We have launched Communication Services with an unfavorable outlook WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE

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1 WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE Audrey Kaplan Head of Global Equity Strategy Ken Johnson, CFA Investment Strategy Analyst October 8, 2018 Our Outlook on the New Communication Services Sector» Wells Fargo Investment Institute initiated the new S&P 500 Index Communications Services sector with an unfavorable rating last month.» In our view, valuation and quality indicators for this sector are less attractive than those for other large-cap equity sectors at this point in the economic cycle.» The earnings revision momentum for the Communications Services sector has deteriorated over the past six months. We anticipate that earnings per share (EPS) forecasts may be downgraded further as this sector faces additional headwinds from new security and regulatory costs. What it may mean for investors» We believe that other S&P 500 Index sectors offer more upside potential in the tactical time frame (6-18 months) than the Communications Services sector does. These sectors include the Health Care sector and sectors that are likely to benefit from continued economic expansion, such as Consumer Discretionary, Financials, and Industrials. We have launched Communication Services with an unfavorable outlook Asset Group Overviews Equities... 5 Fixed Income... 6 Real Assets... 7 Alternative Investments... 8 After the market close on September 28, Standard & Poor s restructured its 11 sector Global Industry Classification Standard (GICS ) lineup to add the Communication Services sector. This involved completing a restructuring of the Telecommunication Services (Telecom Services) sector into a broader new Communication Services (CS) sector and combining it with the reallocation of several Consumer Discretionary and Information Technology (IT) companies to form the new sector. Communication Services was the first new sector to launch since 2016, when the new Real Estate sector was added to the S&P 500 Index, drawing real estate stocks from the Financials sector sub-index. The creation of the new CS sector is a reflection of the blurred business lines among companies in the telecom, media, and internet industries today. We reviewed the fundamental characteristics of the new sector and launched the CS sector with a tactically unfavorable outlook Wells Fargo Investment Institute. All rights reserved. Page 1 of 9

2 Our Outlook on the New Communication Services Sector Chart 1. Profile of the Communication Services sector by industry allocation Sources: Wells Fargo Investment Institute, FactSet, as of October 3, Communication Services Industry Diversified Telecommunication Services Media* Entertainment* Interactive Media & Services* Definition Providers of communications and high-density data transmission services (primarily through a high bandwidth/fiber-optic cable network). Operators of primarily fixed-line telecommunications networks and companies providing both wireless and fixed-line telecommunications services not classified elsewhere. This industry also includes internet service providers offering internet access to end users. Companies providing advertising, marketing or public relations services. Owners and operators of television or radio broadcasting systems, including programming. Includes radio and television broadcasting, radio networks, and radio stations. Providers of cable or satellite television services. This industry includes cable networks and program distribution. Publishers of newspapers, magazines, and books in print or electronic formats. Companies that engage in producing and selling entertainment products and services, including companies engaged in the production, distribution, and screening of movies and television shows, producers and distributors of music, entertainment theaters and sports teams. This industry also includes companies offering and/or producing entertainment content streamed online. Producers of interactive gaming products, including mobile gaming applications. This industry also includes companies providing educational software used primarily in the home. The industry excludes online gambling companies classified in the Casinos & Gaming sub-industry. Companies engaging in content and information creation or distribution through proprietary platforms, for which revenues are derived primarily through pay-per-click advertisements. This industry includes search engines, social media and networking platforms, online classifieds, and online review companies. It excludes companies operating online marketplaces classified in Internet & Direct Marketing Retail. * Represents an industry added to the CS sector from outside of Telecommunication Services. Broadly speaking, the new CS sector has relatively high-beta companies that historically have exhibited strong growth, and low dividend payers (current and forecasted), along with more globally focused companies (when compared to the former Telecom Services sector). The industry composition of the new sector is shown in Chart 1. In the aggregate, these companies have grown well historically. Our calculations show that these companies grew revenue over a four-year period at a lofty 86.7% through September 2018 the fastest pace of all 11 sectors that we reviewed. Yet, we believe that the current pricing reflects an expectation of continued above-average growth rates (so this growth, is, in effect, priced in ) Wells Fargo Investment Institute. All rights reserved. Page 2 of 9

