Quarterly Reflections & Outlook

Transcription

1 SITUATION ANALYSIS Quarterly Reflections & Outlook First quarter 2014 recap: The U.S. economy appears to have remained relatively healthy despite the overhang of winter weather. The recovery from recession continued across the eurozone, but growth slowed across major emerging market economies. Equities ended the first quarter by posting lackluster results. Treasury yields fell as a global flight to quality occurred. Continued demand for U.S. commercial properties is a reflection of the continuing improvement in the economy. Commodities are beginning to reverse many of the price-decline trends experienced during Outlook summary: We expect U.S. growth to be near 3 percent at the end Growth in Europe is likely to be moderate, while emerging market countries are expected to be the largest contributors to global growth. We expect equities to trend higher in 2014, albeit at more moderate levels than The continued tapering of QE is also likely to produce a more volatile interest rate environment. Housing and commercial real estate are expected to continue moving through the recovery phase in A rising tide of global economic growth, particularly in developed economies, is likely to spur demand growth for commodities. First quarter review U.S. economy The first quarter saw weaker economic data because of double the normal amount of snowfall across much of the United States, including major population centers such as New York, Chicago, Atlanta, Cincinnati and Detroit. The winter weather left people homebound, some unable to work, others unable to spend. As data slowed, fears rose of a slowing U.S. economy, particularly as the U.S. Federal Reserve (Fed) embarked on tapering of the quantitative easing (QE) program. New York City Chicago Detroit Atlanta Cincinnati St. Louis Minneapolis Boston Pittsburgh Des Moines, IA Kansas City, MO Washington, DC Buffalo, NY Raleigh, NC Syracuse, NY Denver, CO Fargo, ND Percent of normal winter snowfall Select U.S. cities, Dec Feb % 176% 163% 161% 152% 147% 141% 132% 104% 101% 100% 90% 258% 233% 231% 230% 229% As we moved through the quarter, weakening reports for employment, retail sales and home sales trends led to hopes the Fed might delay additional tapering. However, the Fed remained resolute and continued to reduce bond purchases, and economic data for March seemed to indicate that the slowing data was temporary and favorable fundamentals of the U.S. economy have remained intact. As winter weather hit and we exited the Christmas holiday season, the ISM Manufacturing Index slowed from 56.5 in December to 51.3 in January. Employment indicators weakened as jobless claims remained elevated, retail sales slumped and non-farm payroll growth slowed toward an average of just 100,000 jobs per month. The unemployment rate remained unchanged from the end of 2013 at 6.7 percent after nearing the Fed s target unemployment rate of 6.5 percent in December. Inflation remained benign during the quarter with consumer prices growing at an annualized pace of just 1.2 percent for the first two months of the year (1.4 percent excluding food and energy). While data indicated some weakness, impactful to the securities markets was that many economic Source: Midwest Regional Climate Center Important disclosures provided on page 8.

2 releases disappointed forecasters relative to their expectations for the first quarter as economic growth had been improving and some snap-back was expected after the conclusion of the government shutdown. As March ended, early indicators, such as the ISM Manufacturing Index, which rebounded to 53.7 in March, and the February rebound in durable goods orders indicated the economy is likely to remain relatively healthy despite the overhang of winter weather. First quarter review global economy The recovery from recession continued across the eurozone despite potential impacts from the conflict between Russia and Ukraine. The conflict rapidly subsided as Russia s annexation of Crimea elicited sanctions against key Russian individuals but little else. Europe buys the majority of its natural gas from Russia, leaving little incentive to threaten Russia during the winter heating season. Europe: The turmoil in Ukraine seemed to have little impact on the European economy as purchasing manager composite indices rose over the course of the quarter, indicating the recovery is likely to continue expanding. Employment and loan growth remained headwinds for the economy. Growth has yet to accelerate sufficiently to result in meaningful jobs growth, particularly as austerity policies have yet to conclude in some key economies. Deflation risk has increased over the quarter as consumer prices have risen just 0.5 percent over the past 12 months ending in March, down from 0.8 percent in % change year over year 10% 8% 6% 4% 2% 0% -2% -4% Global inflation Feb 2014 U.S. Japan Euro Area Emerging countries Source: FactSet; gray bar = U.S. recessionary period; emerging countries through 1/31/14; U.S. through 2/28/14 Japan: The promise of Abenomics to rekindle the Japanese economy has yet to be met. Monetary accommodation continues to