Corporate Earnings Picture Remains Healthy

Transcription

1 WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE Sameer Samana, CFA Global Equity and Technical Strategist Corporate Earnings Picture Remains Healthy May 7, 2018 Key takeaways» Many U.S. investors have spent the majority of this year concerned about a host of issues that could impact equity-market valuations and fundamentals. A peak in earnings growth is the most recent concern.» We believe that 2018 may mark the peak in the earnings growth rate, but history shows that it is normal for the pace of profit growth to slow later in the economic cycle. What it may mean for investors» Our outlook calls for domestic profit growth to revert to lower, but more sustainable levels. As the investing backdrop remains favorable, we recommend that investors capitalize upon this market landscape by bringing exposure to U.S. equities in-line with their targeted asset allocation weightings. Asset Group Overviews Equities... 4 Fixed Income... 5 Real Assets... 6 Alternative Investments... 7 Since the start of this year, many U.S. investors have spent a lot of time concerned about a combination of higher volatility, rising interest rates, tighter monetary policy, normalizing inflation, and the possibility of trade restrictions. With the first-quarter earnings reporting period well underway, an additional concern has surfaced whether we have seen a peak in earnings growth. While we believe that 2018 may mark the highwater mark for the domestic earnings growth rate, the level of corporate earnings should continue to grow at a slower, but more sustainable pace. We believe that this profit growth will be enough to continue driving equity-market gains in the U.S. To date in 2018, equity returns have been muted, with volatility rising and investors concerned about a host of issues and how they might impact equity-market valuations and fundamentals. Many investors hoped that first-quarter earnings (which would be the first ones to show the impacts of tax cuts) would act as a catalyst and break equity markets out of their malaise. With about 70% of companies in the S&P 500 Index having reported, year-over-year sales growth has been running at about 7% and earnings have grown at close to 14% (Chart 1) Wells Fargo Investment Institute. All rights reserved. Page 1 of 10

2 Corporate Earnings Picture Remains Healthy Chart 1. Growth in S&P 500 Index sales and earnings per share 75.00% 55.00% 35.00% 15.00% -5.00% % % Sales Growth EPS Growth Sources: Bloomberg, Wells Fargo Investment Institute, May 2, For illustrative purposes only. The S&P 500 is a market capitalization-weighted index generally considered representative of the US stock market. An index is unmanaged and not available for direct investment. While these are solid growth numbers, it also is important to look at how these results compare with expectations. The percentage of companies reporting positive firstquarter earnings surprises is close to 80%, which is the highest percentage since 2009 (Chart 2). Unfortunately, these earnings reports have not been enough to get markets moving as investors have instead focused on future earnings guidance, which has been more cautious. From our standpoint, given the crosscurrents in the global economy, we can see why companies would be cautious in their forecasts, as exact details on key issues, such as tariffs, have not yet been released. Chart 2. Percentage of positive S&P 500 earnings surprises 85% 80% 75% 70% 65% 60% 55% 50% Sources: Bloomberg, Wells Fargo Investment Institute, May 2, For illustrative purposes only Wells Fargo Investment Institute. All rights reserved. Page 2 of 10

3 Corporate Earnings Picture Remains Healthy It also is easy to see why 2018 may be a high-water mark for the earnings-per-share (EPS) growth rate (Chart 1). Historically, it is normal for the EPS growth rate to decelerate later in the economic cycle. If anything, the recently-enacted tax cuts interrupted the natural order of things by creating a windfall that is likely to boost growth rates temporarily in a way that should not be repeated in The more important question for investors going forward is whether future earnings increases will settle back onto a more sustainable path or if a more significant downturn is in the offing. Given our outlook for improving U.S. economic growth and moderating inflation, we see a much higher probability of the former trend (earnings growth continuing, but gradually slowing) than the latter (a downturn). History shows that steady gross domestic product (GDP) growth bodes well for corporate revenues and top-line growth. Interestingly, domestic sales growth currently is accelerating, and it is all organic as the tax cuts have no direct impact on revenues. Also, growth in wages, the largest cost for most firms, remains subdued. We expect a mild reversion to lower EPS growth levels, rather than a more severe EPS growth slowdown, due to this solid revenue expansion and muted wage growth, along with a continuation of historically low rates, moderating inflation, and a Federal Reserve (Fed) that is normalizing monetary policy gradually. While a full-blown trade war remains a risk, we do not view it as one that has a high probability of occurring. For these reasons, we maintain year-end equity targets that show positive returns for the balance of 2018, and we continue to have a favorable view on U.S. equities. We believe that investors should use the current market lethargy as an opportunity to bring domestic equity exposure in-line with targeted asset allocation weightings Wells Fargo Investment Institute. All rights reserved. Page 3 of 10

