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Q4Quarterly Economic Report 2015
2
Table of contents Thoughts from the desk 03
Overview 04
Domestic economy 06
U.S. Federal Reserve & monetary policy 12
Markets & performance 19
Global economy 27
Portfolio management strategy 32
SVB Asset Management | Quarterly Economic Report Q4 2015
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After a false start in September, the Federal Reserve finally provided a glimpse of monetary policy clarity at year-end as it deviated from other central banks and initiated its normalization process. Shaking off continued economic weakness in China, falling commodity prices and stubbornly low inflationary conditions, new Fed policies tilted towards improvements in economic fundamentals – specifically the diminishing of underutilization of labor resources. While further interest rate and quantitative easing policies will attempt to ignite the rest of the advanced economies, markets will focus on the Fed’s pace of future rate hikes which it signals as ‘gradual adjustments.’ We can only interpret that as non-mechanical and highly data dependent.
Benefiting from the Fed’s new policy were short term interest rates as they closed the year near its 52-week high. During the quarter, higher benchmark rates and widening of credit spreads led to drags in price performance of the fixed income sector but stellar returns of high quality credits from prior periods posted excess returns against treasuries with similar maturities. The high yield sector experienced a vastly different fate as it posted negative returns for the year. Other broader market indices squeezed out positive returns but commodities and energy investors were punished with double digit negative returns.
While the implementation of money market fund reform in October will likely have little significant impact to global capital markets it will nevertheless shape the future of short-end markets. After years of contentious battles between money managers and its regulators, approximately 60 percent of this $2.7T industry will convert from a stable net asset value methodology to a market pricing floating asset value, explicitly allowing fund managers to exercise redemption gates and imposed liquidity fees to mitigate fund outflows under a stressed environment. Corporate treasurers seeking daily liquidity with accounting ease will likely deemphasize the use of prime money market funds by shifting into exempt funds or direct investments.
There will be many factors for investors to consider during the year as the U.S. economy enters its ninth year of recovery while slack in the global economy continues to build. As markets shifts and drifts, we will continue to ferret investment opportunities for our clients to exceed their investment objectives.
Thoughts from the desk
SVB Asset Management | Quarterly Economic Report Q4 2015
4
Domestic economy U.S. Federal Reserve & monetary policy
Overview
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Q3 GDP expanded by a healthy 2 percent. The increase was driven by positive contributions from personal consumption, nonresidential fixed income investment, state and local government spending and residential fixed income spending. (p. 7)
ê Strong consumer spending, fueled by improved labor conditions, supported the case for normalization of monetary policy. (p. 8)
ê Personal consumption continues to benefit from an improved labor market, rising home prices and lower fuel costs. (p. 9)
ê The holiday season kicked off on a good start. Retail sales in November were the strongest in four months. (p. 8)
ê The low unemployment rate supported the rate hike in December, however the all-time low in the labor force participation rate will likely be one the reasons the Fed moves gradually with future rate increases. (p. 9)
ê The low level of Core PCE will be another reason the Fed takes a gradual approach to raising rates. (p. 11)
ê Wage growth is expected to pick up in 2016, translating into higher inflation. (p. 11)
ê Short-term interest rates trended upwards during the quarter as markets refocused their attention on a December rate hike. Despite continued weakness in China and commodities, solid U.S. economic data prevailed and the Fed increased the target range by 0.25 percent. Accompanying the move was dovish forward guidance indicating a gradual path to normalization. (p. 13)
ê In the latest FOMC statement, the Fed upgraded its overall assessment of the economy and said they will continue to take into account a wide range of information in future policy decisions, including readings on financial and international developments. Below-target inflation was highlighted with the Committee saying they will carefully monitor progress toward its goal. (p. 15)
ê To accomplish their goal of raising interest rates, the Fed released implementation notes that detail the multilayered approach to policy normalization. (p. 18)
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Overview
