SVB Private Bank Wealth Advisory Market Outlook Q2 2015 vol. 2 / issue 2
SVB Private Bank Wealth Advisory Market Outlook Q2 2015 To learn more about SVB Private Banking and Wealth Advisory, contact your Wealth Advisor, email us at wealth@svb.com or privatebank@svb.com, or call us at 855.838.4212. vol. 2 / issue 2 Our Perspective on the Markets, Interest Rates and the Economy As valuations adjust to lower earnings growth, US equity market performance could moderate in 2015 before reaccelerating in 2016. Analysts expect Eurozone earnings to grow 14.5% in 2015, which could be the positive catalyst needed for a strong equity market. Other highlights: Other major global economies are earlier in the business recovery cycle than the US, and thus have potentially more to offer in terms of profit growth. In emerging markets, we expect sustained volatility and diverging performance results, with country selection being key to results. The outlook for tax-exempt bonds remains positive as the supply-and-demand outlook appears balanced for 2015. As market performance shifts from beta-driven factors to more complex, asymmetric macroeconomic conditions, there may be opportunities for hedge funds to perform well in 2015. Products offered by SVB Wealth Advisory, Inc.: Are Not FDIC Insured Are Not Bank Guaranteed May Lose Value In This Issue: page 2 Fixed Income Outlook for 2015 page 3 Equity Market Outlook for 2015 page 5 Alternative Investment Outlook for 2015 page 6 US Macroeconomic s and Policies page 8 Global Macroeconomic s and Policies page 10 Conclusion page 11 The Fine Print 1
Fixed Income Outlook for 2015 Income Type Fixed Income Outlook for 2015 Demand by global investors for US Treasuries is expected to prevent yields from spiking. On a relative basis, the US continues to be attractive to international investors based on economic growth, relative yields, and a strengthening or stable currency. The outlook for tax-exempt bonds remains positive as the supply-and-demand outlook appears balanced for 2015, and credit conditions are likely to remain strong. Investors are likely to receive total returns close to the yield-to-maturity earned by bonds at the time of purchase. In other words, we believe the days of price appreciation due to falling interest rates have passed. Nonetheless, municipal bonds continue to offer an after-tax yield advantage over Treasuries for investors with high tax brackets; they are effective anchors for equity portfolios and provide sources of liquidity when unexpected cash needs arise. 2
Equity Market Outlook for 2015 Equity Market US Equities US equities are trading at or slightly higher than historical highs, even on the basis of forward earnings estimates. On a trade-weighted basis, the US dollar has appreciated 13% in the last 12 months, reducing the appeal of American products on world markets. With a third of the revenue earned by companies in the S&P 500 sourced from foreign currencies, companies are feeling the impact on earnings. Analysts expect slower 2015 earnings growth for all sectors and are now predicting that S&P 500 earnings will rise 1.6% this year and 12.9% in 2016. This slower growth can be explained in part by the strong US dollar, therefore reducing exports, which make up over 13% of GDP. Investors are likely to remain nervous about the timing of Fed tightening, which often negatively impacts equity market performance. These factors suggest that the US equity market s appreciation in 2015 will be moderate with increased volatility. Conservative investors who wish to deploy cash into long-term portfolios are advised to take advantage of potential draw-downs by dollar cost averaging into target positions. Developed International Equities Other major global economies are earlier in the business recovery cycle than the US, and thus have potentially more to offer in terms of profit growth if quantitative easing programs are successful. In the Eurozone, international equities appear to be more attractively valued than US equities, while margins are likely to be supported by low to negative interest rates, a competitive currency, and low oil prices. Analysts expect Eurozone earnings to grow 14.5% in 2015, which could be a positive catalyst for strong equity market performance. Large European companies receive more than half of their sales from outside their home markets and should be the first to benefit from the lower euro. This positive outlook has investors increasing allocations to European markets as evidenced by fund flows. In Japan, policymakers are implementing changes that could lead the country to sustained (albeit slow) growth for the first time in decades, but they remain challenged by the coordination required of monetary and fiscal programs and the persistence of deflation in the economy. 3
Equity Market Outlook for 2015 (continued) Equity Market Emerging Market Equities While the underperformance of emerging market equities over the last few years has resulted in valuations that appear attractive, country selection remains important to investors. The economies of China and India are benefiting from fiscal and monetary policies, while other emerging market countries are struggling with fiscal deficits caused by lower oil revenues and political instability. In general, we expect sustained volatility in EM capital markets and diverging performance results. Both these factors suggest that active managers who use risk-mitigating country selection factors could outperform passive strategies. Modest exposure to emerging market equities is warranted for long-term investors, but it is too early to overweight this asset class. 4