4 EQUITIES Sean Lynch, CFA Co-Head of Global Equity Strategy U.S. Small Cap Equities U.S. Large Cap Equities U.S. Mid Cap Equities Developed Market Ex-U.S. Equities Defensive sectors struggle with their role Over the past year, three S&P 500 Index sectors have had negative price returns Consumer Staples, Utilities, and Telecom Services. 1 These are defensive sectors that historically have performed relatively well in times of economic stress. They traditionally have offered attractive dividend yields and demand (for their goods and services) that is little changed by economic conditions. For example, grocery, utility, or cell-phone service demand historically has been relatively unchanged when economic troubles arise. As noted, these sectors had negative returns over the 12 months ended on May 2. In fact, Consumer Staples has declined by more than 10% year to date. Many Consumer Staples stocks are down 20% this year and are in correction mode. These stocks now offer relatively attractive dividend yields (as the yield on the S&P 500 Consumer Staples Index is currently 3.3%). This may appear attractive to value-oriented investors. Yet, this sector is facing significant headwinds that have become more apparent in recent quarterly earnings reports. Unit-volume growth is sluggish, and pricing power is coming under pressure from online and private-label retailer competition. This sector, which at one time offered relatively consistent and moderate growth, is likely to see more challenges throughout Telecom Services also is facing significant competitive and pricing pressures. We have a most unfavorable position on Consumer Staples and Utilities and an unfavorable view on Telecom Services. Though some value can be found in these sectors, we favor more cyclical sectors today and recommend that investors resist the urge to increase exposure to these defensive sectors. Key takeaways» The S&P 500 Consumer Staples, Utilities, and Telecom Services sectors had negative price returns over the past 12 months.» Though value can be found in these sectors, we would resist the urge to become more aggressive in the Consumer Staples, Utilities, and Telecom Services sectors today. Defensive sectors have had the weakest one-year performance (through May 2) Unfavorable Emerging Market Equities Index level (indexed at 100 on 5/2/2017) % -0.3% -9.1% -10.3% 85 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 S&P 500 Consumer Staples Sector S&P 500 Telecom Sector S&P 500 Utilities Sector S&P 500 Sources: Wells Fargo Investment Institute, Bloomberg; May 2, For illustrative purposes only. The S&P Sector Indices measure the performance of the widely-used Global Industry Classification Standard (GICSR) sectors and sub-industries, for example, the consumer staples, telecommunications and utilities sectors. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. 1 Returns are for the 12 months ended on May 2, Wells Fargo Investment Institute. All rights reserved. Page 4 of 10

5 FIXED INCOME Brian Rehling, CFA Co-Head of Global Fixed Income Strategy How high can rates go? Unfavorable U.S. Taxable Investment Grade Fixed Income U.S. Short Term Taxable Fixed Income U.S. Intermediate Term Taxable Fixed Income Most Unfavorable U.S. Long Term Taxable Fixed Income Unfavorable High Yield Taxable Fixed Income Unfavorable Developed Market Ex.-U.S. Fixed Income Emerging Market Fixed Income A common question from investors is how high can U.S. interest rates go during this cycle? This is best answered in two parts our outlook for the short-term fed funds rate and our outlook for longer-term 10 year Treasury note yields. The relationship between short- and longer-term rates offers insights on how high rates can go. Short-term rates We look for the Fed to continue raising rates at a gradual pace through At the March Federal Open Market Committee (FOMC) meeting, members projected the median fed funds rate at 3.4% in 2020 and 2.9% in the longer run. Given the current pace of Fed rate hikes and forecasts, we expect the fed funds rate to top out between 3.00% and 3.50% in this cycle. This would imply a total of three rate hikes this year, three in 2019, and one or two in The yield curve The yield curve follows fairly predictable trends steepening early in a recovery before flattening (and then inverting) into an eventual economic downturn. This pattern has been repeated consistently over the past 30 years. Today, the difference between shortterm 3 month Treasury bill rates (1.83%) and 10-year Treasury yields (2.96%) is just over 1%. We expect to see further curve flattening as the Fed continues to raise short-term rates. Longer-term rates If the yield curve remains flat (or flattens further as we expect), the upside risk in longer-term issues should be limited. Yet, the 10-year Treasury yield should increase modestly as the economy continues expanding and labor markets tighten. We expect a fed funds terminal value 2 near 3.25% in this cycle and a 10-year Treasury yield that remains under 4.00%. Key takeaways» Higher short-term rates offer an opportunity for increased income potential in lower risk fixed-income classes.» While curve flattening is the trend, the curve remains sufficiently steep to suggest that the slow-growth environment will continue.» We have a favorable view on short-term taxable fixed income and an unfavorable view on long-term fixed income while targeting below benchmark duration positioning. 3 2 This is the highest Federal Funds rate expected in this business cycle. 3 Duration measures a bond s price sensitivity to interest-rate changes Wells Fargo Investment Institute. All rights reserved. Page 5 of 10