Markets & performance Global economy
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Economic growth largely prevails across most developed and emerging economies, though they are below targets and sub-optimal. (p. 28)
ê Major central banks are positioned to continue easing, even as the Federal Reserve increased interest rates to normalize policy. Extraordinary policies remain key tools for central banks. (p. 28)
ê China lowers its growth target to 6.5% from 7% for 2016, as the economy transitions slowly away from manufacturing-driven to a service-oriented economy. The tech sector remains firm in China. (p. 29)
ê Low interest rates have boosted home prices to historic levels across many developed economies, including Australia, Canada, and Sweden. (p. 30)
ê The pace of growth in emerging economies is at risk from commodity prices, political strife, and security challenges, but these economies are mostly projected to be positive for 2016. (p. 31)
ê Despite wider credit spreads at year-end, the fixed income sector posted positive returns in 2015 due to positive price performance earlier in the year. Higher quality credits materially outperformed their lower quality counterparts. (p. 20)
ê Bonds still play an important role as a diversifier and source of income as they continue to insulate investors from rising interest rates. (p. 21-22)
ê Credit fundamentals of U.S. corporations remain healthy, though profitability may have peaked. (p. 23)
ê Sector-specific divergence in corporate fundamentals is a persistent trend. (p. 24)
ê Credit conditions for the Financial sector are improving, as is the credit performance of the individual issuers. (p. 25-26)
Aria
l 201
5 4:
3
Domestic economy
-10.0%
-5.0%
0.0%
5.0%
10.0%
U.S. GDP Q-o-Q Trailing 4-quarter average
-3.0%
-1.0%
1.0%
3.0%
5.0%
Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP
GDP
GDP and components
7
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
GDP In good health
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Q3 GDP expanded by a healthy 2 percent. The increase was driven by positive contributions from personal consumption, nonresidential fixed income investment, state and local government spending and residential fixed income spending.
ê Corporate profits have been negative in the three of the last four readings. The strong dollar, slow growth and weak energy sector are behind recent contractions.
ê As predicted, inventory accumulation from the prior quarter was a drag in Q3.
ê Strong consumer spending, fueled by improved labor conditions, supported the case for normalization of monetary policy.
40.0 50.0 60.0 70.0 80.0 90.0
100.0 110.0 120.0
Consumer sentiment (UofM) Average
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
$500.0
Vehi
cle
sale
s (m
illio
ns)
Ret
ail &
food
ser
vice
s sa
les
(bill
ions
)
Ex Autos Vehicle sales
0.0%
50.0%
100.0%
150.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
Personal consumption (LHS)
Personal savings (LHS)
Household debt to disposable income ratio (RHS)
Consumption overview
Retail & food service sales Consumer sentiment – University of Michigan
8
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
Consumption Firm footing
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Personal consumption continues to benefit from an improved labor market, rising home prices and lower fuel costs.
ê The holiday season kicked off on a good start. Retail sales in November were the strongest in four months.
ê Households were optimistic about the economy and finances. The majority of consumers in the Michigan survey expect higher borrowing costs in 2016, however that should not spur borrowing-in-advance behavior.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Job hire rate Job quit rate
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)
Employment landscape Labor force participation rate
9
Hires and quits
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
Employment Steady state
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Average monthly job gains in 2015 were approximately 200k. ê Unemployment rate is at a healthy level of 5.0 percent, the lowest
level since 2008. ê The low unemployment rate supported the rate hike in December,
however the all-time low in the labor force participation rate will likely be one the reasons the Fed moves gradually with future rate increases.
ê The hire and quit rates continue to be steady.
62.0%
63.0%
64.0%
65.0%
66.0%
67.0%
68.0%
90
140
190
240
290
Case Schiller 20 city FHFA purchase Median home price
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
0.0
50.0
100.0
150.0
200.0
250.0
Affo
rdab
ility
inde
x
Housing affordability 30-year fixed mortgage rates
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Hom
e su
pply
(mon
ths)
Hom
e sa
les
(mill
ions
)
Total sales (new & existing) Existing home supply
Home sales & supply Home prices – indexed to 100
Housing affordability Household formation
10
Source: Bloomberg and SVB Asset Management.
