Investing in Today s World with Thoughts of Tomorrow Presented by: Jeff Matthias, CFA Wisconsin Coalition of Annuitants May 11, 2018
Today s Key Takeaways Investor Inputs Market Recap Investment Outlook 2
Investor Inputs 3
Why People Invest (the primary reasons) To achieve financial goals To increase current income To accumulate wealth To increase financial security To have funds available during retirement 4
Retirement Concerns Not having enough to do Isolation / loneliness Relationship challenges / marital 5
Retirement Concerns Unexpected health crisis Outliving savings/inflation Costs of long-term care A stock market crash Not having enough to do Isolation / loneliness Relationship challenges / marital 6
Retirement Income 100% Sources of Retirement Income 80% 60% 40% 20% 0% Investment Income Social security Pension Required Minimum Distributions Source: theretirementmanifesto.com 7
Retirement Concerns For 2017, the funding ratio for public pension plans in Wisconsin was 61.5%. Yikes! Source: Madison, American Legislative Exchange Council 8
Retirement Concerns Funded Ratios for State Pension Plans, 2016 Only 4 states had at least 90% of the assets needed to pay promised benefits. Source: Madison, American Legislative Exchange Council 9
Market Recap 10
YTD Performance 1% Year-to-Date Returns (as of 5-8-18) 0% -1% -2% -3% -4% 3-month Tbills U.S. Aggregate Muni Corps High Yield EM Debt S&P 500 Russell 3000 Cash Fixed Income Equities MSCI World (Ex US) MSCI Emerging Markets 11
Sector Performance S&P 500 Sector Returns (12-31-17 thru 1-26-18) Information Technology Consumer Discretionary Energy S&P 500 Financials Health Care Industrials Materials Utilities Real Estate Telecom Services Consumer Staples -5% -3% -1% 1% 3% 5% 7% 9% 11% 12-31-17 thru 1-26-18 12
Sector Performance S&P 500 Sector Returns Year-to-Date (as of 5-8-18) Information Technology Consumer Discretionary Energy S&P 500 Financials Health Care Industrials Materials Utilities Real Estate Telecom Services Consumer Staples -15% -10% -5% 0% 5% 10% 15% Year-to-date 12-31-17 thru 1-26-18 13
Sector Performance (what changed?) 4% 3% 2% 1% Fed Funds & 10-Year Treasury Yields 50 40 30 20 Stock Market Volatility (VIX) 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 10-year Treasury Federal Funds 10 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 Contributing Factors: Macroeconomics Inflation expectations Policy uncertainty Financial conditions Threat of trade wars Shape of yield curve Tax reform Market volatility 14
Investment Outlook Source: Madison, Morningstar 15
Macroeconomics 18% Gross Domestic Product (GDP) 13% 8% 3% -2% -7% -12% 1948 1958 1968 1978 1988 1998 2008 2018 16
Macroeconomics Frequency 10 8 6 4 2 0 1913 1920 1923 1960 1982 Length of Historical Economic Cycles Year Denotes End of Growth Phase 1902 1907 1910 1918 1926 1948 1953 1957 1973 1929 1937 1980 Longest Expansions Rank Start Months Date to Beat 1 Mar 1991 120 Jul 2019 2 Jun 2009 107 May 2018 3 Feb 1961 106 4 Nov 1982 92 1945 2001 2007 1969 1991 < 36 mths 36 to 60 60 to 84 84 to 108 > 108 Source: Madison, National Bureau of Economic Research 17
Macroeconomics Economic Surprise Indices 100 75 50 25 0-25 -50-75 -100 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 U.S. Euro area 18
