Nationwide Market Insights SM

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1 Capital markets Market Insights SM Our perspective on the market and economic forces influencing investment planning and retirement 1st Quarter 2018 Data as of December 31, 2017

2 The provides practical thought leadership and comprehensive solutions to financial advisors and their clients. Through education and insights, client-ready tools and strategies and consultative support, we break down and simplify complex retirement challenges to help advisors and clients plan for a more secure financial future. Introducing Market Insights SM One of those challenges comes in understanding the market forces that affect investment performance and influence investment decisions. With Market Insights, we present insights and informative commentary about the economy and the financial markets from s staff of economists and analysts. You can share Market Insights with clients to help answer questions about investment performance and inspire greater confidence in the guidance you provide. When you work with, you not only get tools and resources from the, but also the strength and stability of a Fortune 100 company standing behind the wide range of financial products we offer from mutual funds and annuities to life insurance and retirement plans. Plus, you can count on consultative support from the Team of Specialists for assistance with the retirement planning challenges you and your clients face. Contact your wholesaler to learn more about Market Insights and other resources available from the or the many solutions offers. 2

3 Table of contents Financial markets 4 U.S. Equity Market 5 Global Markets 13 Fixed Income 27 Commodities 31 Currencies 33 U.S. economy 35 National 36 Regional 46 Executive Summary The financial markets ended the year on a high note, as global economic performance continued to improve and optimism grew over tax reform. The yield curve flattened on the back of another Federal Reserve rate hike and rising expectations for further tightening in Monetary policy also helped to stabilize the dollar, which was flat through most of the quarter. From a broader perspective, the long-running expansion still appears unlikely to be imperiled anytime soon. The labor market continues to tighten, slowly but surely putting upward pressure on wage growth and consumer confidence. In addition, there have been further signs that the business investment rebound that picked up steam last year will prove sustainable. This owes in part to improvements in the global economy, which are fueling a healthy rebound in exports. There will continue to be ebb and flow in both the economy and financial markets, but the underlying path for now should continue to be to the upside. Contributors 48 3

4 Highlights Corrections are naturally recurring features of bull markets Stocks often continue rising after large gains Even the weakest markets are on the rise 4

5 A strong finish to another solid year S&P 500 Index The S&P 500 ended a solid 2017 on a high note with another healthy gain in the fourth quarter. The index has now risen for nine consecutive quarters. Source: Standard & Poor s 5

6 Are we overdue for a correction? Time between corrections and bear markets Months There has been growing concern that stocks are overdue for a downturn given the mostly uninterrupted rally since early The S&P 500 has historically fallen into a correction or bear market every 20 months on average, but there has been quite a bit of variability with frequent declines in the 1960s and 1970s and more prolonged rallies in recent decades. Corrections can occur in any economic environment, but the fundamentals are still too strong to allow a full bear market anytime soon. Source: Bloomberg 6

7 Large gains are often followed by further increases Changes in the S&P 500 in the year after a double-digit increase Prior to 2017, there had been 44 doubledigit annual increases in the S&P 500 and on average they were followed by an abovetrend 8.2% gain in the next year. In more than 70% of all cases, the market was higher in the following year. Source: Bloomberg 7

8 Positively sloped yield curve bodes well for further market gains Median yearly changes in the S&P 500 by level of the 10-year Treasury/fed funds yield curve The most important economic indicator of all the yield curve is pointing to continued healthy gains in stock prices despite recent flattening. When the curve has been positively sloped, the S&P 500 has recorded a median increase of 11.4% over the following year. Source: Bloomberg 8

9 Earnings remain in recovery mode Yearly changes in earnings per share Stocks continue to rise on the back of healthy earnings gains, which are still recovering solidly after the dollar- and commodity-driven decline of Corporate tax cuts should provide a further boost in S&P 500 Source: Bloomberg 9

10 Valuations have little influence over near-term returns The price/earnings ratio of the S&P 500 Ratio Changes in the S&P 500 after the price/earnings ratio has moved above 20 One year Two years The price/earnings ratio of the S&P 500 remains above 20, a level that has raised concerns about overvaluation. This figure is largely in line with the average of the last several decades, however, as changes in accounting rules have on balance structurally lifted P/E ratios over time. This is also evidenced in the much healthier gains in the index in recent decades after the P/E has eclipsed 20. Valuations have never correlated well with near-term performance, and this has been increasingly true over time. Source: Bloomberg 10

11 The growth/value gap is still far from a peak Spread between the price/earnings ratios of the S&P Growth and S&P Value Indices P/E Spread While there was a large disparity in the performance of growth and value stocks in 2017, the valuation gap moved up only modestly and remains far from the peaks of the late 1990s. A steady expansion with limited near-term downside risks is especially favorable for the growthier side of the market. Source: Standard & Poor s 11