6 REAL ASSETS John LaForge Head of Real Asset Strategy Unfavorable Commodities Private Real Estate Public Real Estate Work like you don t need the money, love like you ve never been hurt, and dance like nobody is watching. Nice MLP bounce but we are not convinced --Mark Twain Master limited partnerships (MLPs) were the best-performing major asset class in April. The Alerian MLP Index 4 returned more than 8% last month, with nearly every individual MLP within the index up. Yet, we favor caution as we believe that the two drivers behind April s outperformance (a bounce from oversold conditions, and the oilprice rally) are likely to fade. MLPs oversold conditions were the first driver behind April s outperformance. On March 15, the industry was hit with a negative regulatory ruling. The average MLP lost nearly 10% that day. With most of March s loss regained in April, MLPs now are set to lose their oversold tailwind (in our view). The second driver of April MLP returns was the continued oil-price rally. West Texas Intermediate (WTI) crude oil tacked on an additional $4 per barrel (a 5% price increase), bringing its yearly gain to 12%. With oil inventories beginning to build, and record U.S. oil production, we are skeptical that WTI s rally can continue much longer. If we are right, and oil prices begin to fade, we believe that MLPs will fade too. While it is impressive, April s outperformance does not change our neutral rating on MLPs. As for what would get us to upgrade MLPs, we give you Chart 1. Chart 1 shows the performance of MLPs versus other key assets. Since 2014, MLPs have flat out struggled versus most major assets. We need to see these downtrends change (and not just for a month or two), before we upgrade MLPs. Key takeaways» MLP performance was strong in April. The drivers of the rally, however, look set to fade.» We remain neutral on MLPs. To upgrade MLPs, we need to see more consistent outperformance (relative strength). MLPs versus energy stocks, REITs, and a hypothetical portfolio MLPs/energy stock ratio MLPs/REIT ratio MLPs/hypothetical MG&I portfolio Ratio Sources: Bloomberg, Wells Fargo Investment Institute. Daily data: January 3, 2011 May 2, Indexed to 100 as of 1/3/2011. Performance results for the Moderate Growth & Income Portfolio are hypothetical and for illustrative purposes only. Hypothetical returns do not represent investment returns or the results of actual trading. Index returns represent general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. Unlike most asset class indices, HFR Index returns reflect deduction for fees and expenses. Because the HFR indices are calculated based on information that is voluntarily provided actual returns may be higher or lower than those reported. An index is unmanaged and not available for direct investment. Hypothetical and past performance do not guarantee future results. Please see page 8 for the composition of the MG&I portfolio, asset class risks and the definitions of the indices. REITs = real estate investment trusts. 4 The Alerian MLP Index is the leading gauge of energy MLPs. It is a capped, float-adjusted capitalization-weighted index whose constituents represent approximately 85% of the total float-adjusted market capitalization. The index is disseminated real-time on a price return basis (AMZ) and on a total return basis (AMZX) 2018 Wells Fargo Investment Institute. All rights reserved. Page 6 of 10

