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1 RBC Wealth Management July 19, 2018 Global A closer look Focusing on the other Big 3 Kelly Bogdanova San Francisco Weekly Insight As the U.S. equity market churns along and other markets wobble, questions about three topics trade, the midterm elections, and the dreaded yield curve are dominating investor conversations. We take on these topics and attempt to provide some perspective. Aside from the powerful drama in Helsinki and Washington, three things have been on equity investors minds lately the trade disputes, the forthcoming U.S. midterm elections, and the dreaded Treasury yield curve. Following are answers to frequently asked questions about these important topics: Q: As things stand now, what concerns you most about trade and tariff risks? A: Trade tensions have heated up, although they are not yet boiling over into an all-out global trade war. Even if they never reach a boiling point, a key concern is timing. The longer trade disputes simmer, the more likely they will try business executives patience. The chart shows U.S. CEO confidence has pulled back slightly as trade challenges have mounted, but remains elevated. We believe it will retreat further if additional tariffs are implemented. And if corporate sentiment sours, capital spending decisions could be postponed. While this moderately threatens U.S. economic momentum, it could potentially impact trading partners more. We are already seeing anecdotal evidence that mid-sized Canadian firms are becoming hesitant to spend, for example. Another concern is that a slippery slope could be developing. Markets and industries mainly have been contending with four distinct tariff disputes: 1) U.S. vs. China, 2) steel and aluminum, 3) autos/auto parts, and 4) U.S. vs. NAFTA partners Canada and Mexico. But the U.S. administration just announced it is now investigating whether to slap tariffs on uranium imports based on national security grounds. Two domestic uranium producers petitioned the government to launch this probe. While there may be national security CEO confidence has pulled back but remains elevated U.S. CEO Confidence Index Source - Chief Executive magazine, RBC Wealth Management; data through June 2018 Market pulse 3 U.S. housing starts suffer a sharp drop 3 Canadian software consolidators set to outperform 4 Slowing U.K. inflation may quash rate hike plans 4 Hang Seng under pressure from weak renminbi Click here for authors contact information. Priced (in USD) as of 7/19/18 market close, EST (unless otherwise stated). For important disclosures and required non-u.s. analyst disclosures, see page 7.

2 2 Global Insight Weekly reasons for pursuing these tariffs we ll leave that to the experts this development underscores that the list of tariff disputes could grow beyond the four that are currently on it. If one industry can prompt a trade probe, will others follow? Where does this end? Q: What impact do you think the midterm elections could have on the U.S. equity market? A: We ve recently received more questions about the November midterm elections. Perhaps the ongoing political drama in Washington has piqued an interest. As tough as it may be, we encourage investors to step away from the riveting political angle and use market history as a guide. The historical performance surrounding midterm House and Senate elections is among the strongest of the seasonal equity market cycles we track. It persists regardless of what is or isn t occurring in Washington and around the world, and regardless of which party is in power or is gaining or losing momentum. There is typically a pullback or correction in the U.S. equity market at some point during the 12-month period before the midterm elections, followed by a significant rally, as the upper chart shows. With this in mind, it should be no surprise that the S&P 500 has already succumbed to a pullback in this midterm election year, falling 10% from late January to mid-february. Given the historical pattern, at least part of the midterm election year correction has already been absorbed by the market. But it is unclear if the midterm election year bottom has been reached. The key takeaway from the historical data is that any downside that occurred in midterm election years was more than made up for with subsequent rallies. In all 21 periods we examined stretching back to 1934, the market was higher at some point in the following year, and usually much higher. Q: Is the yield curve signaling a recession? A: The difference between the 10-year and 2-year Treasury yield otherwise known as the yield curve has narrowed to a very low level of 27 basis points (bps) vs. a long-term average of about 100 bps. We expect it to narrow further as the Federal Reserve continues to raise interest rates. But the swift yield curve flattening to such a low level is not an automatic signal of an imminent recession. As the lower chart shows, the curve was very flat for five years in the late 1990s. There was no recession during that period. Instead, the U.S. economy grew by more than 4% annualized and the stock market surged. When the curve does become negative (invert) with the 2-year yield exceeding the 10-year yield, it typically signals Corrections are common in midterm years, and so are follow-on rallies S&P 500 returns surrounding midterm elections ( ) -20.6% Average decline before midterm election* 47.3% Average gain from midterm election year low to high the following year * Measured from the peak within 12 months before the midterm election year low, to that low. Source - RBC Wealth Management, Bloomberg; performance before and after 21 midterm election years Yield curve limbo: How low can it go? Yield difference between 10-year and 2-year Treasuries in basis points (bps) Average 97 bps Five years of a relatively flat yield curve 27 bps Source - RBC Wealth Management, Bloomberg; daily data through 7/19/18 a recession is coming, but it can take many months or more than a year for it to materialize. During much of this time, the market can deliver healthy gains. In the last cycle, for example, this yield curve initially inverted in February The S&P 500 didn t peak until October 2007, and the recession began two months later. We caution investors not to move too far ahead of the yield curve. It typically gives plenty of time to make asset and subasset allocation adjustments in portfolios, even after it inverts.