Inflation Consumer Price Index April 2018 Cumulative 1-Year CPI Category Weight Weight Change Housing 1 42% 42% 3.0% Transportation 17% 58% 4.1% Food and Beverages 14% 72% 1.4% Medical Care 9% 81% 2.2% Education and Communication 7% 87% 0.1% Recreation 6% 93% -3.6% Fuels and Utilities 5% 98% 2.2% Apparel 2% 100% 1.1% 1 - Owners' equivalent rent of residences represents 23.6%. Source: Madison, Bureau of Labor Statistics 19
Inflation Inflation Expectations 2.2% 2.1% 2.0% Jan Feb Mar Apr 10-year Treasury minus 10-year Treasury Inflation Protected Securities 20
Inflation Average Hourly Earnings 4% 3% 2% 1% 0% 2008 2010 2012 2014 2016 2018 21
Policy Uncertainty U.S. Policy Uncertainty Index 400 350 300 250 200 150 100 50 0 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 22
Policy Uncertainty Federal Budget Deficit and Public Debt Outstanding $21 trillion! Surplus (deficit) 10.0% 5.0% 0.0% -5.0% -10.0% 2007 2009 2011 2013 2015 2017 $21,000 $19,000 $17,000 $15,000 $13,000 $11,000 $9,000 $millions Suplus (deficit) Public Debt Outstanding Largest Holders of U.S Treasuries: Federal Reserve, China, Japan, Ireland, Brazil, Cayman Islands, U.K. and Switzerland. Source: Madison, Treasury International Capital System 23
Central Bank Policy Country Policy Rate 2-year 10-year U.S. 1.75% 2.53% 2.96% Canada 1.25% 1.97% 2.40% Germany -0.59% 0.55% France Euro area -0.51% 0.80% -0.40% Italy -0.26% 1.93% Spain -0.34% 1.31% U.K. 0.50% 0.78% 1.43% Japan -0.05% -0.14% 0.05% Switzerland -0.75% -0.77% 0.03% 24
Financial Conditions 685% Household and Non-Profit Networth as Percentage of Disposable Personal Income 635% 585% 535% 485% 435% 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 2012 2018 25
Financial Conditions 1.5 Financial Conditions Index 1.0 0.5 0.0-0.5-1.0 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 26
Financial Conditions 50% BBB-rated Corporate Bonds as Percentage of Outstanding Investment Grade Bonds 45% 40% 35% 30% 2007 2009 2011 2013 2015 2017 27
Financial Conditions Trailing High Yield Option-Adjusted Spread Trailing Baa Option-Adjusted Spread 8% 3% 6% 2% 4% 2% 2011 2012 2013 2014 2015 2016 2017 2018 1% 2011 2012 2013 2014 2015 2016 2017 2018 28
Threat of Trade Wars Countries Vulnerable to a U.S. Trade War U.S. trade balance as % GDP 3% China South Korea 2% Japan Germany India 1% Canada France Russia 0% -1 0 % -5 % 0% 5% 10% Exports as % of GDP 29
Threat of Trade Wars Trade Surplus (Deficit) by Major Category Trade Surplus Business Services Travel Intellectual Property Trade Deficit Food/Beverages Transport Industrial supplies Capital Goods Automotive Consumer Goods -20% -15% -10% -5% 0% 5% Trade Surplus (Deficit) 30
Shape of Yield Curve 3% Treasury Yields 2% 1% Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 2-year 10-year 31
Shape of Yield Curve 1.50% Difference in Treasury Yields 10-year minus 2-year 1.25% 1.00% 0.75% 0.50% 0.25% Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 32
Shape of Yield Curve 50 History of Flat Yield Curves Months 40 30 20 The bars represent the number of months the spread between 10-year and 2-year Treasuries narrowed to 0.50% or less prior to the onset of a recessionary period. 10 0 Jan 1980 - Jul 1980 Jul 1981 - Nov 1982 Jul 1990 - Mar 1991 Mar 2001- Nov 2001 Dec 2007 - Jun 2009 Recessionary Periods 33
