Global Market Snapshot

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Charity Maxwell
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1 July 2018 Global Market Sapshot INVESTMENT STRATEGY Key Market/Ecoomic Observatios Uited States Trade War Risks Resurface; Recovery Turs Nie Trade war risks escalated i Jue, whe Presidet Doald Trump proposed a additioal 10% tariff o $200 billio of imports should Chia refuse to chage its practices. These tariffs are targeted toward patetad techology-sesitive idustries. This aoucemet came i respose to Chia s retaliatio agaist the aoucemet by the Uited States earlier i the sprig of a 25% tariff o $50 billio of imports from Chia. The first wave of tariffs, to be imposed o $34 billio of Chiese goods, is scheduled to take effect o July 6. The situatio cotiues to seem quite fluid, however. As secod-quarter earigs seaso begis, U.S. compaies are likely to address ay trade cocers o their earigs coferece calls. It remais to be see if ad how their outlooks will shift. To date, we have ot see a material impact o earigs expectatios. I terms of quatifyig the impact, eve icludig the potetial for a additioal 10% tariff o $200 billio worth of Chiese goods, the effect o U.S. GDP would be maageable estimated by ecoomists to be about 0.2%. Therefore, we believe the market will be most cocered with sigs of ay further deterioratio i trade egotiatios, as well as certai idirect effects related to busiess cofidece, a stroger dollar, ad supply chai disruptios that could egatively affect U.S. exporters that use imported parts. 1 Despite the headlies, the fudametal backdrop remais soud, i our view. Secodquarter ecoomic growth is poised to reboud from the seasoally slow first quarter. The Federal Reserve Bak of Atlata GDPNow forecasts 4.7% secod-quarter growth. PNC forecasts the expasio to cotiue, estimatig ecoomic growth of 3.0% for all of 2018, up from 2.3% last year. Third-quarter earigs seaso commeces i July, with aalysts curretly forecastig 19.0% growth for the S&P 500 versus the comparable quarter a year earlier. If realized, this will be the secod highest quarterly growth rate sice The strogest quarter for that time frame was i first-quarter 2018, whe earigs grew 24.7%. Eergy is expected to have the fastest growth by sector, followed by Materials, Iformatio Techology, ad Fiacials. Reveues are estimated to grow by 9.5%. The short-term earigs boost from tax reform will likely ease i comig quarters. However, aalysts are still projectig doubledigit earigs growth for the third ad fourth quarters. Curretly the Street is estimatig just uder 20% growth for It is early impossible to determie the precise impact issues like trade have o the market. However, we thik it is safe to say that such variables have govered 2018 performace, ad the ucertaity they geerate is ulikely to subside by year ed. This backdrop, coupled with the presumptio of risig iflatio ad tighter moetary policy, is ot typically associated with expadig market multiples. Therefore, we thik earigs growth is likely to be the most critical driver of equity market returs. 1 Tariff Wars The Phatom Meace (Corerstoe Macro Research, Jue 21, 2018).

