SVB Asset Management Economic Book Q4 2013

Quarterly Economic Report 2013SVB Asset Management

Q4

http://www.svb.com/assetmanagement/

Table of Contents

Thoughts from our CIO 03

Overview 04

Domestic Economy 06

Federal Reserve 16

Markets & Performance 21

Global Economy 31

Regulation 37

2 SVB Asset Management | Quarterly Economic Report Q4 2013

Thoughts from our CIO 03

Overview 04

Domestic Economy 06

Federal Reserve 16

Markets & Performance 21

Global Economy 31

Regulatory 37

In some future year when we look back on 2013, we'll realize it was the year the economy fully turned toward a growth trajectory. We can debate the causes, but there's no doubting the year brought consistency and breadth across the spectrum. Jobs, housing and consumption grew during the year and don't seem to be turning back.

Of course, many challenges remain including the threat of higher interest rates, division in Washington and a lagging global economy. But the Fed and many private sector economists agree that better days lie ahead. As a result, the Fed has already begun to rein in stimulus by announcing a pull-back on monthly bond purchases that were designed to decrease long- term interest rates. Home builders are ramping up activity in the face of what is likely to be a year of rising interest rates. This is evidence they see solid demand in the new year despite higher costs for borrowers. And consumers drove activity through the third and fourth quarters, ignoring the government "shut-down" and its ancillary effects.

Looking forward, the Fed will wind down "quantitative easing" in 2014, but will keep its target rate unchanged as inflation remains well below its target of two percent. A "thaw" in Washington will develop as Republicans will be much more agreeable on the debt ceiling and an Affordable Care Act overhang will keep Democrats from pushing a non-centrist agenda as well.

Higher interest rates may temper growth in the housing sector, although a slowly improving jobs market and a rebound in new household formation will help potential homebuyers keep pace.

Risk markets — both equities and high yield — look fully valued today. Price gains will be tempered by the true economic performance of the underlying issuers which have lagged in recent years. Previously, market price gains were driven by expectations of future corporate income and stability. In 2014, companies will have to show real economic improvement in order to drive outsized market performance. This means the "bubble" question will remain front and center for much of the year, but prices will remain stable with markets eking positive returns within the range of long-term expectations.

No doubt, media and Gen-Xers will continue to be disappointed in the economy as we point to the boom years as our reference point. But continuing steady, positive growth is nothing to look down upon, and 2014 will fit the bill quite nicely.

Joe Morgan, Chief Investment Officer

3

Thoughts from our CIO

Rounding the Corner

SVB Asset Management | Quarterly Economic Report Q4 2013

4

�  Economic growth is on firmer footing as evidenced by stronger gross domestic product numbers. (pg. 7)

� The consumer continues to benefit from rising home values, equity prices and an improved labor market. (pg. 8)

� The rise in household net worth has boosted spending and overall sentiment. (pg. 9)

� Employment has been improving, although at a slow pace. The unemployment rate dropped significantly in 2013; however, the reduction was due to multiple factors beyond simply additional jobs. (pg. 10)

� Inflation continues to run well below the Fed’s target measure of two percent. We believe the Fed will continue its accommodative monetary policy for a significant period. (pg. 14)

Domestic Economy �  The Fed announced at the December FOMC meeting they will

begin tapering of Treasury and MBS purchases to $75 billion from $85 billion. Notably, the Fed is not slamming the breaks, but slowly removing its foot from the gas pedal. (pg.19)

� Enhanced forward guidance was also announced saying the fed funds rate could remain unchanged “well past the time that the unemployment rate declines below 6.5 percent.” (pg. 20)

� A majority of Fed members do not see the fed funds rate being raised until 2015 and three members do not see it rising until 2016. (pg. 17)

� President Barack Obama officially nominated Janet Yellen to become the next chair of the Federal Reserve. (pg. 17)

Special Topic: The Fed

Overview


Overview

5

�  The ‘Great Rotation’ did not materialize in 2013, but the risk of money flowing out of bonds and into equities could present itself in 2014. (pg. 22)

�  Credit spreads have been tight and should continue to tighten with expectations of a U.S. economic recovery. (pg. 23)

�  The Fed’s indecision on tapering in 2013 was the main driver of bond under/over performance. (pg. 24-26)

�  As rates begin to rise post-taper announcement, some companies will increase leverage to take advantage of cheaper financing. (pg. 24)

