2014 Outlook for U.S. Equities

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1 SITUATION ANALYSIS 2014 Outlook for U.S. Equities Executive summary U.S. equities have begun 2014 by trending in a generally sideways fashion as investors appear to be taking a wait and see approach following performance in that was superb and generally above expectations. We expect equities to continue to trend higher in 2014, albeit at more moderate levels than what was experienced in. In our view, 2014 is likely to be a transition year, driven more by earnings and earnings growth than by Federal Reserve (Fed)-driven liquidity and price-earnings (P/E) multiple expansion. Our current 2014 price target for the S&P 500 is 1960, based on a P/E multiple of 16.5 times our earnings estimate of $119. A modest expansion to the P/E multiple implies an upward bias to our price target. performance review Performance of U.S. equities in was remarkably strong, broad-based and resilient. For, the S&P 500 advanced 29.6 percent (32.4 percent, including dividends), its fifth consecutive year of posting positive returns and best annual gain since All 10 S&P 500 sectors advanced, with eight of 10 sectors advancing above 20 percent and four of 10 increasing 30 percent or more. The Consumer Discretionary sector led performance, increasing 41 percent for the year. Conversely, the Telecommunication Services and Utilities sectors lagged, advancing 6.5 percent and 8.8 percent, respectively. Economic improvement: The strong performance of U.S. equities in points toward economic improvement. Small cap stocks outperformed large cap stocks, as evidenced by the small cap-oriented Russell 2000 advancing 37 percent compared to the 29.6 percent increase for the large cap-oriented S&P 500 and 26.5 percent increase for the large cap cyclical-oriented Dow Jones Industrial Average. Additionally, among S&P sectors, favorable performance was posted by both the cyclical and defensive sectors. We believe the fundamental backdrop remains favorable for equities to trend higher in 2014, but at a more moderate pace compared to performance may be driven more by earnings versus Fed-driven liquidity and price-earnings multiple expansion. Valuation, while elevated, is still fair and not at extremes and sentiment is favorable. Market and sector performance Price 2014 Index 1/24/14 Q1 Q2 Q3 Q4 YEAR YTD* S&P 500 1, % 2.4% 4.1% 9.0% 29.6% -3.1% Dow Jones Industrials 15, % 2.3% 1.0% 9.1% 26.5% -4.2% Russell , % 2.7% 8.5% 7.0% 37.0% -1.7% MSCI EAFE 1, % -2.1% 9.8% 4.9% 19.4% 0.0% MSCI Emerging Markets % -9.1% 4.8% 0.6% -5.0% -3.9% Sectors of the S&P 500 Weight Information Technology 18.5% 4.2% 1.2% 5.4% 11.7% 26.2% -1.7% Financials 16.3% 10.9% 6.8% 1.9% 9.0% 33.2% -3.4% Health Care 13.0% 15.2% 3.3% 5.9% 8.2% 38.7% 0.3% Consumer Discretionary 12.6% 11.8% 6.4% 6.7% 9.4% 41.0% -5.0% Energy 10.2% 9.6% -0.9% 4.0% 7.2% 22.3% -4.9% Consumer Staples 9.7% 13.8% -0.2% -0.6% 7.3% 22.7% -3.7% Industrials 10.9% 10.1% 2.2% 7.4% 12.1% 37.6% -4.9% Materials 3.5% 4.2% -2.4% 8.9% 9.5% 22.7% -5.1% Utilities 2.9% 11.8% -3.7% 0.5% 1.4% 8.8% 0.0% Telecommunication Services 2.3% 8.2% -0.1% -5.3% 3.5% 6.5% -4.2% Source: FactSet Research Systems Inc.; price appreciation (excludes dividends); *as of 1/24/14 Important disclosures provided on page 6.