3 3 Global Insight Weekly United States Ben Graham Minneapolis Sluggish U.S. equity markets have seen light trading volumes create outsized impacts on sector performance while broad indexes have held steady, as evidenced by the S&P 500 trading flat in recent days while Financials is up more than 2.2% and Energy is down more than 1.4% over the same period. Strength in the Financials sector is a direct result of earnings releases that could only be characterized as strong. The big four banks all beat consensus estimates and the asset managers have been delivering steady growth as well. As earnings season begins to ramp up, notable large cap names in the Technology, Health Care, and Industrials sectors are scheduled to begin to report in coming days. According to Thomson Reuters I/B/E/S, all S&P 500 sectors are forecast to deliver both earnings and revenue growth. Economically sensitive sectors like Energy, Materials, and Financials, along with Tech stocks, are the expected leaders, while the more conservative, bond-proxy sectors should demonstrate more muted growth. RBC Capital Markets commodity strategists are viewing the recent 10%-plus correction in oil prices as temporary and not an indication of fundamental weakness. In fact, they have termed the correction healthy and view any future knee-jerk reaction to potential reductions in strategic reserves as a timely buying opportunity. This dynamic can be seen in Energy stocks holding up better than the commodity, as they declined a much smaller 5% over the same timeframe as the oil price correction. U.S. housing starts declined 12.3% m/m in June the worst percentage drop since November 2016 stoking fears that labor shortages and rising input costs are slowing starts more quickly than consensus estimates captured. The decline had been estimated to be 2.2% prior to the release of June data. Look for the next housing data point on Monday, July 23, when June data on existing home sales is scheduled to be released. Canada Arete Zafiriou & Richard Tan Toronto RBC Capital Markets believes that the Canadian banks remain core holdings for most investors; however, asset growth is expected to slow in 2019/2020 on the backs of a rising rate environment and an already indebted domestic consumer base. While the banks are expected to provide solid growth in the second half of the year, RBC Capital Economically sensitive sectors lead Q2 EPS growth estimates Q2 18 consensus EPS growth estimates S&P 500 Energy Materials Tech Financials Industrials Cons. Disc. Health Care Telecom. Cons. Stpl. Real Estate Utilities 21.4% 32.8% 25.5% 23.8% 16.1% 16.0% 11.7% 9.9% 9.8% 2.4% 1.6% 145.5% Source - RBC Wealth Management, Thomson Reuters I/B/E/S; data through 7/19/18; Energy bar truncated due to extreme reading Markets is lowering its target price-to-earnings multiples to reflect a normalization in expected credit losses and more moderate efficiency gains. Relative to U.S. banks, the Canadian banks are trading relatively in line with historical averages. Overall, we continue to favour Canadian banks that have greater exposure to international markets as the outlook for the domestic housing market remains soft, in our view. In July, RBC Capital Markets hosted its annual Calgary Stampede Energy Roundtable where participants showcased a constructive tone towards global oil prices. Notable highlights include (1) the view that the AECO market will remain structurally challenged in the near term and that producers will have to incorporate hedging strategies in order to optimize returns, (2) new technology (i.e., artificial intelligence, machine learning, etc.) is being incorporated among some of the E&Ps to reduce cycle times and labour costs, and (3) crude-by-rail is expected to ramp up to 500,000 bbl/d by 2019, more than double the 200,000 bbl/d provided today. Despite Canadian software consolidators currently trading materially above their 10-year average valuations, RBC Capital Markets believes investors should maintain Overweight positions for the group. The ability of the Canadian software consolidators to compound returns via acquisitions has led to outperformance relative to the S&P/TSX Composite over the last 20 years on a totalreturn basis. Investment hurdle rates for the group range between 13% and 25%, well above their cost of capital. RBC Capital Markets believes the group will continue to outperform even if the firms deploy just 50% of excess free cash flow on acquisitions.

