2016: THE YEAR OF TRANSITIONS

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1 2016: THE YEAR OF TRANSITIONS Ron Florance, CFA RMF Consulting, LLC Robertson Stephens, LLC 1

2 WHAT HAPPENED IN 2015 Good riddance, and Happy New Year? 2

3 2015 ECONOMICS Growth never seemed so uninspiring Annual GDP Growth rates USA Euro Zone China India Japan Source: Economist, World Bank 3

4 The Fed Awakens 4 After exactly seven years, the US Federal Reserve raised the federal funds rate 0.25%, stating that the economic recovery has clearly come a long way, although it is not yet complete With the emerging markets in turmoil and credit issues impacting the energy sector, this change in Fed policy hardly marks the end of the Grand Experiment. US Fed Funds Rate 4

5 US DOLLAR 95 US Dollar Index Trade-Weighted Value US DOLLAR INDEX Source: Thomson Reuters Datastream / Fathom Consulting 5

6 US DOLLAR Strength is not always a good thing. 60% U.S. Dollar Index Trade-Weighted Value 50% 40% 30% % 10% 0% % -20% 1 YEAR 5 YEAR 5 YEAR (Ann.) As of December 31, 2015 Source: Thomson Reuters Datastream / Fathom Consulting 6

7 China was a year of huge volatility in the Chinese equity and currency markets. Major downdrafts and government intervention have continued into the beginning of this year. Consensus views still see the world s second largest economy transitioning to a foundation of services and consumer activity, but a lack of transparency now seems to be hindering investors ability to discern between actual and perceived risk. Chinese Equities and the Renminbi 7

8 US Economy 8 US macroeconomic data releases in 2015 produced little more than a constant refrain of mixed signals. Underlying strength in employment and services activity has been tempered by stubbornly weak wages and poor manufacturing data during the latter part of the year. Net of commodities, CPI has been closer if not above - the US Federal Reserve s target level of 2%. In general, consensus views are structurally positive, yet qualified. Dollar and Inflation Manufacturing and Services 8

9 US LABOR MARKET Looking at the full picture isn t so pretty Unemployment Rate vs. Labor Participation Rate Source: US Bureau of Labor Statistics 9

10 Oil 10 Other than a modest rise early in 2015 and some stability during autumn, oil and commodities have done nothing but collapse. As a result, the potential for defaults is now becoming very real across the sector, including the largest companies like Glencore. Fiscal issues are also real; Saudi Arabia and Russia in particular are dealing with difficult domestic finances. Higher prices would be a relief, but these are nowhere in sight. Oil and Commodity Prices 10

11 OIL What are we going to spend the extra $2 trillion on? WTI Crude Oil 60% Price Return 40% 20% 0% -20% % % % 1 YEAR 5 YEAR 5 YEAR (Ann.) As of December 31, 2015 Source: Thomson Reuters Datastream / Fathom Consulting 11

12 COMMODITIES Does everything seem that much cheaper? 60% S&P GSCI Commodity Index Total Return 40% 20% 0% -20% % % % 1 YEAR 5 YEAR 5 YEAR (Ann.) As of December 31, 2015 Source: Thomson Reuters Datastream / Fathom Consulting 12

13 US Equities obviously marks an end to the long upward trend of the US equity markets since Valuations for the S&P 500 remain elevated. This remains true after the correction to begin 2016, and further downside volatility is a real possibility. Strong earnings will need to drive the markets. Interestingly, performance of the large cap S&P 500 Index has been much better than the small cap Russell 2000 Index over the past six months. One would think emerging markets and China exposure in the S&P 500 would drive the inverse. US Equity Indices 120 US Valuations Rebase to S&P 500 Russel 2000 S&P 500-1Q Moving Avg. Russel Q Moving Avg. Source: Thomson Reuters Datastream / Fathom Consulting US Shiller S&P 500 PE Ratio Historical Average +/- 1 Standard Deviation Source: Thomson Reuters Datastream / Fathom Consulting 13

14 Market Indices 14 Outside of commodities and emerging markets, full year 2015 returns across both fixed income and equity strategies were moderate with a mix of positive and negative results in the low single digits. Despite higher interest rates, fixed income benchmarks were slightly positive, and the S&P 500 posted a 1% gain for the year. International indices were flat in local currency terms, yet the appreciation of the US Dollar pushed foreign benchmarks into negative territory. Equity Indices 15% Bond Indices 15% 10% 10% 5% 5% 0% 0% -5% -5% -10% -10% -15% 4Q YEAR (Ann.) -15% 4Q YEAR (Ann.) S&P 500 RUSSELL 2000 MSCI AC ASIA PACIFIC MSCI AC WORLD MSCI EAFE MSCI EM Source: Thomson Reuters Datastream / Fathom Consulting US AGGREGATE US CREDIT GLOBAL AGGREGATE US GOVERNMENT US HIGH YIELD EM LOCAL CURRENCY Source: Thomson Reuters Datastream / Fathom Consulting 14