12 A solid year for most sectors Yearly changes in the S&P 500 sectors Energy and telecoms were the outliers in an otherwise solid and broad-based gain in the S&P. Source: Standard and Poor s 12

13 Continued momentum in international stocks MSCI EAFE Index Index Developed market stocks rose to close out their first winning year since Source: Bloomberg 13

14 Healthy gains across much of the world last year Yearly changes in benchmark equity indices (USD) While Russia continued to lag, the other G7/BRIC markets were mostly robust in Source: Bloomberg 14

15 Global stocks in catch-up mode Changes in global benchmark indices relative to the S&P 500 in the current bull market age Points Most major global markets have lagged the U.S. badly in this cycle, with many trailing the S&P 500 by 100 percentage points or more since the bull market began in The catch-up process looks to finally have gotten underway, however, as the S&P ranked 54th in the world in 2017 among global benchmarks. Source: Bloomberg 15

16 It s not unusual for global stocks to catch up later in the cycle Average annualized changes across S&P 500 bull markets Just as global economies tend to lag the U.S., so do global equity markets. Since the beginnings of the EAFE index in the late 1960s, it has turned in its best performance at the tail end of U.S. bull markets while also outperforming the S&P during these periods. S&P 500 EAFE Source: Bloomberg 16

17 Global economies are generally in earlier stages of the business cycle U.K. Canada Germany France Italy Japan U.S. Mexico The overriding reason behind the underperformance in global stock markets has been the lagging nature of many global economies. Brazil Expansion Recession These economies are virtually all growing now, and they still have plenty of runway, as they are on balance in relatively early stages of the business cycle. 17

18 Where do China and India fit? Recessions since 2000 Number Average yearly real GDP growth, In two of the world s largest economies, historic structural forces (strong labor force growth, burgeoning middle classes, increasing openness) have overwhelmed the typical cyclical dynamics. India hasn t had a recession in more than 20 years while China hasn t had a downturn in nearly 30 years. And even as potential growth rates in these countries are now slowing somewhat, they still tower over the world s other large economies. The pace of expansion in China and India will ebb and flow, but it is likely to be quite some time before either is in outright contraction. Source: Economic Cycle Research Institute, Bloomberg 18

19 Global growth is improving Yearly changes in world gross domestic product The global economy is back in an upswing. Annual world real GDP growth has picked up steadily since early 2016 and is now back above 3%. This is a recovery that is continuing to gain traction while still showing few signs of overheating. Source: Bloomberg 19

20 Global growth is broadening age of the world s economies in recession More than 90% of the world s economies grew last year, marking the third time in the last four years that global breadth improved. And now that Brazil is out of recession, every large economy in the world is currently expanding. The broad-based nature of this recovery is another reason to expect it to continue. Source: Bloomberg 20

21 Feedback loops are strengthening virtually everywhere The eurozone unemployment rate Average monthly changes in Australian employment Thousands Economies are strengthening around the world. The jobless rate in the eurozone, for example, recently fell to a nineyear low while Australian employment growth is coming off of its best year since at least the 1970s. Feedback loops are strengthening around the world and, especially against a backdrop of largely accommodative monetary policies, they are pointing to continued expansion in the quarters ahead. Source: Eurostat; Australian Bureau of Statistics 21

22 Even the weakest economies are gaining ground The Brazil Purchasing Managers Index Index Quarterly changes in Greek real GDP Brazil s long recession finally ended last year while Greece, the poster child for debt-induced stagnation, has expanded for three straight quarters for the first time in more than a decade. Other previously lagging economies such as Japan, France, Italy, and Spain are now advancing at healthy rates as well. The rising tide of global growth is lifting virtually all boats. Source: Markit; National Statistical Service 22

23 Improving economies are pushing earnings higher Yearly changes in EAFE earnings Better economic performance around the world is sending global earnings higher. Net incomes for EAFE companies are growing at a double-digit pace after contracting for much of the last two years. Source: Bloomberg 23

24 Policy remains supportive Current benchmark interest rates relative to the 20-year average Monetary policy around the world remains highly accommodative even after several central banks have started to tighten. Moreover, these nascent tightening cycles are unfolding extremely slowly, suggesting that policy will remain supportive of equity prices for some time to come. Source: Bloomberg 24

25 Emerging markets are starting to outperform again Relative performance of the MSCI Emerging Markets Index vs. the All Country World Index (ACWI) Emerging markets are coming off of a prolonged period of underperformance, having fallen short of the broader global benchmark by more than 50 percentage points on a cumulative basis in the five years prior to EM has outperformed in each of the last two years, however. Relative EM performance tends to come in bunches and when these markets do outperform, they often outpace the developed world by outsized amounts (note that even after the drag from earlier this decade, EM has still more than doubled the gain in the ACWI since 2000). With these economies continuing to outgrow developed markets, the recent trend could well be extended in the years ahead. Source: Bloomberg 25

