Monthly Market Update August 2016 Steven Alexander, CTP, CGFO, CPPT, Managing Director D. Scott Stitcher, CFA, Director Richard Pengelly, CFA, CTP, Director Khalid Yasin, CHP, Senior Managing Consultant Rebecca Geyer, CTP, Senior Analyst Sean Gannon, Analyst One Keystone Plaza, Suite 300 North Front & Market Streets Harrisburg, PA 17101-2044 (717) 232-2723 717-233-6073 fax 300 S. Orange Avenue, Ste. 1170 Orlando, FL 32801 (407) 648-2208 www.pfm.com
Current Market Themes The aftermath of Brexit is all but forgotten Equities rally worldwide, pushing S&P 500 to all-time highs Sovereign yield curves flatten further The Fed remains on hold while central banks worldwide ease The economy s lackluster rate of growth Labor market rebounds after a weak spring Inflation remains subdued The housing market s hot summer 2016 PFM Asset Management LLC 2
The Brexit Effect 4% Equity Markets 10-Year Government Bond Yields 0% -4% Country U.K. U.S. Germany France Switzerlan d Japan U.K. U.S. Germany France Switz. Japan -8% -12% -16% -20% MIB (Italy) IBEX 35 (Spain) FTSE 250 (U.K.) CAC 40 (France) DAX (Germany) Nikkei (Japan) 06/27/16 07/29/16 S&P 500 (U.S.) Yield (07/29/16) 0.69% 1.45% -0.12% 0.10% -0.56% -0.19% Change -0.69% -0.29% -0.21% -0.35% -0.19% -0.05% 8% 4% 0% -4% -8% -12% -16% -20% GBP vs USD Currencies and Commodities GBP vs EUR EUR vs USD JPY vs USD 06/27/16 07/29/16 U.S. Dollar Index Euro Index Source: Bloomberg, as of 07/29/16. Change is from 06/23/16. Oil Gold Credit Indicators June 23 June 27 July 29 Before Brexit After Brexit Month End CDX Investment Grade 76 bps 92 bps 72 bps CDX High Yield 422 bps 479 bps 395 bps Euro Investment Grade 75 bps 99 bps 68 bps Euro High Yield 320 bps 417 bps 317 bps U.S. CDS 25 bps 29 bps 23 bps German CDS 19 bps 24 bps 17 bps U.K. CDS 36 bps 47 bps 36 bps 2016 PFM Asset Management LLC 3
U.S. Stocks Soar to All-Time Highs 2,200 2,150 S&P 500 Brexit All-Time Record High Close: 7 of last 15 days in July 2,100 2,050 2,000 1,950 1,900 1,850 1,800 Dec '15 Jan '16 Feb '16 Mar '16 Apr '16 May '16 Jun '16 Jul '16 Source: Bloomberg, as of 07/29/16. 2016 PFM Asset Management LLC 4
Record Low Bond Yields Global yields have fallen over the last decade in the midst of aggressive monetary policy undertaken by major central banks. Global growth concerns led to an additional decrease in yields in the last 12 months. The Bank of Japan introduced negative interest rates for the first time in late January 2016 while the ECB expanded its stimulus program in March. The Brexit vote led to a steep decline in UK s sovereign bond yields in late June. Sovereign Bond Yields (10-Yr Maturities) 8% U.S. U.K. Italy Germany Japan 7% 6% 5% 4% 3% 2% 1% 0% -1% Jul '06 Jul '07 Jul '08 Jul '09 Jul '10 Jul '11 Jul '12 Jul '13 Jul '14 Jul '15 Jul '16 Source: Bloomberg, as of 07/29/2016. 2016 PFM Asset Management LLC 5