Tax Reform Estimated Effective Tax Rates Across Industries (based upon Stern's January 2017 analysis) Environmental & Waste Services Business & Consumer Services Retail (Grocery and Food) Engineering/Construction Banks (Regional) Insurance (Prop/Cas.) Household Products Chemical (Basic) Aerospace/Defense Drugs (Pharmaceutical) Semiconductor Equip Paper/Forest Products The estimated average corporate tax rate is 26.2%. Oil/Gas (Integrated) 0% 5% 10% 15% 20% 25% 30% 35% 34
Tax Reform Comparison of Pre-Tax Equivalent Yields (Before and After 2017 Tax Legislation) 4.5% Top Personal Tax (39.6% to 37%) Corporate Tax (35% to 21%) 4.0% AA Muni (before), 4.32% AA Muni (after), 4.14% AA Muni (before), 4.02% AA Corp, 3.79% AA Corp, 3.79% 3.5% AA Muni (after), 3.30% 3.0% UST, 2.98% UST, 2.98% Corporate tax rate 2.5% 0.95 1.15 1.35 1.55 1.75 1.95 Pre-Tax Equivalent Yields for various tax brackets Tax Bracket PTE Yield 37% 4.14% 35% 4.02% 32% 3.84% 24% 3.43% 22% 3.35% 21% 3.30% 12% 2.97% 35
Stock Market Volatility S&P 500 Price Volatility (1-day price change) +3% to +4% 1% +2% to +3% 20% +1% to +2% 37% -1% to +1% 26% -2% to -1% -3% to -2% -4% to -3% < -4% 8% 6% 1% 1% 0 20 40 60 80 100 120 140 160 Frequency (trading days) 2018 2017 36
Valuations Investment Grade Corporate Bond Spreads January 2010 through May 8, 2018 250 220 190 160 130 100 70 2010 2011 2012 2013 2014 2015 2016 2017 2018 Average Yield +/- 1 Standard Deviation Month-End Yield 37
Valuations S&P 500 Index: Forward P/E Ratio (based on next 12 months expected earnings) 28 26 24 22 20 18 16 14 12 25-year average: 15.1x 10 8 6 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 38
Valuations 10% The Earnings Yield for Stocks is Still Compelling Compared to Bond Yields S&P 500 Earnings Yield 9% 8% 7% 6% 5% 4% Corporate Bond Yield (Baa) 3% '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 39
Valuations S&P 500 Level Implied by Price to Earnings (P/E) Combinations Earnings Per Price Earnings Multiple Share 12X 14X 15X 16X 17X 19X 20X 22X $ 178 2,136 2,492 2,670 2,848 3,026 3,382 3,560 3,916 $ 176 2,112 2,464 2,640 2,816 2,992 3,344 3,520 3,872 $ 174 2,088 2,436 2,610 2,784 2,958 3,306 3,480 3,828 $ 172 2,064 2,408 2,580 2,752 2,924 3,268 3,440 3,784 $ 170 2,040 2,380 2,550 2,720 2,890 3,230 3,400 3,740 $ 168 2,016 2,352 2,520 2,688 2,856 3,192 3,360 3,696 $ 166 1,992 2,324 2,490 2,656 2,822 3,154 3,320 3,652 $ 164 1,968 2,296 2,460 2,624 2,788 3,116 3,280 3,608 $ 162 1,944 2,268 2,430 2,592 2,754 3,078 3,240 3,564 $ 160 1,920 2,240 2,400 2,560 2,720 3,040 3,200 3,520 $ 158 1,896 2,212 2,370 2,528 2,686 3,002 3,160 3,476 $ 156 1,872 2,184 2,340 2,496 2,652 2,964 3,120 3,432 $ 154 1,848 2,156 2,310 2,464 2,618 2,926 3,080 3,388 $ 152 1,824 2,128 2,280 2,432 2,584 2,888 3,040 3,344 $ 150 1,800 2,100 2,250 2,400 2,550 2,850 3,000 3,300 March 31 S&P 500 Level 2,640 P/E Multiple 2017 Estimated Earnings $124.53 21.2X 2018 Estimated Earnings $156.13 16.9X 2019 Estimated Earnings $172.62 15.3X 40
Outlook Our Equity Scorecard Madison Macro Factor Scorecard (Munis) Considerat ions: - -0 - + Economic Growth - M M + Global U.S. Economy n/c n/c Corporate Profits - M Interest Rates Regulatory/Tax State/Local (fiscal) Credit Trends Liquidity n/c n/c n/c n/c Inflationary Pressures Interest Rate Pressures Rate - M - M Issuance / Fund Flows Liquidity - M Valuations - Negative for Munis - Current + Positive for Munis - Prior n/c - No change Sentiment Valuation - M - M M + Negative for Equities Positive for Equities 41