26 Emerging markets are still outgrowing developed economies Spread in yearly real GDP growth between emerging markets and developed markets The emerging markets continue to outgrow more mature economies by a healthy margin and are accounting for an increasing share of the total world economy. These economies will still be more volatile than more developed markets, but they should also continue to be structurally well-positioned for the long-term. Source: IHS Global Insight 26

27 The yield curve flattens Ten-year and two-year U.S. Treasury yields While ten-year yields were little changed on the quarter, twoyear rates jumped to a nine-year high. The ten-year/two-year curve hasn t been this flat since year 2-year Source: Bloomberg 27

28 Fixed income returns have remained positive during rate hike cycles Annualized returns in the Barclays Aggregate Bond Index during Federal Reserve rate hike cycles While modest real yields and an eventual resumption of Fed tightening will pressure fixed income returns, they won t eliminate them. The carry that these investments earn the income portion of fixed income has meant modest gains even when benchmark rates have risen. Source: Bloomberg 28

29 Corporate spreads narrow again Investment-grade and high-yield option adjusted spreads Corporate spreads have entered the grinding phase of this cycle, as they remain at very low levels. There was some profit taking in high yield last year, but the downside economic risks are likely still too limited to allow a major widening anytime soon. Investment-grade High-yield Source: Barclays 29

30 Broadly positive fixed income performance Yearly changes by asset class Steady growth and low inflation helped the major fixed income asset classes to a healthy year of performance. Source: Barclays 30

31 Commodity prices continue to move jaggedly The CRB Commodity Index Index Commodity prices rose again in the last three months of the year, marking the first back-to-back quarterly increases since Source: Commodity Research Bureau 31

32 Oil prices rise further Yearly changes in commodity prices Crude prices rose again in the fourth quarter, buoyed in part by OPEC s decision to maintain output cuts through Source: Goldman Sachs 32

33 Dollar falls again The trade-weighted dollar index Index Renewed Fed rate hike expectations and tax reform optimism helped to slow the decline in the dollar, which turned in its smallest quarterly decline of the year. Source: Federal Reserve Board of Governors 33

34 Most currencies rose last year against the dollar Annual currency changes The dollar fell broadly in 2017 as the global economy solidified. Source: Bloomberg 34

35 U.S. economy Highlights 39 The yield curve suggests very little risk of a near-term recession The labor market is exceptionally tight Soaring consumer confidence hints at a euphoria stage before this cycle ends 35

36 U.S. economy Economic growth is beginning to perk up again Yearly changes in real gross domestic product (GDP) Right on cue, the pace of expansion is rising again after falling to a three-year low in the middle of The growth rate has been range-bound between 1.0% and 3.0% throughout this cycle and now looks to be back on an uptrend as it was in and Note: Shaded areas depict recessionary periods Source: Bureau of Economic Analysis 36

37 U.S. economy A bifurcated economy Yearly changes in the real GDP components While consumer spending has been up and down in recent quarters, business investment has turned in a convincing recovery from the pullback of Source: Bureau of Economic Analysis 37

38 U.S. economy The expansion has a long way to run Average length of economic expansions & recessions Months Changes in benchmark Fed interest rates prior to recessions Expansions Recessions The expansion is more than eight years old, but that doesn t necessarily mean that its end is imminent. Over time, recoveries have grown longer while recessions have generally gotten shorter. Each of the last three expansions lasted longer than six years and together averaged almost eight years in length. More to the point, these cycles ended as all modern cycles did via tighter monetary policy from the Federal Reserve. With the Fed indicating that it is likely to raise rates only gradually from here, the next recession continues to appear distant. Sources: National Bureau of Economic Research, Federal Reserve Board of Governors 38

39 U.S. economy The yield curve is pointing to continued expansion Spread between the 10-year U.S. Treasury yield and the federal funds rate The indicator that best encapsulates the stance of monetary policy relative to the state of the economy is the yield curve, the spread between long and short-term interest rates. In fact, the curve has been the single best leading indicator of economic performance, as it has inverted in front of virtually all modern recessions and has steepened before every recovery. The curve has been flattening thanks to Fed rate hikes, but it still has some way to go before monetary policy is truly restrictive and the recovery is in jeopardy. Note: Shaded areas depict recessionary periods Source: Bloomberg 39

40 U.S. economy Recessions take hold only after yield curve inversions Median time between yield curve inversions and the beginning of recessions Months Yield curve inversions tend to be complete and they tend to occur roughly one and a half years before expansions come to an end. The fact that the curve has yet to invert in this cycle is a good indication that the next recession is still likely at least a few years off. Source: Bloomberg 40

