RBC WEALTH MANAGEMENT. Weekly. A calm economy and uncalm markets? 20% 16% 12%

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1 RBC WEALTH MANAGEMENT February 8, 2018 Global A closer look A calm economy and uncalm markets? Kelly Bogdanova San Francisco Weekly Insight Now that the U.S. equity market s abnormal calm has been shattered, can the U.S. economy remain calm and carry on? We see that there s usually a detachment between pullbacks and economic trends, and with consumer trends likely to remain healthy, the economy should as well. One of the key issues that arises when volatility increases and equity markets pull back forcefully, similar to recent trading sessions, is whether the market shock can in-and-of-itself knock an otherwise healthy economy off of its trajectory. Put another way, can a correction and persistent volatility raise recession risks? The perception among some investors is that it can, and this is important to consider because in market cycle after market cycle, it is typically recessions that bring things to a screeching halt. Bull markets turn into bear markets right about when recessions strike. For quite some time our positive view on the U.S. and global equity markets has hinged on low recession risks. We have been willing to give equities the benefit of the doubt in the face of earnings or economic inconsistencies, and political or geopolitical risks, so long as recession indicators weren t flashing red or even yellow. Our assessment of the business cycle s health is the cornerstone of our outlook for U.S. and global equities. RBC Capital Markets, LLC Chief U.S. Economist Tom Porcelli dug into the relationship between equity pullbacks and economic trends and found that they are a lot more detached than one might think. Durable consumers Consumer trends, in particular, are important to gauge. U.S. and other developed economies tend to stand on the shoulders of consumers. When consumer confidence and spending are improving or sturdy, these economies usually thrive. But when consumer indicators soften, they can teeter. Equity markets have pulled back meaningfully across regions 6-month price returns 20% 16% 12% 8% 4% 0% Hong Kong Japan U.S. Canada Europe U.K. -4% Aug Oct Dec Feb Note: Hong Kong is the Hang Seng, Japan is the TOPIX, U.S. is the S&P 500, Canada is the TSX, Europe is the STOXX Europe 600, and the U.K. is the FTSE All-Share Source - RBC Wealth Management, Bloomberg; data through 2/7/18 Market pulse 3 Give the U.S. equity pullback time to play out 3 A look at the S&P/TSX in the aftermath of the selloff 4 More momentum for the European integration agenda? 4 How to approach Asian equities after the selloff Click here for authors contact information. Priced (in USD) as of 2/8/18 market close, EST (unless otherwise stated). For important disclosures and required non-u.s. analyst disclosures, see page 7.

2 2 Global Insight Weekly Porcelli examined the U.S. market s previous four pullbacks during this secular bull cycle and found that consumer confidence was not impacted after the episodes. Consumer attitudes continued the trend they had established prior to the market pullback meaning if confidence was drifting higher it continued to do so, and if confidence was drifting lower it maintained that path (see upper chart). A similar detachment between consumer trends and the market is also borne out over a longer period. Porcelli s team studied the relationship between consumer confidence and three important variables: the S&P 500, gasoline prices, and unemployment. Porcelli concluded, The thing that matters most to consumers (by a country mile) is the state of the labor backdrop. In fact, the S&P even plays second fiddle to gasoline prices. The lower chart shows these relationships. The U.S. unemployment rate, at 4.1%, is currently at its lowest level since The labor market is so strong, Porcelli forecasts that it could break below 4% later this year and could reach 3.5% in 2019, which hasn t happened since the late 1960s. If this plays out, consumer confidence should remain elevated and healthy. Furthermore, it is commonly thought that a decline in the stock market leads to a drop in consumer spending (because of the lost wealth), but that s not necessarily the case. Porcelli s data from three prior economic expansion periods show there is no relationship at all between household equity holdings and real consumption growth. RBC Capital Markets also studied a broader group of indicators that tend to be a good gauge of the current state of the economy to see if they were negatively impacted by stock market swoons. The team s work demonstrates the indicators were not impacted when the market pullback/correction was more technical in nature meaning not driven by fundamental flaws in the economy or extreme valuations or asset bubbles. We view the current economic and corporate backdrop as being sturdy, and valuations as elevated but reasonable, so coincident economic indicators are unlikely to break down during this market pullback. Patience required We think the data demonstrate that U.S. consumer