INVESTMENT. Overview. La Dolce Vita in Pictures INVESTMENT. Economic & Market QU ARTERLY. Economic & Market $300. Overview.

Transcription

1 Both equities (particularly equities) and fixed income experienced growth over the past 10 years. Bonds and stocks both delivered real returns to investors over the period as returns for both asset classes exceeded the rate of inflation. A N A F F I L I AT E O F B A N K E R S T R U S T C O M PA N Y Growth of $100 Investment Over Last 10 Years $300 Bonds Stocks Inflation FIRST QUARTER 2018 International Stocks $251 $2 contributed by Jon Augustine, CFA, Chief Investment Officer $200 $172 $143 $1 Since the equity markets bottomed nine years ago, registering what has been referred to as a generational low, investors have enjoyed a highly rewarding and relatively calm investment environment. Looking exclusively at domestic markets, stocks and bonds have both been rewarding for investors as equities have returned 9.6% annually over the past 10 years while investment-grade bonds have delivered 3.6% over the same period. Making these returns even more impressive is the acknowledgment that this 10-year period includes the significant downdraft in asset prices associated with the financial crisis in Foreign equities delivered a more modest return of 2.7% over the 10-year period but all three asset classes easily surpassed the 1.5% annualized rate of inflation. A term that could be used to describe this period of relative investor bliss is la dolce vita, an Italian phrase that translates into the sweet life. $117 $100 $ Indices: Bonds (Bloomberg Agg Bond), Stocks (Russell 3000 ), Inflation (US CPI Urban), International Stocks (MSCI ACWI Ex ) Modest volatility characterized the last decade, particularly from the generational low in March 2009 to the end of Fixed income volatility was even more subdued than the equity markets with low to moderate interest rate levels prevailing over the entire 10-year span. Intra-year declines in equity prices are not unusual. Since 1980, the average intra-year decline has been 14%. As illustrated, the low equity market volatility was particularly pronounced in 2017, a year when no month had a negative total return. However, intra-year declines in equity prices are not unusual. Since 1980, the average intra-year decline has been 14%. Stock and Bond Market Price Movements MOVE Index (Bond Price Volatility) Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 0 Mar-18 MOVE Index Values (Bonds) Bringing the Investment Expertise of BTC Capital Management Directly to You VIX Index Values (Stocks) 80 VIX Index (Stock Price Volatility) The first quarter of 2018 brought investors a less hospitable environment, one with rising interest rates, declining stock prices and heightened volatility. The period was also impacted by the increased use of tariffs in regard to global trade policy, privacy concerns regarding social media platforms and technology companies, and a presidential administration in the that continues to undergo a high level of personnel turnover in some of its highest-level positions. Economic Outlook Despite the environmental shift in financial markets, one thing that hasn t materially changed over the past several months is the growth outlook for the domestic and global economies. At the beginning of 2018, we established a range of expected real GDP ISSUE TOPICS Equity The Race Is Not to the Swift Fixed Income Providing somewhat of an offset to the positive impact of American tax law changes is the increased utilization of tariffs. The concern regarding tariffs is the potential for them to escalate into a full-fledged trade war. Currently a large-scale escalation is not expected but the potential for it certainly bears monitoring. The other economic variable that we are watching closely is the rate of inflation. While inflation is anticipated to move higher this year, we continue to feel the pace of growth will be modest. If labor markets tighten further and lead to more rapid wage growth, the inflation pace may quicken and lead us to alter our outlook. Conclusion While the investment environment throughout the remainder of 2018 will most likely not be a continuation of la dolce vita, we are, at this juncture, not ready to capitulate to a return scenario that precludes investors from meeting their long-term investment objectives. With the heightened volatility seen in the first quarter and anticipated to be more visible throughout the remainder of 2018, investors will find their resolve periodically tested and should use this environment to validate the appropriateness of their stated investment objectives and levels of risk tolerance. Asset Allocation growth of % for the year, and we are still comfortable with that estimate. We do expect, however, that given recent economic data, the end result for the year will most likely be at the upper end of the range. In January, the International Monetary Fund increased its estimate of global economic growth to 3.7%. Driving their outlook is the stimulus anticipated by recently enacted changes to American tax policy as well as a continuation of the economic momentum that manifested itself during Quarterly Highlight CONTACT US QU ARTERLY 453 7th Street Des Moines, IA Scott Eltjes CFA, FLMI CEO and President (515) Brian Rolland CPA, CMA, CTP (319) Dave Jackson (515) May lose value No bank guarantee