2 Europe As Europea Cetral Bak (ECB) Moves to Normalize Policy, Politics ad Ecoomics Cotiue to Cloud the Outlook The Europea ecoomy, broadly, cotiues to expad, but coditios remai less tha impressive. Leadig idicators cotiue to cofirm that growth o the cotiet is stable, but slowig: The IHS Markit Eurozoe Maufacturig PMI dropped to 55.0 i Jue. This is still above historical averages, but it s sigificatly dow from the 60.6 readig at the ed of last year. U.S. tariffs o Europea metal exports wet ito effect at the begiig of Jue. Though there was o major market fallout, as most aalysts cotiue to assume a trade war will be avoided, the Europea Uio affirmed it would retaliate with its ow set of tariffs. The roughly $3 billio worth of U.S. goods (about half the amout of the U.S. tariffs o the Europea Uio) mostly target America agricultural goods. The Europea Uio also filed a suit with the World Trade Orgaizatio. After avoidig a bit of a crisis (see the Jue 2018 Global Market Sapshot), Italia lawmakers affirmed the coutry s commitmet to the euro ad the Eurozoe, which further supported markets. But, Europea markets have ot yet fully recovered from the fallout. The 10-year yield o Italia bods has come dow from its highs, but remais 107 basis poits above its recet lows (as of Jue 28, it was 2.79%). Yields o other Eurozoe coutries debt are similarly dow from their highs, but remai above their precrisis lows. Italy is ot the oly coutry facig political istability: After Prime Miister (PM) Mariao Rajoy lost a vote of o cofidece, the Spaish parliamet replaced him with Socialist Pedro Sachez. Perhaps to avoid the same volatility experieced by Italy, the ew PM immediately took steps voicig his support for the Eurozoe. The ECB aouced at its Jue meetig that it iteds to ed its quatitative easig program by the ed of the year; however, bod reivestig will cotiue. Surprisig ivestors, the cetral bak stated that it iteds to maitai curret rates through the summer of 2019, at least. This dovish surprise led to a weakeig of the euro/dollars, with iterest rate differetials betwee the two regios cotiuig to wide. Japa Abeomics Leadig to Diverget Moetary Policy ad Equity Valuatios Ogoig trade tesios betwee Chia ad the Uited States have give ivestors reaso to questio the global ecoomic growth outlook. Export heavy ecoomies, like Japa, ofte serve as idicators of how cosumers ad compaies are reactig to the ucertaity. Thus far Japaese export growth has bee resistat to the trade war rhetoric, risig 8.1% year over year i May (latest data available), outpacig the expectatio of 7.5%. The directio of moetary policy from the Bak of Japa (BOJ) cotiues to diverge from its U.S. ad Eurozoe couterparts. At its Jue meetig, the BOJ maitaied its short-term policy rate of -0.1%; the 10-year govermet bod yield target of 0%; ad Japaese Govermet Bod, exchage-traded fud, ad real estate ivestmet trust asset purchasig programs. I Jue the BOJ also dowgraded its assessmet of iflatio to a rage of 0.5% to 1%, margially lower tha first-quarter iflatio ad well off Goveror Haruhiko Kuroda s target of 2.0%. With few, if ay, moetary policy actios left to employ, we expect the highly accommodative moetary policy to remai i place through 2019 ad possibly loger. Irrespective of egative iterest rates ad hyperaccommodative moetary policy, the ye has margially appreciated versus the dollar 2

3 year to date, likely beefitig from safe-have iflows i respose to risig geopolitical risks. We would expect the ye to weake relative to major currecy pairs (the dollar ad the euro) due to wideig iterest rate differetials ad a arrowig curret accout. Despite less-tha-favorable ecoomic coditios ad demographic challeges such as a agig populatio, valuatios of Japaese equities remai favorable relative to other major developed markets. As of Jue 25, 32% of the compaies i the Nikkei 225 were tradig at price-to-book ratios less tha oe; however, oly 14% ad 4% of compaies i the STOXX Europe 600 ad S&P 500, respectively, were tradig at discouts to book value. Emergig Markets Ecouragig Survey Data Trumped by Geopolitics Emergig market (EM) equities had aother difficult moth i Jue. As