grow as the Bank of Japan implements quantitative easing, but the economy has yet to reconcile the impending April increase in the consumption tax and meaningful structural reforms for the economy have yet to be enacted. Wage growth remained virtually nonexistent and price inflation remained well below the Bank of Japan s 2 percent target. However, business sentiment improved as evidenced by stronger purchasing manager surveys and the weaker yen relative to other currencies, such as the U.S. dollar, which should provide further support to export activity. Growth slowed across major emerging market economies in the first quarter. For commodity-producing economies such as Brazil and Russia, the driver was weaker commodity prices in For economies such as India and China, monetary policies were the primary constraint as central bankers attempted to bring inflation under control. Russia: Russia s annexation of Crimea triggered a selloff in stock and bond markets, which helped pressure economic output further. While U.S. and European sanctions of key Russian citizens are unlikely to be a key driver of economic activity, they indicate a rebound in growth is unlikely. Brazil: A downgrade of their debt by Standard & Poor s to one notch above junk status indicated growth is likely to continue to struggle. Rising debt levels and rising inflation are constraining economic growth, despite the potential benefits of infrastructure investments for this summer s soccer World Cup games in Brazil and for the 2016 summer Olympic Games in Rio de Janeiro. China/India: In China and India, moderating price pressures may provide some monetary flexibility later in the year. For India, fourth quarter 2013 growth slowed to 4.7 percent year over year, well below the 7 percent average since Rising manufacturing activity late in the quarter may have provided some indication that activity could improve. For China, activity remained sluggish, especially for smaller companies. The first quarter also saw some defaults of a wealth management trust product, as well as some debt for a couple of companies. The central bank also managed the currency lower relative to the U.S. dollar in order to discourage speculative flows and intends to widen the band for trading to 2 percent from the current level of 1 percent. These measures indicate Chinese policymakers may be attempting to stem flows of speculative money, but are also testing the markets Important disclosures provided on page 8. Page 2

3 with the potential for losses as well as gains on risky assets. This would seem to indicate the planned transition toward consumption from investment-led growth continues to progress. First quarter review capital markets Equities: Equities ended the first quarter by posting lackluster results largely due to economic uncertainty and heightened geopolitical risk. The S&P 500, Dow Jones Industrial Average, NASDAQ Composite, Russell 2000, international-oriented MSCI EAFE and international emerging markets-oriented MSCI Emerging Markets indices all posted first quarter returns ranging from negative 0.8 percent to positive 1.3 percent. For the S&P 500, six of 10 sectors posted favorable returns, led by the Utilities, Healthcare, Materials and Financial sectors. The Consumer Discretionary sector lagged. The strong outperformance of the Utilities sector was somewhat surprising given the defensive nature of the sector and its tendencies to underperform during periods when expectations of rising interest rates are increasing. Market and sector performance Index Price 3/31/ YTD * S&P 500 1, % 1.3% Dow Jones Industrials 16, % -0.7% Russell , % 0.8% MSCI EAFE 1, % 0.0% MSCI Emerging Markets % -0.8% Sectors of the S&P 500 Weight Information Technology 18.5% 26.2% 1.9% Financials 16.3% 33.2% 2.2% Health Care 13.0% 38.7% 5.4% Consumer Discretionary 12.6% 41.0% -3.2% Energy 10.2% 22.3% 0.2% Consumer Staples 9.7% 22.7% -0.2% Industrials 10.9% 37.6% -0.4% Materials 3.5% 22.7% 2.3% Utilities 2.9% 8.8% 9.0% Telecommunication Services 2.3% 6.5% -0.7% Source: FactSet; *YTD data through 3/31/14 equity performance. Importantly, as evidenced by first quarter performance, 2014 is proving to be a transition year, with equity price trends impacted more by the prospects for economic and earnings growth versus Feddriven liquidity and price-earnings multiple expansion. To that end, we believe the visibility of earnings should begin to improve in April and beyond following first quarter earnings results. Fixed Income: Global developed government bond yields dropped substantially during the first quarter amid a global flight-to-safety due to emerging market currency stress, continued softness in domestic economic data and the situation in the Ukraine. At the Federal Open Market Committee (FOMC) meeting in March, the Fed opted to remove the thresholds for both unemployment and inflation as guides to the future path of the policy rate. Instead, they have moved to more qualitative guidance around the health of the labor market. This is now being referred to as the Yellen dashboard. In addition to the traditional unemployment rate, this dashboard includes the U6 underemployment