�  Commodities are seeing a pop after the announcement of reduced government purchases with expectation of a decline, once again, as the dollar strengthens. (pg. 27)

Markets/Performance Global Economy �  Debt ceiling debate continues and is

expected to heat up in late 1Q2014. More rhetoric is expected, but debt ceiling will continue to be raised. (pg. 38)

� Volcker Rule released in Dec 2013 but with many uncertainties and challenges. (pg. 39)

� Banks are trying to get ahead of regulations and are well prepared to meet the new requirements once they are implemented. There will be plenty of time to adjust to the new changes. (pg. 39)

� We expect further developments on the MMF reform in late Q1 2014. (pg. 40)

Regulatory �  Europe: Sustaining low growth levels;

current account surplus keeping Euro firm. (pg. 32-33)

� China: Yuan strengthened by exports, foreign direct investment; waft higher on strong current account. (pg. 34)

� Japan: BOJ stokes inflation and growth with QQE policy in short term; Yen lower on improving U.S. (pg. 35)

� U.S.: Dollar stabilizes amid tame inflation, macroeconomic strength, trimmed QE program. (pg.36)


Domestic Economy Domestic EconomySVB Asset Management


-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

GDP Improvements On The Horizon GDP

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 annualized.

GDP and Components GDP Y-o-Y Growth 4Q Average – Long View

�  The final Q3 GDP was revised higher to an annualized 4.1 percent from 3.6 percent.

�  The upward revision was due to an increase in the estimated growth in services such as healthcare and companies investing in software.

�  Inventories contributed to a third of gains in Q3 GDP as corporate outlook for consumer demand brightened.

�  Stronger growth in the second to last quarter of the year support the Federal Reserve’s outlook that the U.S. economy is on a sustainable path.

�  The fiscal drag in 2013 should dissipate in 2014.


-10.0%

-5.0%

0.0%

5.0%

10.0%

U.S. GDP Q-o-Q Trailing 4-Quarter Average

-1.0%

1.0%

3.0%

5.0%

Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP

Consumption Promising Signs Consumer Sentiment – University of Michigan

Source: U.S. Bureau of Economic Analysis (BEA), Census.gov, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management.

Retail & Food Services Sales Personal Consumption – % Change

�  The consumer has benefited from improvements in the labor market, housing market and stock market.

�  Consumer sentiment hit a five- month high in December as it climbed to 82.5 ̶ a signal that Americans are likely to continue to spend in 2014.

�  Consumer purchases came in relatively strong, growing two percent in the third quarter. Consumers increased spending on services such as healthcare and recreation.


-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%

$5.0

$10.0

$15.0

$20.0

$25.0

$250.0

$300.0

$350.0

$400.0

$450.0

Vehi

cle

Sal

es (M

illio

ns)

Ret

ail &

Foo

d S

ervi

ces

Sal

es (B

illio

ns)

Ex Autos Vehicle Sales

40.0

60.0

80.0

100.0

120.0

Average

Consumption Promising Signs Personal Income

Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management.

Personal Savings as a % of Disposable Income

Household Net Worth �  Personal incomes dipped into negative territory at the start of

the fourth quarter due to a drop in farm revenue. This should be a temporary effect.

�  Savings rates as a percentage of disposable income have been hovering around 4.8 percent most of the year. Many Americans are still working to rebuild their balance sheets.

�  Household net worth continues to be on the rise due to higher home values and rising equity prices. The net worth of U.S. households and non-profit groups increased to $77.3 trillion, up over seven percent on a year-over-year basis.


-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

Mon

thly

Per

cent

age

Cha

nge

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

$0.0

$20.0

$40.0

$60.0

$80.0

Bill

ions

Employment Superficially Better Employment Landscape

Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months.

Full-Time Employment

Long-Term Unemployment �  The unemployment rate (U-3) has dropped to seven percent. In 2013

the unemployment rate decreased by almost one percent.

�  The underemployed rate (U-6) has also dropped, however, it remains relatively high compared to pre-recession figures.

�  The economy has been adding jobs at a decent pace, but the quality of jobs added has been weak with more part-time than full-time jobs being added.

�  The number of long-term unemployed has come down since the peak, but remains elevated.


-15.0%

5.0%

25.0%

-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)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Recession Period Unemployed 27 Weeks and Over

0.0

5,000.0

10,000.0

100,000.0

105,000.0

110,000.0

115,000.0

120,000.0

125,000.0

Thou

sand

s

Thou

sand

s

Full Time Employment (LHS) Part Time for Economic Reasons (RHS)

Employment Superficially Better Fewer Workers Supporting Greater Population

Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management.