7 ALTERNATIVE INVESTMENTS Justin Lenarcic Global Alternative Investment Strategy Analyst Private Equity Hedge Funds-Macro Hedge Funds-Event Driven Hedge Funds-Relative Value Most Hedge Funds-Equity Hedge Credit investing involves both corporate and structured credit The idea of investing in structured credit can be intimidating, especially considering the acronyms that constitute structured. The alphabet soup of structured credit can cause some investors to avoid the asset class entirely, preferring to focus their credit allocation on more traditional investment-grade and high-yield corporate debt. We believe that a diversified credit allocation should include both corporate and structured credit. Yet, it is important for investors to understand the difference in fundamental drivers supporting structured credit and corporate credit. Moreover, just like with corporate credit, there are both investment-grade and high-yield sectors within structured credit, which can present different risks and opportunities. Our guidance on structured credit is geared toward investment-grade securities, but hedge funds often invest across the capital structure seeking the best value regardless of credit rating. For example, in 2016 and 2017, we saw a tremendous opportunity for highyield commercial mortgage-backed securities (CMBS) relative to high-yield corporate credit, upon which many structured credit hedge funds capitalized. Currently, within the structured credit asset class, we see the best opportunities within residential mortgage-backed securities (RMBS). Extremely low unemployment and wage inflation are fundamentally positive for the U.S. consumer, while strong trends in existing and new home sales, along with continued home value appreciation, provide a technical tailwind to RMBS. This combination of supportive fundamentals and attractive pricing is the primary reason that we have a slightly favorable view on Relative Value hedge funds focused on structured credit. Key takeaways» We believe that credit investing should include both corporate debt and structured credit.» There is a difference in the fundamental drivers for corporate and structured credit. This can allow investors to potentially capitalize upon relatively attractive pricing differentials. Fundamental and technical support for Residential Mortgage-Backed Securities Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not suitable for all investors and are only open to accredited or qualified investors within the meaning of U.S. securities laws. U.S. existing home sales (millions) U.S. new home sales (thousands) May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov U.S. existing home sales (LHS) U.S. new home sales (RHS) Sources: Wells Fargo Investment Institute, Bloomberg. May Wells Fargo Investment Institute. All rights reserved. Page 7 of 10

8 Risks Considerations Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. In addition to the risks associated with investment in debt securities, investments in mortgage-backed and asset-backed securities will be subject to prepayment and call risks. Changes in prepayments may significantly affect yield, average life and expected maturity. If called prior to maturity, similar yielding investments may not be available for the Fund to purchase. These risks may be heightened for longer maturity and duration securities. Commercial Mortgage Backed Securities (CMBS) are a type of mortgage-backed security backed by commercial mortgages rather than residential real estate. CMBS tend to be more complex and volatile than residential mortgage-backed securities due to the unique nature of the underlying property assets. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions. Investment in energy-related Master Limited Partnerships (MLPs) is subject to the risks of investing in MLPs and the energy sector. Investment in securities of MLPs involves certain risks which differ from an investment in the securities of a corporation. Holders of MLP units have limited control and voting rights on matters affecting the partnership. In addition, there are certain tax risks associated with an investment in MLP units and conflicts of interest may exist between common unitholders and the general partner, including those arising from incentive distribution payments. MLPs may be sensitive to price changes in oil, natural gas, etc., regulatory risk, and rising interest rates. A change in the current tax law regarding MLPs could result in the MLP being treated as a corporation for federal income tax purposes which would reduce the amount of cash flows distributed by the MLP. Other risks include the volatility associated with the use of leverage; volatility of the commodities markets; market risks; supply and demand; natural and man-made catastrophes; competition; liquidity; market price discount from NAV and other material risks. A downturn in the energy sector of the economy, adverse political, legislative or regulatory developments or other events could have a larger impact on a portfolio that concentrates in the sector. The energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources and risks that arise from extreme weather conditions. Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is suitable only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing. Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund. MLPs versus Energy Stocks, REITs, and Hypothetical MGI Portfolio Compositions and Definitions MLPs/Energy Stock Ratio: Shows the ratio of the Alerian MLP Index to the S&P 500 Energy Sector Index. MLP/REITs Ratio: Shows the ratio of the Alerian MLP Index to the FTSE NAREIT All Equity REITs Index. S&P 500 Energy Index comprises those companies included in the S&P 500 Index that are classified as members of the GICS energy sector. FTSE NAREIT All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs. MLP/Hypothetical Moderate Growth & Income Portfolio: Shows the performance of MLPs as represented by the MLP Alerian Index to a hypothetical Moderate Growth & Income Portfolio. S&P 500 Index (Total Return) (18%), Russell Midcap Index (Total Return) (7%), FTSE NAREIT Developed REITs Index (Total Return) (3%), Russell 2000 Index (Total Return) (5%), Dow Jones Private Equity Index (Total Return 2018 Wells Fargo Investment Institute. All rights reserved. Page 8 of 10