trends and broader economic indicators can remain healthy and recession risks can stay low even if the stock market endures additional volatility and downside. This is important for most equity markets, as the U.S. economy sets the tone for the global economy. Disruptive market episodes and heightened volatility can take time to play out, but they tend to have less impact on consumer psyches than one might think. We remain comfortable holding a moderate Overweight position in global equities and Market Weight exposure in U.S. equities. Consumer attitudes tend to stay on their trajectories after market routs U.S. consumer confidence surrounding equity pullbacks during the current bull market cycle* Market pullback 05/20/10 08/04/11 08/24/15 01/20/16 Average t-28 t-21 t-14 t-7 t t+7 t+14 t+21 t+28 t+35 t+42 * t is the time of the market pullback. Numbers indicate months before and after the pullback. Example t-28 is 28 months before the pullback; t+42 is 42 months after the pullback. Source - RBC Capital Markets U.S. Economics, weekly Bloomberg consumer confidence data Consumer confidence has a much tighter relationship to unemployment than it does to stock prices U.S. consumer confidence relationship to the unemployment rate (U-3), gasoline prices, and S&P 500 (all data indexed to 100 on January 1992) Unemployment R² = Gasoline S&P 500 R² = R² = Note: R-squared is a measure of how well data fits onto a regression line. The higher the number, the smaller the dispersion of data around the line. In this chart, for example, unemployment explains roughly 73% of consumer confidence and the S&P 500 explains a mere 6% of consumer confidence. Source - RBC Capital Markets U.S. Economics, Haver Analytics, Conference Board; data from January 1992 through January 2018 For additional thoughts about the recent market pullback, please see our report: Volatility is back: What the selloff means

3 3 Global Insight Weekly United States Kelly Bogdanova San Francisco; Bob Dickey Minneapolis True to form, the U.S. equity market swung back-and-forth in a wide trading range in the sessions following Monday s plunge and weakened further on Thursday. The Dow traded in a 1,167-point range on Tuesday, followed by 508 points on Wednesday, and 1,054 on Thursday. It s likely the unwinding of volatility-linked derivatives pressured the market again on Thursday. The Dow and S&P 500 are down 10.4% and 10.2%, respectively, since the late January all-time highs. While every sector has fallen since then, Energy has been the weakest, dropping 14%. The stock market continues to have one eye on the bond market. Treasury yields have been relatively calm since the correction began, but the 10-year yield is challenging its recent high. Investors remain concerned about the upward pace of yields and inflation, and the related impact on Federal Reserve interest rate policy. Recent comments by some Fed officials indicate to us they seem committed to basing interest rate decisions on a wide range of economic indicators, not just the hot wage growth data that helped spark the correction. From our perspective, this could lead to a continuation of the Fed s gradual interest rate moves instead of a faster pace like some investors are fearing. Corporate share buybacks should provide a shock absorber for the equity market if volatility persists and the recent lows are tested or breached. Traders indicate corporations purchased their stock in size and some non-corporate institutional investors put cash to work following Monday s swoon. Often when markets pull back abruptly, corporations step in to repurchase stock. We think capacity for buybacks is greater this go-around because (1) tax cuts have increased 2018 cash flow prospects and provide companies with greater flexibility to buy back shares, and (2) many companies were already flush with cash. But even with corporate buyback power at the ready, we think this pullback could take some time to play out. On an intermediate-term level, meaning weeks to months, there has been a change in the overall trend of the market that suggests to us that the next several months will not be like what we have become accustomed to over the past two years of fairly steady gains. Instead, we see an overall range developing that could still see a lower low than this week, with more volatility in both directions, as the markets absorb the gains and rest after the previous two years of strength. This is all normal stuff that allows the fundamentals to catch up to the current higher valuations, and eventually provide for attractive entry After a smooth acceleration lasting two years, the current pullback is normal and healthy S&P 500 and technical suppport Feb 2016 Aug 2016 Feb 2017 Aug 2017 Feb 2018 Source - RBC Wealth Management, Bloomberg; data through 2/8/18 zones on many stocks. We worry about investors who see the volatility as a reason to react quickly, as that rarely results in a good experience. Canada Farazeh Mahboob & Richard Tan Toronto Following the selloff in North American equity markets earlier in the week, the S&P/TSX Composite is down