41 U.S. economy Where are we in the business cycle? GDP Yield Curve Steepens Jobs Incomes Spending Inflation Expansion Recession We are here Rates Yield Curve Inverts GDP Expansions and recessions are amplified through the labor market before being ended via changes in inflation and interest rates. Those shifts are a long time in developing, though, and are still in their early stages in this cycle. Jobs Rates Incomes Inflation Spending 41

42 U.S. economy The labor market is extremely tight The four-week moving average of initial unemployment claims Thousands After a hurricanerelated blip in the fall, jobless claims quickly reverted to the downtrend that has been in place for nearly nine years. Along with the falling unemployment rate and the rising number of businesses having trouble filling open positions, this is a convincing indication of an unusually tight labor market. Faster wage growth should follow. Source: Labor Department 42

43 U.S. economy Labor market strength is driving confidence higher Consumer confidence Index Consumer confidence was back on the rise in the fourth quarter, soaring to a new 17-year high. With the labor market still strengthening and the expansion continuing to appear sustainable, there are the makings here of a euphoria stage before this cycle comes to an end. Source: The Conference Board 43

44 U.S. economy Nearly all major industries are adding workers Yearly changes in employment growth by major groups Jobs continue to be added across almost every major sector of the economy. The widespread nature of payroll gains is another sign that the labor market is on firm footing. Source: Bureau of Labor Statistics 44

45 U.S. economy Inflation has retreated Yearly changes in the core personal consumption expenditures price index Index A mature expansion and a tight labor market have yet to put much upward pressure on inflation. In fact, price pressures receded through the spring and summer and the annual inflation rate slipped further below the Fed s 2.0% target. Inflation lags the business cycle and will eventually respond to the more positive fundamentals, but it is for now giving the Fed the leeway to continue to adjust policy slowly. Source: Bureau of Economic Analysis 45

46 U.S. economy Widespread job growth in 2017 Changes in nonfarm payrolls Source: Bureau of Labor Statistics 46

47 U.S. economy Much of the U.S. is growing at a healthy clip Annual changes in gross state product Gross State Product -5.0% 5.0% Source: Bureau of Economic Analysis 47

48 Contributors The experience and perspective of s staff economists and market analysts assure advisors and clients of a relevant viewpoint that s easy to understand. You may be able to apply this information to specific financial planning situations for your clients. Bryan Jordan, CFA Deputy Chief Economist Bryan is a frequent author and knowledgeable source on economic topics, and has been featured in The Wall Street Journal and New York Times. Bryan holds degrees in Economics and Political Science from Miami University and has earned the Chartered Financial Analyst designation. He currently serves as Chairman of the Ohio Council on Economic Education and is a member of the Ohio Governor s Council of Economic Advisors, the National Association for Business Economics, and the Bloomberg monthly economic forecasting panel. Additional contributions by: Ben Ayers, Gail Chang, Ankit Gupta, Dan Hadden, Scott Murray, and Aaron Reincheld 48

49 Contributors Economic and financial market thought leadership David Berson, PhD Senior Vice President, Chief Economist David holds a doctorate in Economics and a master s degree in Public Policy from the University of Michigan. Prior to, David served as Chief Economist & Strategist and Head of Risk Analytics for The PMI Group, Inc., and Vice President and Chief Economist for Fannie Mae. David has also served as Chief Financial Economist at Wharton Econometrics and visiting scholar at the Federal Reserve Bank of Kansas City. His government experience has included roles with the President s Council of Economic Advisors, U.S. Treasury Department and the Office of Special Trade Representative. He is a past President of the National Association for Business Economics. Mark Hackett, CFA, CMT Chief of Investment Research Investment Management Group Mark is a leader for s capital markets analysis and thought leadership initiative, developing content to educate financial advisors and their clients on financial markets and implications for investors. In this role he is responsible for asset class research, market commentary, white papers and topical market pieces and has been featured in numerous financial publications and webinars. Mark brings over 17 years of experience in the asset management industry, including roles in research for both Nuveen and Vanguard Group and as a Portfolio Manager for Nuveen. He earned his BBA in Finance and Economics at the University of Richmond. 49

50 Not a deposit Not FDIC or NCUSIF insured Not guaranteed by the institution Not insured by any federal government agency May lose value The information in this report is general in nature and is not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account any specific investment objectives, tax and financial condition or particular needs of any specific person. The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they will not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness. Investment Services Corporation (NISC), member FINRA. The is a division of NISC. Funds distributed by Fund Distributors LLC (NFD), member FINRA, Columbus, Ohio, NFD is not affiliated with any subadviser contracted by Fund Advisors (NFA), with the exception of Asset Management, LLC (NWAM). NFD separate but affiliated with NISC., the N and Eagle, is on your side and the are service marks of Mutual Insurance Company NFM-13126AO.15 (1/18)