15 Global Equities 15 Developed markets had flat returns that ultimately ended moderately negative with currency taken into account. As in the US, valuations remain elevated. markets suffered a more serious correction, but are bifurcated: lower valuations and higher uncertainty in some locales, and higher valuations in others where risk is lower. Global Equity Indices 110 Currency Effect 5% % % % Rebase to MSCI EAFE MSCI EM MSCI EAFE - 1Q Moving Avg. MSCI EM - 1Q Moving Avg. Source: Thomson Reuters Datastream / Fathom Consulting -15% 1 Year Return 2 Year Return MSCI Europe MSCI Asia MSCI Europe Local Currency MSCI Asia Local Currency Source: Thomson Reuters Datastream / Fathom Consulting 15

16 Developed Markets 16 Unlike the US and the UK, the central banks in Japan and Europe continued to be very proactive and supportive for their respective economies. Both have quantitative easing programs in place (although have not expanded the programs recently). European data has been routinely positive with not much acceleration, but the turmoil in China will certainly affect Japan negatively in the short term. Overall, an investment thesis in these regions apart from accommodating monetary policy would be welcome. Japan Policy Rate ECB Balance Sheet 16

17 Markets 17 market economies are managing a multitude of issues. The collapse in commodities and political uncertainty has raised the level of risk in Brazil. China has cut interest rates routinely since the beginning of 2015, and Russia is managing a severe budget deficit with energy prices so low. India is a bright spot with projected 2016 GDP growth of 7%, but equity markets recently have been weak like others. Positive views on emerging markets remain intact in the long run, although with an accompanying high level of expected risk. Brazil 5 Year CDS Credit Spread PBoC Cuts Rates 6 Times in 12 Months 17

18 FIXED INCOME At least it wasn t negative U.S. 10 Year Treasury Note 40% Total Return 30% % 10% 0% % 1 YEAR 5 YEAR 5 YEAR (Ann.) As of December 31, 2015 Source: Thomson Reuters Datastream / Fathom Consulting 18

19 FIXED INCOME U.S. 10 Year Treasury Note 4.0 Yield Bloomberg Commodity Index Source: Thomson Reuters Datastream / Fathom Consulting 19

20 US Rates 20 The US Federal Reserve raised interest rates in December, and there was little, if any, impact. The US Treasury curve is modestly higher versus one year ago. Published FOMC expectations are for steady, quarterly 0.25% interest rate increases through The market though is indicating a belief that volatility and corporate credit issues could hinder these plans. US Treasury Yield Curve US Federal Funds Rate 20

21 US Credit 21 The biggest factor in fixed income returns in 2015 was the price of oil. Spreads across US credit sectors generally remain below historical averages, although high yield is an exception. And even the broad market in high yield market was basically fine outside the energy sector. While there may be some pockets of value in energy, the collapse in oil prices (especially since January 1) and the potential for defaults and broader issues combine to create real uncertainty. High Yield Spread Sectors Source: J.P. Morgan. Source: Robert W. Baird & Co. 21

22 Private Equity 22 Risk aversion and slightly higher interest rates reduced activity levels in private equity. Overall, though, the market continues to be healthy. Venture capital investment is as large as it has ever been, and 2015 was the Year of the Unicorn, with 75 companies globally reaching a valuation above $1 billion. PE Deal Count Falls Year of the Unicorn Source: PitchBook Data Inc. Source: PitchBook Data Inc. 22

23 Real Estate 23 The recovery in real estate is full steam ahead. All primary sectors continue to perform well. The US Multifamily sector has been best since the global financial crisis as the US home ownership rate has declined. REIT performance is also strong yet definitely volatile. Despite predictions of disaster once interest rates began to increase, REIT performance in 2015 was one of the strongest sectors in the market with both underlying property appreciation and dividend growth driven by solid underlying cash flows. US Real Estate Sector Performance US Equity REIT Performance Source: CoStar Group 23

24 2016 THEMES Change is hard, but the payoffs are worth it. 24

25 2016 FORECASTS Low expectation can lead to positive surprises Federal Reserve makes 2 interest hikes in 2016 to 0.75% Long end of the curve won t behave. US Dollar stabilizes Helps US multinationals and commodities US GDP growth doesn t surprise anybody Global GDP growth does surprise to the upside, but not from China US Equity earnings growth: 5.5% You ll be happy with that as a total return Volatility across all asset classes will continue Active rebalancing will be the key to successful asset allocation 25

26 THE SLOW MARCH UP FOR RATES This may take a while. 26

27 PRICE OF OIL STABILIZING? Ya think the Saudis may be manipulating the market? 27

28 GLOBAL UNREST They were just angry, now they are cash poor and angry 28

29 MARKET VOLATILITY The new normal is the old normal Source: Zega Financial 29

30 VOLATILITY? Equity Indices 200 Rebased to S&P 500 MSCI EAFE MSCI EM Source: Thomson Reuters Datastream / Fathom Consulting 30