3 Our Outlook on the New Communication Services Sector Profile of Communication Services four key market characteristics When establishing our tactical guidance for the CS sector, we reviewed four key market characteristic pillars (growth, value, quality, and macroeconomic conditions). Through that analysis, we identified several risks relative to other more favorable sectors. From a growth perspective, as of October 1, the newly launched sector scored least attractively on analyst revision momentum compared to the other 10 large-cap sectors that we monitor. Its dividend growth also has lagged most of the other sectors we view more favorably. While the consensus EPS growth forecast for the CS sector over the next 12 months remains at 19.3%, we see concerns over additional security requirements, regulatory hurdles, and additional costs driving the sector s forecasted EPS growth lower in the coming months. We have more confidence in the consensus EPS growth forecasts for the Industrials sector (at 14.2%) and Information Technology (at 15.2%). Further, both of these sectors offer a higher dividend growth trend. From a value perspective, Communications Services is the only sector that is currently offering a near-zero total forecasted yield. This valuation indicator measures the combined total of the forecasted dividend yield plus the buyback yield. 1 The other 10 S&P 500 Index sectors that we analyzed had a minimum total forecasted yield in the 1-2% range (with some sectors offering a total yield of 4-5%). Consequently, we identified a CS total yield disadvantage. Additionally, other valuation indicators that we reviewed, such as the trailing price/earnings (P/E) ratio, were less attractive for the CS sector than for the majority of other large-cap sectors. The P/E ratio for Communications Services was less attractive than it was for several of our favored sectors, including Financials and Industrials. From a quality perspective, our analysis showed that analyst forecast dispersion for the CS sector was high, indicating low conviction in the analysts average EPS forecasts for the 2018 and 2019 fiscal years. Another quality metric that we favor, return on equity, was subpar relative to some of the sectors we rate as favorable, such as Financials, Industrials, and Health Care. At this point in the economic cycle, we believe that quality indicators are particularly important. From an economic perspective, the capital spending of S&P 500 companies has increased across many sectors, but companies in the Communication Services sector have historically had capital-light business models. The new capital expenditures fueled by tax reform (and its new depreciation rules) should help to drive increased revenues in manufacturing sectors such as Industrials and IT at a time when the CS sector could face headwinds from additional self-regulation and/or government regulation. Moreover, we believe that a resolution of the trade dispute with China would be most favorable to the rest of the market (such as the Industrials, IT, and Health Care sectors), while we believe that a favorable trade-tariff outcome would have a neutral impact on CS companies. 1 Buyback yield divides the amount of outstanding shares repurchased (through a share buyback) by the existing market capitalization of a company. An index is unmanaged and not available for direct investing. Forecasted yields should not be interpreted as an indication of how the industries within the sectors will perform in the future Wells Fargo Investment Institute. All rights reserved. Page 3 of 9

4 Our Outlook on the New Communication Services Sector Over the three years that ended on September 28, the newly launched CS sector accounted for 9.9% of the S&P 500 Index total return. This is nearly the weight at which this sector launched (as a percent of the S&P 500 Index). But, for the first eight months of this calendar year, the CS sector accounted for just 7% of the index s total return. In summary, following our review of four key market pillars, our conclusion was that the risk was to the downside for the CS sector. Thus, we believe that below-market-level exposure is appropriate for Communication Services in the tactical time frame Wells Fargo Investment Institute. All rights reserved. Page 4 of 9