2 Asset Allocation contributed by Mark Mandziara, Sr. Managing Director We entered 2018 with most strategists and investors anticipating a continuation of In our commentary from the fourth quarter of 2017, we opined, it seems as though sentiment is quite high in light of the current market narrative of coordinated global growth. While we expressed our conviction to overweight risk-based assets, we communicated our expectation for both political events and market volatility to be two key themes that would result in unexpected surprises [that] will shake out a little of the euphoria at some point during the year. This seems to have taken place during this past quarter. Cash appeared to be the safe haven during the first quarter as both bonds and equities faltered. Investment-grade bonds declined 1.46% as the Federal Reserve (Fed) followed through with its plans to raise interest rates while reducing the size of its balance sheet. A result was the rise in yields across the maturity spectrum. As Justin Carley points out in our Fixed Income, corporate bonds weakened in the face of widening spreads. Global equities followed a similar pattern as domestic equities declined 0.64% while foreign equities fell 1.18%. Thematic concerns, primarily those involving politics versus underlying fundamentals, influenced a risk-off event which pushed broad equity valuations lower. Volatility, as anticipated, increased during the quarter, spiking during the latter part of the quarter. markets the MSCI ACWI ex USA Growth Index declined 1.03% versus its value component s decline of 1.49%. In a similar vein, the performance of our asset allocation models reflected this same pattern. Those allocations that emphasize equities outperformed those that include, or are limited to, fixed income. Additionally, our emphasis of growth over value within large-caps mitigated overall downside participation within portfolios employing this conviction. Going Forward We mention throughout this edition our anticipation of a continuation of those macro events that support our conviction toward risk-based assets. Justin mentions in our Fixed Income the Fed s intent to raise interest rates. While investors may anticipate this to mean a rise in interest rates across the yield curve, the impact of Fed policy may be restrained to the short end of the curve. As Justin mentions, institutional and individual investors may seek yield, which implies a focus on intermediate- and longer-term maturities. A result would be a flattening of the overall yield curve as short-term rates move higher while intermediate- and longterm rates endure, supported by investor sentiment. Outside the, central banks have continued to maintain their rate structure. While each may not be expanding their quantitative easing programs, their sustainment of a low interest rate environment coupled with a high degree of liquidity should support continued emphasis on risk-based assets. Within equities, the macro environment over the remainder of this year appears positive. As Kuuku Opoku Saah points out in our Equity, the recent drawdown in equity valuations may provide opportunity going forward. Analyst estimates of earnings for both domestic and foreign equities are very optimistic. Analyst revisions remain positive, especially in certain economic regions outside the A key factor in this outlook is that analyst estimates for growth in corporate revenues appear stronger than those seen in recent years. Domestically, corporate revenues are projected to exceed that of 2017 and almost double the year-over-year average exhibited since the financial crisis in Outside the, corporate revenues are expected to grow at a rate far above that seen since Risk-Aware Positioning We did not make any changes to our targeted allocations during the first quarter. As Jon Augustine mentions in our, the fluidity of economic and political events is ever before us. We continue to evaluate the potential impact of these events within our risk-aware asset allocation framework and stand ready to initiate change, as necessary or desirable. Emerging markets continued their leadership, rising 1.42% during the quarter. This asset class was promoted by a continuing decline in the dollar, which closed the quarter down 2.33%. One thematic aspect that continues to capture relative return is growth versus value. This style-orientation play has been evident in both domestic and foreign equity markets. Specifically within domestic markets, the Russell 3000 Growth Index exhibited positive returns of 1.41% for the quarter versus a decline of 2.83% for its value component. Conversely, within foreign Asset Allocation Positioning (as of 3/31/18) Income Conservative Moderate Aggressive Growth Growth Growth Growth Cash Equivalents Over Over Over Over Over Total Fixed Income Under Under Under Under N/A Core Bonds Under Under Under Under N/A High-Yield Bonds Neutral Neutral Neutral Neutral N/A Total Equities N/A Over Over Over Neutral Large / Mid-Cap N/A Neutral Neutral Neutral Neutral Small-Cap N/A Neutral Neutral Neutral Neutral Total Foreign Equities N/A Neutral Neutral Neutral Neutral Developed Market N/A Neutral Neutral Neutral Neutral Emerging Market N/A Neutral Neutral Neutral Neutral