U.S. Housing Stable
SVB Asset Management | Quarterly Economic Report Q4 2015
-3000
-2000
-1000
0
1000
2000
3000
4000
Thou
sand
s
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$0.0
$50.0
$100.0
$150.0
Pric
e pe
r bar
rel
Crude oil Daily national average of gasoline prices (RHS)
Core PCE – % change from prior year Crude oil and gasoline prices
11
Univ. of Michigan Survey of inflation expectations
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
Inflation Below target
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Core PCE continues to hold at 1.3 percent. ê Given the low level of Core PCE, the Fed can take a gradual
approach to raising rates. ê Wage growth is expected to pick up in 2016, translating into
higher inflation. ê Gas and oil prices fell significantly in 2015, contributing to the
lack of inflation.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Cha
nge
from
prio
r yea
r
1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5%
Core PCE Fed target Monetary policy threshold
1 year ahead 5-10 years ahead
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U.S. Federal Reserve & monetary policy
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Historical interest rates We have liftoff
SVB Asset Management | Quarterly Economic Report Q4 2015
Q1 2015 Q2 2015 Q3 2015 Q4 2015
The ECB announces a bond purchase program, and central banks across the globe announce further easing measures.
U.S. economic data reveals some softness as Q1 GDP contracts 0.2 percent.
Anxieties over Greece dissipate early in the quarter, but then concerns over China’s growth and currency devaluation take the spotlight.
The Fed’s tone shifts at the October FOMC meeting and markets refocus their attention on a December rate hike.
U.S. job growth continues to be robust, although a strengthening dollar weighs on growth expectations.
Headlines center on a potential “Grexit” with a standoff between Greece and its creditors.
The U.S. economic landscape continues to improve: Unemployment drops to 5.1 percent, Q2 GDP expands 3.9 percent and inflation holds at 1.3 percent.
Employment and inflation readings head in the right direction. October’s report was the strongest of the year and the unemployment rate fell to 5 percent. Core CPI reaches the important 2 percent level. Core PCE stands at 1.3 percent.
Market consensus is for a Fed funds rate liftoff in September of this year.
Fed hints at rate hike this year, but a gradual path to normalization.
The Fed delayed rate liftoff, citing “recent global economic and financial developments.”
Continued weakness in China and depressed oil prices make headlines throughout the quarter.
Source: Bloomberg and SVB Asset Management. Data as of December 31, 2015.
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
2-year Treasury yield 1-year Treasury yield
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Hun
dred
s
14 SVB Asset Management | Quarterly Economic Report Q4 2015
Federal Reserve rate projections Gradual path ahead
December 2015 Median 0.375% 1.375% 2.375% 3.250% 3.50%
September 2015 Median 0.375% 1.375% 2.625% 3.375% 3.50%
June 2015 Median 0.625% 1.625% 2.875% 3.75%
Source: Bloomberg and Federal Reserve. Data as of December 16, 2015. Percentages below the chart reference the median forecasted rate at the end of each period.
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Yellen’s dashboard Heading in the right direction
SVB Asset Management | Quarterly Economic Report Q4 2015
Source: Bloomberg and SVB Asset Management. Data as of December 31, 2015.
Pre-recession level (2004-2007 average)
Worst level since 2008 Current level
Layoffs/discharges rate 1.4% 2.0% 1.2%
Job openings rate 3.0% 1.6% 3.5%
Nonfarm payrolls (3-month average) 161.8K -826.0K 284K
Unemployment rate 5.0% 10.0% 5.0%
Hires rate 3.8% 2.8% 3.6%
Quits rate 2.1% 1.3% 2.0%
U-6 underemployment rate 8.8% 17.2% 9.9%
Long-term unemployed share 19.1% 45.3% 25.7%
Labor force participation rate 66.1% 62.4% 62.6%
Target Threshold Current level
Inflation (core PCE) 2.0% 2.5% 1.3%
The Federal Reserve has a dual mandate to promote “maximum employment” and to keep prices stable. Below are the factors the Fed is considering to determine the path of monetary policy normalization.
The dollar & oil
The labor market
16
Source: Bloomberg and SVB Asset Management. Data as of December 31, 2015.