2 Index level Overcoming headwinds: What also seemed noteworthy about performance in was that U.S. equities advanced despite significant headwinds, including the fiscal cliff, economic uncertainty, geopolitical issues and the partial government shutdown. Through it all, equities managed to trend higher. The average annual total return (including dividends) for the S&P 500 from 1926 through is 12 percent. When comparing performance with the past, despite the headwinds, the total return for the popular index was 32.4 percent, well above and in the top quartile of historical norms Deficit talks stall again Fed minutes suggest bond buying changes Poor U.S. consumer confidence data Fiscal cliff agreement U.S. economic data disappoints 4Q GDP growth sluggish Cyprus bank crisis Italian elections causes political impasse S&P actions Industrial data disappoints Fed hints at reducing bond buying Strong April retail sales data Japan announces $1.4 tln stimulus OECD cuts world economic outlook U.S./EU begin free-trade talks y jobs data disappoints Syria chemical attack tensions Fed hints at tapering asset purchases Jobless claims lowest in 5 years Positive G20 eases U.S. jobs report austerity talks et Yellen testifies at Senate Banking Committee Fed s taper caper Strong jobs report U.S. mulls military action in Fed reiterates Syria Government accomodative shutdown monetary policy Fed tapers Congressional leaders reach budget deal Strong 3Q GDP report Government shutdown ends, debt ceiling raised Feb Mar Apr May Jun Aug Sep Oct Nov Dec Source: Strategas Research Partners (data through 12/31/13, trailing 12-month basis) S&P total returns Year Return Year Return Year Return Year Return Year Return Source: Strategas Research Partners; includes dividends (data through 12/31/13) S&P 500 calendar year total return A standout year even among seven standout decades % -20% -10% 0% 10% 20% 30% 40% Source: Strategas Research Partners (1/3/14) International lagged: International stocks, on average, lagged their U.S. brethren largely due to concerns over the pace of economic growth. In the international segment, particularly among emerging markets, modestly higher labor costs, interest rates and commodity prices all hampered economic growth and price performance outlook We expect equities to trend higher in 2014, but at more moderate levels than what was experienced in. The generally sideways trending equity market being experienced in early 2014 is understandable as investors await insight to be gleaned from fourth quarter earnings results, another round of economic releases to gauge the pace of economic improvement following the disappointing December jobs report and further clarity from the Fed surrounding the timing, pace and execution of QE tapering. Importantly, 2014 is likely to be a transition year with equity performance driven more by earnings than by Fed-driven liquidity and P/E expansion. Fed-driven liquidity: Fed-driven liquidity is a fancy way of saying low interest rates. The Fed s current program to purchase $85 billion per month in treasuries and mortgage-backed securities, often referred to as quantitative easing (QE), is designed to do just that keep interest rates low, particularly long-dated maturities, in the interest of promoting economic activity and inflating asset prices. This has helped boost the housing recovery and push equities to higher levels. At present, the Fed professes to maintaining an accommodative (low interest rate) policy for the foreseeable future despite signs of economic improvement and the initial tapering of the Important disclosures provided on page 6. Page 2

3 QE stimulus program. That said, Fed-driven liquidity is beginning to moderate and market expectations are for a modest uptick in interest rates at some future date. Expectations of rising interest rates tend to constrain P/E multiples and overall equity performance. 30x approximate 20 percent increase in the P/E multiple above current levels in an environment where Fed stimulus is moderating S&P 500 P/E with long-term average U.S. Federal Reserve Bank s total assets and S&P 500 index level 25x $4.5 $4.0 S&P 500 index level x 15x Average $ in trillions $3.5 $3.0 $ S&P 500 index level 10x 5x $2.0 U.S. Federal Reserve Bank s total assets 900 Source: Strategas Research Partners (data through 12/31/13, trailing 12-month basis) $ Source: Bloomberg (12/1/13) Price-earnings expansion: Equities have benefitted from P/E multiple expansion, which is simply how much investors pay for $1 of company earnings. Historically, during times of similar economic conditions (such as the 1960s and early 1970s) that number has ranged between 15 to 18 times. At the start of, the consensus