U.S. Treasury Curve Flattening Longer maturity treasury yields have fallen substantially this year over concerns about global growth and global demand given negative yields abroad. On the shorter end of the curve, rates rose modestly during July, paring June declines, as Brexit fears abated. 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% U.S. Treasury Yield Curve July 29, 2016 April 30, 2016 July 31, 2015 Yield Curve History 07/29/16 04/30/16 07/29/15 1-Mo. 0.18 0.16 0.03 3-Mo. 0.26 0.21 0.06 6-Mo. 0.37 0.38 0.15 1-Yr. 0.49 0.55 0.31 2-Yr. 0.66 0.78 0.66 3-Yr. 0.75 0.94 0.97 5-Yr. 1.03 1.30 1.53 7-Yr. 1.29 1.62 1.92 0.0% 361 my 2 y 3 y 5 y 7 y 10 y 15 y 20 y 30 y 10-Yr. 1.45 1.83 2.18 30-Yr. 2.18 2.68 2.91 Source: Bloomberg. 2016 PFM Asset Management LLC 6
U.S. Treasury Yield Changes 0.20% 0.00% -0.20% -0.40% -0.60% -0.80% -1.00% 0.20% 0.00% -0.20% -0.40% -0.60% -0.80% -1.00% -0.01% 1-Month Change in Yield As of July 29, 2016 0.06% 0.07% 0.05% 0.02% -0.02% -0.10% 3-m T-Bill 12-m T-Bill 2-Year 3-Year 5-Year 10-Year 30-Year 0.09% -0.11% YTD Change in Yield As of July 29, 2016-0.39% -0.56% -0.74% -0.82% -0.83% 3-m T-Bill 12-m T-Bill 2-Year 3-Year 5-Year 10-Year 30-Year Source: Bloomberg. 2016 PFM Asset Management LLC 7
Short Maturity Yield Environment Yields on commercial paper and negotiable bank CDs remain very attractive alternatives to Treasury Bills and short-term agencies. Spreads remain significantly wider beyond three months amid looming money market reform in October. CP/CD rates vary significantly by issuer, credit quality and structure. Yield 1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% Money Market Yield Curves July 29, 2016 CD/CP Range Federal Agencies U.S. Treasuries Very wide spreads 0.00% 1 2 3 4 5 6 7 8 9 10 11 12 Maturity in Months Source: Bloomberg, PFMAM. Information on CD/CP ranges are estimates based on independently compiled data. 2016 PFM Asset Management LLC 8
FOMC Statement Highlights July 27 June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months. Inflation continued to run below the Committee s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments. Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 0.25 0.50%. The stance of monetary policy remains accommodative In light of the current shortfall of inflation from 2%, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate. Source: Federal Reserve. 2016 PFM Asset Management LLC 9
FOMC Dot Plot 5% 4% Jun-16 Minutes Mar-16 Minutes Jun-16 Median Mar-16 Median Fed Fund Futures 3% 2% 1% Fed members lowered expectations in June 0% 2016 2017 2018 Longer Term Source: FOMC; Fed Funds Futures as of 07/29/2016. Individual dots represent each of the 17 FOMC members judgment of the midpoint of the appropriate target range for the federal funds rate. One participant did not submit longer-run projections in the June 2016 meeting. 2016 PFM Asset Management LLC 10
U.S. Economy on Moderate Growth Track U.S. GDP growth continued at a lackluster pace of 1.2% in the second quarter of 2016, according to the first estimate by the Bureau of Economic Analysis. The 1 st quarter s rate of expansion was revised down to 0.8% from its final estimate of 1.1%. Second quarter GDP reflected positive contributions from personal consumption, contributing the most to GDP since the 4 th quarter of 2014. Business investment detracted from GDP for the 3 rd quarter in a row, the most since the 2 nd quarter of 2009, amid a significant decline in inventories. Net exports and government consumption were also slight drag on growth. U.S. Real GDP 6% 5% 4% 3% 2% 1% 0% -1% 2.0% 0.9% 0.8% 1.2% -2% Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 QoQ % Change; Seasonally Adjusted Annualized Rate Bloomberg Survey of Economists 2012 2013 2014 2015 2016 2017 Source: Bureau of Economic Analysis; Bloomberg survey results as of 08/03/2016. 2016 PFM Asset Management LLC 11