SVB Asset Management | Quarterly Economic Report Q4 2015
Tracking key indicators Concerns remain Inflation
Wage growth
0.0
20.0
40.0
60.0
80.0
100.0
120.0
70.0 75.0 80.0 85.0 90.0 95.0
100.0 105.0
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
60.0% 61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0%
-1,000.0 -800.0 -600.0 -400.0 -200.0
0.0 200.0 400.0 600.0
Thou
sand
s
0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%
DXY index (LHS) Brent crude index (RHS) Fed target
Average hourly earnings YoY % change
Core PCE Yoy
Nonfarm payrolls(LHS) Labor force participation rate (RHS)
17
Central Bank economic projections Divergent policies
SVB Asset Management | Quarterly Economic Report Q4 2015
2015 2016 2017 2018 Longer run
Economic projections: United States
Change in real GDP 2.1% 2.4% 2.2% 2.0% 2.0%
Unemployment rate 5.0% 4.7% 4.7% 4.7% 4.9%
Core PCE inflation 1.3% 1.6% 1.9% 2.0%
Interest rate projections: United States
Federal funds target rate 0.4% 1.4% 2.4% 3.3% 3.5%
Economic projections: Eurozone
Change in real GDP 1.5% 1.7% 1.9%
CPI inflation 0.1% 1.0% 1.6%
Unemployment rate 11.0% 10.5% 10.1%
Economic projections: China
Change in real GDP 7.0%
CPI inflation 3.0%
Unemployment rate 4.5%
Economic projections: Japan
Change in real GDP 1.7% 1.5% 0.2%
CPI inflation 0.7% 1.9% 1.8%
Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japan. Data as of December 31, 2015. Forecasts are not available for all periods.
18
Monetary policy implementation Multilayered approach
SVB Asset Management | Quarterly Economic Report Q4 2015
• Interest on excess reserves (IOER): Interest rate raised to 0.50 percent • Overnight reverse repurchase facility (ON RRP): Interest rate raised
to 0.25 percent and removed overall program cap with a counterparty limit of $30 billion per day.
• Term deposit facility (TDF): No change • Securities holdings: Continue rolling over Treasuries at maturity and
reinvesting principal payments on agency debt and agency MBS.
Target range raised to 0.25-0.50 percent
• Open market operations: Undertake as necessary to maintain the target range. This includes approved overnight and term reverse repurchase operations.
• Reserve requirements: No change • Discount rate: Interest rate raised to 1.00 percent
Fed funds target range
Core policy tools
Supplemental tools
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Markets & performance
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Fixed income returns Overview
SVB Asset Management | Quarterly Economic Report Q4 2015
Spread is based on Option Adjusted Spread. Duration is based on Modified Duration. Data as of December 31, 2015. Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management.
Basic statistics Spread change Total return % Excess return %
Spread Yield Duration QTD YTD QTD YTD QTD YTD 1-3yr Treasuries 0.00 1.06 1.87 - - -0.44 0.54 - - 1-3yr Agencies 9.00 1.16 1.83 2.00 5.00 -0.37 0.69 0.03 0.08 0-3yr MBS 18.00 1.67 2.18 -30.00 -1.00 0.42 1.12 0.84 0.45 1-3yr ABS 84.00 1.72 1.30 12.00 31.00 -0.19 0.90 0.11 0.48 1-3yr IG corporates 108.00 2.17 1.90 -6.00 20.00 -0.13 1.01 0.35 0.38 3-5yr IG corporates 136.00 2.96 3.64 -4.00 25.00 -0.46 1.52 0.46 0.23 5-10yr IG corporates 185.00 3.96 6.29 -8.00 30.00 -0.44 0.78 0.86 -1.00 1-5yr High yield 850.00 10.08 2.83 59.00 272.00 -2.67 -5.23 -2.05 -6.12
1-3yr Corporates by rating AAA 22.00 1.36 2.11 -16.00 0.00 -0.10 1.03 0.39 0.33 AA 56.00 1.63 1.90 -8.00 14.00 -0.14 1.05 0.34 0.42 A 81.00 1.90 1.90 -12.00 17.00 -0.03 1.19 0.46 0.55 BBB 172.00 2.83 1.90 2.00 28.00 -0.26 0.74 0.21 0.11
1-3yr Corporates by sector Financial 96.00 2.03 1.86 -14.00 8.00 0.04 1.33 0.52 0.72 Industrials 116.00 2.25 1.92 -1.00 28.00 -0.23 0.83 0.25 0.18 Utility/energy 118.00 2.28 1.97 0.00 36.00 -0.41 0.25 0.09 -0.41
Total return comparisons Stability in bonds
21
All returns above are on Total Return basis. YTD 2015 returns are on an annualized basis up to December 31, 2015. FI Credit refers to Barclays 1-3 year US Investment Grade Fixed Income portfolio; Treasury refers to Barclays 1-3 year US Treasury portfolio; Gold refers to S&P GSCI Gold Spot; WTI refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index. Source: Thomson Reuters, Barclays Live and SVB Asset Management.