rate, non-farm payrolls, layoffs/ discharges rate, job openings rate, quits rate, hires rate, long-term unemployed share and the labor force participation rate. Following the FOMC press conference, commentary from several FOMC members was perceived as more hawkish, potentially indicating a possible earlier rise in the fed funds rate than the market had been anticipating. As a result, we saw a substantial flattening of the yield curve by quarter end. The 30-year Treasury yield was down nearly 35 basis points to end the quarter at 3.56 percent and the 10-year Treasury dropped 31 basis points to 2.72 percent, while the two-year Treasury was up three basis points to end the quarter at 0.42 percent. Following remarkably strong equity performance in 2013, it is difficult to draw meaningful conclusions from the price trends of U.S. and international equities as a result of trading action in the first quarter. In aggregate, performance among both domestic and international equity asset classes during the quarter was below the quarterly return levels experienced over the past 20. Additionally, there were few significant differences between the performance of U.S. or international indices, large-cap and small-cap stocks, and cyclical versus defensive sectors in the quarter. Concerns over the Russia-Ukraine conflict and economic uncertainty associated with adverse winter weather continued to impact economic readings and weigh on 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% months 2 Source: Bloomberg U.S. Treasury yield curve One month ago 10 Current One year ago Important disclosures provided on page 8. Page

4 Treasury Inflation-Protected Securities (TIPS) and mortgage-backed securities continued to underperform the broader fixed income market as inflation remained subdued and the Fed gradually reduced their purchase program. Investment grade corporates fared better in this environment posting a nearly 3 percent return for the quarter. Utilities outperformed industrials and financials as the curve flattening benefitted this longer duration sector. Municipals performed well, posting a quarter-end return of nearly 3.8 percent as investors moved back into the sector after a difficult 2013, and demand for municipal issues increased while supply remained subdued. Although emerging debt had a difficult start to the year, valuations reached levels that remained too attractive for investors to ignore. Emerging debt ended the quarter, posting a return of about 3.7 percent. High yield continued to outperform, posting a quarter-end return of 3 percent, with the lower quality CCC sector outperforming triple and single B sectors. Real Estate: Both new and existing home sales were hampered by increased mortgage rates and widespread severe winter weather throughout the United States. Continuing the 2013 double-digit year-over-year increases, prices in January eased a bit to percent. In markets where demand exceeded supply and where other factors such as a barrier to entry or significant job growth was occurring, housing was even more robust. Price increases reduced the number of borrowers with negative equity (13 percent in the third quarter of 2013) and encouraged homeowners to list their homes, which increased supply, yet the supply is still tight. Increased mortgage rates and a severe winter have led to decreased mortgage applications and fewer home sales. % change 1 year ago U.S. existing home sales 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% Existing home sales Existing home sales Sources: FactSet, National Association of Realtors; 9/30/03-2/28/14; gray bar = U.S. recessionary period Millions of units Continued demand for U.S. commercial properties is a reflection of the continuing improvement in the economy. Warehouse vacancies declined to 7.8 percent at the end of 2013 and rents appeared to be rebounding. Office properties showed some improvement, likely due to increased job growth. Commodities: The first quarter saw commodities reverse many of the price decline trends experienced during While the S&P GSCI dropped more than 1 percent in 2013, it jumped nearly 3 percent to start 2014, helped by weather-related gains in agricultural markets, as well as a recovery in the gold market. Rising geopolitical risks, as Russia annexed Crimea from Ukraine, also supported prices for gold, as well as oil and wheat. However, weaker economic data, particularly for emerging market countries such as China, helped pressure oil prices in the remainder of the quarter, as well as pressuring industrial metals prices, such as copper. Gold prices jumped nearly 10 percent in the first two months of the quarter before falling 3 percent in March. Technical adjustments in the futures market, as well as rising physical demand due to the Lunar New Year celebrations in China, provided support in January, and the Russia-Ukraine conflict provided further fuel for the rally in February. As tensions eased in Ukraine, the Federal Reserve continued its plan to taper quantitative easing and improving U.S. economic data sapped support for gold prices. Agricultural prices jumped nearly 16 percent for the quarter. The drought