of Jue 28, EM equities have give back almost all of their relative performace advatage versus U.S. equities after returig over 37% i Sice the ed of 2016, EM equities are up 25.8%; durig the same time period, U.S. equities are up 25.3% ad developed iteratioal equities are up 23.2%. While the arrative surroudig tariffs is primarily focused o Asia coutries, Lati America equities have struggled from both trade headwids ad geopolitical risks. Argetia, for example, was recetly loaed $50 billio by the Iteratioal Moetary Fud, its largest loa i history, as the Argetie peso is at its weakest level relative to the dollar o record. Although Chia is somewhat limited i terms of its ability to retaliate with additioal tariffs give the amout they import from the Uited States, other possible resposes iclude makig it more difficult for U.S. compaies to do busiess i Chia ad weakeig the yua/dollar to support Chiese exporters. Yua weakess is a immediate threat to other EM currecies, ad further EM currecy weakess would be a immediate egative for both stocks ad bods i that asset class. If the dollar cotiues to appreciate versus EM currecies, EM debt stress will likely mout it is harder to service debt deomiated i dollars whe your local currecy is depreciatig. Over the last 20-plus years, EM compaies have dramatically icreased their issuace of foreigcurrecy-deomiated debt. We should temper this short-term cocer with a loger-term perspective. Over the past decade, U.S. equities have dramatically outperformed EMs. For cotext, the S&P 500 has a cumulative total retur over the past 10 years of 164%, while dollar-deomiated EM has retured 29%. We believe this performace divergece will ultimately reverse, makig EM a attractive log-term allocatio. Eergy Eergy Outperformace Cotiues o Improved Earigs Outlook, Higher Crude Prices Eergy stocks took a breath this moth, fearig OPEC would agree to materially icrease output at its Jue meetig. To date, the Eergy sector cotiues to outpace the S&P 500 by about 3.5%. OPEC reached a agreemet i priciple to boost oil productio, i a move aimed at offsettig productio declies i Ira ad Veezuela. The prelimiary agreemet calls for a additioal 600,000 barrels per day i productio, which equates to approximately 0.5% of global supply. The agreed-upo productio icrease was smaller tha the market feared, ad additioal commets from Presidet Trump discouragig our allies from purchasig Iraia oil led to a icrease i West Texas Itermediate crude from below $65 per barrel to over $70. Eergy stocks gaied more tha 3% after the OPEC meetig. 3

4 We believe that if oil prices remai at or ear curret levels, Eergy stocks will cotiue to beefit without a material drag o U.S. ecoomic growth. Permia oil productio ow exceeds takeaway capacity from midstream pipelies. As a result, geographic pricig differetials have wideed substatially, with o additioal pipelie capacity expected to come olie util secod-half Higher differetials are likely to spur productio i other basis as the cost of trasportatio i the Permia icreases, both of which are a positive for midstream pipelies. Strategy Views Do Curret U.S. Debt Levels Pose a Risk to the Ecoomic/Market Expasio? Risig debt levels seem to be a permaet fixture o the list of thigs to worry about. I 1972, a TIME magazie cover was titled Is the U.S. Goig Broke? Throughout recet history, oe ca fid coutless examples of similarly worded, debt-fueled axieties. With little exceptio, lower levels of leverage provide for a more stable system, but are we curretly o the brik of a debt-drive crisis? We do t believe so. Govermet The Cogressioal Budget Office believes the U.S. budget deficit will reach $1 trillio, or 4.6% of GDP, by Overall debt levels cotiue to rise, ad curretly sit at over 100% of GDP. With tax cuts ad additioal fiscal spedig servig as the ewest ad most visible strai o U.S. govermet fiaces, it is oly atural for ivestors to cosider how this may affect fiacial markets, ad i tur, their portfolios. Let us first keep i mid that we have bee here before. The Uited States has t ru a budget surplus sice 2001, ad from 2009 to 2012 the deficit exceeded the curret 2020 forecast. While