Remix S&P EPS estimates by sector: Tech up, Energy down

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1 The Allocator September 8, 17 Remix S&P EPS estimates by sector: Tech up, Energy down David Bianco Chief Investment Strategist, Americas Deutsche Asset Management 17E S&P EPS still $131: Weaker dollar offsets weaker oil Our 17 S&P earnings per share (EPS) estimate was set with assumptions of 100 DXY, ~$55 oil, and ~2.5% 10yr US Treasury yield. However, WTI oil struggles to exceed $50 despite extended OC cuts and a weaker dollar. Also, Energy profits disappointed in 1H. Thus, we trim our 17E & 18E Energy earnings. Our 17E Financials earnings remain well supported, albeit some P&C loss and capital market uncertainty, but without Fed hikes and higher 10yr yields our 18E Financials earnings are at risk. On the upside, the weaker dollar is a tailwind to multinationals, especially Tech. We raise our 17E & 18E Tech earnings, which offset the cuts to Energy. Our 17E & 18E S&P EPS remains $131 & $140 without a U.S. corporate tax cut. Persistently low real yields support s, but next 5% move is likely down S&P price-to-earnings ratio () is ~% above history. Usually mid to late cycle s above history make the equity market more susceptible to negative shocks. But the S&P has shrugged off escalating tensions with North Korea, policy paralysis in D.C. and doubts on further Fed hikes. The S&P hasn t yet had a 5%+ pullback this year. Since 1960, only 3 years that the S&P didn t dip 5%+ from its 6-month high: 1964, 1993, and We think a 5%+ pullback is likely over the next 10 weeks upon greater doubts of a corporate tax cut and a December Fed hike. We think this threat is greatest at Value, Small Caps and Financials. We do not think that market valuations reflect a 0% chance of a corporate tax cut or that Banks are trading at a ~25% chance of a Dec Fed hike. Sep-Oct is a volatile time for markets as investors assess yearend upside, we think a pullback is required to provide attractive yearend upside. Weakening dollar hasn t helped oil price recovery, we remain bearish Energy Dollar has weakened by 11% from the 16 year end high. The still wide U.S.-Germany rate differential suggests there is little downside to the USD. A rising dollar will put more pressure on West Texas Intermediate (WTI) recovery. S&P Energy sector market cap is now $1.18tr. If we apply a 15x fair on whatever the normalized earnings are, it implies ~$80bn normalized earnings for the S&P Energy sector, which requires $60-65/bbl WTI oil. In our view this is unlikely in 18 or even 19. Energy is trading at 35x our 17E EPS, suggesting an 18% downside to reach its fair value. No Dec Fed hike might be good for Growth/Tech but bad for Value/Banks We still think the U.S. Federal Reserve (Fed) should hike in Dec. Inflation has been shy of 2%, but not cratering and 1-2% inflation shouldn t be considered particularly problematic when the trend in real U.S. gross domestic product (GDP) growth is 2%. A Dec hike and two more hikes in 18 should stop the decline in long-term yields and help improve NIMs at Banks. The simple corporate tax cut plan that we advocate We still believe a simple and significant corporate tax cut can happen by yearend. This will benefit Banks and small caps the most because most of their profits are U.S. generated and this fiscal stimulus should boost interest rates. For Sep-Oct, we still favor Growth over Value, but Value (especially Banks) and small caps should perform well if clarity emerges on a corporate tax cut before yearend. We advocate dropping the U.S. corporate tax rate to 25% and keeping the global system with deferral in place for now. A 25% statutory rate removes repatriation taxes for companies that paid ~25% abroad. It reduces the allure of foreign domiciles, reduces the value of interest tax shields and other tax reduction strategies. Moreover, this gives small firms that are organized as pass-through entities that want to reinvest their profits for growth an attractive C class option. S&P 500 Outlook S&P Dividend Yield 2.1% 2.1% S&P total return 9.4% 6.4% Next 5%+ price move (Up / Balanced Risk / Down) Risk of near-term correction (Low / Moderate / High) Down Low S&P EPS $119 $131 $140 on trailing EPS DPS $49 $53 Allocations for taxable / USD capital as of September 8, 17 Deutsche AM View Current Long-term Fixed Income 35% 35% Equities 60% 55% U.S. Equities 35% 40% S&P % 35% Small Caps (R2) 0% 0-10% Foreign DM Equities % 15% Foreign EM 5% 0-10% Alternatives 5% 10% Risk & Duration: Preference shaded Low Risk β Stocks Down Gold TIPS Cash Treasury Bonds Short Duration IG Bonds Muni Long Duration Bond Substitutes Cyclical Stocks Value Stocks Growth Stocks Oil /Copper Source: Deutsche AM. All opinions and claims are based upon data on 9/8/17 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. For illustrative purposes only. * Generally Accepted Accounting Principles (GAAP) Yields Up Yields Down Defensive Stocks HY Bonds Stocks Up High Risk β Contributor - Ju Wang, Investment Strategist & Portfolio Analyst For institutional client and registered representative use only. Not for public viewing or distribution.