approximately 7% from its 2018 high close. While the decline has been sharp, the domestic market has fared slightly better relative to the S&P 500. The outperformance of the S&P/TSX may be attributed in part to valuations, which are more modest in a historical context relative to those of the S&P 500. Through the recent market turbulence, selling pressure in Canada was most acutely felt in the resource sectors and those negatively correlated with interest rates (i.e., high-yielding equities). In light of the renewed volatility within global equity markets, we reiterate our Market Weight allocation to Canadian equities. We believe this fairly reflects the balance between more attractive relative valuations and local market risks, including ongoing NAFTA negotiations, a weaker housing market in the year ahead, and a lack of visibility in the oil and gas industry. A handful of Canadian-domiciled energy producers with refining and/or upstream assets in the U.S. should see some benefit to earnings from U.S. tax reform, according to RBC Capital Markets. However, there has yet to be any

4 4 Global Insight Weekly quantitative disclosure on the impact from tax reform on Canadian energy infrastructure companies with material U.S. operations. RBC Capital Markets believes there will be a relatively modest adverse impact to earnings and/or cash flows for the group. Fueled by strong growth within the e-commerce space, the paper and packaging industry continues to show favourable trends. The American Forest & Paper Association released data indicating that box suppliers were operating at nearly full capacity. Current operating rates are above 90%, which provide for quicker inventory turnover, and elevated demand will provide box suppliers with significant pricing power. Overall, RBC Capital Markets forecasts strong demand for the industry going out until Europe Thomas McGarrity & Jamie Hayes London The correction spread to the FTSE All-Share and STOXX Europe 600 ex UK equities, which were both down more than 7% from their January peaks. In both markets, Financials and banks in particular outperformed, losing less value than the respective indexes, while Utilities, which are bond proxies and thus could suffer from higher interest rates, underperformed. Bond yields on Bunds and Gilts have settled at higher levels, reflecting increased expectations for a steeper path for interest rates and a quicker exit to accommodative monetary policy. U.K. 10-year Gilts are yielding above European yields rise as equities slide Last 6 months 1.0% 0.8% 0.6% 0.4% %, up from the 2018 low of 1.21%, whilst the equivalent German paper is yielding in excess of 0.75%, up from the 0.45% low. In Germany, the two main parties, Chancellor Angela Merkel s CDU/CSU and her former coalition partner centre-left SDP announced an agreement to form a coalition after months of bargaining. The final agreement will be put to a vote of SDP members. Although we think an approval is likely, it is by no means a formality as there has been some discontent at the grassroots level of the SDP. Results are expected to be announced March 4 the same day as the Italian elections. If is it agreed upon, the consensus amongst political observers is that the coalition will have a substantial pro euro bias, and it is reasonable to expect this new German government would work with its French counterpart to drive the European integration agenda. As a result, markets experienced a substantial tightening in the yield spreads for peripheral sovereign debt to lower-risk German Bunds. The results season continues unabated. In the Health Care sector, GlaxoSmithKline slightly beat consensus estimates as growth from its newer drugs in its respiratory portfolio helped offset the pricing pressure for existing blockbuster Advair. U.K. pharma peer AstraZeneca expects earnings to return to growth this year on the back of its new oncology drugs growing market share. Meanwhile, Sanofi s guidance disappointed the market. It recently announced it will acquire U.S. biotech firm Bioverativ for $11.6B. We expect M&A to remain a prominent feature within the pharma universe as many of the large-cap companies look for ways to grow in order to counter the revenue erosion from biosimilar competition as patents expire for many existing blockbuster drugs, as well as general pressure on pricing. Elsewhere, leading global catering firm Compass Group delivered organic growth ahead of consensus expectations (+5.9% vs. 4.5%). Oil & gas major Total beat consensus expectations for earnings and cash flow, while Swiss insurer Zurich increased its dividend for the first time in seven years (from CHF 17 to CHF 18). 0.2% 0.0% Aug Oct Dec Feb 10-year German Bund yield (left axis) Continental European equities (right axis) Source - RBC Wealth Management, Bloomberg; data through 2/8/ Asia Pacific Jay Roberts Hong Kong Asian equities pulled back sharply, entirely taking their cues from the action in the U.S. In the Global Insight 2018 Outlook, we opined that some Asian equity markets were susceptible to profit-taking after a very strong year in 2017.