Participation Rate At Low

Hires and Quits Remain Depressed �  Post financial crisis the U.S. economy continues to operate

with fewer workers despite a growing population.

�  The laborforce participation rate has been dropping for the last 13 years and is currently at a 35-year low.

�  Average hourly earnings have been relatively flat the last year.

�  Turnover, as measured by job hires and quits, is slowly trending upwards.


57.0%

59.0%

61.0%

63.0%

65.0%

3.0%

8.0%

Unemployment Rate (LHS) Employment to Population Rate (RHS)

1.0%

2.0%

3.0%

4.0%

5.0%

Job Hire Rate Job Quit Rate

1.0%

2.0%

3.0%

4.0%

5.0%

60.0%

62.0%

64.0%

66.0%

68.0%

Labour Force Participation Rate (LHS)

Avg Hourly Earnings Growth (RHS)

U.S. Housing Market Potential Slowdown Ahead Home Sales & Supply

Source: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.

Housing Starts Home Prices – Indexed to 100

�  Homes (single) sales have benefitted from last year’s pent-up demand and limited inventory.

�  Starts are most important when forecasting the industry’s effect on the overall economy. Unfortunately, housing starts remain at depressed levels.

�  Home prices reflect the same trend with double-digit, one-year increases, but levels remain below their prior peak.

�  Declining home affordability could hamper growth in 2014.


0.0

70.0

140.0

210.0

280.0

350.0

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

Pop

ulat

ion

(Mill

ions

)

Hou

sing

Sta

rts

(Tho

usan

ds)

Housing Starts U.S. Population

0.0

5.0

10.0

15.0

3.0

5.0

7.0

9.0

Hom

e S

uppl

y (m

onth

s)

Hom

e S

ales

(Mill

ions

)

Total Sales (new & existing) Existing Home Supply

90.0

140.0

190.0

240.0

Case Schiller 20 City FHFA Purchase Median Home Price

U.S. Housing Market Potential Slowdown Ahead Homeownership Rate

Source: Census.gov, National Association of Realtors and SVB Asset Management.

Housing Affordability Composite Index

Home Foreclosures - % of Total Loans �  The drop in homeownership during the current downturn is a

positive when considering what the future may bring.

�  Home affordability continues to be high, but a turn in interest rates ̶ and mortgage rates – have impacted this figure.

�  Foreclosures continue to drop and are approaching pre-recession levels.


0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

62.0%

64.0%

66.0%

68.0%

70.0%

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

CPI Components 12-month ChangeFood & Bev. 1.3%Housing 2.1%Apparel less Footw ea -0.4%Transportation -2.4%Medical Care 2.3%Recreation 0.4%Educ. & Comm. 1.6%Other 1.6%Headline CPI 1.0%Less:

Energy -4.8%Food 1.3%

Core CPI 1.7%

Inflation Nowhere In Sight Component Distribution

Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management.

Core PCE

Consumer Price Index Producer Price Index


41.1%

17.0%

15.1%

7.2%

6.7%

5.9%

3.6% 3.4%

Housing

Transportation

Food & Bev.

Medical Care

Educ. & Comm.

Recreation

Apparel less footwear

Other

-5.0%

0.0%

5.0%

10.0%

15.0%

% c

hang

e fro

m p

rior y

ear

CPI Ex Food & Energy CPI

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

% c

hang

e fro

m p

rior y

ear

Core PCE Fed Target Monetary Policy Threshold

-10.0%

-5.0%

0.0%

5.0%

10.0%

% c

hang

e fro

m p

rior y

ear

PPI Ex Food & Energy PPI

Inflation Nowhere In Sight Wage Growth – Average Hourly Earnings

Source: U.S. Bureau of Labor Statistics (BLS), U.S. Energy Information Administration (EIA), University of Michigan / Thomson Reuters - Survey of Consumers and SVB Asset Management.

Crude Oil – Spot & Futures

Univ. of Michigan Survey of Inflation Expectations �  Inflationary measures have come down recently, with core

PCE well below the Fed’s target of two percent.

�  The Fed has acknowledged that inflation has been running below its long-term objective and this could create issues for economic performance.

�  The Fed plans to monitor inflation developments carefully in search of evidence that inflation will move towards its target.