Ass
et c
lass
retu
rns
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
WTI 40.82%
REIT 34.18%
WTI 57.68%
US Treasury 6.67%
WTI 78.00%
Gold 29.67%
Gold 10.23%
REIT 16.47%
Wilshire 33.06%
REIT 28.24%
S&P 500 1.40%
Gold 18.36%
Gold 22.95%
Gold 31.35%
Gold 5.53%
Wilshire 28.29%
REIT 26.97%
WTI 8.15%
Wilshire 16.05%
S&P 500 32.39%
S&P 500 13.69%
REIT 1.30%
Wilshire 6.38%
S&P 500 15.79%
US Treasury 7.31%
FI Credit 0.30%
S&P 500 26.46%
Wilshire 17.18%
REIT 7.48%
S&P 500 16.00%
WTI 7.32%
Wilshire 12.70%
FI Credit 0.85%
S&P 500 4.91%
Wilshire 15.78%
FI Credit 5.96%
S&P 500 -37.00%
REIT 26.27%
WTI 15.10%
S&P 500 2.11%
Gold 6.96%
FI Credit 1.45%
FI Credit 1.12%
Wilshire 0.70%
FI Credit 1.89%
FI Credit 4.66%
Wilshire 5.61%
Wilshire -37.23%
Gold 23.96%
S&P 500 15.06%
FI Credit 1.75%
FI Credit 3.69%
REIT 1.26%
US Treasury 0.63%
US Treasury 0.56%
US Treasury 1.62%
US Treasury 3.93%
S&P 500 5.49%
REIT -39.05%
FI Credit 11.59%
FI Credit 4.15%
US Treasury 1.55%
US Treasury 0.43%
US Treasury 0.36%
Gold -1.51%
Gold -10.50%
WTI -0.34%
REIT -17.84%
WTI -53.52%
US Treasury 0.80%
US Treasury 2.40%
Wilshire 0.98%
WTI -7.08%
Gold -28.26%
WTI -45.76%
WTI -30.50%
SVB Asset Management | Quarterly Economic Report Q4 2015
Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management. Data as of December 31, 2015.
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Sector returns Primary source of returns
SVB Asset Management | Quarterly Economic Report Q4 2015
-‐2.23
-‐1.12
-‐1.50
-‐1.03
-‐1.55
-‐2.24
-‐1.33
-‐0.61
-‐3.41
-‐3.14
-‐2.05
-‐1.44
-‐0.99
-‐1.42
-‐2.72
-‐1.51
-‐3.51
-‐1.66
-‐1.77
-‐1.82
2.70
1.66
2.14
1.73
2.28
3.06
2.20
1.52
4.38
4.14
3.09
2.54
2.11
2.55
3.88
2.71
4.83
3.03
3.18
3.28
0.47
0.54
0.64
0.70
0.73
0.82
0.87
0.90
0.98
1.00
1.05
1.10
1.12
1.12
1.17
1.20
1.32
1.37
1.41
1.46
-‐4.00 -‐3.50 -‐3.00 -‐2.50 -‐2.00 -‐1.50 -‐1.00 -‐0.50 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50
Basic industry US Treasury US Agency
AutomoAve Technology Insurance
Energy ABS
CMBS UAlity
Capital goods Healthcare
MBS TelecommunicaAons
Media Consumer goods
Services Banking
Financial services Real estate
Total return % YTD Income return % YTD Price return % YTD
During the quarter, higher benchmark rates and widening of credit spreads led to drags in price performance of the fixed income sector but stellar returns of high quality credits from prior periods posted excess returns against treasuries with similar maturities.
U.S. U.S.
YTD 1-3 year sector returns %
23 SVB Asset Management | Quarterly Economic Report Q4 2015
S&P 500 Index fundamentals
Credit cycle: Corporate credit health remains resilient While operating margins may have peaked, it remains well elevated and leverage is still near historic lows.