5 5 Global Insight Weekly The MSCI AC Asia Pacific Index declined by 6%, the Hang Seng Index by 6.2%, and the TOPIX by 5.6%. Japanese stocks were not helped by some appreciation in the yen, a common occurrence when global equities correct. The Hang Seng Index is down 8.2% from its 2018 high and TOPIX is down 7.6%. Both indexes could see some further weakness in the short term. If that were the case, all else equal, this would be a buying opportunity, in our view, especially for Japanese equities where there are a number of tailwinds. The Hong Kong market may be supported to some extent from continued investment flows from mainland China. China s foreign exchange reserves rose for the 12th consecutive month in January to $3.16T. Reserves have been gradually building through the year due to a combination of appreciation in the yuan, capital controls, and a solid domestic economy. The selloff in equities sent both the Australian dollar and the New Zealand dollar to two-month lows against the dollar. The Reserve Bank of Australia kept interest rates on hold, as forecast. Shares in DBS Group (DBS SP), the largest bank in Southeast Asia, rose by the most in nearly eight years as net income in Q4 increased by 33% to S$1.22B ($920M). Earnings were helped by higher interest rates and growth in the wealth management division. The bank raised its dividend and also proposed a special dividend of 50 cents per share. Asian equities pulling back after strong 2017 gains Percent declines from 2018 highs, local currency China Hong Kong -8.4% -8.2% Japan Asia Pacific region* -7.6% -7.6% South Korea -7.3% Australia -4.2% Note: South Korea is the Kospi Index, Hong Kong is the Hang Seng, Japan is the TOPIX, Asia Pacific is the MSCI All Country Asia Pacific Index, Australia is the S&P/ASX 200, and China is the Shanghai Composite Source - RBC Wealth Management, Bloomberg; data through 2/8/18 unless denoted by an * in which case the data is through 2/7/18

6 6 Global Insight Weekly MARKET SCORECARD Data as of February 8, 2018 Equities (local currency) Level MTD YTD 1 yr 2 yr S&P 500 2, % -3.5% 12.5% 39.3% Dow Industrials (DJIA) 23, % -3.5% 19.0% 48.9% NASDAQ 6, % -1.8% 19.3% 58.2% Russell , % -4.7% 7.7% 51.0% S&P/TSX Comp 15, % -7.1% -3.1% 20.2% FTSE All-Share 3, % -6.6% 0.7% 26.0% STOXX Europe % -3.9% 2.8% 19.0% EURO STOXX 50 3, % -3.6% 4.3% 21.3% Hang Seng 30, % 1.8% 29.7% 57.9% Shanghai Comp 3, % -1.4% 3.0% 18.0% Nikkei , % -3.8% 15.2% 28.7% India Sensex 34, % 1.0% 21.6% 41.7% Singapore Straits Times 3, % 0.4% 11.4% 30.2% Brazil Ibovespa 81, % 6.7% 25.8% 100.9% Mexican Bolsa IPC 47, % -3.0% 2.0% 11.9% Commodities (USD) Price MTD YTD 1 yr 2 yr Gold (spot $/oz) 1, % 1.2% 6.2% 10.9% Silver (spot $/oz) % -3.1% -7.7% 7.2% Copper ($/metric ton) 6, % -5.1% 16.3% 48.2% Oil (WTI spot/bbl) % 1.2% 16.8% 106.0% Oil (Brent spot/bbl) % -3.9% 16.6% 95.5% Natural Gas ($/mmbtu) % -8.8% -13.8% 25.9% Govt bonds (bps chg) Yield