Trends & Long-Term Outlook for Fixed and Stable Value Funds CPPC Conference August 2013 Cathe Tocher CFA, Senior Vice President
AGENDA Introduction: Short-term noise pay attention Preparing for the future: A Challenge Economic Review: Working with trends Capital Markets: Framework for fixed income investing Outlook: Positioning for the long-term 2
Short-term term Noise STOCKS BONDS Bond Market Ride 3
Stocks S&P 500 +19% return 1720 ytd to 8/7 1670 1620 1570 1520 1470 6/18 6/24: -4.8% Taper Talk 1420 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Source: Bloomberg 4
Bonds 10 year UST Yields -5.6% return Yield % ytd to 8/7 2.7 2.5 23 2.3 2.1 1.9 Taper Talk 17 1.7 1.5 Dec 12 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Source: Bloomberg 5
PREPARING FOR THE FUTURE 6
There are always challenges.. growth sequester 7
And responses to those challenges This cycle: Fiscal & Monetary Policy Intervention Fiscal policy: TARP, bailouts, increased spending, tax cuts, emergency benefits sequester, austerity Monetary policy: Fed Funds rate cut to 0%, use of Fed s balance sheet for security purchases to push rates down = quantitative easing QE 1 QE4, Operation Twist 8
U.S. ECONOMY: CHANGE IN TREND 9
State of the Economy Real GDP Growth Ann % Chg 3.0 2.0 1.0 00 0.0-1.0-2.0 20-3.0 2009 2010 2011 2012 2013E 1 st half growth: 1.4% Real GDP Growth qoq annualized Gaining tractionti 12/31/2012 / 3/31/2013 / 6/30/2013 / 9/30/13 / E 3.0% 2.0% 1.0% 0.0% Source: Bloomberg 10
State of the Consumer INCOME TAXES HOME PRICES HOUSEHOLD NET WORTH EMPLOYMENT Consumer Spending STOCK PRICES The consumer accounts for approximately 70% of total expenditures based GDP!! 11
State of the Consumer $75,000 $70,000 $65,000 $60,000 $55,000 yoy % change in net worth right Household Net Worth Recovery Peak to trough (07 09): 26% 2007 Peak to current: +6.6% Key to 20.0% confidence and 10.0% spending 0.0% $50,000000 $45,000 $40,000 $35,000 Net worth in billions of US$ left scale 10.0% 20.0% 0% $30,000 30.0% 1q05 1q07 1q09 1q11 1q13 Source: Federal Reserve 12
Housing Market Recovery Index Level 200 Case Shiller 20 City Home Price Index 175 +12.5% 150 125 100 May-08 May-09 May-10 May-11 May-12 May-13 Index Level left axis YOY % Change rt axis Source: Bloomberg 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% Supply / demand d imbalance - inventories down - demand up - Homebuilders more optimistic - traffic up - mtge rates remain relatively low -yield curve steep, bank lending picking up 13
Secondary Impacts Consumer + business confidence & sentiment spending & lending Consumer demandd + business response home prices rising Housing market recovery = growth engine for the economy hiring business growth economy 14
Personal Income Real Personal Income 5.0 yoy y % chge 3.0 1.0 1.0 3.0 Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Jun 13 Source: Bloomberg 15
Job Market Labor Market Trends 17.0% 14.0% 11.0% 8.0% 7.4% Outlook improving 14.0% 5.0% 7.4% 2.0% 700,000000 550,000000 400,000 250,000 100,000 Jul-03 Jul-05 Jul-07 Jul-09 Jul-11 Jul-13 Unemployment Rate Underemployment Rate Claims rt axis # of jobs created since 2010: 6.4 million # of jobs lost through h the crisis: 8.7 million Source: Bloomberg # of unemployed: 11.5 million 16
Consumer Behavior Confidence & Spending 4.0 100 % chge yo oy 2.5 1.0 0.5 2.0 75 50 25 3.5 0 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Real Consumer Spending left axis Confidence fd right axis Source: Bloomberg 17
Business Behavior Spending & Confidence 10 8 Companies are sitting on a lot of cash % 20.0 10.00 6 4 2 0 Corporate balance sheets are in good shape 2Q08 2Q09 2Q10 2Q11 2Q12 2Q13 E Confidence left axis Spending qoq right axis 0.0 10.0 20.0 30.0 40.0 Source: Bloomberg 18