2 Deutsche AM S&P 500 Annual EPS Outlook 11A 12A 13A 14A 15A 16A y/y 17E y/y 18E y/y 17E y/y 18E y/y ($) % of 17 S&P 500 EPS (historical constituents) $97.82 $ $ $ $ $ S&P 500 EPS (current constituents) $ $ $ $ $ $ % $ % $ % $ % $ % $ % Sector ($ bn) Consumer Discretionary % % % % % % Consumer Staples % % % % % % Energy % % % % % % Financials % % % % % % Health Care % % % % % % Industrials % % % % % % Inf ormation Technology % % % % % % Materials % % % % % % Real Estate % % % % % % Telecommunication Services % % % % % 30 85% Utilities % % % % % % S&P 500 ($ bn) % % % % % % S&P ex. Financials & Real Estate ($bn) % % % % % % S&P ex. Energy ($bn) % % % % % % S&P ex. Tech ($bn) % % % % % % Energy & Financials & Real Est ($bn) % % % % % % S&P ex. Energy & Financials/RE ($bn) % % % % % % Source: IBES, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. * Normalized 17 are mid-cycle normal earnings estimates and the ratios represent normal relative to 17E. Deutsche AM View: S&P 500 fair value by sector: Assuming a ~5.5% real cost of equity (CoE) for overall S&P 500 Market Value ($bn) Current 17 17E Earnings ($bn) Normal Ratio Normal 17E Earnings Source: IBES, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. S&P 500 EPS historical constituents represents the earnings per share (EPS) of S&P 500 index constituents at the time, while S&P 500 EPS current constituents represents the earnings per share of index constituents as of the date the data was compiled 6/30/17. Market impact of natural vs. man-made disasters Accounting Quality Adjustment Fully Adjusted Earnings Bottom-up Consensus (IBES) Real Steady CoE State Value Growth Premium 17 Start Fair Value ($bn) Deutsche AM View 17E Div idend Yield 17 End Fair Value ($bn) 17 End Fair Value Normalized 17* Source: Deutsche AM as of 9/8/17. Past performance may not be indicative of future results. For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 2 17 end Upside % Consumer 2, % % % 2,096 3% 2, % 2, % Disc. Consumer 1, % % % 1,718 0% 1, % 1, % Staples Energy 1, % % % 935 0% % % Financials 2, % % % 3,168 0% 3, % 3, % Banks 1, % % % 1,508 0% 1, % 1, % Health Care 3, % % % 3,057 5% 3,9 1.7% 3, % Industrials 2, % % % 1,869 0% 1, % 1, % Technology 5, % % % 4,281 5% 4, % 4, % Materials % % % 514 0% % % Real Estate % % % 571 0% % % Telecom % % % % % % Utilities % % % 668 0% % % S&P 500 ($ 21, % % % 19,414 2% 19, %,876-2% bn) S&P 500 Index ($/sh) % % % % % % Date 1 w eek before Event day 1 w eek after 1 month after 3 month after Natural Disasters (Avg) -0.7% -0.4% 0.9% 1.3% 3.8% Hurricane Sandy 23-Oct % -1.4% -0.1% -1.6% 5.8% Hurricane Katrina 29-Aug % 0.6% 1.7% 0.4% 3.7% Hurricane Andrew 24-Aug % -1.0% 0.8% 1.6% 3.9% Loma Prieta earthquake 17-Oct % -0.5% 0.7% -0.2% -1.1% Northridge earthquake 17-Jan % -0.3% -0.3% -0.2% -6.5% Volcano eruption of Mount St. Helens 18-May % 0.3% 2.7% 7.8% 16.8% M an-made Disasters (Avg) -0.4% -1.0% -3.2% -1.2% -0.6% September 11 attacks 11-Sep % -4.9% -7.0% 4.9% 7.8% Cuban missile crisis 15-Oct % 0.6% -4.0% 5.0% 12.9% Three Mile Island nuclear meltdow n 28-Mar % -0.4% 0.5% -0.3% 0.1% BP oil spill -Apr % 0.8% -1.9% -7.6% -10.2% Iraq invasion of Kuw ait 2-Aug % -1.1% -3.3% -8.2% -13.5%

