Chart 1. Gross domestic product of China, the U.S. and other major economies

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1 John LaForge Head of Real Asset Strategy WEEKLY GUIDANCE FROM OUR I NVESTMENT STRATEGY COMMITTEE January 22, 219 Commodities What Are They Saying About China? Key takeaways» Commodity prices started getting hit hard last May, at the same moment that the U.S./China trade rhetoric heated up in earnest. The reason is that commodity prices can be quite sensitive to Chinese growth as China is frequently the largest buyer of commodities.» Since the September low, many commodity prices have stabilized (outside of oil). What it may mean for investors» Wells Fargo Investment Institute s (WFII) baseline case for 219 Chinese growth is quite close to what commodities may be suggesting that 219 Chinese growth slows from 6.5% to 6.2% but that it does not get much worse (in other words, no hard landing). Each problem I solved became a rule which served afterwards to solve other problems. Rene Descartes Asset Group Overviews Equities... 5 Fixed Income... 6 Real Assets... 7 Alternative Investments... 8 At $2 trillion, the U.S. is the world s largest economy (Chart 1, blue line). Yet China, with gross domestic product (GDP) of roughly $13 trillion, has been closing in fast (Chart 1, red line). China now accounts for almost a third of global economic growth each year. In 218, China s 6.5% GDP growth rate was roughly double that of the United States. With the U.S. and China clearly #1 and #2 in the world, it is no wonder that markets have been concerned with a trade war between the two. Chart 1. Gross domestic product of China, the U.S. and other major economies GDP in current U.S. dollars (billions) China Japan Germany U.K. U.S. Russia France Sources: Bloomberg, World Bank, Wells Fargo Investment Institute. Yearly data: Wells Fargo Investment Institute. All rights reserved. Page 1 of 1

2 Commodities What Are They Saying About China? The 218 tariff tiff between the U.S. and China already has had an impact. A few weeks ago, Chinese leaders confirmed that growth was slowing and slashed the country s anticipated 219 GDP growth rate from 6.5% to 6.2%. This may not sound like much of a cut, but 6.2% is the slowest Chinese growth rate in 3 years. Anecdotal evidence also has started to surface, as we have heard increasing reports of weak Chinese demand from assorted consumer companies. These range from cell phone makers to high-end retailers and coffee distributors. Of course, China is not sitting idly by. In recent weeks, Chinese leaders have rolled out additional pro-growth policies, such as tax cuts, reduced reserve requirements, and initiatives to stimulate sales of cars and appliances. Lenders also are being asked to provide more loans to private companies, which make up the majority of employment in China. As for the blame in the recent slowdown, many pin it on the 218 trade tariff mudslinging between the U.S. and China. Commodity prices can be a good way to track how investors feel about the potential economic impact of a U.S./China trade war. Leading up to President Trump s May announcement of an additional $25 billion in tariffs aimed at China, the Bloomberg Commodity Index (BCOM) had gained 5%. Over the course of the next four months, as China retaliated, the BCOM fell by 1%. We did not find it coincidental that commodity prices started getting hit hard last May, at the same moment that the U.S./China trade rhetoric heated up in earnest. The reason is that commodity prices can be quite sensitive to Chinese growth, as China is frequently the largest buyer of commodities (it does depend on the commodity, however). So, we find it interesting that since the September 218 commodity price lows most commodity prices have been relatively stable (except for oil). Should commodity prices continue to stabilize in the coming months, they could very well be signaling that Chinese growth could stabilize too. WFII s baseline case for 219 Chinese growth is quite close to what commodities may be signaling that Chinese growth will slow from 6.5% to 6.2%, but that it will not get much worse (in other words, no hard landing ). Chart 2. Chinese commodity consumption as a percent of world consumption Chinese consumption as % of world consumption Aluminum Nickel Zinc Copper Tin Corn Wheat Soybeans Lead Sources: Bloomberg, U.S. Department of Agriculture (USDA), World Bureau of Metal Statistics, Wells Fargo Investment Institute, January 16, 219. Yearly data: December 31, 1981 through December 31, Wells Fargo Investment Institute. All rights reserved. Page 2 of Chinese consumption as % of world consumption