in Brazil supported prices for coffee (up 57 percent) and soybeans (up 16 percent) due to potential crop damage. U.S. winter weather raised fears of damage to the winter wheat crop (up 18 percent), and the conflict in Ukraine also helped support prices. Lower initial indications of U.S. plantings supported corn prices (up 18 percent). Prices for cyclical commodities struggled in the quarter as oil prices were virtually unchanged and copper prices dropped more than 9 percent. Weaker economic data from China pressured both commodities. Copper prices also suffered as housing data slowed in the United States. Natural gas prices, up 12 percent for the quarter, were helped by U.S. winter weather, which dropped more than double the normal snowfall in New York, Chicago and Atlanta. Important disclosures provided on page 8. Page 4

5 Outlook U.S. economy In the United States, the harsh winter weather experienced in many major cities across the country has muted economic data. Improving jobs and housing markets, as well as a conclusion to Federal government austerity offer support for improving growth over the remainder of the year. We expect growth to be near 3 percent by the end of Corporate capital spending may be the key to faster-than-expected growth if companies unleash some cash stockpiles to replenish their capital stock. Fed tapering of QE is unlikely to hamper economic growth at this time. Inflation is likely to increase this year due to rising housing prices, but will remain below the Federal Reserve s target of 2 percent unless wage growth improves. Outlook global economy Optimism for the global economy in 2014 has been tempered as the polar vortex dampened U.S. economic data, a civil uprising in Ukraine boiled over into the Russian annexation of Crimea and credit defaults in China spurred fears of a credit crisis. From this base, we believe global growth is poised to improve as U.S. economic fundamentals remain sound, the eurozone continues its recovery from recession and China may create some stimulus as inflation and economic growth have slowed. Geopolitical risk will remain a factor over We are likely to see further conflict between Russia and Ukraine, negotiations with Iran continue over their nuclear capability, civil unrest continues in Iraq, Syria and Libya while new elections loom in Egypt. Growth in Europe is likely to average just 1 percent as the recovery from the recession continues to be hampered by bank deleveraging. Political leaders are drawing austerity programs to a close and may replace them with growthoriented policies to improve the employment situation. In Japan, growth and inflation are likely to be modest as monetary accommodation has not yet been coupled with structural reform. Share of global GDP (PPP weighted) 80% 70% % 40% 30% 20% Emerging economies outweigh advanced ones Emerging economies Advanced economies Source: Strategas Research Partners; GDP (Gross Domestic Product) PPP (Purchasing Power Parity); (1/1/90-12/31/13) Emerging markets are still the largest contributor to global growth, but weaker commodity prices and relatively tighter monetary policies have led to slowing growth and now slowing inflation. Growth in China will likely average just 7 to 7.5 percent. Growth in manufacturing centers, such as Korea and Taiwan, may improve with developed market growth. Commodity-producing economies may struggle as commodity prices have been weak. Outlook capital markets Equities: To a large degree, the performance of equities throughout the second quarter is likely to be contingent on first quarter earnings results and company guidance. Guidance is important as it provides an updated read on the pace of economic improvement. In our view, an improving economy is needed to drive company earnings, and accelerating earnings are needed to drive equity prices to meaningfully higher levels. Our 2014 price target for the S&P 500 is 2,030, based on a price-earnings multiple of 17.5 times our 2014 earnings estimate of $116, which is consistent with earnings growth of roughly 7 to 8 percent over 2013 levels. 30x 25x S&P 500 P/E with long-term average 20x 15x Average 10x 5x Source: Strategas Research Partners (data through 3/25/14, trailing 12-month basis) Important disclosures provided on page 8. Page 5

6 While investor sentiment and conviction remain fragile, we continue to believe that the backdrop remains favorable for equities to trend modestly higher. Company earnings are increasing, with current 2014 consensus earnings growth for the S&P 500 at roughly 8 percent over yearago levels. Interest rates remain low, despite talk of future interest rate hikes that rattled the equity markets in late March, and economic growth appears to be moderate yet robust enough to not put pressure on earnings and slow enough to keep inflationary pressures contained. Additionally, valuation, while elevated, appears fair and not at extremes, and importantly, inflation remains benign, reducing the pressure for price-earnings multiple contraction. Among international markets, we continue to like the longer-term growth prospects for developed and emerging markets. The near-term outlook, however, is