Labor Costs Outpace Production Nonfarm Productivity 150 Unit Labor Costs Output per Hour 140 130 Annual Rate of Change: Unit Labor Costs 8.1% Output per Hour 2.1% 120 110 100 90 Jun '11 Sep '11 Dec '11 Mar '12 Jun '12 Sep '12 Dec '12 Mar '13 Jun '13 Sep '13 Dec '13 Mar '14 Jun '14 Sep '14 Dec '14 Mar '15 Jun '15 Sep '15 Dec '15 Mar '16 Jun '16 Source: Bureau of Labor Statistics, as of 07/29/2016. Both indices are normalized from 100, starting 06/30/2011. 2016 PFM Asset Management LLC 12
U.S. Labor Market Rebounds in June The U.S. Labor market added 255,000 jobs in July. Together with June s jobs, July marked the biggest 2-month increase since last year. The unemployment rate remained at 4.9%, as the additional jobs were met with an increase in the labor force participation rate. Average hourly earnings increased by 0.3% in July while rising 2.6% year-over-year. Monthly Change in Nonfarm Payrolls Unemployment Rate 350K Nonfarm Payrolls 12-Month Moving Average 10% 300K 9% 250K 8% 200K 7% 150K 6% 100K 50K 5% 0K 4% Jul '11 Jan '12 Jul '12 Jan '13 Jul '13 Jan '14 Jul '14 Jan '15 Jul '15 Jan '16 Jul '16 Jul '11 Jan '12 Jul '12 Jan '13 Jul '13 Jan '14 Jul '14 Jan '15 Jul '15 Jan '16 Jul '16 Source: Bureau of Labor Statistics, as of 08/05/2016. 2016 PFM Asset Management LLC 13
Economic Backdrop 61 59 57 55 53 51 49 47 ISM PMI ISM Non-Manufacturing ISM Manufacturing 45 Jul '11 Jul '12 Jul '13 Jul '14 Jul '15 Jul '16 Consumer Confidence 120 100 80 60 40 20 0 Jul '11 Jul '12 Jul '13 Jul '14 Jul '15 Jul '16 Millions (SAAR) Auto Sales 19 18 17 16 15 14 13 12 Jul '11 Jul '12 Jul '13 Jul '14 Jul '15 Jul '16 Millions (SAAR) Existing Home Sales 5.6 5.4 5.2 5.0 4.8 4.6 4.4 4.2 4.0 Jun '11 Jun '12 Jun '13 Jun '14 Jun '15 Jun '16 Source: Bloomberg. As of 07/29/2016. SAAR is the seasonally adjusted annualized rate. 2016 PFM Asset Management LLC 14
Yield Environment As of July 29, 2016 Maturity Treasury Federal Agency AA Corporate A Corporate AAA Taxable Municipal 3-Month 0.26% 0.33% 0.60% 0.74% - 6-Month 0.37% 0.45% 0.71% 1.03% - 1-Year 0.49% 0.54% 0.81% 0.94% 0.61% 2-Year 0.66% 0.78% 1.00% 1.17% 0.85% 3-Year 0.75% 0.88% 1.19% 1.38% 1.06% 5-Year 1.03% 1.19% 1.58% 1.74% 1.41% 10-Year 1.45% 1.75% 2.36% 2.52% 2.17% Source: Bloomberg BVAL yield curves for Treasury, Corporate and Municipal yields, TradeWeb for Federal Agency yields. 3 and 6 month corporate yields from commercial paper; A-1+ for AA and A-1 for A. 2016 PFM Asset Management LLC 15