3 Commodities What Are They Saying About China? The reason we watch commodity prices for clues on Chinese growth is that the country s rise to the #2 economy in the world was built on the back of basic commodities metals especially. Chart 2 shows China s consumption of select commodities as a percentage of the world s total consumption. As the solid colored lines indicate, China now consumes more than 4% of the world s aluminum, nickel, zinc, copper, and tin. This is up from less than 5% in 198. Chart 3 shows the close tie between commodity prices (blue line) and the Chinese Business Cycle Index. Chart 3. Commodities versus China s business cycle China Business Cycle Signal (year-over-year %) China Business Cycle Signal Index yoy % (six-month average) BCOM Index yoy % (six-month average) Sources: Bloomberg, National Bureau of Statistics of China, Wells Fargo Investment Institute, January 16, 219. Monthly data: January 31, 1991 December 31, 218. The Bloomberg Commodity Index (BCOM) is a broadly diversified index comprised of 22 exchange-traded futures on physical commodities and represents 2 commodities weighted to account for economic significance and market liquidity. The China Business Cycle Signal Index is jointly developed by the National Bureau of Statistics of China and Goldman Sachs. It is used for monitoring the situation of the macro-economic performance and forecasting the trend of future development. Index value above = very hot; = hot; = stable; = cold; 63.3 or below = very cold. BCOM is unmanaged and not available for direct investment. Over the past 2 years, China s economic rise has forced it to import more and more commodities. Chart 4 shows that the connection between commodity prices (blue line) and Chinese imports (yellow line) has tightened since the 199s. Chart 4. Commodities versus China imports China imports (year-over-year %) China imports yoy % (six-month average) BCOM Index yoy % (six-month average) Sources: Bloomberg, Customs General Administration PRC, Wells Fargo Investment Institute, January 16, 219. Monthly data: January 31, 1991 December 31, 218. For illustrative purposes only. Chinese Imports measures all goods and services brought into the country from another country typically for use in trade. Import goods or services are provided to domestic consumers by foreign producers. A lower than expected number is considered positive to the BCOM while a higher than expected number is viewed as negative. The chart takes the year over year percentage change and then smooths that line by taking the rolling 6 month average of the year over year change of both the BCOM and China Imports. 219 Wells Fargo Investment Institute. All rights reserved. Page 3 of BCOM (year-over-year %) BCOM (year-over-year %)

4 Commodities What Are They Saying About China? Tracking metal imports, particularly, has helped us to better understand China s GDP growth direction. The importance of metal imports is clearly evident in Chart 2. This remains the case today, even as the Chinese government (in recent years) has stated that it would like more GDP growth to come from the consumer, rather than from capital expenditures (capex). There is no escaping the fact that China continues to grow; needs industrial metals; does not produce enough internally; and ultimately must import the difference. Because of this dynamic, tracking metal imports, such as copper, can help us to better understand the trajectory of China s GDP growth. Chart 5 tracks the price of copper (orange line) versus China s net copper imports (blue line). Notice that China s net copper imports began falling in 217, along with copper prices. This gave us an early warning sign that not all was ok on the Chinese growth front. Since the fourth quarter of 218, however, copper imports and copper prices have more or less stabilized. Chart 5. Copper prices versus China net imports 6 5. China copper net imports (billion U.S. dollars) China copper net imports (scale left) Copper price (scale right) 2.5 Copper price (U.S. dollars per pound) Sources: Bloomberg, Wells Fargo Investment Institute, January 16, 219. Monthly data: March 31, 28 December 31, 218. The bottom line is that many commodity prices have stabilized in recent months. Should this continue, it could be signaling that Chinese growth may soon stabilize too. WFII s baseline case for 219 Chinese growth is quite close to what commodities may be suggesting that 219 Chinese growth slows from 6.5% to 6.2% but that it does not get much worse (no hard landing). 219 Wells Fargo Investment Institute. All rights reserved. Page 4 of 1