less conclusive. The Russia-Ukraine conflict has added regional instability. Russia supplies roughly 30 percent of Europe s natural gas, as well as significant amounts of oil and coal, and China is transitioning from an export- to consumption-driven economy. In general, our attraction to emerging markets and Europe is based on relative low valuations and stable-to-improving growth prospects. Fixed Income: In our view, tapering will likely be completed by September, which is possibly earlier than the market may be anticipating. In reviewing the FOMC minutes and Summary of Economic Projections (SEP), it appears the Fed believes the recent weakness is mostly weather related and expects the economy to post substantial improvement in the coming months. This outlook has already been reinforced by the recent jobs data, industrial production and ISM manufacturing PMI. This should lead to increased interest rate volatility, and by extension, foreign exchange volatility as well. As QE is reduced and eventually concluded, Treasury yields, particularly at longer maturities, are free to move in a wider range without the downward pressure of QE. Fed Governors Plosser and Fisher may contribute to some additional volatility as their dissenting views will carry much more weight as FOMC voting members this year. This has the potential to somewhat muddle Yellen s message as Chair. The capital markets interpretation of Fed comments and action may also support a continued increase in volatility. The recent shift in the path of the policy rate away from the qualitative thresholds should cause the Yellen-led Fed to be highly transparent and weigh heavily on forward guidance as a monetary policy tool. With Fed Governors Jeremy Stein s resignation, the FOMC may not lean as heavily on the financial stability component as the previous statement had indicated. Instead the Fed is likely to revert focus back to their dual mandate of employment and inflation, resulting in a more balanced approach to policy rate increases. Despite recent flattening, the Treasury curve is likely to remain steep for a good portion of the year. The Fed has been steadfast in its commitment to a low policy rate for an extended time. Although better-than-expected economic growth may challenge the Fed s forward guidance at some point, the Fed s easing bias in regard to the policy rate is likely to keep short-dated Treasury yields anchored and keep the Treasury yield curve relatively steep over the next six months. For this reason, our year-end target on the 10-year Treasury remains in the range of 3.5 percent. Index level Treasury yield volatility remains well below its historical average 2005 Average 2007 MOVE index Source: BofA Merrill Lynch; Bloomberg; data through 3/31/14 MOVE Index (Merrill Option Volatility Estimate) We continue to favor credit risk over interest rate risk. Treasuries, mortgage-backed securities and TIPS will likely struggle in an environment of gradually increasing interest rates, low inflation and a Fed reduction of QE. In our view, recent dollar weakness is likely to be short-lived as a stronger economy and a reduction of Fed accommodation pushes the dollar higher. This will likely create a headwind for future performance of non-dollar developed sovereign and emerging debt. We encourage clients to focus on hard currency or dollar-denominated emerging debt. Investment grade corporates and municipal debt should be able to post modest positive returns over the next quarter. We believe high yield should continue to outperform the broader fixed income market as the current low default rate environment, stronger domestic economic growth and less sensitivity to rises in interest rates should all support this sector of the fixed income markets. Important disclosures provided on page 8. Page 6

7 Real Estate: In our view, housing and commercial real estate are expected to continue moving through the recovery phase in In commercial real estate, economic and demographic changes are likely to drive demand as the cheap interest rates and capitalization (cap) rate compression give way to operating fundamentals. We believe 10-year Treasury rates will rise moderately, as will mortgage rates. If these increases are evidence of an improving economy, then increased borrowing costs will be offset by increased demand for commercial space, and with the current relatively low new construction, we may very well see some rental rate increases. As housing continues moving ahead, the double-digit year-over-year price appreciation experienced throughout 2013 will likely cool a bit. We expect somewhat increased supply. Investor activity is likely to be reduced as housing approaches fair value. The prolonged and severe winter weather throughout much of the country has had a profound effect on both new and existing home sales. As we move into spring and beyond, and as the broader economic and job market recoveries continue, we will continue to watch and monitor the activity of mortgagedependent buyers. If mortgage demand remains subdued as it has the first months of 2014, then the continued recovery is possibly disrupted. However, we ve recently