4 4 Global Insight Weekly Europe Laura Cooper, Rufaro Chiriseri & Thomas McGarrity, CFA London The British pound came under pressure on July 18, as a downside inflation surprise and disappointing retail sales data in June prompted markets to pare back expectations for the Bank of England (BoE) to raise its key interest rate at its August 2 policy meeting. The implied potential for a 25 basis points (bps) rate increase slipped from above 90% to just above 80%, as headline inflation remained unchanged at 2.4% in June but core inflation slowed to a 15-month low of 1.9%. A solid jobs report that showed employment reached a record high in May and wage pressures continue to build still provides support for the BoE to increase rates in August by 25 bps, in our view. The latest GDP report that showed the economy is improving after a weather-led slowdown earlier this year adds further credence to our view. U.K. 10-year gilt yields fell on the back of the string of data reports. We continue to maintain an Underweight position in gilts reflecting, in part, the political headwinds facing the U.K. around Brexit uncertainty. We continue to maintain our Market Weight view on U.K. corporate credit and U.K. equities. In both, we maintain a strong bias towards international companies relative to domestically-focused ones. Prime Minister Theresa May faces opposition from all sides of parliament regarding her Brexit plan and is also dealing with rebellions within her party. The government was able to pass the customs bill which allows the government to create a standalone customs regime post- Slowing U.K. inflation may cause the BoE to put rate hike plans on hold U.K. headline and core inflation 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Headline CPI Core CPI Source - RBC Wealth Management, Bloomberg; monthly data through 6/30/18 2.4% 1.9% -0.5% Jun 2012 Jun 2014 Jun 2016 Jun 2018 Brexit. However, the bill passed by just three votes as 14 conservative members of parliament (MPs) opposed the bill and the government had to rely on the votes of opposition MPs. This demonstrates how fragile the political landscape remains in the U.K. Q2 reporting season kicked off in Europe. Consensus estimates are for earnings to increase by a relatively moderate 8.5% in the region. Given the strength of the domestic European and global economy, these expectations look achievable, in our view. Asia Pacific Jay Roberts, CFA Hong Kong The MSCI AC Asia Pacific Index was unchanged for the week. However, equities in China and Hong Kong remain weak. The Hang Seng Index is flirting with the 28,000 level and looks set to move below it, in our view. The index came under renewed pressure as the Chinese renminbi weakened over the week. The currency has dropped from USDCNY6.50 to 6.76 in The 4% decline, in the context of the somewhat tightly controlled currency, is a fairly large move. RBC Capital Markets forecast is USDCNY6.80, but it notes there is upside risk to that forecast, that is for the renminbi to decline more against the dollar than expected. The 2019 forecast is The market consensus forecast is 6.60 for year-end 2018 and an average of 6.45 for According to an unsubstantiated report by Reuters, China Tower, a company established by China s big three phone operators China Mobile, China Unicom, and China Telecom to run China s telecoms towers, may list in Hong Kong. The report cited people close to the deal as indicating that the valuation of the company may be up to $35B. Listing 25% of the company would mean that the China Tower IPO would surpass that of the recent listing of Chinese tech company Xiaomi (1810 HK), which raised HK$42.6B ($5.4B), and would be the world s largest IPO since Alibaba (BABA) in 2014, according to Reuters. Tiger Global Management, a large hedge fund investor, bought more than $1B of stock in Japan s Softbank Group (4726 JP), according to a client letter seen by Bloomberg. Softbank owns telecom businesses in Japan and the U.S. and is also one of the world s largest investors in technology. Tiger Global stated that the company was trading at too steep a discount to its net asset value. In particular, the stock failed to reflect the value of its holding in Alibaba Group (BABA), which has performed strongly. Softbank is the largest shareholder in Alibaba, owning over 30%. Tiger Global estimated Softbank s net asset value at $190B, double the current market capitalization of the company.