was that a multiple of 14 to 15 times was appropriate, but as the year progressed and the market worked through one headline after another, expectations for a higher multiple climbed to a point where a multiple in the 16 to 17 times range was considered both appropriate and warranted. Importantly, in the absence of inflation (and meaningfully higher interest rates), P/E ratios at or near current levels seem justified. To illustrate, looking back to previous periods of high inflation, such as during the late 1970s and early 1980s when inflation began to ramp, interest rates increased and the 10- year Treasury yield rose to over 14 percent in During that period, P/E ratios fell to the 7 to 8 times range at the low point. In contrast, today inflation is benign. In this scenario, we believe P/E ratios will stay near current levels, with arguably still some upside room for modest expansion. On the other hand, in 2014, unlike, it is hard to envision another 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Multiple expansion Contribution to S&P 500 return: earnings growth vs. multiple expansion S&P 500 return Earnings growth Source: Strategas Research Partners (data through 12/31/13, trailing 12-month basis) Earnings/earnings growth: In our view, moderating Fed-driven liquidity and generally status quo P/E ratios place increased importance on an improving economy to drive earnings and equity prices to meaningfully higher levels. To that end, key economic drivers are pointing toward improvement. Housing, employment, retail sales and manufacturing, to name a few, are all showing signs that economic improvement is occurring. For 2014, this seemingly places increased importance on company quarterly results and future guidance. It would also seem to imply increased market volatility during the reporting periods. At present, our 2014 earnings estimate for the S&P 500 is $119, approximately 10 percent above levels. Important disclosures provided on page 6. Page 3

4 Favorable backdrop The fundamental backdrop remains favorable for U.S. equities. Key drivers for earnings growth: At present, the market internals look constructive. The global economy appears to be slowly improving. U.S. household balance sheets are strengthening partly the result of higher home and stock prices. Corporate balance sheets continue to reflect mounting cash levels, and expectations are for a modest increase in capital expenditure spending in In total, this seemingly presents a favorable backdrop for company earnings. At present, we are forecasting earnings growth in the 8 percent to 10 percent range for 2014, modestly above what was experienced in. Additionally, according to Strategas Research Partners (an independent research firm), for U.S. non-financial companies, cash as a percent of total assets is 4.8 percent, near 50-year highs. Also, dividends as a percent of earnings (payout ratio) are near historical lows. This seemingly presents a favorable backdrop for dividend-paying equities. % of total assets Corporate cash at levels last seen consistently in the 1960s 6% 5% 4% 3% U.S. non-financial corporations cash 2% Source: Strategas Research Partners (1/3/14) 1990 Average S&P 500 dividend payout ratio (1936 ) Average Source: Strategas Research Partners (1/3/14) Looking beyond earnings: We believe favorable valuation, sentiment and inflation indicators present a fundamental backdrop that seems supportive of still higher equity prices. Valuation, while elevated, remains fair and not at extremes. Sentiment is generally favorable, driven by the wealth effect associated with higher stock values, increasing home prices, relatively low gasoline prices and slowly improving employment trends. And, importantly, inflation is low, justifying price-earnings ratios at or near current levels. Supply and demand/fund flows: Contributing to past and future performance may be changing supply and demand characteristics. According to the World Federation of Exchanges, the number of companies listed on U.S. exchanges has declined approximately 40 percent from peak 1997 levels. With lessening supply, and assuming demand remains relatively constant, this could help provide an upward bias to equity prices. Additionally, it is generally known that significant funds have flown into bonds since the 2008 financial crisis, partially at the expense of equities. According to Strategas Research Partners, from 2008 through nearly $1 trillion has flowed into bonds with $377 billion coming out of equities. While this trend reversed somewhat in the second half of, the rotation from bonds to equities arguably remains in the early innings and may serve as a catalyst supporting higher equity prices. Number of companies listed on U.S. exchanges 9,500 9,000 8,500 8,000 7,500 7,000 6,500 6,000 5,500 5,000 4, Source: Strategas Research Partners (1/3/14); includes the sum of AMEX, NASDAQ and NYSE exchanges Important disclosures provided on page 6. Page 4