5 EQUITIES Scott Wren, Global Equity Strategist Ken Johnson, CFA, Investment Strategy Analyst U.S. Large Cap Equities U.S. Mid Cap Equities U.S. Small Cap Equities Developed Market Ex-U.S. Equities Our Consumer Staples upgrade In late September, we upgraded our guidance for the Consumer Staples sector to neutral from most unfavorable. For the nearly four years that we recommended investors underweight this sector relative to the S&P 500 Index, Consumer Staples dramatically underperformed the index (see chart below). Today, valuation indicators such as the trailing 12-month P/E and price-to-free-cash-flow ratios generally appear more favorable for this sector, and they are far more attractive than they were when we initially downgraded it. In addition, our quality rankings for this sector outpace those of all other large-cap sectors. Whether we examine debt levels, earnings dispersion, or return on equity, we find attractive opportunities in this sector which are in sharp contrast to those of recent years. Yet, it is important for investors to remember that the Consumer Staples sector tends to be a defensive one. In other words, this sector typically outperforms at the very end of a cycle as the economy slows. Historically, it also has outperformed halfway through the ensuing slowdown or recession. Increases in consumer spending and wages, which we expect in the coming quarters, usually have tended to benefit the Consumer Discretionary sector, rather than a defensive sector like Consumer Staples. But we do believe that companies in this sector will see incremental benefits as consumer spending rises, consumer sentiment remains at elevated levels, and wages rise in an improving labor market. Given the results of our recent analysis, we were comfortable moving to a neutral rating at this time.» We recently upgraded Consumer Staples to a neutral tactical rating (from most unfavorable).» This upgrade was based on favorable valuations and quality measures such as return on equity. The Consumer Staples sector has underperformed the S&P 500 Index since early Emerging Market Equities Index level (indexed at 100 on 9/30/14) Consumer Staples / S&P 500 S&P 500 Sources: Wells Fargo Investment Institute, Bloomberg; October 4, The S&P 500 Sector Indices measure the performance of the widely-used Global Industry Classification Standard (GICS ) sectors and sub-industries. Each index comprises those companies included in the S&P 500 that are classified as members of their respective GICS sectors. The S&P 500 is a market capitalization-weighted index generally considered representative of the U.S. stock market. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results Wells Fargo Investment Institute. All rights reserved. Page 5 of 9

6 FIXED INCOME George Rusnak, CFA Co-Head of Global Fixed Income Strategy 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 quick and painful move in interest rates U.S. Treasury yields rose dramatically last week across the yield curve as strong economic data, weaker overseas fixed-income demand, and comments from the Federal Reserve (Fed) chair fueled higher rates. In an interview last week, Fed Chair Powell reinforced that he believed we are exiting a period of extremely low rates and stated "Interest rates are still accommodative, but we're gradually moving to a place where they will be neutral. We may go past neutral, but we're a long way from neutral at this point, probably." 2 This indicated that the Fed may be expecting to raise rates to levels above what the market had anticipated. Additionally, recent economic data has been more robust than market participants had expected. This has led many to believe that the U.S. economy has more fuel in the tank than was first anticipated. Finally, U.S. bond yields that are, albeit, higher than European and Japanese yields have not been attractive enough to offset the higher currency hedging costs that have resulted from U.S.-dollar strength. This has weakened demand for Treasury securities from buyers abroad, and it has contributed to the higher Treasury yields that we recently have seen. We believe that the Fed likely will raise rates at its December meeting, and we expect several more rate hikes in We recommend that investors favor the short part of the yield curve (over the long end) and move up in credit quality as high-yield debt spreads are now at levels not experienced since 2007.» Treasury yields rose across the yield curve last week as economic data, comments from Fed Chair Powell, and weakened overseas demand drove rates higher.» We recommend that investors favor shorter-maturity issues and move up in credit quality while remaining broadly and globally diversified. More positive economic surprises: economic surprises moving to the upside Bloomberg Economic Surprise Index level Source: Bloomberg, October 4, The Bloomberg Economic Surprise Indices track the degree to which published economic data differ from forecasts. 2 Jerome Powell, October 3, Wells Fargo Investment Institute. All rights reserved. Page 6 of 9

