III. ACTIVITY: Informational Request for Direction Action Proposed Exploratory

Transcription

1 333 Bush Street San Francisco, CA (415) Date: February 6, 2015 TO: MEMBERS, INVESTMENT COMMITTEE I. AGENDA ITEM # AND TITLE : Open Agenda Item 4 - Economic and Investment Outlook II. NAME AND PROGRAM: Treasury and Investments III. ACTIVITY: Informational Request for Direction Action Proposed Exploratory IV. JUSTIFICATION: Standard/Required Item Board Request New Item New Topic from Staff V. EXECUTIVE SUMMARY: The attached slides highlight BlackRock s Economic Outlook and provide a list of the Five Things To Know and the Five Things To do in State Compensation Insurance Fund Open Agenda Item 4 Economic and Investment Outlook

2 2015 Outlook: What to Know, What to Do For professional clients / qualified investors only State Compensation Insurance Fund

3 The BlackRock List 5 Things to Know 1 Central Banks Diverge: Dollar Likely Higher 2 Long-Term Rates: Still Low for Long 3 U.S. Economy Leads the Pack 4 Inflation: Not on the Horizon Yet 5 A Bumpier Road Ahead for Stocks 1 Prefer Stocks Over Bonds, But Be Choosy 5 Things to Do For professional clients / qualified investors only 5 Stock Up Outside the U.S., Too Watch Your Step in Bonds Resist the Urge to Exit Seek Growth in a Low-Growth World State Compensation Insurance Fund 2

4 Investing involves risk, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Investing in alternative strategies such as a long/short strategy, presents the opportunity for losses which exceed the principal amount invested. The opinions expressed are as of January 2015 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. Past performance is no guarantee of future results BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. USR

5 APPENDIX 4

6 Asset Class Performance: 2014 Easy monetary policy has suppressed volatility and pushed up asset prices across the board. Many assets look cheap only because everything else is so expensive. Asset Class Performance in 2014 (% Return) China Shanghai A German Bund S&P 500 Nasdaq Composite Dollar index U.S. 10-year Treasury Japan Topix MSCI Asia ex Japan JPM EMBI Emerging Debt MSCI Developed Equities ($) MSCI Europe Equities ML Global Investment Grade UK FTSE 100 ML Global High Yield Gold MSCI Emerging Equities ($) Yen Copper GSCI Soft Commodities CRB Commodities Index Brent Crude Oil Sources: Thomson Reuters Datastream, BlackRock Investment Institute, December 31, Notes: Total return in local currency except currencies, gold and copper, which are spot returns. Government bonds are 10-year benchmark issues, 5

7 1 Central Banks Diverge: Dollar Likely Higher We expect tightening financial conditions in the U.S. and U.K. Lackluster growth and low inflation expectations support looser monetary policy elsewhere. GDP Growth & Financial Conditions in Selected Economies Central Bank Liquidity Injections Nominal Growth More 14% 12% 10% 8% 6% China Brazil United Kingdom India Billion ($) QE1 QE2 Operation Twist QE3 Less 4% 2% Japan United States Eurozone -200 ECB Kuroda QE/ LTRO Abenomics % Loose(r) Financial Conditions Tight(er) Sources: BlackRock Investment Institute and IMF, October Notes: Nominal growth forecasts are from the IMF World Economic Outlook. Global GDP weights of economies are based on purchasing power parity, rather than on current exchange rates. Financial conditions are BlackRock s estimates of monetary policy, fiscal policy, exchange rates and credit conditions. Bank of England Bank of Japan European Central Bank U.S. Federal Reserve Total Sources: BlackRock Investment Institute and Citi Research, November Notes: Liquidity injections are net securities purchases plus long-term repos. Data are rolling three-month averages. LTRO is long-tern repurchase operation, the ECB program to provide financing to eurozone banks. 6

8 1 Central Banks Diverge: Dollar Likely Higher The prospect of U.S. rate hikes and a shrinking trade deficit support a stronger dollar, which puts downward pressure on commodities and inflation. Trade-Weighted Major Currency U.S. Dollar Index U.S. Trade Deficit Index Trade Deficit Share of GDP Other Goods & Services 70 1 Petroleum Products Source: Bloomberg, 12/31/14. Note: The shaded areas show the periods of a rising U.S. dollar Sources: BlackRock Investment Institute, U.S. Census Bureau and U.S. Bureau of Economic Analysis. November