5 EQUITIES Audrey Kaplan, Head of Global Equity Strategy; Ken Johnson, CFA, Investment Strategy Analyst U.S. Large Cap Equities U.S. Mid Cap Equities Neutral U.S. Small Cap Equities Neutral Developed Market Ex-U.S. Equities Where is U.S. sector growth leadership in 219? Significant market declines amid valuation repricing like the late-218 S&P 5 correction generally have been followed by rebounds. 1 Growth sectors often decline in recessions, but we expect S&P 5 growth sectors to outperform in the soft landing economic scenario we predict for 219. How do we identify S&P 5 sector growth leaders? As discussed in the Equity Sector Insights in a Changing Market Landscape report, we use three growth characteristics to predict which industries could outperform when future growth is achieved. 2 Our $173 S&P 5 earnings per share forecast for 219 reflects a 7% growth rate. The consensus forecasts that 8 of 11 S&P 5 sectors will exceed 7% earnings growth this year, with the exception of Consumer Staples, Utilities, and Real Estate. 3 We use a composite sector growth indicator based on three growth characteristics that ranks sectors from most favorable to least favorable. For example, Consumer Discretionary (CD) has the best composite growth ranking because 219 earnings growth is expected to exceed 15%; the dividend growth trend is forecast at 7.7%; and composite earnings revisions downgrades are lower (-5.4%) than for other high-growth sectors (see chart). We believe that CD will provide S&P 5 growth leadership; we have a favorable view. Other sectors with a strong growth composite indicator include: Industrials, Health Care, Financials, and Information Technology (Materials, Utilities, and Energy lag). Key takeaway» Our Growth Pillar is most favorable on the Consumer Discretionary and Industrials sectors. It is unfavorable on the Material, Utilities, and Energy sectors. S&P 5 sector growth pillar with three metrics illustrated Composite revision ratio Next 12 months EPS growth (in percent) Dividend growth trend (in percent) Most Emerging Market Equities Cons Staples Utilities Comm Serv Real Estate Cons Disc Health Care Industrials Financials Info Tech Energy** Materials Sources: Wells Fargo Investment Institute, FactSet; January 15, 219. **Y-axis was capped at 3; however, earnings per share (EPS) growth for the S&P 5 Energy sector is forecast to be 71.7% over the next 12 months. Composite revision ratio is the consensus earnings forecast change rate today versus the rate from six months ago. Dividend growth trend is the next 12 months forecast dividend yield versus the growth rate over the past four years, using a regression analysis. Regression analysis is a statistical method that allows an examination of the relationship between the forecast dividend yield and the actual historical dividend yield. Earnings per share often serves as an indicator of a company's profitability. No forecast is guaranteed and is subject to change. 1 Wells Fargo Investment Institute analysis, which evaluated the weakest 25 quarters for the S&P 5 Index from 1928 through Equities In Depth, Equity Sector Insights in a Changing Market Landscape, December 2, Wells Fargo Investment Institute; consensus estimates from Refinitiv (formerly Thomson Reuters); IBES estimates. 219 Wells Fargo Investment Institute. All rights reserved. Page 5 of 1