1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Ann

ual p

erce

ntag

e ch

ange

1.5%

2.5%

3.5%

4.5%

5.5%

1 Year Ahead 5-10 Year Ahead

$0.0

$50.0

$100.0

$150.0

Pric

e pe

r bar

rel

Crude Oil Crude Oil Futures

Special Topic: The Federal Reserve SVB Asset Management

Special Topic: The Federal Reserve


Federal Reserve A New Fed Regime


In the fourth quarter, President Obama officially nominated Janet Yellen to become the next chairman of the Federal Reserve. Ben Bernanke’s eight year tenure as FOMC Chairman will end on January 31.

Ms. Yellen is currently the longest serving Fed official having started out in 1977 as an economist, then served as a Fed governor from 1994-1997. Followed by a position as president of the Federal Reserve Bank of San Francisco from 2004-2010 and then becoming the Federal Reserve’s Vice Chair in 2010.

With 18 Fed policymakers, each with divergent viewpoints, arriving to a policy consensus could be difficult.

To the right is a breakdown of the current assembly and how that may change. The bottom line is that it looks like the regime may be less dovish next year.

Current Camp Voting (2013) Voting (2014) Permanent Board Members

Ben Bernanke (Chair) Dove Yes No – term ends at the end of January

Janet Yellen (Vice Chair) Dove Yes New Fed Chair

Daniel Tarullo Dove Yes Yes

Sarah Bloom Rakin Dove Yes No – leaving the board of governors

Jeremy Stein Dove Yes Yes

Jerome Powell Dove Yes No – term ends at the end of January

William Dudley Dove Yes Yes

Bank Presidents

Eric Rosengren Dove Yes No

Charles Evans Dove Yes No

James Bullard Dove Yes No

Esther George Hawk Yes No

Sandra Pianalto Dove No No – announced retirement

Dennis Lockhart Dove No No

Narayana Kocherlakota Dove No Yes

John Williams Dove No No

Charles Plosser Hawk No Yes

Jeffrey Lacker Hawk No No

Richard Fisher Hawk No Yes

Federal Reserve Is Q.E. Working? Are Record Low Mortgage Rates Helping?

Source: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.

Will the Wealth Effect be Sustainable? Low Participation Rate Impacts the Unemployment Rate

�  The stock market has been the biggest benefactor of quantitative easing with the S&P 500 and Dow Jones Industrial average closing at all-time highs and NASDAQ reaching levels not seen in 13 years.

�  Mortgage rates are still at very low levels even though they have increased from the beginning of the year.

�  Although U.S. homeownership fell this year to the lowest levels since 1995, the Census Bureau recently released data showing homeownership increased in Q3.

�  The unemployment rate has been dropping, but largely due to a drop in the participation rate. There is also concern that the quality of the jobs added is weakening with an increase in job growth coming from low-paying sectors and many of the jobs being part-time positions.


0.0% 1.5% 3.0% 4.5% 6.0%

$9.0 $9.5

$10.0 $10.5 $11.0 $11.5

Bill

ions

Mortgage Outstanding (LHS) 10 YR Treasury (RHS) U.S. Home Mortgage 30 Year Fixed National Average (RHS)

600

1,100

1,600

2,100

$150.0

$170.0

$190.0

$210.0

$230.0

$250.0

Home Prices (LHS) S&P 500 (RHS)

0.0%

2.5%

5.0%

7.5%

10.0%

12.5%

62.0%

63.5%

65.0%

66.5%

68.0%

Labour Force Participation Rate (LHS) Unemployment Rate (RHS)

Thou

sand

s

Federal Reserve Taper Finally Announced Markets continued to be fascinated with quantitative easing in Q4. Although a tapering announcement in September did not occur, the September FOMC meeting notes revealed members viewed a tapering as a “close call.”

With the improved economic data in Q4 (lower unemployment rate, stronger GDP, improved retail sales) a taper was highly anticipated to be announced at either the December or January FOMC meeting.

At the December FOMC meeting, the Federal Reserve announced it will begin tapering the monthly purchases of Treasuries and Mortgage-Backed Securities (MBS) beginning in January 2014.

The Fed plans to scale back purchases of both asset classes by $5 billion bringing the total monthly purchases down to $75 billion from $85 billion ($40 billion Treasuries / $35 billion MBS).

Source: Federal Reserve and SVB Asset Management.