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
Source: Standard & Poor’s and Bloomberg
Operating margin (RHS) Total debt to total asset (LHS)
S&P 500 sector-level fundamentals ê Energy continues to be the weakest, with the highest
leverage and negative margins. ê Information technology remains the strongest
with the lowest leverage and the highest margins of all sectors.
ê Financials are the most profitable, followed by Information technology and Utilities.
ê Trend of diverging fundamentals is expected to continue as credit cycle matures.
24 SVB Asset Management | Quarterly Economic Report Q4 2015
Credit focus: Corporate sectors divergent in fundamentals
Sources: Eurostat, Bloomberg and SVB Asset Management.
-5.00
0.00
5.00
10.00
15.00
20.00
25.00
Debt to EBITDA Operating margin
Moody’s ratings – SAM actively traded approved issuer list S&P ratings – SAM actively traded approved issuer list
25
Actively traded approved issuer list
Source: Bloomberg & SVB Asset Management. Note: Active issuers are currently traded issuers. Identical list of issuers have been used for both 2006/07 as in 2015.
Credit cycle Strengthening of the financial institutions sector
SVB Asset Management | Quarterly Economic Report Q4 2015
ê In SVB Asset Management’s view, it is comfortable recommending selected Financial Institution names due to improved credit fundamentals and relatively higher spreads.
ê Various downgrade activities in the sector have largely occurred due to the methodology changes as NRSROs reassess government support assumptions as a result of various new regulations and establishment of resolution regimes.
ê More stringent regulatory requirements on higher and better quality of capital, lower leverage, higher quality liquid assets and less participation in riskier lines of business are credit positive for the banks.
ê Due to capital adequacy requirements, banks are unlikely to distribute high dividends as they must build capital to provide improved stability in stress situations.
0
5
10
15
Baa3 Baa2 Baa1 A3 A2 A1 Aa3 Aa2 Aa1 Aaa
2006/07 2015
0 2 4 6 8
10 12
BBB- BBB BBB+ A- A A+ AA- AA AA+ AAA
2006/07 2015
Pre-recession level average
2004-2007
Worst level since 2008
Current level
2014/15*
Loan/deposits (%) 117.75 333.56 97.42
T1 RBC ratio (%) 9.33 7.35 12.86
Leverage ratio (%) 32.99 61.93 24.53
Total assets (USD million) $603,671 NM $869,387
Nonperforming loans (%) 0.99 9.09 1.03
A+/A/A- Issuers yield curve
Source: Bloomberg and SVB Asset Management.
AA+/AA/AA- Issuers yield curve
26
Credit cycle Banks vs industrials – December 31, 2015
SVB Asset Management | Quarterly Economic Report Q4 2015
ê These graphs represent the 3-year yield curve for the entire U.S. banks and U.S. industrials universe captured in Bloomberg.
ê U.S. bank issuers provide more value on a relative basis than U.S. Industrials. Issuer selection continues to be important to mitigate risk in the sector while still taking advantage of these relatively attractive yields.
ê Industrials are susceptible to economic and event risk and tend to perform relatively weaker than financial institutions in a rising rate environment.
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Global banks A+/A/A- U.S. industrials A+/A/A-
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Global banks AA+/AA/AA- U.S. industrials AA+/AA/AA-
Aria
l 201
5 4:
3
Global economy
United States United Kingdom Eurozone China Japan
Central Bank Federal Reserve Bank of England European Central Bank People's Bank of China Bank of Japan
Benchmark Rate 0.25-0.50% 0.5% 0.05% 4.35% 0.1%
Current Policy
Additional hikes to occur in 2016 if inflation nears 2% target with stable employment
Weak cost pressure, falling energy prices preventing a 25 bps rate hike
Cut deposit rate, extended QE, reiterated additional easing to reach 2% inflation
Interest rate and reserve ratio were cut 5 and 4 times, respectively, in 2015
Reinforced Quantitative & Qualitative program to hit 2% inflation target in 2017
Inflation
Unemployment 5.0% 5.2% 10.7% 4.0% 3.3%
Analysis
Expect 2 additional rate hikes during 2016, as Fed normalizes monetary policy
Rate hike delayed until mid-year by uncertain inflation path
Bias for further easing due to falling oil prices hindering inflation
Further rate cuts ahead to support 6.5% annual growth target
Further easing in 2016 if fiscal stimulus fails to generate faster inflation
1.5%
0.0% 0.5% 1.0% 1.5% 2.0%
Source: Federal Reserve, European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, Bloomberg and SVB Asset Management.
