GLOBAL MARKET OUTLOOK Max Darnell, Managing Partner, Chief Investment Officer All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss. Past FOR INSTITUTIONAL USE ONLY
Framework for thinking about state of financial markets Key indicators What this means today What this framework misses 2
MARKET STATES VARY FROM FRAGILE TO RESILIENT Fragile Markets Markets are most fragile when investors are nervous and when the economy is weak. Asset prices are more vulnerable to negative news or events when fragile. 3 Resilient Markets Markets are most resilient when investors are confident and when the economy can better withstand shocks. Asset prices will tend to bounce back more quickly after initial negative reactions to news or events when resilient.
MARKET STATES VARY FROM FRAGILE TO RESILIENT Fragile Markets This is not a forecast of returns This is a measure of how markets would likely react in the face of bad news 4 Resilient Markets
SLOW GLOBAL GROWTH RELATIVE TO PRE-CRISIS GPD Growth (annual %) 5 Source: The World Bank
STILL NO SIGNS OF WORRISOME INFLATION GLOBALLY Consumer Price Inflation (annual %) 6 Source: The World Bank
US STOCKS CERTAINLY NOT CHEAP Shiller PE Ratio 7 Source: http://www.multpl.com/shiller-pe/
S&P 500 options prices below median Gold options prices near median 8 Oil options prices above median Source: Google Finance (VIX, GVX, OVX)
Low-end investment grade bonds reflecting concern 9 High-end investment grade bonds also reflecting concern Source: Federal Reserve Bank of St. Louis
FORECASTING BOND YIELDS IS EASY. HA! 10 Source: Deutsche Bank Research - FRB, FRBPHIL, Haver Analytics, DB Global Markets Research
HARD TO ADJUST TO NEW REALITY? 11 Source: Federal Reserve Bank of St. Louis
BASIS FOR LOW YIELDS 12 Source: Federal Reserve Bank of St. Louis
Brazil Philippines Turkey Pakistan Switzerland Israel Thailand Peru Sweden Britain Denmark United States Chile Mexico South Korea Canada Hungary Colombia Euro area Argentina China New Zealand Norway Saudi Arabia Czech Republic Indonesia Australia Poland Egypt Japan Taiwan Singapore South Africa India Malaysia Hong Kong Russia STRONG DOLLAR? JULY 2015 US Dollar has plenty of room to rise from here 60 40 20 0-20 13-40 At market exchange rate Source: The Economist, Big Mac Index adjusted for GDP per person (July 2015)
% deviation from fair value BIG DOLLAR RALLY HAS LEFT DOLLAR FAIRLY VALUED 14 Source: First Quadrant, proprietary PPP model comparing US dollar valuation against developed world currency basket
MARKET STATES VARY FROM FRAGILE TO RESILIENT Gulf War Jan 1990 Jun 1993 Recovery Jul 1993 Aug 1997 EM Currency Crisis and Tech Bubble Sep 1997 Mar 2003 Recovery Apr 2003 Dec 2007 Credit Crisis Jan 2008 Jan 2012 Recovery Feb 2012 Dec 2014 Fragile Markets 1.25 1.00 0.75 0.50 15 0.25 Resilient Markets 0.00-0.25 Jan-90 Apr-92 Jul-94 Oct-96 Jan-99 May-01 Aug-03 Nov-05 Feb-08 May-10 Sep-12 Dec-14 Sources: First Quadrant, L.P., Bloomberg LP Crisis MRI
MODEST FRAGILITY TODAY Fragile Markets We view the markets as having moved into a modestly fragile state in 2015. The markets (US, Europe, commodities) is modestly high on average; credit spreads are modestly wide signaling growing investor concern, and the global economy has weakened somewhat. 16 There are extenuating circumstances, in a most fragile state. Resilient Markets
1. There is no Yellen or Draghi put 2. -War high 3. QE is not going to work in Europe the way it did in the US 17
DIVERSIFIED. ARE YOU? Global Stocks CAPITAL ALLOCATION RISK ALLOCATION Small Cap Stocks Emerging Markets Real Estate Commodities High Yield Bonds Sovereign Bonds 18 TIPS Long-Duration Sovereign Bonds Long Duration TIPS 92% of the risk is in equities in a typical asset allocation approach (as measured by the correlation of the total portfolio to equities). IN AN INCREASINGLY FRAGILE MARKET ENVIRONMENT, THIS IS A CONCERN. Sources: First Quadrant, L.P., StyleAdvisor, Bloomberg LP, Global Financial Data (GFD)
CONTACT INFORMATION Max Darnell has served as First Quadrant's Managing Partner since 2012, and Chief Investment Officer since 2002. Max is responsible for setting the strategic direction of the firm, and for overseeing the firm's investment products with emphasis on strategic research and development initiatives. Max began his career at First Quadrant in 1991, managing derivatives research throughout the decade. In 2000 he was named Director of Research. Max earned a Master's degree in Economics from the University of California, Los Angeles, in 1991. Max Darnell MANAGING PARTNER, CHIEF INVESTMENT OFFICER DIRECT 626 683 4163 EMAIL MDARNELL@FIRSTQUADRANT.COM 19