Sea Change: The Ebbing of Quantitative Easing Policy and its Impact on the Capital Markets William W. Priest CEO, Co-CIO & Portfolio Manager The information contained herein reflects, as of the date hereof, the views of Epoch Investment Partners, Inc. and sources believed by Epoch Investment Partners, Inc. to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein. In addition, there can be no guarantee that any projection forecast or opinion in these materials will be realized. The views expressed herein may change at any time subsequent to the date of issue hereof. These materials are provided for informational purposes only.
Policy response to the GFC ended the liquidity crisis 4.00 Z-Score U.S. BFCI 2.00 0.00-2.00-4.00-6.00 Euro Zone -8.00-10.00-12.00-14.00 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Source: Bloomberg. September 18, 2013 The Bloomberg U.S. Financial Conditions Index combines yield spreads and indices from U.S. money markets, equity markets, and bond markets into a normalized index. The Bloomberg Euro-area Financial Conditions Index combines yield spreads and indices from euro-area money markets, equity markets, and bond markets into a normalized index. 1
The Global Financial Crisis the key role of financial sector leverage U.S. Financial Sector Debt as Percent of GDP 120% 100% 80% 60% 40% 20% 0% Source: Federal Reserve, Epoch Investment Partners, Inc. 2013 2
Too much debt remains a global problem policy choices Advanced Economies Gross General Government Debt to GDP Debt to GDP (%) 120 110 100 95 101 105 110 113 90 80 70 60 60 64 68 70 73 74 73 73 74 72 72 73 76 80 79 77 74 81 50 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 e 2013 Potential Solutions to the Overriding Debt Problem 1. Growth 4. Financial Repression (QE) 2. Austerity 5. Devaluation 3. Default 6. Hyperinflation Source: International Monetary Fund, World Economic Outlook Database, Epoch Investment Partners 2013 3
Quantitative easing became a global phenomenon Central Bank Balance Sheet Expansion Index 500 450 400 350 300 250 200 150 100 50 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Fed BoE ECB BoJ Source: Pavilion Global Markets; 2013 4
Sea Change June 19, 2013
June 19, 2013 September 19, 2013 The end of easy money but very S L O W L Y We also see inflation moving back toward our 2 percent objective over time. If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. Chairman Bernanke s Press Conference June 19, 2013 the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. FOMC Meeting Minutes September 18, 2013 6
Bernanke s tapering comments drive yields higher U.S. Treasury Yield Curve: May 1, 2013 vs. September 18, 2013 4.0 3.5 (%) September 18, 2013 3.0 2.5 2.0 103 bps May 1, 2013 1.5 1.0 0.5 0.0 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr 10-Year Treasury Yield 30-Year Treasury Yield June 18, 2013 2.20 3.34 September 18, 2013 2.69 3.75 Source: US Department of the Treasury, Epoch Investment Partners; September 18, 2013 7
Apple bond offering On April 30, 2013, Apple issued a total of US$17.05 billion worth of bonds in six tranches with a weighted coupon of approximately 1.8% and a weighted duration of approximately 10 years Issue Coupon Current Price 1 10 Year 2.40% 89.07 30 Year 3.85% 83.03 1 As of September 19, 2013 8
The movie run backwards 10-Year Treasury Constant Maturity Rate (%) 4.5 4.0 3.5 June 19, 2013 3.0 September 18, 2013 2.5 2.0 1.5 Jan-08 Jun-09 Nov-10 Apr-12 Sep-13 2014 2015 2016 Future Source: Federal Reserve, Epoch Investment Partners; September 6, 2013 9
Recent global returns driven by multiple expansion Breakdown of MSCI World Performance Annualized Total Return: 19% 21% Annualized Total Return: 33% 14% 4% 75% 92% Mar 2009 - May 2012 Jun 2012 - May 2013-6% Expected Earning Growth Fwd P/E Expansion Dividend (Inc. Reinvestment) Source: Bloomberg, MSCI, Bernstein Analysis; May 2013 10
Looking beyond QE in the U.S. Stocks are attractive in the long term, especially relative to bonds, providing the world grows Extreme valuation disparities present an investment opportunity As interest rates rise and other macro factors wane, equity returns will be more dependent on company fundamentals Companies with growing free cash flow and effective capital allocation policies should outperform 11
Summary A sea change underway the end of ZIRP in the U.S. but very S L O W L Y June 19, 2013 September 19, 2013 Discount rate for financial assets will rise Bonds most adversely affected Equities to experience P/E headwinds Global Themes Best positioned geography: U.S. Wait and see: Japan Valuations becoming attractive in Europe As macro factors wane, equity returns will be more dependent on company fundamentals Slow economic growth will limit revenue and earnings growth Shareholder yield will continue to play a dominant role in total return strategies Companies with growing free cash flow and effective capital allocation policies should outperform P/E expansion limited 12