3 Equity contributed by Kuuku Opoku Saah, CFA, Investment Analyst The Race Is Not to the Swift 2017 was a great year for equity markets. A lot of investors came into 2018 expecting returns similar to what we saw in That happened for the first 26 days of the year. were up over 7%. Nothing could go wrong In his last quarter, Jon Augustine discussed specific risks that could cause the positive outlook for this year to be adjusted. He highlighted the impact of politics on equity markets, as well as the expectation of increased volatility in I discussed the potential for inflation to rise faster than expected due to wage growth in that same issue. Additionally we saw over the past three months some of these risks reared their ugly heads impacting returns for the first quarter of The first major market downturn, which happened after the January 26 high, saw the broad equity market lose roughly 10% of its value. The drop was partly attributed to fears about inflation which were precipitated by a better than expected increase in wage growth. Conditions had been so good, it seemed like the market was looking for an excuse to raise the anxiety levels of investors. We will give credit for the second downturn, which started on March 9, to politics and, to a lesser extent, privacy concerns. reacted negatively to rhetoric about the placing tariffs on certain imports. The European Union reacted by considering increasing taxes on large tech companies. China reacted by threatening additional tariffs on exports from the heartland. The tech sector was again hit after concerns were raised about thirdparty access to data from social networking companies and the potential impact of these fears on business strategy and earnings. As of the end of March, global equity markets were down 0.96% for the year. Outlook Looking at a half-full glass, we re more constructive to equities given market valuations after the downturns in the first quarter. The forward P/E for the S&P 0 went from 20x in December 2017 to 16x currently. Though prices are down for the index, earnings growth expectations are still high. Earnings are expected to grow by 16.34% for the first quarter. This is on top of last season s earnings growth of 14.40%. The equity sub-classes expected to see the fastest earnings growth are small-caps and emerging markets. The MSCI Emerging Index forward P/E was at 12x at the end of the quarter. Valuation levels for emerging markets are looking very attractive as we can see in the chart to the below. Investing for the future is a marathon, not a sprint. Short-term overreaction to transitory market forces is a sure way to erode longterm gains. We continue to take a long-term approach when investing in equity markets. Large-Caps Small-Caps Developed Emerging P/E Ratio Our major concerns for equity markets revolve around stagnating global growth, inflation, and a trade war. Slowing global economic growth may be the single biggest impact on revenue and earnings growth. Inflation continues to stay below the Federal Reserve s targeted 2% level. There are concerns that inflation could shoot up, transferring money from investors to debtors, which would be bad for equity markets. The talk about import tariffs could devolve into an all-out trade war which could eliminate gains seen from recent tax cuts. Our equity outlook for the coming quarter is positive. The current economic climate should continue to be beneficial to equity markets. We remain in a stimulatory environment with easy fiscal policy tax cuts and the potential for increased infrastructural spending with interest rates still being historically low after considering the discussed three to four Fed increases this year. Forward P/E Ratio Value Core Growth Value Core Growth Proxies Russell 1000 US Large Core, Russell 1000 Value US Large Value, Russell 1000 Growth US Large Growth, Russell 2000 US Small Core, Russell 2000 Value US Small Value, Russell 2000 Growth US Small Growth, MSCI EAFE Developed Core, MSCI EAFE Value Developed Value, MSCI EAFE Growth Developed Growth, MSCI Emerging Emerging Core. Source - Bloomberg Large-Caps Small-Caps Developed Emerging Disclosures: The information provided within this document is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Information has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized. This commentary contains no investment recommendations, and you should not interpret the statements in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.