5 $ in billions YTD* Net flows into mutual funds ($ billions) Equity Money Bond Year Domestic International Market 2008 (148.8) (80.3) (29.4) (583.6) (81.2) (529.0) 2011 (132.5) (16.6) (156.0) (0.3) TOTAL (547.9) ,073.0 (484.6) Feb Mar Apr May Jun Aug Sep Oct Nov Dec 18.4 (1.4) 2.3 (1.1) (3.9) (4.5) 8.7 (1.3) (4.6) (7.6) (59.8) (17.1) (29.1) (11.6) (15.6) (18.1) (20.6) (11.1) (31.6) (58.3) (24.4) 28.3 (17.1) (12.1) 5.3 NA TOTAL (78.4) (28.8) Source: Strategas Research Partners; *data through 12/23/13 $1,200 $1,000 $800 $600 $400 $200 $0 -$200 -$400 -$600 Cumulative net flows into equity vs. bond mutual funds Bond Equity Things to worry about Possible concerns related to our 2014 outlook are the unknowns. To a degree, the wall of worry has seemingly vanished when compared to issues and concerns weighing on the minds of investors at the start of. There appears to be less Washington-related brinksmanship and more willingness for collaboration, lessening the threat of another government shutdown or possible debt rating downgrade. The tapering roadmap for the Fed s QE stimulus program is becoming clearer. In Europe, economic conditions appear to be improving and global tensions have eased. Mindful to expect the unexpected, the list of potential concerns is perhaps unlimited. The list includes such things as flaring geopolitical tensions, higher interest rates, slower-than-expected economic and earnings growth, slowing in the pace of the housing recovery and deflation, to name just a few. Fundamentally, U.S. profit margins are near 50-year peak levels, partially the result of lean cost structures and low wage growth. In fact, the ability of companies to prosper in a tough economic environment has been a key characteristic of the current economic cycle. Looking further into 2014, as long as interest rates remain relatively low and earnings hold up, it seems plausible for margins to hold up as well. We do expect increased volatility in 2014 and some of these concerns or issues could be the driving force behind future price swings. Source: Strategas Research Partners U.S. profit margins are elevated Favored sectors and companies: We continue to favor cyclical sectors and companies that tend to benefit from economic growth. U.S. economic growth is solidifying and broadening, and the prospects for growth outside of the United States are slowly 9% 8% 7% improving. When we look at sectors that may be well positioned for favorable performance in 2014, our 6% bias is for cyclical sectors and companies that have an international footprint and tend to do well in a slow growth, low interest rate, low inflation economy such as industrials, technology, financials, and select 5% 4% consumer discretionary and health care companies We also like companies with increasing cash levels. Source: The Bank Credit Analyst, uary 2014 Companies with high cash flow and strong balance sheets present investors with both dividend growth and price appreciation potential. Important disclosures provided on page 6. Page 5 Operating profits (% of sales)

6 Conclusion We continue to believe equities will trend higher in 2014, although at more moderate levels compared to. In our view, 2014 is likely to be a transition year, driven more by earnings and earnings growth than by Fed-driven policies designed to keep interest rates low and P/E multiple expansion. We continue to believe the following longer-term drivers for higher equity prices remain in place: Valuation, while elevated, remains fair and not at extremes Sentiment is generally favorable Inflation is low, which justifies P/E ratios at or near current levels Potential 2014 forecast surprises include such things as: Stronger-than-expected economic growth, resulting in wage pressures squeezing profit margins and stoking inflationary fears Slower-than-expected economic growth hampering earnings growth Slowing in the rate of growth in Europe and emerging markets Flaring global tensions Our current 2014 price target for the S&P 500 is 1960, based on a P/E multiple of 16.5 times our earnings estimate of $119. A modest expansion of the multiple would imply some upside to our published price target. Contributed by: Terry D. Sandven Chief Equity Strategist 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 uary 24, 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 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. 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 U.S. Bank N.A. (1/14) Page 6