5 5 Global Insight Weekly market scorecard Data as of July 19, 2018 Equities (local currency) Level MTD YTD 1 yr 2 yr S&P 500 2, % 4.9% 13.4% 29.6% Dow Industrials (DJIA) 25, % 1.4% 15.8% 35.1% NASDAQ 7, % 13.4% 22.6% 55.4% Russell , % 10.8% 18.0% 41.7% S&P/TSX Comp 16, % 2.1% 8.5% 13.9% FTSE All-Share 4, % 0.1% 3.9% 16.6% STOXX Europe % -0.8% 0.2% 14.5% EURO STOXX 50 3, % -0.9% -0.8% 18.4% Hang Seng 28, % -6.4% 5.0% 29.2% Shanghai Comp 2, % -16.2% -14.2% -8.7% Nikkei , % 0.0% 13.7% 36.1% India Sensex 36, % 6.7% 13.8% 30.8% Singapore Straits Times 3, % -3.7% -1.4% 12.3% Brazil Ibovespa 77, % 1.4% 18.9% 36.7% Mexican Bolsa IPC 48, % -1.2% -4.6% 3.6% Commodities (USD) Price MTD YTD 1 yr 2 yr Gold (spot $/oz) 1, % -6.1% -1.4% -8.1% Silver (spot $/oz) % -9.5% -5.9% -23.0% Copper ($/metric ton) 6, % -15.0% 3.3% 23.3% Oil (WTI spot/bbl) % 15.0% 47.4% 55.6% Oil (Brent spot/bbl) % 8.6% 46.1% 55.6% Natural Gas ($/mmbtu) % -6.2% -9.7% 1.5% Govt bonds (bps chg) Yield MTD YTD 1 yr 2 yr U.S. 10-Yr Tsy 2.836% Canada 10-Yr 2.109% U.K. 10-Yr 1.185% Germany 10-Yr 0.330% Fixed Income (returns) Yield MTD YTD 1 yr 2 yr U.S. Aggregate 3.31% 0.2% -1.4% -0.6% -0.7% U.S. Invest Grade Corp 3.99% 0.7% -2.6% -0.9% 1.2% U.S. High Yield Corp 6.38% 0.6% 0.7% 2.4% 13.1% Currencies Rate MTD YTD 1 yr 2 yr U.S. Dollar Index % 3.3% 0.4% -2.0% CAD/USD % -5.2% -4.9% -1.8% USD/CAD % 5.5% 5.2% 1.8% EUR/USD % -3.0% 1.2% 5.7% GBP/USD % -3.7% 0.0% -0.7% AUD/USD % -5.8% -7.5% -1.9% USD/JPY % -0.3% 0.4% 5.9% EUR/JPY % -3.2% 1.5% 11.9% EUR/GBP % 0.7% 1.2% 6.4% EUR/CHF % -0.6% 5.7% 7.1% USD/SGD % 2.5% 0.1% 1.2% USD/CNY % 4.1% 0.3% 1.2% USD/MXN % -3.2% 8.4% 2.8% USD/BRL % 15.6% 21.6% 17.8% Source - Bloomberg. Note: Equity returns do not include dividends, except for the Brazilian Ibovespa. Bond yields in local currencies. Copper Index data and U.S. fixed income returns as of Wednesday s close. Dollar Index measures USD vs. six major currencies. Currency rates reflect market convention (CAD/USD is the exception). Currency returns quoted in terms of the first currency in each pairing. Data as of 8:35 pm GMT 7/19/18. Examples of how to interpret currency data: CAD/USD 0.75 means 1 Canadian dollar will buy 0.75 U.S. dollar. CAD/USD -5.2% return means the Canadian dollar fell 5.2% vs. the U.S. dollar year to date. USD/JPY means 1 U.S. dollar will buy yen. USD/JPY -0.3% return means the U.S. dollar fell 0.3% vs. the yen year to date.

6 6 Global Insight Weekly Authors Kelly Bogdanova San Francisco, United States RBC Capital Markets, LLC Ben Graham Minneapolis, United States RBC Capital Markets, LLC Arete Zafiriou Toronto, Canada RBC Dominion Securities Inc. Richard Tan Toronto, Canada RBC Dominion Securities Inc. Laura Cooper London, United Kingdom Royal Bank of Canada Investment Management (U.K.) Ltd. Thomas McGarrity, CFA London, United Kingdom Royal Bank of Canada Investment Management (U.K.) Ltd. Rufaro Chiriseri London, United Kingdom Royal Bank of Canada Investment Management (U.K.) Ltd. Jay Roberts, CFA Hong Kong, China RBC Dominion Securities Inc. Disclosures and Disclaimer Analyst Certification All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report. Important Disclosures In the U.S., RBC Wealth Management operates as a division of RBC Capital Markets, LLC. In Canada, RBC Wealth Management includes, without limitation, RBC Dominion Securities Inc., which is a foreign affiliate of RBC Capital Markets, LLC. This report has been prepared by RBC Capital Markets, LLC. which is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Non-U.S. Analyst Disclosure: Arete Zafiriou, Richard Tan, and Jay Roberts, employees of RBC Wealth Management USA s foreign affiliate RBC Dominion Securities Inc.; and Laura Cooper, Rufaro Chiriseri, and Thomas McGarrity, employees of RBC Wealth Management USA s foreign affiliate Royal Bank of Canada Investment Management (U.K.) Limited; contributed to the preparation of this publication. These individuals are not registered with or qualified as research analysts with the U.S. Financial Industry Regulatory Authority ( FINRA ) and, since they are not associated persons of RBC Wealth Management, they may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts. In the event that this is a compendium report (covers six or more companies), RBC Wealth Management may choose to provide important disclosure information by reference. To access current disclosures, clients should refer to GLDisclosure/PublicWeb/DisclosureLookup.aspx?EntityID=2 to view disclosures regarding RBC Wealth Management and its affiliated firms. Such information is also available upon request to RBC Wealth Management Publishing, 60 South Sixth St, Minneapolis, MN References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Dividend Growth (RL 8), the Guided Portfolio: ADR (RL 10), and the Guided Portfolio: All Cap Growth (RL 12), and former lists called the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global Equity (U.S.) (RL 11). 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