4 Fixed Income contributed by Justin Carley, CFA, Managing Director Interest rates moved higher during the first quarter of the year. Much of the move occurred in January when equity markets were surging. There was some modest improvement in bond prices in the second half of the quarter with economic data surprising to the downside and equities sliding, but it could not overcome the large losses in January. In the end, both the Bloomberg Barclays Treasury Index and the Russell 3000 Index generated negative returns for the quarter. It was the first time this had occurred since the second quarter of The last time both Treasuries and equities fell for two consecutive quarters was during the The Great Bond Market Massacre in Risk-Off Corporate bonds were the weakest link in the Bloomberg Barclays Aggregate Bond Index and were victims of the pullback in risk appetite over the last two months. This was the worst three-month performance for corporate bonds since the first quarter of Aside from the risk-off sentiment, there were two key factors that led to weakness. First, the recently passed tax legislation incentivized repatriation of cash held overseas by large companies. Much of this was held in short-term corporates. Large selling in this space pushed out spreads. Secondly, there was a fairly large pickup in longer-date corporate bond supply led by the $40 billion CVS Health deal. Confident Fed The Federal Reserve (Fed) increased the federal funds rate to 1.75% at its March meeting. The committee released more detailed forecasts on a quarterly basis, and this was once again the main point of focus for the markets. The median projection among the committee remains at three increases for calendar However, the expectation for rate hikes in 2019 and 2020 was adjusted higher. The Fed is forecasting a long-run federal funds rate of 3% to go along with inflation of 2%, or a 1% real rate. This continues to be the biggest discrepancy between the Fed and market participants. The market remains skeptical that 3% will be achieved, but more so that the economy will be able to sustain positive real rates given the elevated debt in the global financial system. Where and when inflation and real rates peak out this cycle remains one of the biggest factors to impact returns across all asset classes as the current business cycle approaches the longest on record. 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Real Fed Funds Rate (Fed Funds - Core PCE YoY) Staying the Course For the quarter, the Bloomberg Barclays Aggregate Index declined 1.46%. As noted above, Treasuries fared the best while corporate bonds underperformed. We don t foresee an imminent increase in yields as global growth is becoming increasingly less synchronized and risk assets face elevated volatility and drawdowns. We remain overweight corporate bonds on the expectation that global institutional accounts will seek out yield unless earnings visibility becomes a clear headwind. Currently the earnings backdrop is quite robust. Favorable to this thesis is the fact that high-yield bonds are not faring any worse than investmentgrade bonds during the recent pullback. Also, BBB-rated corporate bonds are performing in line with or better than A-rated bonds, which is not indicative of a cyclical peak. 0.2% MARKET RETURNS (period ending 3/31/18) Equity Market Total Returns (%) Asset Class 3 Mo. 12 Mo. 3 Yr. 5 Yr. Global Equities Large-Cap Small-Cap Developed Emerging Bond Market Total Returns (%) Asset Class 3 Mo. 12 Mo. 3 Yr. 5 Yr. Investment-Grade Bonds Treasury Government Agency Credit Mortgage-Backed Corporate High-Yield Tax-Exempt Municipal Source: Morningstar Direct Source: Morningstar Direct

5 Both equities (particularly equities) and fixed income experienced growth over the past 10 years. Bonds and stocks both delivered real returns to investors over the period as returns for both asset classes exceeded the rate of inflation. A N A F F I L I AT E O F B A N K E R S T R U S T C O M PA N Y Growth of $100 Investment Over Last 10 Years $300 Bonds Stocks Inflation FIRST QUARTER 2018 International Stocks $251 $2 contributed by Jon Augustine, CFA, Chief Investment Officer $200 $172 $143 $1 Since the equity markets bottomed nine years ago, registering what has been referred to as a generational low, investors have enjoyed a highly rewarding and relatively calm investment environment. Looking exclusively at domestic markets, stocks and bonds have both been rewarding