6 Luis Alvarado Investment Strategy Analyst FIXED INCOME U.S. Taxable Investment Grade Fixed Income U.S. Short-Term Taxable Fixed Income U.S. Intermediate Term Taxable Fixed Income U.S. Long-Term Taxable Fixed Income High Yield Taxable Fixed Income Developed Market Ex.-U.S. Fixed Income Analyzing the Fed s balance-sheet runoff Last October, the Federal Reserve (Fed) announced an increase in its monthly balance sheet reduction target to $3 billion in Treasury securities and $2 billion in mortgagebacked securities (MBS). As the Fed continues its balance-sheet normalization, we believe that it will maintain this $5 billion monthly reduction target throughout 219. One key question is at what level will the Fed stop trimming its balance sheet? The answer to this question is difficult to predict, and this creates concern among some investors who worry that the Fed could end up draining too much money from the banking system and cause bank reserves to become scarce. Today, total Reserve Bank credit at the Fed stands at $4.2 trillion and securities held by the Fed total $3.86 trillion. 4 At this pace, roughly $6 billion of securities would run off from the Fed s balance sheet in 219. Yet, some estimates suggest that the actual runoff will be below the targets, with peak runoff occurring in the second quarter and declining thereafter. We believe that the Fed will maintain a much larger normalized balance sheet (closer to $3. trillion) going forward than it did before the financial crisis (it was $8 billion before quantitative easing began). It likely will take a few more years to get to that level at the Fed s current target runoff rate; however, there also is a possibility that the runoff could end sooner than is expected. Key takeaways» The Fed s balance sheet reduction effort has been a generally passive process to date. We believe that the Fed will monitor excess Reserve Bank credit and interest paid on excess reserves for warning signs on any liquidity concerns.» We expect Fed balance sheet runoff, combined with increased Treasury issuance, to fuel a slight increase in Treasury yields. We also expect higher participation from private investors to absorb the supply of Treasury and MBS securities. The Fed s balance-sheet runoff projection Billions $5, $4,5 $4, $3,5 $3, $2,5 $2, Projection $1,5 Emerging Market Fixed Income $1, $5 $ 1/7 1/8 1/9 1/1 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19 1/2 MBS Treasury securities Reserve Bank Credit at the Fed Sources: Bloomberg, Wells Fargo Investment Institute, January 15, 219. Chart shows the projection of securities held by the Fed for calendar years 219 and Federal Reserve Bank of St. Louis, as of January 9, Wells Fargo Investment Institute. All rights reserved. Page 6 of 1

7 REAL ASSETS Austin Pickle, CFA Investment Strategy Analyst Commodities Private Real Estate Public Real Estate U.S. or international REITs? Others have seen what is and asked why. I have seen what could be and asked why not. --Pablo Picasso We are unfavorable toward public real estate, which encompasses both U.S. and international real estate investment trusts (REITs). We often get asked do we have a preference between U.S. and international REITs? The short answer today is, no. Why is this? First, we are only forecasting modest 219 dollar depreciation and not a complete collapse like we saw when the U.S. Dollar Index (DXY) dropped from 13 to 88 between 217 and early 218. The performance benefit to international REITs from a dollar move of that magnitude would be hard to bet against (notice in the chart how the relative performance of U.S. REITs versus international REITs tends to track the DXY). Second, the risks appear higher overseas as international economies have appeared to be more vulnerable than the U.S. economy has been to exogenous shocks (think Brexit, trade disputes, etc.). Additionally, we expect the U.S. economy to remain the envy of many developed economies this year. However, U.S. REITs seem to lack a catalyst for outsized returns, given that commercial property prices, net operating income, and occupancy appear to have peaked. The flip side to the U.S. economy (and REITs) having been more resilient is that they likely lack the same bounce-back return potential should the global macro overhangs get resolved. With U.S. REITs having a lower return expectation but also lower risk in our view and international REITs having higher return potential but greater risk we see the risk/return profile as similar. At this time, we believe that investors should not favor one or the other in their public real estate allocations. Key takeaways» U.S. and international REITs appear to have similar risk/return profiles.» We believe that investors should not favor one or the other in their public real estate allocations. U.S. versus international REITs and the U.S. Dollar Index (DXY).36 U.S. REITs / international REITs U.S. Dollar Index 15 Ratio U.S. Dollar Index value Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Sources: Bloomberg, Wells Fargo Investment Institute. Daily data: January 1, 213 through January 16, 219. U.S. REITs represented by the FTSE NAREIT All Equity REIT Index. International REITs represented by the FTSE EPRA/NAREIT Developed ex-u.s. Index. Ratio is the U.S. REITs index divided by the international REITs index. For illustrative purposes only. Index returns do not represent investment returns or the results of actual trading. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Please see the end of this report for the definition of the indices and a description of the asset class risks. 219 Wells Fargo Investment Institute. All rights reserved. Page 7 of 1

