RHS)
0.0%
10.0%
20.0%
30.0%
40.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Cha
nge,
Yea
r Ove
r Yea
r
Maj
or B
ank
Req
uire
d D
epos
it R
eser
ve
Reserve Ratio (LHS) M2 (RHS)
Real Estate Investment (3-Month Average)
Projected GDP %
Purchasing Manager’s Index
29
Source: World Bank, European Central Bank, Bank of Japan, Bank of England, Markit, Bloomberg and SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q3 2015
Global Economics Still Growing…Mostly
Manufacturing and services activities remain comfortably in expansion mode for major developed economies. U.S. growth remains the strongest, with the Eurozone activity accelerating in 2015. China and emerging markets have recently dipped marginally into contraction territory. In China, services continue to grow, while manufacturing activity has been shrinking most of 2015.
Lower fuel prices, improving labor markets and accommodative monetary policies are expected to remain supportive of gradual economic pickup in developed economies. Diverging central bank policies, disruptive asset shifts and global trade imbalances still pose near-term risk to global growth. Monetary and fiscal policy effectiveness are expected to remain key drivers of domestic economic activity.
-6.0%
-1.0%
4.0%
9.0%
14.0%
Cha
nge,
Yea
r Ove
r Yea
r
US Eurozone UK China Japan
45 47 49 51 53 55 57 59 61
PM
I Ind
ex: >
50 =
Exp
ansi
on
Emerging Markets Eurozone China U.S. U.K.
-2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
10.0% 12.0% 14.0% 16.0% 18.0%
Cha
nge,
Yea
r Ove
r Yea
r
Brazil China India Russia
-2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0%
Cha
nge,
Yea
r Ove
r Yea
r
US Eurozone UK Japan
Consumer Price Index – Developed Economies
Consumer Price Index – Emerging Economies
30
Source: International Monetary Fund, Bloomberg and SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q3 2015
Global Economics Muted Prices
Weaker currencies in some emerging economies, compared to developed economies, have boosted import prices, pushing inflation higher. Inflation is expected to moderate over the medium term. Commodity-focused economies have been weakened by a substantial fall in the prices of coffee, wheat, soybeans, copper and other exported commodities, which also has weakened currencies. Emerging economies remain susceptible to local and regional gyrations, such as a tight pork supply in China, an onion shortage in India and sanctions in Russia, that can keep inflation lofty in the short term.
Low oil prices have helped push headline inflation below 2 percent in many major developed economies, preventing interest rate hikes and keeping monetary policy skewed to the downside. Underlying economic strength in the U.S. and U.K., particularly in the housing and services sectors, has failed to push inflation higher, as cheaper fuel costs have offset rising rental and medical costs. Meanwhile, consumer demand remains tepid in the Eurozone. Technological efficiencies in developed economies have controlled labor costs, despite falling unemployment.
32
Portfolio Strategy Macro Overview
SVB Asset Management | Quarterly Economic Report Q3 2015
Solid economic data in the third quarter. GDP for Q1 revised up from negative growth to +0.6 percent, while Q2 beat expectations with a growth rate of +3.9 percent. Labor market gains averaged 200,000 new jobs per month. Retail sales grew more than 2.0 percent, year-over-year.
Interest rates continued to gradually rise in the third quarter. 12-month T-bills rose ~24bps intra-quarter from peak to trough. Two-year Treasury ended the quarter where they began, at about 0.65 percent. A gradual rise in the short end should continue while the 2- to 3- year part of the curve is expected to trade in ranges.
Overweight spread products / Defensive on duration. Short and Intermediate benchmarks: Long duration vs. benchmark as coupon income should offset price volatility. Intermediate Duration Strategies: Stay neutral to benchmark. Long Duration Strategies: Short duration to manage price fluctuations.
Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
Economy
Rates
Strategy
33
Portfolio Strategy Duration and Sector Overview
SVB Asset Management | Quarterly Economic Report Q3 2015
Strategy
Duration Target
Short Duration Benchmark 3-month
Intermediate Duration Benchmark
6-month
Intermediate Plus Duration Benchmark
9-month
Long Duration Benchmark 1 and 2+ years
-30% Neutral +30%
-30% Neutral +30%
Neutral -30% +30%
Sector
Overview
Governments
• Favor Treasuries over Agencies for liquidity purposes
and the reduced spread pick of Agencies over Treasuries.
• 18-month and 2.5-year Treasuries offer better relative value for Total Return volatility trades vs. on-the-run two-year and three-year Treasuries.
Corporate Bonds
• Bank and broker-dealer corporate bonds offer better liquidity and value as both regulation and performance have increased credit fundamentals.
• Industrials continue to have strong balance sheets and positive earnings. We favor consumer cyclical and non-cyclical on improving fundamentals in consumer spending.
Asset-Backed Securities • Strong consumer credit fundamentals and stable
spreads in auto and credit card receivables make this a sought-after sector.
Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
-30% +30% Neutral
34
Portfolio Strategy Relative Value Curve Analysis
SVB Asset Management | Quarterly Economic Report Q3 2015
0.075
0.095
0.115
0.135
0.155
0.175
0.195
0.215
0.235
0.255
0.275
Treasury Yield Curve Pickup (bps)
12mo to 18mo 18mo to 24mo
12-month Yield
18-month Yield
Difference
0.354% 0.554% +0.20
18-month Yield
24-month Yield
Difference
0.554% 0.682% +0.13
Where is the current value? Although rates have been trending higher, we analyze where the current value is on the curve. One such trade we analyze is the 12-to-18 months vs. 18-to-24 months part of the curve. The yield pickup from 12-to-18 months is approximately 20bps. The yield pickup from 18-24 months is approximately 13bps. Over the past couple years the average yield pickup for both has been approximately 15bps. From a relative value standpoint, we conclude that the 18-month part of the curve is most attractive.
Source: SVB Asset Management and Bloomberg. Data as of 9/17/2015. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
Portfolio Management Team
Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected] Hiroshi Ikemoto [email protected] Jason Graveley [email protected]
President, SVB Asset Management
Lauri Moss [email protected]
Head of Investment Strategy and Portfolio Management
Ninh Chung [email protected]
Head of Credit Research
Melina Hadiwono, CFA [email protected]
Credit and Risk
Tim Lee, CFA [email protected] Daeyoung Choi, CFA [email protected]
Silicon Valley Bank Partners
Jackie Pierce Teresa Quizon
SVB Asset Management | Quarterly Economic Report Q3 2015 35
Our Team
This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. © 2015 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of the FDIC and the Federal Reserve System. Silicon Valley Bank is the California bank subsidiary of SVB Financial Group (Nasdaq: SIVB). SVB, SVB FINANCIAL GROUP, SILICON VALLEY BANK, MAKE NEXT HAPPEN NOW and the chevron device are trademarks of SVB Financial Group, used under license. (0915-071) B-15-14388 Rev. 10-19-15.
Products offered by SVB Asset Management::
36
Are Not insured by the FDIC or any other federal government
agency
Are Not Deposits of or guaranteed by a Bank
May lose value
SVB Asset Management | Quarterly Economic Report Q3 2015