ot a reaso to celebrate, it does uderlie the poit that perhaps we are ot sailig ito completely ucharted waters. This also eables us to use history as a Chart 1 Stocks Have Advaced Amid Risig U.S. Debt (As of 12/31/16) Aualized Percetage Chage ( ) % Source: Pesioparters.com 9.70% US Natioal Debt S&P 500 guide i terms of aalyzig market behavior i similar eviromets. Sice 1966, the U.S. atioal debt has rise i every caledar year. Through every admiistratio, Democrat ad Republica alike, the oe costat has bee more debt from $320 billio i 1966 to early $20 trillio today. With a curret budget deficit orth of $600 billio, the atioal debt cotiues to mout. Just 10 years ago, atioal debt as a percetage of GDP was 62%. As metioed above, today this ratio is over 100%. How have markets historically reacted to periods of risig debt? I reality, it is hard to idetify ay discerable patter. As the U.S. atioal debt icreased 8.4% aually sice the mid-1960s, the stock market rose 9.7% each year, o average (Chart 1). What about risig debt-to-gdp ratios? Surely this measure is a better idicatio of how markets react to icreasig fiscal stress? Agai, history would prove otherwise. From 1982 to 2016, this ratio moved from 32% to 105%. Over the same time period, the S&P 500 gaied 11.7% per year. 2 There will likely be a breakig poit, but it is hard to kow precisely whe. Accordig to a study coducted by Moody s i 2015, the Uited States remais i the fiscal safe zoe (Chart 2, page 5). 2 Bilello, Charlie. Should Ivestors Fear Risig Natioal Debt? July 12, 2017, pesioparters.com/should-ivestors-fear-risig-atioal-debt/. 4

5 Chart 2 U.S. Likely Still Safe As of 12/31/15 Japa Italy Greece Portugal Irelad Spai Frace Uited Kigdom Caada Uited States Germay Filad Swede Israel Switzerlad Australia Hog Kog South Korea Norway There is o questio that risig atioal debt is a valid cocer, ad if left completely uchecked it will probably have a egative impact o the ecoomy. However, it is hard to fid a clear relatioship betwee risig debt ad market performace, ad timig the exact momet whe the atioal debt matters is likely a fool s errad. There are coutless risks i every market eviromet, ad to protect our portfolios from the volatility associated with those risks (risig debt levels icluded), the best medicie is likely good old-fashioed diversificatio. What about other areas of the ecoomy? Could they be the bigger risk from a debt perspective? Household Safe (> 124) Cautious (70-124) At Risk (<70) Distace to Debt Limit (as Measured by Debt-to-GDP Ratio) Source: Moody s Ivestors Service, Ic. Debt i the household sector has actually falle sice the fiacial crisis, which is uusual durig a ecoomic expasio. Iterest coverage ratios are similar to levels see i the early 1980s ad 1990s, ad household assets are about seve times larger tha total liabilities. Loa deliquecy rates i the household sector remai at multi-decade lows ad household debt relative to et worth has retured to levels last see i Eve studet loa default rates (a highly publicized issue) are fallig. It is hard to argue that the curret cycle is at risk from household sector debt. 3 Corporate The corporate debt backdrop paits a similar picture. First, debt-to-gdp ratios for corporatios fail to accurately measure a compay s ability to cover debt expeses, leavig out thigs like foreig sales, structurally higher profit margis, ad sigificatly higher corporate cash levels. S&P 500 compaies ca cover iterest costs by seve times give the curret level of earigs. This is a more comfortable margi tha ay time durig the 1990s or 2000s. Also, deliquecy rates, at 1.1%, are curretly at the lowest level of the past three ecoomic expasios. Agai, i the ear term, there are o sigs that compaies are goig to have issues meetig their debt obligatios. 4 Jeffrey D. Mills Hawthor Chief Ivestmet Strategist Daiel J. Brady Ivestmet & Portfolio Strategist Erik Casaliuovo, CFA Seior Ivestmet Strategist Marsella Martio Seior Ivestmet Strategist Michael Zoller Ivestmet Strategist 3 Time to Not Freak Out About Debt Agai, The Fat Pitch (blog), Jue 11, 2018, 4 Ibid. 5