3 Fed Funds Futures implied probability of Fed hikes Source: Bloomberg Finance, Deutsche AM as of 9/8/17. Past performance may not be indicative of future results. US 10yr TIPS yield and breakeven inflation % Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep % Real 10yr yield (lhs) 10yr inflation breakeven (rhs) Source: FRB, Deutsche AM as of 9/6/17. Past performance may not be indicative of future results. S&P 500 vs. implied Equity Risk Premium: Red dot shows implied ERP if 10 yr. TIPs yield was 1.5% Overstated EPS from inflation distortions Long-term growth optimism Return to normal 12% 10% Low offered ERP contributes to crash 8% 6% 4% 5 2% 0 0% Recession Trailing (lhs) Implied ERP (rhs) Avg ERP = 4% Avg ERP ex = 3.5% Avg = 15.9 Source: Federal Reserve, S&P, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 3

4 S&P 500 forward Before 1985: on actual forward 4-qtr EPS Since 1985: on I/B/E/S consensus NTM EPS Recession S&P 500 Forward Avg = 14.2 (1960 now) Source: S&P, IBES, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. S&P 500 trailing Recession S&P 500 Trailing Avg = 16.0 (1960 now) Source: S&P, IBES, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. EUR/USD vs. Germany Bund US Treasury (2yr) % 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% EUR/USD (lhs) Germany Bund Yield - US Treasury Yield (2yr) Source: Bloomberg Finance, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 4

5 Inflation and US$ adjusted WTI oil price Recession Inflation and US$ adjusted WTI oil price 12m ma Avg = 60.8 Note: Headline CPI is used for inflation adjustment and trade-weighted U.S. dollar vs. major currencies is used for dollar adjustment. Source: EIA, FRB, Deutsche AM as of August 17. Past performance may not be indicative of future results. WTI crude oil price: (1) Unadjusted; (2) Inflation adjusted; (3) Inflation and US$ adjusted Recession WTI oil Inflation adjusted Inflation and US$ adjusted Note: Headline CPI is used for inflation adjustment and trade-weighted U.S. dollar vs. major currencies is used for dollar adjustment. Source: EIA, FRB, Deutsche AM as of August 17. Past performance may not be indicative of future results. Crude oil and US dollar y/y 14 y/y 15 y/y 16 y/y 1Q17 y/y 2Q17 y/y 3Q17 y/y avg. avg. % chg avg. % chg avg. % chg avg. % chg % chg % chg qtd % chg WTI Oil ($/bbl) % % % % % % % Brent Oil ($/bbl) % % % % % % % Natural Gas ($/mmbtu) % % % % % % % DXY dollar index % % % % % % % Trade-w eighted broad index % % % % % % % Trade-w eighted major currency % % % % % % % EUR/USD % % % % % % % GBP/USD % % % % % % % USD/JPY % % % % % % % Trade-w eighted OITP % % % % % % % Source: EIA, CME, FRB, Deutsche AM as of 9/7/17. Past performance may not be indicative of future results. For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 5

6 Key Investment Forecasts Economic forecasts 16 17E Interest rates 16 17E Equities 16 17E 18E Global GDP 3.1% 3.5% 2yr Treasury* 1.% 1.85% S&P U.S. GDP 1.6% 2.1% 10yr Treasury* 2.45% 2.60% price return 7.2% 4.2% Capex 0.2% 3-5% 10yr TIPS* 0.50% 0.75% dividend yield 2.1% 2.1% S&P total return estimate 9.4% 6.4% Fed Funds rate LT IG Muni* 3.35% ~3.0% DXY Next 5%+ price move: Down Euro* IG Corp* 3.39% 3.60% Oil/bbl (WTI)* HY Corp* 6.46% 6.40% Risk of near-term correction: Low Source: Deutsche AM as of 9/8//17. *Forecasts for June 18 Allocations for taxable/u.s. dollar capital as of Sept. 8, 17 Deutsche AM View Current Long-term Considerations Fixed Income 35% 35% Expected return/risk Treasury/Agency % seek neg. correlation Municipals 10% > return, < liquid Corp. Credit 5% selective HY > IG Equities 60% 55% Expected return/risk U.S. Equities 35% 40% S&P % 35% S&P is global + Tech Small Caps (R2) 0% 0-10% Beyond beta booster? Foreign DM Equities % 15% Unique? Valuation? Financials 5% 3% OW Foreign Banks Non-Financials 15% 12% OW DM Industrials Foreign EM 5% 0-10% Alternatives 5% 10% Is it truly uncorrelated? Real Estate/ Private Equity Commodities/FX/Vol/Alpha Tactical adjustments (<6mos): -10% from equity, +10% treasury = Down Suggested allocations for taxable / USD capital S&P 500 Outlook Dare to ask: 17 end target: 2400 Why not 2800 S&P cycle-high? 2800 = 18x 19E EPS of ~$ end target: 2500 S&P 500 to reach 2800 by 19 end on a long expansionary cycle of moderate growth. 16A 17E 18E S&P avg. trailing 4qtr S&P EPS $119 $131 $ on trailing EPS DPS $46 $49 $ DPS/EPS 38% 37% 38% "S&P stands on the shoulders of bonds" S&P Quarterly EPS: Most favored sectors: 1Q16 $ Q17 $31.00 Healthcare, Tech, Financials 2Q16 $ Q17 $ Q16 $ Q17E $33.00 Least favored sectors: 4Q16 $ Q17E $34.00 Energy, Industrials Source: Deutsche AM as of 9/8/17 Source: Deutsche AM as of 9/8/17 For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 6