seen an ending to the weather-related distortions in jobs and believe this may be a preview of better news ahead for housing. Index change 40% 30% 20% 10% 0% -10% -20% -30% U.S. real estate returns and economic growth -40% NCREIT total expected return 8.02% NCREIF GDP FTSE NAREIT Composite NAREIT total expected return 7.76% 5% 3% 2% 1% -3% -5% * 2014* Sources: NCREIF, NAREIT, World Economic Outlook database, Emerging Trends in Real Estate 2014 survey. *GDP forecasts are from World Economic Outlook, NCREIF/NAREIT data for 2013 are annualized as of second quarter 2013, and the forecasts are based on the Emerging Trends in Real Estate 2014 survey. GDP change Commodities: Rising geopolitical risks during the first quarter, as well as changing weather patterns helped support commodity prices. Geopolitical risks likely remain a factor in 2014 and may lead to higher market volatility, but the story of commodities over the full course of the year will likely be driven by changing demand dynamics. A rising tide of global economic growth, particularly in developed economies, may spur demand growth, especially for oil but eventually industrial metals as well. While the Russia-Ukraine conflict has eased for now, tensions remain and could lead to further commodity market volatility. Other issues include negotiations over Iran s nuclear capability, civil unrest in Iraq and Libya, elections in Egypt and the civil war in Syria. Thousands of barrels per day Weekly domestic oil production ready to exceed imports U.S. crude oil field production U.S. crude oil imports Source: FactSet; Imports (1/31/94-3/28/14); Production (1/7/94-3/28/14) Improving demand dynamics could lead to modestly higher oil prices and, eventually, industrial metals, such as copper. Price expansion will be tempered by the continued rise in global supplies. U.S. energy production is leading to our lowest imports of oil in decades, helping to moderate global price volatility. Gold prices are likely to struggle through the year as improving global economic growth and the reduction of the Fed s monetary accommodation reduce demand. Crop prices may also moderate over the year as planting trends and long-range weather forecasts seem to indicate a strong crop cycle. We continue to recommend modest allocations to the broad commodity complex. While we believe price increases may be modest, commodity investments potentially offer a relatively efficient hedge against unexpected inflation in food and energy prices. Important disclosures provided on page 8. Page 7

8 Contributed by: Edgar W. Cowling, Jr., CCIM Director of Specialty Assets Robert L. Haworth, CFA Senior Investment Strategist Terry D. Sandven Chief Equity Strategist Jennifer L. Vail Head of Fixed Income Research reserve.usbank.com Investments are: Not a Deposit Not FDIC Insured May Lose Value Not Bank Guaranteed Not Insured by Any Federal Government Agency This commentary was prepared on April 18, 2014 and the views are subject to change at any time based on market or other conditions. This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not responsible for and does not guarantee the products, services or performance of third-party providers. Any organizations mentioned in this commentary are not affiliates or associated with U.S. Bank in any way. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Dow Jones Industrial Average (DJIA) is the price-weighted average of 30 actively traded blue chip stocks. The NASDAQ Composite is a marketcapitalization weighted average of roughly 5,000 stocks that are electronically traded in the NASDAQ market. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index includes approximately 1,000 companies representing the stock markets of 21 counties in Europe, Australasia and the Far East. The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. The S&P GSCI is a composite index of commodity sector returns that is broadly diversified across the spectrum of commodities. The FTSE NAREIT (North American Real Estate Investment Trust) includes Real Estate Investment Trusts (REITs) listed on the New York Stock Exchange, NASDAQ and American Stock Exchange and is designed to span the commercial real estate space across the U.S. economy, offering exposure to all investment property sectors. The NCREIF (National Council of Real Estate Investment Fiduciaries) National Private Real Estate Index (NPI) is a quarterly time series composite total rate of return measure of investment performance of a large pool of individual commercial real estate properties acquired in the private market for investment purposes. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer s ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. A Treasury Inflation-Protected Security (TIPS) is a special type of note or bond designed to offer protection from inflation. Interest payments vary with the rate of inflation. These securities offer a lower return compared to other similar investments. The principal value may increase or decrease with the rate of inflation. Investments in mortgage-backed securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults) U.S. Bank N.A. (4/14) Page 8