8 ALTERNATIVE INVESTMENTS Ryan McWalter Investment Research Analyst Neutral Private Equity Neutral Hedge Funds-Macro Neutral Hedge Funds-Event Driven Hedge Funds-Relative Value 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. The pool of stressed credits may be getting deeper During the fourth quarter, there was a dramatic increase in the percentage of high-yield (HY) bonds trading between $75 and $95 amid the credit market volatility. 5 In fact, over the past 14 months, the percentage of HY corporate debt priced between $75 and $95 has risen approximately seven-fold. 6 Historically, HY bonds trading at the lower end of this price range reflect growing market concerns over corporate fundamentals. Hedge funds, especially those focused on corporate credit, can find abundant opportunities for both long and short positions within this segment of the HY credit market. This is because stressed credits rarely remain stressed for long; they either trade down further into distressed territory as the market anticipates default or they trade higher once the company improves its balance sheet. In the corporate credit market, long positioning has been a powerful source of performance in the period following the financial crisis. However, we could be in the early innings of an expanding opportunity set for the Long/Short Credit strategy as rising rates pressure overleveraged companies and investors become less willing to take on credit risk. More flexible, nimble investing during bouts of volatility can be a vital aspect to diversification. Going forward, we expect that the ability to short troubled corporate credits could provide valuable downside protection as the credit cycle matures. Key takeaways» The opportunity set for credit investors in the alternatives space has grown immensely over the past year as the HY credit market has faced headwinds.» As the credit cycle matures, we believe that less directional hedge fund strategies such as Long/Short Credit can provide valuable diversification benefits. Expanding opportunity set for credit investors Percent of HY index priced between $75 and % 4.% 35.% 3.% 25.% 2.% 15.% 1.% 5.%.% 6.61% 14.76% Oct-17 Aug-18 Dec % Sources: Bank of America and ICE Data Indices LLC, December 219. The HY index shown in the chart is the Bank of America Merrill Lynch Global High Yield Index. An index is unmanaged and not available for direct investing. Past performance is no guarantee of future results. Please see end of this report for the definition of the index and for the risks associated with long/short credit investing. 5 Bank of America Merrill Lynch Global High Yield Index; ICE data indices, January Ibid. 219 Wells Fargo Investment Institute. All rights reserved. Page 8 of 1

9 Risk 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. Long/short credit strategies seek to mitigate interest rate and credit risks regardless of market environment through investment in creditrelated and structured debt vehicles. These strategies involve the use of market hedges and involve risks such as derivatives, fixed income, foreign investment, currency, hedging, leverage, liquidity, short sales, loss of principal and other material risks. There is no guarantee such strategies will be successful. Definitions BofA Merrill Lynch U.S. High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. FTSE NAREIT All Equity REITs Index, a subset of the All REITs Index, is designed to track the performance of REITs representing equity interests in (as opposed to mortgages on) properties. It represents all tax-qualified REITs with more than 5 percent of total assets in qualifying real estate assets, other than mortgages secured by real property that also meet minimum size and liquidity criteria. FTSE EPRA/NAREIT Developed ex US Index is designed to track the performance of listed real estate companies in developed countries worldwide other than the United States. S&P 5 Index is a market capitalization-weighted index composed of 5 widely held common stocks that is generally considered representative of the US stock market. S&P 5 Energy Index comprises those companies included in the S&P 5 that are classified as members of the GICS energy sector. U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies. An index is unmanaged and not available for direct investment. 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, 219 Wells Fargo Investment Institute. All rights reserved. Page 9 of 1

10 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 1 of 1