for investors as equities have returned 9.6% annually over the past 10 years while investment-grade bonds have delivered 3.6% over the same period. Making these returns even more impressive is the acknowledgment that this 10-year period includes the significant downdraft in asset prices associated with the financial crisis in Foreign equities delivered a more modest return of 2.7% over the 10-year period but all three asset classes easily surpassed the 1.5% annualized rate of inflation. A term that could be used to describe this period of relative investor bliss is la dolce vita, an Italian phrase that translates into the sweet life. $117 $100 $ Indices: Bonds (Bloomberg Agg Bond), Stocks (Russell 3000 ), Inflation (US CPI Urban), International Stocks (MSCI ACWI Ex ) Modest volatility characterized the last decade, particularly from the generational low in March 2009 to the end of Fixed income volatility was even more subdued than the equity markets with low to moderate interest rate levels prevailing over the entire 10-year span. Intra-year declines in equity prices are not unusual. Since 1980, the average intra-year decline has been 14%. As illustrated, the low equity market volatility was particularly pronounced in 2017, a year when no month had a negative total return. However, intra-year declines in equity prices are not unusual. Since 1980, the average intra-year decline has been 14%. Stock and Bond Market Price Movements MOVE Index (Bond Price Volatility) Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 0 Mar-18 MOVE Index Values (Bonds) Bringing the Investment Expertise of BTC Capital Management Directly to You VIX Index Values (Stocks) 80 VIX Index (Stock Price Volatility) The first quarter of 2018 brought investors a less hospitable environment, one with rising interest rates, declining stock prices and heightened volatility. The period was also impacted by the increased use of tariffs in regard to global trade policy, privacy concerns regarding social media platforms and technology companies, and a presidential administration in the that continues to undergo a high level of personnel turnover in some of its highest-level positions. Economic Outlook Despite the environmental shift in financial markets, one thing that hasn t materially changed over the past several months is the growth outlook for the domestic and global economies. At the beginning of 2018, we established a range of expected real GDP ISSUE TOPICS Equity The Race Is Not to the Swift Fixed Income Providing somewhat of an offset to the positive impact of American tax law changes is the increased utilization of tariffs. The concern regarding tariffs is the potential for them to escalate into a full-fledged trade war. Currently a large-scale escalation is not expected but the potential for it certainly bears monitoring. The other economic variable that we are watching closely is the rate of inflation. While inflation is anticipated to move higher this year, we continue to feel the pace of growth will be modest. If labor markets tighten further and lead to more rapid wage growth, the inflation pace may quicken and lead us to alter our outlook. Conclusion While the investment environment throughout the remainder of 2018 will most likely not be a continuation of la dolce vita, we are, at this juncture, not ready to capitulate to a return scenario that precludes investors from meeting their long-term investment objectives. With the heightened volatility seen in the first quarter and anticipated to be more visible throughout the remainder of 2018, investors will find their resolve periodically tested and should use this environment to validate the appropriateness of their stated investment objectives and levels of risk tolerance. Asset Allocation growth of % for the year, and we are still comfortable with that estimate. We do expect, however, that given recent economic data, the end result for the year will most likely be at the upper end of the range. In January, the International Monetary Fund increased its estimate of global economic growth to 3.7%. Driving their outlook is the stimulus anticipated by recently enacted changes to American tax policy as well as a continuation of the economic momentum that manifested itself during Quarterly Highlight CONTACT US QU ARTERLY 453 7th Street Des Moines, IA Scott Eltjes CFA, FLMI CEO and President (515) Brian Rolland CPA, CMA, CTP (319) Dave Jackson (515) May lose value No bank guarantee