9 2 Long-Term Rates: Still Low for Long Long-term interest rates may inch up this year, but expect them to be low for some time to come. Real GDP - Rebased to Current vs. Past Recoveries from Recession Global 10-Year Government Bond Yields (%) recession range Average recession Big-five financial crises US Eurozone Norway Denmark Germany Years before Switzerland recession Years after recession Sources: BlackRock Investment Institute. Thomson Reuters Datastream and IMF Current Yield Average Yield Last 5 Years November Notes: Real GDP is rebased to 100. The big five financial crises are Sources: Thomson Reuters Datastream, BlackRock Investment Institute, December Spain (1977, Norway (1987), Finland (1991), Sweden (1991) and Japan (1992). The average recession (two straight quarters of contraction) is based on G20 countries since The recession range is based on an average of the three best and worst recessions. 8 Greece South Africa New Zealand Australia Poland United States Italy United Kingdom Canada Spain Ireland France Japan

10 3 U.S. Economy Leads the Pack We believe the U.S. economy will show gross domestic product (GDP) growth in the area of 2.5% to 3% in The biggest challenge facing the U.S. economy is what transpires overseas. Economic Surprise Indices GDP Impact of $25 Oil Price Fall (Percentage Points) China India U.S. U.K. Germany Index 0 Eurozone Brazil Japan Canada Australia US Eurozone China Japan Sources: Thomson Reuters Datastream, Citigroup, BlackRock Investment Institute, December Notes: Surprise tracks actual economic data relative to consensus estimates of market economists. A number above zero shows data on average beating expectations. Norway Russia -1.9 Developing Countries -0.7 Developed Countries Source: BlackRock Investment Institute and UBS, November Note: The chart shows the simulated impact on GDP after one year from a permanent $25 decline in the price of oil, as estimated by UBS in an econometric model that takes into account linkages between existing economies, GDP and inflation. 9

11 4 Inflation: Not on the Horizon Yet Inflation remains low in the U.S., but wage growth warrants watching. Elsewhere in the world, particularly in Europe, deflation is the greater concern. U.S. Wage Growth and Unemployment Eurozone Inflation Rates vs. Target Wages (Annual Change) Nov 2014 Nov Short-Term Unemployment Rate Sources: BlackRock Investment Institute and U.S. Bureau of Labor Statistics, November Note: The short-term unemployment rate is defined as those unemployed less than six months as a share of the total labor force. Wages are represented by the Employment Cost Index, which tracks the total cost of U.S. labor including wages, benefits and bonuses. Greece -1.8 Spain -0.2 Slovakia 0.0 Slovenia 0.1 Portugal 0.1 Italy 0.2 Belgium 0.3 Cyprus 0.3 Luxembourg 0.4 Netherlands 0.4 Ireland 0.4 Estonia 0.5 France 0.5 Malta 0.7 Germany 0.7 Finland 1.2 Austria 1.4 Eurozone Target Sources: BlackRock Investment Institute and Eurostat, November

12 5 A Bumpier Road Ahead for Stocks With the Fed ready to change tack, the economy struggling in Europe and geopolitical tensions in places like Ukraine, we expect higher volatility in Implied Volatility in the Equity Markets S&P 500 Index Bernanke states bond purchases may be tapered U.S. Sequester Goes into Effect Fed reiterates intention to taper US Government 16-day Partial Shutdown September 2014 FOMC meeting ISIS and Iraq Tensions VIX Index Boston Marathon Bombing Emerging Market Volatility Ebola Scare Monetary Policy Divergence 1400 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan S&P 500 Index, left scale VIX Index, right scale Source: Bloomberg, BlackRock, January Note: The Chicago Board Options Exchange Volatility (VIX) Index shows the market's expectation of 30-day volatility in the S&P

13 5 A Bumpier Road Ahead for Stocks With the Fed ready to change tack, the economy struggling in Europe and geopolitical tensions in places like Ukraine, we expect higher volatility in Events to Watch in 2015 Source: BlackRock Investment Institute, November

14 1 Prefer Stocks Over Bonds, But Be Choosy Valuations range from sky-high (government bonds) to average (most credit and developed equities). We continue to prefer stocks over bonds and cash, even with volatility expected to rise. Valuations by Percentile vs. Historical Norms 100 Fixed Income Equities Percentile Ranking Expensive Average Cheap 0 Japanese Bonds German Bund UK Gilt US Treasury US TIPS Euro High Yield Euro credit US High yield UK non-gilts US Credit EM $ Debt US Canada Germany France Spain Australia UK Japan Italy South Africa Mexico India Taiwan Brazil December 2013 Korea China Russia Source: BlackRock Investment Institute (BII) and Thomson Reuters as of 12/31/14. Valuation percentiles are based on an aggregation of standard valuation measures versus their longterm history. Government Bonds are 10-year benchmark issues. Equity valuations are average percentile ranks versus available history of earnings yield, cyclically adjusted earnings yield, trend real earnings, dividend yield, price to book, price to cash flow and forward 12-month earnings yield 13