Fixed-Income Index Returns July 31, 2016 1-3 Year Indices Effective Duration Periods Ended 07/31/2016 Yield YTD 1 Month 3 Month 1 Year 3 Years 5 Years U.S. Treasury 1.88 0.67% 1.38% (0.06%) 0.43% 1.20% 0.91% 0.75% Agency 1.59 0.80% 1.25% (0.03%) 0.36% 1.17% 0.98% 0.86% Corp A-AAA 1.91 1.33% 2.09% 0.16% 0.70% 2.30% 1.71% 1.86% MBS (0 to 3 Years) 2.07 1.28% 1.28% 0.13% 0.66% 2.55% 1.75% 1.46% Municipals 1.86 0.66% 1.18% 0.20% 0.49% 1.44% 1.08% 1.06% 1-5 Year Indices U.S. Treasury 2.72 0.78% 2.35% (0.04%) 0.77% 2.19% 1.56% 1.26% Agency 2.07 0.87% 1.83% (0.02%) 0.55% 1.77% 1.49% 1.25% Corp A-AAA 2.75 1.53% 3.19% 0.32% 1.11% 3.43% 2.63% 2.59% MBS (0 to 5 Years) 3.20 1.75% 2.68% 0.17% 1.00% 3.22% 2.96% 2.42% Municipals 2.48 0.79% 1.65% 0.25% 0.65% 2.15% 1.68% 1.59% Master Indices (Maturities 1 Year and Greater) U.S. Treasury 6.67 1.15% 6.11% 0.42% 2.80% 6.13% 4.04% 3.37% Agency 3.84 1.16% 3.79% 0.26% 1.58% 3.75% 2.93% 2.37% Corp A-AAA 7.19 2.35% 7.97% 1.22% 3.19% 8.41% 5.55% 4.97% MBS (0 to 30 Years) 3.35 1.84% 3.32% 0.22% 1.17% 3.94% 3.82% 2.84% Municipals 6.76 1.68% 4.35% (0.05%) 1.89% 7.10% 6.21% 5.33% Source: BofA Merrill Lynch Indices. Returns greater than on year are annualized. 2016 PFM Asset Management LLC 16
Sector Preferences August 2016 Sector MMF/LGIP Commercial Paper/CDs Treasury: T-Bill T-Note Agency: <= 3 years > 3 Years Corporates: Financials Industrials Municipal Bonds Asset-Backed Mortgage Backed PFMAM Investment Preference Sector Considerations CP/CDs CP/CD rates beyond 3 months continue to slowly march higher as upcoming money market reform has diminished demand for maturities beyond the October 14th implementation date of reform. This dynamic has resulted in very attractive yields for investors without near-term liquidity needs. Treasuries New issuance shrinking as federal deficit improves; 1-5 year maturities offer value near the upper end of recent trading ranges, but the yield curve continues to flatten, reducing value in longer maturities. Federal Agencies Spreads have narrowed modestly over the month, but remain close to their YTD wides in the front end. Along the curve, we find the front end, primarily 2 and 3 year maturity securities offer the most value, as continued supply has kept spreads elevated. The spread curve remains relatively flat out in longer maturity securities. Corporates Accommodative central bank policies continue to support corporate spreads. We favor banks as spreads are attractive and fundamentally sound. Industrial spreads defy aggressive balance sheet action and M&A risk. Issuer selection is critical. Municipals Taxables offer value compared to other spread products but remain deal specific with limited availability of inventory. ABS Economic outlook supports incremental value in AAA prime fixed-rate auto loan, equipment and credit card tranches. Collateral performance remains relatively strong and within rating agency expectations. Swap spread widening has increased relative value in the two to three year part of the curve. The new issue market offers the most attractive avenue to add. MBS Given the recent tightening on both an OAS and nominal basis, the sector is now trading at fair valuation levels. Over the near-term, performance should remain highly market directional outperforms with a Treasury market selloff, underperforms with a rally. Source: PFMAM., as of 07/29/2016. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. Analysis is subject to changes in the market environment, and may vary based on the client s particular circumstances. 2016 PFM Asset Management LLC 17
Disclosures This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities. 2016 PFM Asset Management LLC 18