Inflation Employment Cost Index & Ave Hourly Earnings (% chge yoy) 3.5 30 3.0 2.5 2.0 1.5 1.0 Wage deflation a Federal Reserve concern Core PCE (% chge yoy) 3.00 Core inflation persistently Dec 08 Jun 10 Dec 11 Jun 13 250 2.50 weak Ave. Hourly Earnings Employment Cost Index Source: Bloomberg 2.00 Inflation Expectations 6.0 5.0 1.50 1.00 0.50 4.0 3.0 2.0 10 1.0 0.0 J 08 S 08 M 09 J 10 S 10 M 11 J 12 S 12 M 13 Source: Bloomberg 0.00 Dec 07 Sep 08 Jun 09 Mar 10 Dec 10 Sep 11 Jun 12 Mar 13 Inflation expectations well-anchored 19
the pieces are SLOWLY moving into place 20
BUT the FED is Still Present OBJECTIVES: Real GDP Growth Ann % Chg 3.0 2.0 GROWTH 1.0 1) Foster growth 00 0.0-1.0-2.0-3.0 30 2009 2010 2011 2012 2013E 2) increase inflation Core PCE (% chge yoy) 3.00 INFLATION 2.50 2.00 1.50 1.00 050 0.50 Source: Bloomberg 0.00 Dec 07 Sep 08 Jun 09 Mar 10 Dec 10 Sep 11 Jun 12 Mar 13 21
QE TAPERING: will it stall the recovery?? 1. The FED is NOT tightening g policy 2. Question: is the economic recovery sustainable without the FED? 22
FED POLICY: IMPACT ON CAPITAL MARKETS
Fed U.S. Policy: Treasury Impact Curve / Yields on Capital Markets bps 600 10Year U.S. Treasury Yields 500 Percent 3.8 400 300 200 Corporate Spreads 3.3 QE1 QE2 2.8 23 2.3 1.8 1.3 100 Dec 08 Sep 09 Jun 10 Mar 11 Dec 11 Sep 12 Jun 13 QE4 QE3 Operation Twist Dec 08 Sep 09 Jun 10 Mar 11 Dec 11 Sep 12 Jun 13 Taper Talk Source: Bloomberg and Barclays Live 24
Post Crisis Flows into Bonds Source: Deutsche Bank 25
Post Crisis Flows into Equities Source: Deutsche Bank 26
OUTLOOK FOR FIXED INCOME
Where Should UST Yields Be?? Real Treasury Yields: 5 & 10 Year % 3.0 10 YR 2.0 1.0 5 YR 10 year just turned positive 0.0 1.0 2.0 7/29/03 7/29/05 7/29/07 7/29/09 7/29/11 7/29/13 Forward Curve 7/29/13 Current 3 months 6 months 1 year 5 year 1.38% 1.70% 1.87% 2.22% 10 year 2.60% 2.89% 2.85% 3.22% Nominal yield expectations one year out Source: Bloomberg 28
Treasury Yields: Looking forward 10 year UST Historical Yields % 15.0 13.0 11.0 9.0 Secular decline in interest rates 70 7.0 5.0 3.0 1.0 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 Source: Bloomberg Change in trend 29
10 year Corporate Bond Yields: Looking forward 18.0 16.0 Y 14.0 i 12.0 e l 10.0 d 8.0 % 6.0 4.0 10 year A.L. Corporate Bond Historical i Yields Secular decline in corporate bond yields Change in trend 2.0 Jul-77 Jul-83 Jul-89 Jul-95 Jul-01 Jul-07 Jul-13 Source: Barclays Live 30
Short Term Corporate Bond Yields: Holding Y i e l d % Short Duration Corporate Bond Historical Yields 18.0 16.0 14.0 12.0 10.0 80 8.0 6.0 40 4.0 2.0 Secular decline in corporate bond yields Consolidation 0.0 00 Jul 77 Jul 81 Jul 85 Jul 89 Jul 93 Jul 97 Jul 01 Jul 05 Jul 09 Jul 13 Source: Barclays Live 31
Managing g Fixed Income Funds in a Low Rate Environment maintain or increase yield = add duration, add alternative asset classes, increase/decrease diversification / issuer concentration, decrease Portfolio quality increased risk short duration consistently lower portfolio yields; money market funds yielding 0 10 basis points 10 year U.S. Treasury yields are 130 basis points higher than they were at the lows established July,2012 Still a low rate environment 32
Strategy: Positioning for higher yields Why will rates rise?? Increased economic activity = good Portfolio positioning: contributions and portfolio cash flows participate in rising rate environment = ladder yield curve, amortizing i cash flows Disciplined and consistent processes - take advantage of short-term t disorderly d market responses within the framework of a long-term outlook e.g. following Bernanke s taper talk Diversify between and within asset classes 33
The Power of Diversification on Performance 40% 30% 20% 26.4% 23.5% 17.0% 19.8% 10% 0% 10% -6.4% 0.0% 20% 30% 40% 50% S&P 500 Barclay's Credit (Bonds) 50%S&P / 50% Credit -21.7% -23.4% -38.5% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: Barclays Live 34