7 Deutsche AM S&P 500 Intrinsic Valuation Model S&P 500 Capitalized EPS Valuation S&P 500 Cost of Equity & Fair Book Multiple Deutsche Asset Mgmt's 17E S&P 500 EPS $ Fair long-term nominal return on S&P 500 index 7.50% Components of estimated fair S&P 500 return: DeAM's "normal 17E" S&P 500 EPS $ Long-term real risk free interest rate 1.50% "Normal 17E" EPS / 17E EPS 102% + Long-term fair S&P 500 equity risk premium* 4.00% = Long-term real S&P 500 cost of equity 5.50% Accounting quality adjustment to pro forma EPS -$ Long-term inflation forecast 2.00% = S&P 500 nominal cost of equity 7.50% Normal 17E S&P 500 EPS fair to capitalize $123 * S&P 500 ERP usually bps, w/ real 5.5% - 6.5% Key principle: steady-state value = normal EPS / real CoE Fair S&P 500 Market Value and Book Value Multiple S&P 500 EPS Capitalization Valuation 16 end S&P 500 book value per share $800 Normal EPS / (real CoE - (EM /payout) - EM ): Fair PB = Fair * normal aggregate ROE 2.78 S&P 500 intrinsic value at 17 start 2227 Fair =(inc ROE-g)/(inc real ROE* (real CoE-real g)) 18.2 S&P 500 intrinsic value at 17 end 2345 Implied S&P 500 fair value of book at 17 start 2227 Implied fair fwd in early 17 on 17E $131 EPS 17.1 Steady-state PB = normal agg. ROE / real CoE 2.78 Implied fair trailing at 17 end on 17E $131 EPS 18.0 Confirmed by fair steady-state = 1 / real CoE 18.2 S&P 500 Dividend Discount Model S&P 500 Long-term EPS & DPS Growth Deutsche AM's 17E S&P 500 DPS $49.00 Deutsche AM's 17E S&P 500 aggregate ROE 16.3% 17E dividend payout ratio 38% 16 end S&P 500 book value per share $800 DB's "normal 17E" S&P 500 DPS $49.00 DeAM's "normal 17E" S&P 500 aggregate ROE 15.3% Normal dividend payout ratio 40% S&P EPS retained for true reinvestment 36% EPS directed to net share repurchases $30.00 Estimated ROE on reinvested S&P EPS 7.50% Normal share repurchase payout ratio 24% Economic margin (EM ) or ROE-CoE 0.00% Total payout of S&P 500 EPS $79.00 Sources of long-term earnings growth: Total payout ratio of normal and quality adj. EPS 64% + Long-term inflation forecast 2.00% + Fair return on true reinvestment 1.95% S&P 500 DPS Discount Model + Value added return on true reinvestment 0.00% Normal DPS / (nominal CoE - DPS growth): = Long-term earnings growth 3.95% S&P 500 intrinsic value at 17 start Growth from net share repurchases 1.35% S&P 500 intrinsic value at 17 end 2345 = Long-term S&P 500 EPS/DPS growth 5.30% Implied fair forward yield on 17E DPS of $ % + Fair normal dividend yield 2.% Implied fair trailing yield on 17E DPS of $ % = Total long-term return at constant 7.50% Normal EPS / (real CoE-value added EPS growth) 2227 DPS discount model using true DPS (all payout) 2227 Value added growth premium in fair value est. 0% Normal 17E economic profit per share $78.50 S&P 500 EPS discount model 5 steps to value: 1) Estimate normalized S&P 500 EPS 2) Adjust normalized EPS for pro forma accounting quality 3) Estimate a fair long term real return on S&P 500 ownership (CoE) 4) Capitalize normalized and accounting quality adj. EPS at real CoE 5) Consider long term potential for value added growth opportunities Normal 17E S&P 500 EPS $125 $130 $ $135 $ % Real 5.25% cost of 5.50% equity 5.75% % Source: Deutsche AM as of 9/7/17 Normal 17 earnings per share (EPS) represents an estimate of mid-cycle normal earnings. Equity Risk Premium (ERP) is the expected excess return that investing in the S&P 500 provides over the return from government Treasury bonds. For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 7