MTD YTD 1 yr 2 yr U.S. 10-Yr Tsy 2.833% Canada 10-Yr 2.378% U.K. 10-Yr 1.617% Germany 10-Yr 0.762% Fixed Income (returns) Yield MTD YTD 1 yr 2 yr U.S. Aggregate 3.06% -0.7% -1.8% 0.9% 2.3% U.S. Invest Grade Corp 3.56% -1.0% -1.9% 3.3% 9.8% U.S. High Yield Corp 6.02% -0.7% -0.1% 5.3% 30.9% Currencies Rate MTD YTD 1 yr 2 yr U.S. Dollar Index % -2.0% -9.9% -6.5% CAD/USD % -0.2% 4.4% 10.6% USD/CAD % 0.2% -4.2% -9.6% EUR/USD % 2.0% 14.5% 9.4% GBP/USD % 2.9% 10.9% -3.6% AUD/USD % -0.3% 1.8% 9.9% USD/JPY % -3.5% -2.8% -6.1% EUR/JPY % -1.6% 11.2% 2.7% EUR/GBP % -0.8% 3.2% 13.5% EUR/CHF % -2.1% 7.7% 3.7% USD/SGD % -0.3% -6.0% -5.2% USD/CNY % -2.7% -7.8% -3.7% USD/MXN % -3.9% -7.8% 1.2% USD/BRL % -0.8% 5.5% -15.8% Source - Bloomberg. Note: Equity returns do not include dividends, except for the German DAX and Brazilian Ibovespa. Bond yields in local currencies. Copper Index data and U.S. fixed income returns as of Wednesday s close. Dollar Index measures USD vs. six major currencies. Currency rates reflect market convention (CAD/USD is the exception). Currency returns quoted in terms of the first currency in each pairing. Data as of 9:35 pm GMT 2/8/18. Examples of how to interpret currency data: CAD/USD 0.79 means 1 Canadian dollar will buy 0.79 U.S. dollar. CAD/USD -0.2% return means the Canadian dollar fell 0.2% vs. the U.S. dollar year to date. USD/JPY means 1 U.S. dollar will buy yen. USD/JPY -3.5% return means the U.S. dollar fell 3.5% vs. the yen year to date.

7 7 Global Insight Weekly Authors Kelly Bogdanova San Francisco, United States RBC Capital Markets, LLC Bob Dickey Minneapolis, United States RBC Capital Markets, LLC Farazeh Mahboob Toronto, Canada RBC Dominion Securities Inc. Richard Tan Toronto, Canada RBC Dominion Securities Inc. Jamie Hayes London, United Kingdom Royal Bank of Canada Investment Management (U.K.) Ltd. Thomas McGarrity, CFA London, United Kingdom Royal Bank of Canada Investment Management (U.K.) Ltd. Jay Roberts Hong Kong, China RBC Dominion Securities Inc. Disclosures and Disclaimer Analyst Certification All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report. Important Disclosures In the U.S., RBC Wealth Management operates as a division of RBC Capital Markets, LLC. In Canada, RBC Wealth Management includes, without limitation, RBC Dominion Securities Inc., which is a foreign affiliate of RBC Capital Markets, LLC. This report has been prepared by RBC Capital Markets, LLC. which is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Non-U.S. Analyst Disclosure: Farazeh Mahboob, Richard Tan, and Jay Roberts, employees of RBC Wealth Management USA s foreign affiliate RBC Dominion Securities Inc.; and Jamie Hayes and Thomas McGarrity, employees of RBC Wealth Management USA s foreign affiliate Royal Bank of Canada Investment Management (U.K.) Limited; contributed to the preparation of this publication. 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