28 SVB Asset Management | Quarterly Economic Report Q4 2015
1.3%
0.0% 0.5% 1.0% 1.5% 2.0%
1.2%
0.0% 0.5% 1.0% 1.5% 2.0%
0.20%
0.0% 0.5% 1.0% 1.5% 2.0%
0.90%
0.0% 0.5% 1.0% 1.5% 2.0%
Rising Stable
Easing
Easing
Easing
Central banks Diverging views
$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0
2009 2010 2011 2012 2013 2014 2015*
Bill
ions
Annual foreign direct investment: information transmission, computer services, software
46
48
50
52
54
56
PMI i
ndex
, >50
= e
xpan
sion
Manufacturing Non-manufacturing
-10%
0%
10%
20%
30%
40%
50%
Cha
nge,
yea
r ove
r yea
r
Fixed asset investment: information transmission, computer services, software
Economic activity Tech still attracting outside investors
29
Tech spending remains strong
Source: National Bureau of Statistics of China, the People’s Bank of China, Bloomberg, SVB Asset Management. * Through November 2015
China The big bang theory
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Manufacturing has been weak, but services continue to grow at a steady pace, indicating a maturing and transitioning economy.
ê The technology sector continues to fuel the transition to a service-driven economy.
ê While slowing growth has sparked overall capital outflows, technology continues to attract foreign investment.
0.0
0.5
1.0
1.5
102
107
112
Per
cent
age
Inde
x, 2
007
= 10
0
Nonperforming loans (RHS) New housing price index (LHS)
Overnight rate (RHS)
-1.0
0.0
1.0
2.0
3.0
1.7
1.9
2.1
2.3
2.5
2.7
Per
cent
age
Aver
age
pric
e, m
illio
ns S
EK
Nonperforming loans (RHS) Sweden home sales price (LHS)
Overnight repo rate (RHS)
0.0
1.0
2.0
3.0
4.0
5.0
98
108
118
128
138
Per
cent
age
Inde
x, 2
011-
2012
= 1
00
Nonperforming loans (RHS) Established home price index
Overnight rate (RHS)
Australia Canada
30
Sweden
Source: Australian Bureau of Statistics, Statistics Canada, Statistics Sweden, the World Bank, Bloomberg, SVB Asset Management.
Developed economies Uncertainty continues
SVB Asset Management | Quarterly Economic Report Q4 2015
ê Low interest rates have pushed housing prices to historic highs across many developed economies.
ê Housing prices are vulnerable in commodity-sensitive economies, such as Australia and Canada, where foreign buyers have also contributed to rising prices.
ê Swedish housing prices have been supported by supply constraints. ê Overall nonperforming loans have been stable, as home prices remain
largely aloft, in part, due to low loan-to-values.
-6% -4% -2% 0% 2% 4% 6% 8%
10% 12%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Cha
nge,
yea
r ove
r yea
r
Brazil Argentina Chile Peru
0%
2%
4%
6%
8%
10%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Cha
nge,
yea
r ove
r yea
r
Nigeria South Africa Egypt Kenya
-8% -6% -4% -2% 0% 2% 4% 6% 8%
10% 12%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Cha
nge,
yea
r ove
r yea
r
Iran Israel Saudi Arabia UAE
South America Middle East
31
Africa
Source: International Monetary Fund, Bloomberg, SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q4 2015
ê The International Monetary Fund projects positive Gross Domestic Product expansion across many emerging economies.
ê Low commodity prices, political strife, and security challenges represent primary risks to the pace of growth.
ê Technology, consumer goods, infrastructure, and financial services are sectors positioned for increased investment.
ê Idiosyncratic events will keep the pace of near-term growth erratic in some emerging economies, though they remain the foundation for global growth over the long term.