15 1 Prefer Stocks Over Bonds, But Be Choosy Greater value can be found in sectors positioned to benefit from economic growth, such as technology and large, integrated oil companies. Equity Market Total Return by Source of Return U.S. High- and Low-Beta Stocks vs. Yield Changes Last 12 Months Total Return (%) Average Monthly Return Low Beta High Beta Monthly Yield Change (Basis Points) US Japan Eurozone AC World $ UK Emerging Sources: BlackRock Investment Institute, November Note: The analysis plots the Dividends Earnings Multiple Expansion Total Return monthly performance of two portfolios of U.S. stocks ( one high-beta and one low-beta) against monthly yield changes in 10-year treasuries. The average monthly returns are excess returns above the risk-free rate and are based on a rolling window of 30% of the available Sources: BlackRock Investment Institute, December history. Historical returns are not indicative of future performance. 14

16 2 Stock Up Outside the U.S., Too We would focus on opportunities in certain international markets. Japan remains the most attractively priced developed market, with catalysts for further stock gains on the horizon. P/B and Dividend Yield by Country Japanese Buybacks and Dividend Payouts Brazil UK Australia Dividend Yield (%) Poland Hong Kong South Korea Europe Canada Japan China South Africa Switzerland US Mexico Price-to-Book Ratio Sources: Goldman Sachs, January Note: The analysis is based on 1,689 Tokyo Source: Bloomberg, January Past performance is no guarantee of future results. Stock Exchange-listed companies are Goldman Sachs estimates E Buybacks, tn yen Dividends, tn yen Return on equity, % 15

17 3 Watch Your Step in Bonds With rising interest rates, bond principal is at risk. Be wary of shorter maturities in particular, which would be most affected by a Fed rate hike. U.S. Treasury Yield Curve Cumulative Global Fixed Income ETP Flows Treasury Yields (%) Billions ($) Jul-13 Dec-13 Dec-14 Source: Bloomberg, BlackRock, December Sources: BlackRock Investment Institute, December Notes: ETP is a exchangetraded product. Industry flow data collected by BlackRock 16

18 3 Watch Your Step in Bonds While the Fed may hike, a lack of bonds likely to keep long-term yields low. Low defaults still lend support to high yield. Weight in Select Universe, in % Fixed Income Assets Yielding Over 4% Global High Yield Emerging Market U.S. CMBS Global Corporate IG U.S. MBS Euro Peripheral U.S. Municipal U.S. Agency Euro Core U.S. Treasury U.S. High Yield Default Rate vs High Yield Spread Sources: BlackRock Investment Institute, Barclays and Thomson Reuters, June 2014 Note: The bars show market capitalization weights of assets with an average annual yield over 4% in a Default Rate Spread select universe that represents about 70% of the Barclays Multiverse Bond Index. Euro core is based on French and German government debt indexes. Euro peripheral is an average of government debt Source: Barclays, J.P. Morgan, BlackRock, December 2014 indexes for Italy, Spain and Ireland. Emerging markets combine external and local currency debt. Default Rate (%) 16% 14% 12% 10% 8% 6% 4% 2% 0% Spread (Basis Points) 17

19 4 Resist the Urge to Exit It s important to hold some cash, but too much can set you back. Cash comes with a cost after inflation and taxes. Compound Returns of Cash After Inflation and Taxes ( ) Return (%) Stocks After Inflation After Taxes Bonds After Inflation After Taxes Cash After Inflation -0.8 After Taxes Sources: BlackRock; Morningstar; Tax Foundation. Past performance is no guarantee of future results. Assumes reinvestment of income and no transaction costs. This is for illustrative purposes only and not indicative of any investment. Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $110,000 in 2012 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. For the period covered ( ), the high capital gains tax rate was 28% and the low was 3%. The high ordinary income tax rate was 55% and the low was 3%. No state income taxes are included. Stocks are represented by the S&P 500 Index. Bonds are represented by the Morningstar/Ibbotson Intermediate-Term Government Bond Index. Cash is represented by the Morningstar/Ibbotson 30-Day U.S. Treasury Bill Index. Inflation is represented by the Consumer Price Index. It is not possible to invest directly in an index. 18

20 5 Seek Growth in a Low-Growth World Expand beyond traditional assets in an effort to optimize your portfolio s results. Use non-traditional tools to diversify and seek a smoother ride Infrastructure Long/Short Strategies TRADITIONAL STOCKS AND BONDS + SEEK A SMOOTHER RIDE Flexible Investments Real Estate Consider long/short strategies, infrastructure, real estate, and flexible investments 19