6 Hawthor Asset Allocatio Playbook As of: 6/1/2018 Asset Class Equities U.S. No-U.S. Sub Asset Class Large Cap Mid Cap Small Cap Itl. Large/Mid Cap Itl. Small Cap Emergig Markets Fixed Icome Short Mui Fixed Icome Core Mui Fixed Icome U.S. U.S. High Yield U.S. Leveraged Loas U.S. TIPS Global Bod Ucostraied Bod No-U.S. Emergig Market Bod Alteratives Private Hedge Fuds Cash Private Real Estate Private Debt Private Equity Equity Log/Short Evet Drive Relative Value Directioal Favorability - Neutral + Poits of View Relative valuatio causes us to arrowly favor large over small. Small Caps have outperformed year to date as ivestor cocers related to trade ad, more recetly, a stroger dollar have drive them to seek protectio from less exposed small cap stocks. Smaller compaies may also beefit from positive tax reform related forward guidace, however, valuatios remai quite expesive at 22.5 times o a forward earigs basis. 30% of small cap idexes like the Russell 2000 still have o earigs, so be selective whe ivestig i the asset class. Valuatios appear relatively more attractive versus domestic equities, potetially creatig attractive log-term opportuities i may iteratioal markets. Still largely accommodative moetary policy by global cetral baks ad solid earigs mometum should also provide additioal support. However, political risk is agai elevated ad ecoomic mometum has weakeed versus what we are seeig i the Uited States. Although we like emergig market (EM) for the log term give curret valuatios, we believe the rally to be overexteded. The shorter-term bear case for EM equities rests maily o tighteig i Chia, as well as the ewfoud stregth i the dollar. Year to date, EM has uderperformed both developed iteratioal ad U.S. markets. Although iterest rates may drift higher give solid ecoomic mometum, we believe we may have already see the bulk of the move higher i rates for this busiess cycle. Therefore, we favor positioig fixed icome portfolios i the itermediate part of the curve. The credit cycle is agig, ad valuatios should become a icreasig headwid for below-ivestmet-grade bods. Leveraged loas, although more seior i the capital structure, have see issuace balloo i recet years while coveats have weakeed. Give our view o iterest rates, credit risk may be startig to outweigh the protectio from higher rates. Less value i TIPS with breakeve iflatio rates ow aroud 2.20%. We prefer to hedge iflatio over the log-term via our equity exposure. Although we are ot overly egative o credit give the stregth of the ecoomy, we do believe slowly shiftig to higher-quality areas of fixed icome is sesible give the level of spreads. Ucostraied fuds have reached for yield i lower-rated credits. Key drivers iclude a still relatively costraied supply backdrop, modest leverage levels, ad the fact that capital flows ito the asset class are becomig icreasigly global (that is, ivestor demad is quite robust). Middle-market ledig i the corporate sector is still quite costraied, cotiuig to create opportuities for private debt ivestors. Some bakig deregulatio may ope this space up to more traditioal bak ledig, however. Opportuity i ew/less efficiet markets, ad a more diverse ivestable opportuity set; for example via secodaries ad co ivestmet optios. That said, as with public markets, valuatios are exteeded. A trasitio from a primarily macro-drive market eviromet to a more fudametally drive oe will be positive for these alphageeratig strategies. Cetral baks ow appear more committed to a steady ormalizatio of iterest rates tha they have bee i years past. We believe differetiated retur streams ca add value i today s market versus a tradtioal equity/bod portfolio. 6