31 ASSET ALLOCATION Don t abandon diversification Year 10 Year Global Agg Bonds 4.8% Market Equity 79% US Real Estate 28.5% US Real Estate 8.6% Market Equity 18.6% US Small Cap 38.8% US Real Estate 30.4% US Real Estate 2.5% US Large Cap 12.6% US Real Estate 7.4% Market Bonds -10.9% US High Yield 57.5% US Small Cap 26.9% Market Bonds 8.5% Market Bonds 18.5% US Large Cap 32.4% US Large Cap 13.7% US Large Cap 1.4% US Real Estate 11.9% US Large Cap 7.3% Hedge Funds -19% EAFE 32.5% Market Equity 19.2% Global Agg Bonds 5.6% EAFE 18% EAFE 23.3% Market Bonds 5.5% Market Bonds 1.2% US Small Cap 9.2% US High Yield 6.8% US High Yield -26.4% US Real Estate 28.6% US High Yield 15.2% US High Yield 4.4% US Real Estate 17.8% Hedge Funds 9.1% US Small Cap 4.9% EAFE -0.4% Market Bonds 5.1% US Small Cap 6.8% US Small Cap -33.8% Market Bonds 28.2% US Large Cap 15% US Large Cap 2.1% US Small Cap 16.4% US High Yield 7.4% Hedge Funds 3% Hedge Funds -0.9% US High Yield 4.8% Market Bonds 6.7% US Large Cap -37% US Small Cap 27.2% Market Bonds 12% US Small Cap -4.2% US Large Cap 16% US Real Estate 2.5% US High Yield 2.5% Global Agg Bonds -3.2% EAFE 4.1% Hedge Funds 4.1% US Real Estate -37% US Large Cap 26.5% Hedge Funds 10.3% Hedge Funds -5.3% US High Yield 15.6% Market Equity -2.3% Global Agg Bonds 0.6% US Small Cap -4.4% Hedge Funds 2.3% Market Equity 4% EAFE -43% Hedge Funds 19% EAFE 8.2% EAFE -11.7% Hedge Funds 6.4% Global Agg Bonds -2.6% Market Equity -1.8% US High Yield -4.6% Global Agg Bonds 1% Global Agg Bonds 3.7% Market Equity -53.2% Global Agg Bonds 6.9% Global Agg Bonds 5.5% Market Equity -18.2% Global Agg Bonds 4.3% Market Bonds -6.6% EAFE -4.5% Market Equity -14.6% Market Equity -4.47% EAFE 3.5% Source: Addepar 31

32 DIVERSIFICATION? So much for diversification 80% 60% Equity Returns As of December 31, % 20% 0% -20% % % 1 YEAR 5 YEAR 5 YEAR (Ann.) S&P 500 MSCI EAFE MSCI EM Source: Thomson Reuters Datastream / Fathom Consulting 32

33 LIQUIDITY THE FAVORITE FACTOR I just want it on demand Illiquidity Premium? Equity Hedge Arbitrage Macro Relative Value US Invest Grade Bonds S&P year annualized return Source: S&P, Reuters, HFRI, Q

34 TECH SHAKE UP For a while it was show me the invitation, now it is show me the money. 34

35 ENVIRONMENTAL CHATTER El Nino can t wash away all our problems 35

36 THE GLOBAL CONSUMER What are they going to buy with the $2 trillion not spent on oil? 36

37 2016 POLITICS Death of the Republican Party 37

38 Tactical Market Views January 2016 GLOBAL EQUITIES Valuations are fair to high across global equity markets. Mixed signals from the US economy leave some doubt around corporations ability to grow earnings. Proactive international central bank policies provide a supportive backdrop for Europe and Japan. Uncertainty is heightened in the Markets. US Large Cap US Mid/Small Cap Int l Dev Markets Markets Private Equity HEDGE FUNDS Performance has been disappointing, and expected returns broadly are low. Long credit strategies are bifurcated between high risk restructurings or lower risk, liquid opportunities that provide some incremental return before better investments can be sourced. Equity opportunities are scattered, but with less confidence broadly in the bull market, short portfolios may grow and contribute to returns. Hedged Credit Activist Equity Long/Short Equity Event Driven Distressed Debt Long Credit Relative Value REAL ASSETS US real estate continues to perform well, although prices are high. Higher rental rates in many sectors are increasing cash flow, and development activity is accelerating as banks return to riskier areas of the lending markets. The MLP sector represents value with less exposure to commodity prices, but other natural resource areas are uncertain. Energy / MLP US Real Estate Int l Real Estate Infrastructure Commodities GLOBAL FIXED INCOME All developed sovereign interest rates remain historically low, although the U.S. Federal Reserve raised interest rates and has indicated its commitment to further increases in Uncertainty in the Markets and difficult fiscal situations are increasing the risk profile of many issuers in the hard and local currency markets. Short Duration Core Strategies Bank Loans Convertible Bonds Global High Yield Long Duration Core Strategies Dev & USD EM Debt Local EM Debt Source: Robertson Stephens Advisors, Mercer Consulting 38