Emerging economies Growing pains
Aria
l 201
5 4:
3
Portfolio management strategy
33
Portfolio strategy Macro overview
Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
SVB Asset Management | Quarterly Economic Report Q4 2015
Economy
Rates
Duration
Sector
Solid economic data
• Q3 GDP +2 percent. 2015 average at +2.2 percent
• Labor market averaged 200,000 new jobs per month
Short end rates higher
• 6-month T-bills rose from single-digit yields to over 0.50 percent before December FOMC meeting.
• 2-Year Treasury rose above 1 percent for the first time in 5 years.
Defensive on duration
• Short & intermediate benchmarks: Long duration vs. benchmark as coupon income should offset price volatility.
• Intermediate plus benchmarks: Stay neutral to benchmark.
• Long benchmarks: Shorter to manage price fluctuations
Overweight spread product
• Prefer finance sector in corporate bonds and credit card & auto asset-backed securities
• As rates rise spread product will help protect bond prices due to higher income accruals.
34
Portfolio strategy Relative value curve analysis
Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
SVB Asset Management | Quarterly Economic Report Q4 2015
Source: SVB Asset Management and Bloomberg. Data as of 12/31/2015.
Where is the current value? ê Although rates have been trending higher, we analyze where the current value is on the curve. ê In the 4th quarter we saw short-end rates rise ahead of the December FOMC meeting. ê 6- and 9-month part of the curve is relatively flat with 9-month yields only 3 basis points higher. ê We see similar flat yield pick up around the 2-year part of the Treasury curve. ê From a relative value standpoint, in the short end we prefer the 6-month part of the curve and prefer 18-months vs 2-years.
Bond
Yield
Yield pick up from shorter
tenure
3-‐month T-‐bill 0.16% -‐-‐-‐-‐
6-‐month T-‐bill 0.47% +0.31
9-‐month T-‐bill 0.51% +0.03
1-‐year Tsy 0.74% +0.24
1.5-‐year Tsy 0.94% +0.20
2-‐year Tsy 1.05% +0.11
2.5-‐year Tsy 1.18% +0.13
3-‐year Tsy 1.31% +0.13
Flat
Flat
Flat
35
Portfolio strategy Duration and sector overview
Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
SVB Asset Management | Quarterly Economic Report Q4 2015
Strategy
Duration Target
Short duration benchmark 3-month
Intermediate duration benchmark 6-month
Intermediate plus duration
benchmark 9-month
Long duration benchmark
1- and 2+ years
-30% Neutral +30%
-30% Neutral +30%
-30% Neutral +30%
Neutral -30% +30%
Sector
Overview
Governments
• Favor Treasuries over Agencies for liquidity
purposes and the reduced spread pick of Agencies over Treasuries.
• 12- to 18-month Treasuries offer better relative value yield pick up than extending further out the curve. 18- to 24-months is relatively flat vs. shorter end of yield curve.
Corporate bonds
• Bank and broker-dealer corporate bonds offer better liquidity and value as both regulation and performance have increased credit fundamentals.
• Industrials continue to have strong balance sheets and positive earnings. We favor consumer cyclical and non-cyclical on improving fundamentals in consumer spending.
Asset-backed
Securities • Strong consumer credit fundamentals and stable
spreads in auto and credit card receivables make this a sought-after sector.
Portfolio Management Team
Eric Souza esouza@svb.com Paula Solanes psolanes@svb.com Renuka Kumar, CFA rkumar@svb.com Jose Sevilla jsevilla@svb.com Hiroshi Ikemoto hikemoto@svb.com Jason Graveley jgraveley@svb.com
President, SVB Asset Management
Lauri Moss lmoss@svb.com
Head of Investment Strategy and Portfolio Management
Ninh Chung nchung@svb.com
Head of Credit Research
Melina Hadiwono, CFA mhadiwono@svb.com
Credit and Risk
Tim Lee, CFA tlee@svb.com Daeyoung Choi, CFA dchoi@svb.com Nilani Murthy nmurthy@svb.com
Silicon Valley Bank Partners
Teresa Quizon
SVB Asset Management | Quarterly Economic Report Q4 2015 36
Our team
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SVB Asset Management | Quarterly Economic Report Q4 2015