Recent Balance Sheet Trends


$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

Trill

ions

Other Fed Reserve Assets Central Liquidity Swaps Other Aurora Maiden Lane III Maiden Lane II Maiden Lane I TALF AIG Seasonal Credit Secondary Credit Primary Credit Other Loans Treasury Currency Outstanding Special Drawing Gold Stock MBS Federal Agency Debt Securities U.S. Treasury Securities

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

0.0%

1.0%

2.0%

3.0%

Core PCE (LHS) Core PCE Thresholds (LHS)

U.S. Unemployment Rate (RHS) U.S. Unemployment Thresholds (RHS)

Federal Reserve Enhanced Guidance The FOMC has a dual mandate of max employment and price stability. The two key data points they focus on for these mandates are the unemployment rate and inflation. In 2012 the Fed announced for the first time in history explicit thresholds for unemployment and inflation in setting monetary policy.

At the December FOMC meeting they added some “enhanced forward guidance” to these thresholds. The Fed said the fed funds rate could remain unchanged “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee’s two percent longer-run goal.”

The future of tapering will be data dependent. If the economy continues to improve, the FOMC is projected to taper monthly purchases at a measured reduction and future reductions are not on a preset course.

Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management.

Fed Inflation, Employment Thresholds Worry Two of the Fed Presidents


U.S. Unemployment Target 6.5%

Core PCE Threshold 2.5%

Markets & Performance SVB Asset Management

Markets & Performance


Funds Flow Filling Up The Tank

Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management.

Equity Flows & Stock Performance

Net New Fund Flows Money Market Fund Flows

�  The trend of outflow from bond funds persisted through Q3 but began to reverse in Q4.

�  Flows into equity funds were strong despite a downturn in performance driven by mixed signals from the Fed and lackluster top line revenue growth.

�  With the recent announcement to reduce government bond purchases expect net new flows into equity funds to decline.

�  Money market funds dipped in assets during the regulatory comment period and are bouncing back as investors await further developments.


-$80.0

-$40.0

$0.0

$40.0

Bill

ions

Total Equity Total Bond

-20.0%

-10.0%

0.0%

10.0%

20.0%

-$40.0

-$20.0

$0.0

$20.0

$40.0

Mill

ions

Net New Cash Flow (LHS) Total Return on Equities (RHS)

$2.4

$2.5

$2.5

$2.6

$2.6

$2.7

Trill

ions

MMF AUM

-200

300

800

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0

50

100

150

200

250

Spre

ad (b

ps)

Inv. Grade Corporates U.S. Agency MBS ABS

Bond Sector Spreads Close to the Floor

SVB Asset Management | Quarterly Economic Report Q4 2013 23

Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management.

Spread Performance by Asset Class

Short-term risk-free rates sold off approximately 15bps in 2013 but experienced 30bps in higher rates for a six week duration. The negative price movement reversed until the FOMC tapering announcement in December. Investment grade bonds generated ~200bps in excess returns, mainly as a result of credit tightening of financial issuers. In the securitization market, investors could not get enough of consumer backed bonds. Performance of ABS was as steady as they come in terms of both price and income.


Source: Bloomberg, BoAML , and SVB Asset Management.

BofAML 1-3 year Government/Credit IndexYear 1994 1999 2004 2009 2010 2011 2012 2013Price -5.486 -2.796 -2.662 0.329 0.077 -0.849 -0.739 -1.066Income 6.086 6.048 3.873 3.506 2.741 2.411 2.217 1.888Total 0.6 3.252 1.211 3.835 2.818 1.562 1.478 0.822

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Fed Funds Target Rate 2 Year Treasury Yield 3 Year Treasury Yield

Yields No Carry Without Income

Bond Market It’s All About Income Despite higher rates and fear of Fed tapering, fixed income investors were rewarded for stepping further onto the risk curve in 2013.

Negative price returns as a result of higher rates were more than offset by positive income returns from coupons with MBS being the exception.

Regulatory challenges and negative headlines resulted in largest credit spreads in the banking and financial sectors. Bank fundamentals in turn made substantial and continued improvements especially high investment grade issuers.

Credit spreads were essentially non-existent for industrial issuers as this sector reached all-time lows in credit spreads.

Source: Bloomberg, BoAML and SVB Asset Management.