8 S&P 500 Sector and Industry Allocations Market Weight (%) Price as of 9/7/17 Source: Deutsche AM Allocated Weight (%) Sector Overweight Equal weight Underweight 17 Ov er-weight 14.9% 18.0% Financials Banks Insurance Capital Markets Consumer Finance Div ersif ied Financial Serv ices % 18.0% Health Care Biotechnology Health Care Prov iders & Serv ices Health Care Equipment & Health Care Technology Lif e Sciences Tools & Serv ices Pharmaceuticals % 23.0% Inf ormation Communications Equipment Electronic Equipment Technology Internet Software & Services IT Services Sof tware Semiconductors Technology Hardware Storage & Peripherals Equal weight 12.4% 12.5% Consumer Internet & Direct Marketing Retail Auto Components Distributors Discretionary Multiline Retail Automobiles Div ersif ied Consumer Serv ices Specialty Retail Hotels Restaurants & Leisure Leisure Products Household Durables Media Textiles Apparel & Luxury Goods % 3.5% Utilities Electric Utilities Independent Power Producers Multi-Utilities.6.1 Water Utilities % 3.0% Real Estate REITs Real Estate Mgmt. & Development Under-weight 9.2% 8.5% Consumer Food & Staples Retailing Bev erages Staples Food Products Household Products Personal Products Tobacco % 6.0% Industrials Airlines Air Freight & Logistics Aerospace & Def ense Building Products Construction & Engineering Commercial Serv ices & Supplies Electrical Equipment Prof essional Serv ices Industrial Conglomerates Machinery Road & Rail Trading Companies & % 2.0% Materials Chemicals Construction Materials Containers & Packaging Metals & Mining % 3.5% Energy Energy Equipment & Serv ices Oil Gas & Consumable Fuels % 2.0% Telecom Div ersif ied Telecommunication Aggregate : Deutsche AM View Ov erweight Equalweight Underweight & 18 EPS & Bottom-up Cons. EPS Bottom-up Cons & 18 Ex Energy Btm-up Cons. Ex Energy For institutional client and registered representative use only. Not for public viewing or distribution. Remix S&P EPS estimates by sector 8

9 Deutsche AM June 18 equity index forecasts Source: Deutsche AM as of 8/17/17. Past performance may not be indicative of future Deutsche Bank AG. All rights reserved. R (9/17) Not for public viewing or distribution. Remix S&P EPS estimates by sector 14

10 Contact Information David Bianco Ju Wang , , Want to start to receive The Allocator and other materials from our thought leaders directly in your inbox? Go to the Subscription Center on deutscheam.com: And sign up and request the types of thought leadership materials you would like to receive by topic (The World, The Markets, and Asset Class Perspectives) or exclusively by one or more of our experts. For purposes of ERISA and the Department of Labor s fiduciary rule, we are relying on the sophisticated fiduciary exception in marketing our services and products through intermediary institutions, and nothing herein is intended as fiduciary or impartial investment advice. Deutsche Bank does not render legal or tax advice, and the information contained in this communication should not be regarded as such. The comments, opinions and estimates contained herein are based on or derived from publicly available information from sources that we believe to be reliable. We do not guarantee their accuracy. This material is for informational purposes only and sets forth our views as of this date. The underlying assumptions and these views are subject to change without notice. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Investments come with risk. The value of an investment can fall as well as rise and your capital may be at risk. You might not get back the amount originally invested at any point in time. Deutsche Asset Management represents the asset management activities conducted by Deutsche Bank AG or any of its Deutsche Bank AG. All rights reserved. R (9/17) Not for public viewing or distribution. Remix S&P EPS estimates by sector 14