9 (6%), RCA CPPI Composite National Index (5%), Bloomberg Barclays U.S. Aggregate 5-7 Year Bond Index (Total Return) (12%), Bloomberg Barclays U.S. Aggregate 10+ Year Bond Index (Total Return) (5%), Bloomberg Barclays U.S. Treasury Bills Index (Total Return) (3%), Bloomberg Barclays U.S. Corporate High Yield Index (Total Return) (6%), JPMorgan EMBI Global Index (Total Return) (6%), JPMorgan Non- U.S. Global GBI Hedged Index (2%), HFRI Relative Value (Total) Index (3%), HFRI Macro (Total) Index (3%), HFRI Equity Hedge (Total) Index(2%), HFRI Event-Driven (Total) Index (2%), MSCI Emerging Markets Index (Total Return) (4%), MSCI EAFE Developed Market Index (Total Return) (6%), Bloomberg Commodity Index (Total Return) (2%). Dow Jones Private Equity Index tracks the performance of globally listed private equity stocks and is composed of the 25 largest and most liquid stocks of private equity companies listed on the world s stock exchanges. Dow Jones Indexes is responsible for the selection of the index components, the index calculation, the ongoing maintenance and the index dissemination. To ensure that the Private Equity Index is always accurate and is calculated with the most up-to date constituent data, the component data (i.e. number of shares, free float factor, weighting factor) of the Private Equity Index is reviewed on a quarterly basis. The resulting changes to the index are implemented after the closing on the third Friday in March, June, September, and December and are effective the next trading day. RCA CPPI Composite National Index measures property price at a national level. It is based on repeat-sales transactions that occurred at any time up through the month prior to the current report. Because CPPI allows for backward revisions and incorporates any new data we receive subsequent to publishing, full history (from inception to current month) of future indices will reflect adjustments due to additional transaction data. Index Definitions: Public Market Bloomberg Barclays U.S. Treasury Bills (1-3M) Index is representative of money markets. Bloomberg Barclays U.S. Aggregate 5-7 Year Bond Index is unmanaged and is composed of the Barclays U.S. Government/Credit Index and the Barclays U.S. Mortgage-Backed Securities Index. Bloomberg Barclays U.S. Aggregate 10+ Year Bond Index is composed of the Barclays U.S. Government/Credit Index and the Bloomberg Barclays U.S. Mortgage-Backed Securities Index. Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the U.S. dollardenominated, non-investment grade, fixed-rate, taxable corporate bond market. Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements. FTSE EPRA/NAREIT Developed Index is designed to track the performance of listed real-estate companies and REITs in developed countries worldwide. JPMorgan GBI ex-us Index (Unhedged) in USD is an unmanaged index market representative of the total return performance in U.S. dollars on an unhedged basis of major non-u.s. bond markets. JPMorgan EMBI Global Index (USD) is a U.S. dollar-denominated, investible, market cap-weighted index representing a broad universe of emerging market sovereign and quasi-sovereign debt. JPMorgan Non-U.S. Global Government Bond Index (Hedged) is an unmanaged market index representative of the total return performance, on a hedged basis, of major non-u.s. bond markets. It is calculated in U.S. dollars. MSCI EAFE (DM) and MSCI Emerging Markets (EM) Indices are equity indices which capture large and mid cap representation across 21 DM countries (excluding Canada and the U.S.) and 23 EM countries around the world. Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25% of the total market capitalization of the Russell 1000 Index. Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. S&P 500 Index is a market capitalization-weighted index generally considered representative of the US stock market. Index Definitions: Hedge Fund Strategies: The HFRI Indices are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways. HFRI Relative Value Index maintains positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative, or other security types. HFRI Equity Hedge Index maintains positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations, and valuation ranges of typical portfolios. HFRI Macro Index is composed of a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency, and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of topdown and bottom-up theses, quantitative and fundamental approaches, and long- and short-term holding periods. Although some strategies employ RV techniques, macro strategies are distinct from RV strategies in that the primary investment thesis is predicated on predicted or 2018 Wells Fargo Investment Institute. All rights reserved. Page 9 of 10

10 future movements in the underlying instruments rather than realization of a valuation discrepancy between securities. HFRI Event Driven Index maintains positions in companies currently or prospectively involved in corporate transactions of a wide variety including, but not limited to, mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance, or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated and frequently involve additional derivative securities. Event driven exposure includes a combination of sensitivities to equity markets, credit markets, and idiosyncratic, company-specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative) with the realization of the thesis predicated on a specific development exogenous to the existing capital structure. General Disclosures Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR Wells Fargo Investment Institute. All rights reserved. Page 10 of 10