Alternative Investment Outlook for 2015 Alternatives Hedge Funds Hedge funds took advantage of dynamic global monetary conditions in the first quarter to trade in volatile currency and commodity markets, outperforming the S&P 500 for the first time since the third quarter of 2011. Alternative investments add value through trading and hedging strategies, including use of fundamental, quantitative, trending and countertrend models. These investments can be well suited to capturing mispricing opportunities as market performance shifts from beta-driven factors to more complex, asymmetric macroeconomic conditions. These conditions offer opportunities for hedge funds to perform well in 2015. Certainly when an extended equity downturn occurs, carefully selected hedge funds could prove to be a welcome addition to equity portfolios. 5
US Macroeconomic s and Policies Indicators Macroeconomic s Although the US economy had a slow start to the year, this is widely considered to be a temporary setback caused by the severe winter in the East, and the Los Angeles dockworker strikes in the West. The consensus view for US Real GDP growth is 3% in 2015. Four factors make up GDP: consumer spending, government spending, net exports and investment. Of these four, consumer spending is by far the most important component, making up close to 70% of GDP. In the first quarter, three of these factors missed expectations: consumer spending fell below expectations, net exports fell due to the strong US dollar, and investment spending stalled along with weak corporate profits. The US is in its sixth year of expansion, and the Fed is closer than the European and Japanese central banks to normalizing monetary conditions. See Global Macroeconomic s below. Inflation and Interest Rates In the US, inflation remains low, at an annualized rate of 1.3%. Several factors are headwinds on inflation: a lack of increases in wages, soft employment, e-commerce retail competition, an aging population, the collapse in oil prices, and new technologies. Over the last year, the Federal Reserve has repeatedly lowered its projection of the fed funds rate, and has indicated that it would need to be confident that inflation would move toward 2% before any rate increase would begin. Although Janet Yellen and other key policymakers continue to indicate that interest rates could increase this year, unless more progress is made toward achieving the Fed s inflation and employment targets, it is increasingly likely the Fed will delay its first hike until 2016. Furthermore, once hikes are initiated, they are likely to be raised gradually, as the Fed will want to avoid finding itself ahead of the curve and in the awkward position of having to cut rates after having just raised them. 6 Employment Mixed Although economists expected about 275,000 new jobs per month through 2015, March employment data reported payroll growth below 200,000 for the first time in more than a year, as well as a dip in the Fed s Labor Market Conditions Index. These indicators are key to the future of the economy, because employment growth drives wage growth, which drives consumer spending, which is essential to sustained GDP growth.
US Macroeconomic s and Policies (continued) Indicators Consumer Spending Mixed Economists expected consumer spending to get a boost in 2015 from lower oil prices and easing credit conditions. Low oil prices alone were expected to add 1.5% to consumer spending. Instead, consumer spending stalled in the first quarter. Headwinds include the fourth-quarter spending spree, unusually severe winter storms in the eastern US, and the dock labor strikes. The lack of wage growth is likely a larger and more troublesome factor across America; median inflation-adjusted wages are no higher today than they were when the financial crisis hit. Slack in the labor market, including a large number of workers in parttime jobs who wish to be fully employed ( part time for economic reasons ), and the number of discouraged workers who have left the workforce are keeping the lid on wage inflation. American companies are anticipating higher wages in 2015, evidenced by Walmart and McDonald s, both of which recently announced pay raises, and by more than a dozen states which have announced increases in minimum wages. It remains to be seen whether low wage inflation will persist or whether wages are on the cusp of an uptrend, but this is an important and closely watched factor. Housing Housing sales have had a strong start in 2015, and sales could accelerate in the months ahead. Nationally, the pending-home-sales index jumped 12% in February (from a year earlier). In March, pending sales were up 30.6% in Houston, 27.8% in San Diego, 24.2% in Seattle and 23.7% in the Riverside and San Bernardino market in California. Employment growth and an easing of borrowing requirements, as well as the fact that many borrowers have repaired their credit enough to qualify for mortgages, are boosting home sales. Moreover, the potential for the Federal Reserve to start increasing interest rates as early as June has prompted some buyers to take the plunge to lock in today s low borrowing costs. Rates on 30-year, fixed-rate mortgages have been near or below historic lows since November. 7
