Quarterly Investment Briefing February 5, 2014 Clayton T. Bill, CFA Stephen J. Nilles, CFP
Agenda Topic Page 2013 Review 3 Corporate Earnings and Profit Margins 5 Equity Market Valuations 7 Bonds and Expected Returns 9 Outlook and Market Assessment 11 U.S. Government Fiscal Outlook /Taxes 13 Employment 15 Summary 16 Source: Russell
Year In Review: 2013 Was A Great Year For Equities Amidst political brinkmanship, global stock market climbed 24% Growth of $100 130 125 120 115 110 105 100 MAR: U.S. sequestertriggered spending cuts and tax increases began. APR: Bank of Japan launched bold stimulus program to boost growth and inflation. AUG: Eurozone exited 18-month recession, led by Germany and France. OCT: Congressional brinkmanship led to U.S. government shutdown. DEC: Federal Reserve announced plans to begin winding down bond-buying program. Janet Yellen nominated to lead the Federal Reserve. MAR: Cyprus sought financial MAY: Bernanke s taper talk 95 rescue; Italy struggled to form got a reaction. Equities 1 a government weeks after pulled-back -6% between general election. May 21 June 24. Russell Global Index 90 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Source: Russell 3
Capital Market Returns Period Ending December 31, 2013 40 35 30 U.S. Equities Emerging Market Equities Real Estate 33.5 Non-U.S. Equities Fixed Income Rate of Return % 25 20 15 10 5 0-5 10.1 21.7 18.7 16.2 13.1 16.5 15.2 11.4 7.3 7.9 5.8 7.6 7.4 7.4 3.7 3.3 4.4 4.5 2.4 0.0-0.1-0.7-2.0-1.4 4Q 1YR 3YR 5YR 10YR Source: Russell 4
A Good Earnings Season Thus Far Source: J.P. Morgan 5
Why Are U.S. Companies So Profitable? Source: BofA Merrill Lynch 6
Market Valuations Don t Appear Overextended Current Price/Earnings levels suggest prices are fairly valued 28 23 99 tech bubble = 27 U.S. Large Cap P/E Ratio = Average stock price of an index Overall corporate earnings of an index P/E 18 13 8 2008: Extremely low earnings Average = 16.3 U.S. and Europe appear near historic averages Emerging Markets appear moderately undervalued 28 Europe 28 Emerging Markets 23 23 P/E 18 Average = 16.2 P/E 18 Average = 14.4 13 13 8 8 Source: Russell 7
Lower Emerging Market Valuations Consistent With Growth Expectations Price over 36-month trailing earnings for selected global equity indexes 60 50 40 In the early 2000s, valuations in the developed world were much higher than those in emerging markets 30 Valuations across regions are now more similar 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 FTSE Emerging Index United States FTSE Developed Ex US Index Source: Vanguard 8
Bonds Can Provide Ballast In An Equity Bear Market Median return of various asset classes during the worst decile of monthly equity returns, 1988-2012 2% 0% -2% Median return -4% -6% -8% -10% Source: Vanguard 9
Bond Math = Low Expected Returns Source: Vanguard 10
Outlook: Market Assessment According to Fidelity s Business Cycle Board, composed of portfolio managers responsible for a variety of asset allocation strategies across Fidelity s asset management unit, the U.S. macro environment provides a stable backdrop for U.S. assets. The global economy has cyclical momentum, but policy risks have become more acute among emerging economies. Source: Fidelity 11
Coordinated Central Bank Action Supported Growth 140 United States Quantitative Easing Federal Reserve s Treasury Bond buying program started in March 2009 and later extended to include mortgages Eurozone Outright Monetary Transaction In 3Q 2012, European Central Bank (ECB) President Draghi committed ECB to buying debt to protect weaker Euro members Japan Abenomics Prime Minister Abe s economic plan announced in January 2013 targeted fiscal and monetary reform 130 120 Index Value 110 100 90 80 70 QE2 Operation Twist QE3 Whatever it takes 60 QE1 50 Abenomics 40 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 12/30/2011 12/31/2012 12/31/2013 Russell 1000 Russell Large Cap Japan Russell Developed EuroZone Source: Russell 12
Improved 2014 Fiscal Outlook: Less Drag, Lower Deficit Tax increases and budget cuts in 2013 reduced the federal budget deficit and created significant drag on the economy. The budget outlook is expected to improve further in 2014 but with much less fiscal drag, which, combined with the two-year budget deal struck by Congress, provides greater certainty and a better near-term fiscal outlook than at any point in years. Source: Fidelity 13
Are You Ready For Higher Taxes? Taxable distributions have increased Strong market returns have created sizable gains Generally, investment vehicles must pass along these gains to taxable investors Tax rates have increased for many investors New top marginal rate Increased capital gains rates New investment income tax Marginal Taxable Income Rates 2013 10% $17,850 or less 15% $17,851 $ 72,500 25% 28% $72,501 $146,401 $146,400 $223,050 33% 35% $223,051 $398,350 $398,351 $450,000 35% $450,001 or more 39.6% New MARRIED FILING JOINT *Source: Internal Revenue Service, January 2014 It s not what you earn, it s what you keep! Work with your advisor to try maximizing after - tax wealth. Source: Russell 14
Retirements Now Driving Decline in Participation Rate The aging of the U.S. population has been pushing the labor force participation rate lower for close to a decade. Although the recession caused a cyclical decline in the participation rate, the number of discouraged workers peaked in 2012, which suggests that demographics have been a stronger driver of recent participation-rate declines than employment conditions. Source: Fidelity 15
Diversification Over Time Annualized Excess Returns 20.0 15.0 10.0 5.0 0.0-5.0-10.0 5.6 Non - U.S. Equity U.S. Equity Excess Return vs. Other Asset Classes 2009-2013 2.2 14.3 3.5 17.2 U.S. stocks outperformed non - U.S. stocks by 5.6% per year EM Equity U.S. Bonds Global REITs Commodities 20.0 15.0 10.0 5.0 0.0-5.0-10.0-3.8 Non - U.S. Equity U.S. Equity Excess Return vs. Other Asset Classes 2004-2008 U.S. stocks underperformed non - U.S. stocks by 3.8% per year - 8.5-6.6-2.1-2.2 EM Equity U.S. Bonds Global REITs Commodities 2013 s +33% U.S. equity return highlights a superior five - year stretch The prior five years demonstrate how dramatically markets can swing Russell believes diversified portfolios are best positioned to capitalize on this behavior Annualized Excess Returns Source: Russell 16
It s Time For Action Ideas to discuss with Indiana Trust Rebalance Create a game plan for maximizing after-tax wealth Reassess the amount and types of fixed income exposure Ask yourself, Are my lifestyle expectations consistent with a more modest return outlook? Source: Russell