7 REAL ASSETS Austin Pickle, CFA Investment Strategy Analyst It always seems impossible until it is done. --Nelson Mandela Permian DUCs are flying high Commodities Private Real Estate Public Real Estate Over the past few years, the Permian basin in Texas and New Mexico has driven much of the U.S. oil-production growth. Since October 2017, Permian oil production has risen from 2.7 million barrels per day (mmbd) to 3.4 mmbd, a year-over-year increase of 26%. As impressive as this growth has been, constraints such as insufficient oil pipeline capacity in the area have prevented even faster production gains. Evidence of this bottleneck is clear in the substantial discount to West Texas Intermediate (WTI) oil prices that Permian producers receive at the wellhead. The good news for producers in the region is that this takeaway constraint (and related wellhead price discount) is scheduled to be resolved in the second half of 2019 as additional pipelines begin service. Oil producers in the region seem to be preparing to open the floodgates once these additional pipelines are in place. The chart below illustrates this by showing drilled but uncompleted wells (DUCs) in the Permian basin divided by Permian oil production (DUCs are wells that have been drilled but have not been made ready for production). Notice how growth in DUCs is outpacing oil production (the increasing blue area). This suggests two things: 1) the growth in Permian basin oil production this past year has been lower than it could have been (if those DUCs had been completed), and 2) once pipeline capacity is sufficient (expected for the second half of 2019), producers should be able to quickly increase oil production. This pent-up supply potential is one of the reasons why we expect oil prices to fade in the second half of 2019.» Permian DUC growth has outpaced the Permian basin s oil production.» This DUC inventory should allow a quick pickup in oil production in the second half of 2019 once sufficient oil pipelines become available. Permian DUCs versus oil production 1.1 Permian drilled but uncompleted wells / Permian oil production Ratio Sources: Bloomberg, Energy Information Administration (EIA), Wells Fargo Investment Institute, October 4, Wells Fargo Investment Institute. All rights reserved. Page 7 of 9

8 ALTERNATIVE INVESTMENTS Justin Lenarcic Global Alternative Investment Strategist Private Equity Hedge Funds-Macro Hedge Funds-Event Driven Hedge Funds-Relative Value Most Hedge Funds-Equity Hedge 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. Despite a challenging quarter, trends in dispersion should improve We often point to dispersion as an indicator of a healthy environment for active management. Yet, the definition of dispersion can be quite broad, ranging from fundamental dispersion to return dispersion. The chart below shows two simple metrics, but they tell vastly different stories. The dispersion in returns among S&P 500 Index stocks is coming off of a historically low base, and that is a good sign. But a more important indicator for hedge funds is the dispersion within Russell 2000 Index stocks. For Russell 2000 (small-cap) stocks, we saw a significant 2016 increase in individual security return dispersion, which we believe led to strong 2017 performance for the Equity Hedge strategy but an abrupt collapse late last year. This has led to a pause in the long-term trend, which bears close watching (in our view). The first half of this year was strong for Long/Short Equity managers, as a more favorable stock-picking environment led to alpha (excess returns) on the long side, and modest alpha on the short side. The third quarter has produced challenges, with several factor reversals hampering returns. The simple truth is that a shift in growth, value, and/or momentum factors often can overpower what otherwise would be a good stockpicking environment. Despite a challenging third quarter, we maintain a most favorable view on Long/Short Equity strategies, because we anticipate an increase in large-cap and small-cap dispersion for the remainder of 2018 and next year.» Return dispersion for small-cap equities is an important indicator for Long/Short Equity managers. Significant moves above the average such as those seen in 2016 and 2017 can coincide with strong strategy returns.» While the third quarter was challenging for many Long/Short Equity managers, we believe that the decline in small-cap dispersion is likely to be short-lived. We anticipate a better environment for stock selection in the fourth quarter and Will small cap dispersion regain its form? Dispersion of returns 440% 390% 340% 290% 240% 190% 140% 90% 40% Jun-95 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 Dispersion of Russell 2000 stocks (max. - min., 6 mo. average) Dispersion of S&P 500 stocks (max. - min., 6 mo. average) 24 period moving avg. (dispersion of Russell 2000 stocks (max. - min., 6 mo. average)) 24 period moving avg. (dispersion of S&P 500 stocks (max. - min., 6 mo. average)) Source: Strategas Research Inc., October The moving average is an indicator used in technical analysis. It looks at the average price of a particular stock (or sector, market or asset class) over a rolling time period. There is no guarantee that these movements or trends can or will be duplicated in the future. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The S&P 500 Index is generally considered representative of the U.S. stock market. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Long/short equity strategies seek to add value through selecting which stocks to go long or short and by deciding when to go net long or net short the market Wells Fargo Investment Institute. All rights reserved. Page 8 of 9

9 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. 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. 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. 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 9 of 9