7 Tactical Allocatios Tactical Master Limited Parterships Ifrastructure Currecy Hedged Europe Currecy Hedged Japa Eergy U.S. Baks Structured Note (Drawdow) Performace has suffered after a strog start to the year. Markets pealized the sector after a potetially ufavorable tax rulig, however we believe the overall impact will be small. Stroger fudametals ad risig eergy prices could spur ivestor iterest give curretly depressed valuatios ad uderweight eergy positioig amog equity portfolio maagers. Defesive qualities ad icome potetial that we like i this market. Stable ecoomic coditios, improvig earigs growth, ad relatively attractive valuatios put Europea equities i a good positio despite recet political volatility. The currecy hedge has bee additive to 2018 performace. Valuatios are attractive, earigs growth is strog, ad cosumer cofidece is high. We still like the currecy hedge as the BOJ remais easy relative to the Fed ad ye positioig (ow et log) is o loger supportive of a move higher. With higher ad more stable oil prices, better capital disciplie, ad attractive relative valuatios, we believe Eergy sector equities ca outperform the broad market o a tactical basis. We thik valuatios, the regulatory backdrop, ad the cotiuatio of this busiess cycle are compellig reasos to tilt toward U.S. baks withi value allocatios. Baks are historically correlated with icreases i cap ex which we believe will cotiue this year. Ability to ear a coupo while waitig for a more attractive etry poit ito equities ca be a attractive strategy. However, cash has become more palatable give the rise i short-term iterest rates. The PNC Fiacial Services Group, Ic. ( PNC ) uses the marketig ame Hawthor, PNC Family Wealth to provide ivestmet, wealth maagemet, ad fiduciary services through its subsidiary, PNC Bak, Natioal Associatio ( PNC Bak ), which is a Member FDIC, ad to provide specific fiduciary ad agecy services through its subsidiary, PNC Delaware Trust Compay or PNC Ohio Trust Compay. Stadaloe custody, escrow, ad directed trustee services; FDIC-isured bakig products ad services; ad ledig of fuds are also provided through PNC Bak. This report is furished for the use of PNC ad its cliets ad does ot costitute the provisio of ivestmet advice to ay perso. It is ot prepared with respect to the specific ivestmet objectives, fiacial situatio, or particular eeds of ay specific perso. Use of this report is depedet upo the judgmet ad aalysis applied by duly authorized ivestmet persoel who cosider a cliet s idividual accout circumstaces. Persos readig this report should cosult with their PNC accout represetative regardig the appropriateess of ivestig i ay securities or adoptig ay ivestmet strategies discussed or recommeded i this report ad should uderstad that statemets regardig future prospects may ot be realized. The iformatio cotaied i this report was obtaied from sources deemed reliable. Such iformatio is ot guarateed as to its accuracy, timeliess, or completeess by PNC. The iformatio cotaied i this report ad the opiios expressed herei are subject to chage without otice. Past performace is o guaratee of future results. Neither the iformatio i this report or ay opiio expressed herei costitutes a offer to buy or sell, or a recommedatio to buy or sell, ay security or fiacial istrumet. Accouts maaged by PNC ad its affiliates may take positios from time to time i securities recommeded ad followed by PNC affiliates. PNC does ot provide legal, tax, or accoutig advice uless, with respect to tax advice, PNC Bak has etered ito a writte tax services agreemet. PNC does ot provide services i ay jurisdictio i which it is ot authorized to coduct busiess. PNC Bak is ot registered as a muicipal advisor uder the Dodd- Frak Wall Street Reform ad Cosumer Protectio Act ( Act ). Ivestmet maagemet ad related products ad services provided to a muicipal etity or obligated perso regardig proceeds of muicipal securities (as such terms are defied i the Act) will be provided by PNC Capital Advisors. Securities are ot bak deposits, or are they backed or guarateed by PNC or ay of its affiliates, ad are ot issued by, isured by, guarateed by, or obligatios of the FDIC, the Federal Reserve Board, or ay govermet agecy. Securities ivolve ivestmet risks, icludig possible loss of pricipal. Hawthor, PNC Family Wealth is a registered service mark of The PNC Fiacial Services Group, Ic The PNC Fiacial Services Group, Ic. All rights reserved. 7

Global Market Snapshot

Global Market Snapshot December 2018 Global Market Sapshot INVESTMENT STRATEGY Key Market/Ecoomic Observatios Uited States Earigs Growth ad Iterest Rates Reach New Highs; Markets Tur Focus to Future Growth ad Federal Reserve