Global Macroeconomic s and Policies Indicators Global Macroeconomic s The Eurozone and Japan should continue to see growth pick up in 2015 as the combination of cheap currencies, lower interest rates, a gradual easing of fiscal austerity, and lower oil prices boost their economies. In Europe, credit conditions are improving for small business, and analysts are upgrading earnings forecasts. Consumer spending is required to sustain growth, but unemployment in the Eurozone remains stubbornly high at 11.8%. Employment stability is needed before consumers will open their wallets and spend. Japan s prospects of ridding deflation for good are more challenging and will require coordination of fiscal and monetary policy to reach its 2% inflation target. Conditions in emerging market countries are split. Oilimporting countries with sound fiscal conditions and healthy private sector balance sheets will largely avoid the troubles. Oil-exporting countries with fiscal deficits that rely on foreign capital investment are likely to experience economic challenges. China s growth is slowing as policymakers try to reduce the country s reliance on debt and succeed in a soft landing. Global Monetary Policy Globally, deflation continues to be the main driver of monetary policy as central banks have placed a premium on overcoming deflation risk. In Europe, the quantitative easing program has driven rates low or even negative, and boosted export growth through a weaker euro. ECB President Mario Draghi has assured markets that the purchases will continue until Eurozone inflation stabilizes near 2%. Likewise, Japan continues to apply monetary stimulus through its bond purchase program to avoid a prolonged recession. Benefiting from a weaker yen, the program has made its central bank the biggest buyer of bonds and reduced the supply in the secondary market. This could make selling bonds more difficult in the future. Britain is taking a monetary pause while the economy digests the impact of a stronger pound. The People s Bank of China has cut its deposit and lending rates by 25 bps. As quantitative easing removes bond supply from the market, massive increases in central bank balance sheets are manipulating longer-term interest rates down and driving asset prices up. These actions make it more difficult for investors to depend on the yield curve for insight into the fair market value of asset values, and introduce the risk of a bubble/bust occurrence in the future. However, for the near term, a dramatic spike in global intermediateto long-term rates is unlikely in 2015. 8
Global Macroeconomic s and Policies (continued) Indicators Geopolitical Risk Neutral Grexit (a Greece exit from the euro) remains a risk primarily for Greece. Markets are recognizing that the impact of Greece defaulting is less of a market risk than before, as most of Greek debt is held by its Troika of lenders (European Central Bank, the European Commission and the International Monetary Fund) and not banks or investors. Greece managed to scrape together its 458m repayment to the IMF on April 9, but another 950 million comes due in May. For the second month in a row, the finance ministry is scrambling for cash to pay pensions and salaries. Greece needs to reach a deal with its Troika creditors to unlock $7.8 billion in loans and avoid default. Other global challenges such as the Iran nuclear deal, the Syrian civil war, Middle East political instability, and the Ukraine crisis currently have a limited impact on the trend of world capital markets. 9
Conclusion Economic trends indicate that, despite disappointing Q1 growth, US economic growth should be sustained into 2015, with real GDP forecasted to be 3%. US equity market performance could moderate as valuations adjust to lower earnings growth in 2015 before reaccelerating in 2016. Given this backdrop, global developed equity markets could lead the US markets in 2015 as Eurozone and Japanese quantitative easing stimulates growth, consumer spending and corporate profits. Stock, country, and sector selection will likely continue to be important determinants of return and risk. In the fixed income markets, global yield-seeking investors are keeping a lid on rapidly adjusting interest rates, and, while rates are low in taxable and tax-exempt bonds, credit remains strong and bonds should provide a total return close to current coupons. Risks to the outlook include the uncertain timing of the Federal Reserve s first move to the federal funds rate since 2006. Equities often react negatively in the year following the first Fed action. In addition, quantitative easing in the Eurozone and Japan need to broadly stimulate the economy to increase consumer spending through improved employment and the easing of credit to ensure that those economies don t fall back into recession and deflationary monetary conditions. 10
The Fine Print This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. Past performance is not a guide to future performance. Opinions and estimates are as of a certain date and subject to change without notice. All material presented, unless specifically indicated otherwise, is under copyright to SVB Wealth Advisory and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Wealth Advisory. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. 2015 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Wealth Advisory, Inc. is a registered investment advisor and non-bank affiliate of Silicon Valley Bank and a member of SVB Financial Group. Products offered by SVB Wealth Advisory, Inc.: Are Not Deposits Are Not FDIC Insured of or Other Obligations May Lose Value of Silicon Valley Bank Neither SVB Wealth Advisory, Inc., Silicon Valley Bank, nor its affiliates provide tax or legal advice. Estate planning requires legal assistance. Please consult your tax or legal advisors for such guidance. Banking services are provided by Silicon Valley Bank, and wealth advisory services are provided by SVB Wealth Advisory, Inc. (0415-0014) 11 SVB Private Bank 2770 Sand Hill Road Menlo Park, CA 94025 855.838.4212 privatebank@svb.com SVB Wealth Advisory, Inc. 555 Mission Street, Suite 900 San Francisco, CA 94105 415.764.3100 wealth@svb.com 05/15