-3.15

-1.06

-1.21

-1.19

-3.61

-2.19

-2.76

-1.86

-1.92

-2.80

-1.25

-1.48

-2.27

-1.91

-2.53

-1.83

-1.12

-1.49

-1.30

1.877

1.449

1.738

1.856

4.296

3.164

3.736

2.937

3.037

3.998

2.798

3.041

3.849

3.621

4.313

3.746

3.04

3.542

3.486

-1.271

0.388

0.529

0.668

0.682

0.97

0.972

1.08

1.116

1.203

1.546

1.562

1.582

1.714

1.788

1.915

1.919

2.057

2.182

-5.0 -3.0 -1.0 1.0 3.0 5.0

MBS

US Treasury

US Agency

ABS

CMBS

Consumer Cyclical

Basic Industry

Consumer Non-Cyclical

Healthcare

Media

Technology & Electronics

Capital Goods

Energy

Telecommunications

Services

Insurance

Automotive

Financial Services

Banking

YTD Sector Returns %

Total Return % YTD Income Return % YTD Price Return % YTD

Benchmark Performance

Investment Performance Where’s the Horsepower?

Ticker 2013 2012 2011 2010 2009 2008 2007 Short Benchmarks 3-Month Treasury Bill G0O1 0.073 0.111 0.103 0.126 0.207 2.057 5.004 3-Month Citi/Salomon CD SBMMCD3 0.204 0.307 0.289 0.310 0.822 3.442 5.448 6-Month Treasury Bill G0O2 0.180 0.171 0.268 0.365 0.579 3.582 5.607 6-Month Cit/Salomon CD SBMMCD6 0.272 0.488 0.389 0.437 1.611 3.756 5.459 1-yr Treasury Bill G0O3 0.277 0.204 0.496 0.792 0.813 4.746 5.948 Treasury 1-3 yr Treasury G1O2 0.358 0.434 1.554 2.348 0.785 6.609 7.317 3-5 yr Treasury G2O2 -0.913 1.577 6.229 5.695 -0.672 12.153 9.836 Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt B1A0 0.705 1.478 1.562 2.818 3.835 4.693 6.872 3-5 yr Corp/Govt B2A0 -0.158 3.817 5.415 6.231 6.400 4.577 7.846 Agencies 1-3 yr Agencies G1P0 .0.424 0.847 1.536 2.338 2.189 7.034 6.735 3-5 yr Agencies G2P0 -0.531 2.588 5.290 4.900 3.223 8.971 8.261 Municipals - Tax Exempt 1-3 yr Pre-refunded U1AF 0.807 0.520 1.800 0.923 3.189 5.875 4.710 3-7 yr Pre-refunded U2AF 0.952 1.539 4.951 2.087 5.345 7.992 5.390 Auto Asset Backed Securities ABS, Autos, Fixed Rate, (1.45yrs) R0U0 0.802 2.291 1.689 3.077 14.845 -0.682 5.723 Other Indices Dow Jones Industrial Average INDU 23.591 7.257 5.544 11.023 3.116 -33.762 6.432 S&P 500 SPX 26.390 13.405 2.110 12.783 23.454 -38.486 3.530 NASD CCMP 34.198 15.906 -1.799 16.910 43.888 -40.541 9.812 MSCI World Index MXWO 21.478 13.184 -7.615 9.262 27.283 -42.081 7.093 CRB Index (Commodities) CRY -5.837 -3.372 -8.264 15.430 23.563 -39.450 16.679


Source: Bloomberg, BoAML, Morgan Stanley.

Commodities U.S. Politics Driving Price Crude Futures – Per Barrel

Source: Bloomberg and SVB Asset Management.

Gold Prices – An Ounce Iron Ore Futures – Per Ton

�  Commodities were on the decline while the future of U.S. economic recovery took a stronger footing.

�  Oil prices were rising due to supply concerns then dipped on easing Eastern tension only to begin a rally once again after the Fed said it would reduce stimulus.

�  Iron ore prices have seen a recent rise driven by stock piling in Asian countries in preparation for winter and icy logistics.

�  The expected strengthening of the U.S. dollar will weaken commodity investments as the economy recovers post-taper.


$80.0

$90.0

$100.0

$110.0

$120.0

$1,200.0

$1,400.0

$1,600.0

$1,800.0

$100.0

$120.0

$140.0

$160.0

Loan Market Fundamentals

Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group

Credit Spreads Continue to Run Below 2009 Peak

Fundamentals Remain Steady 3-Month LIBOR Remains at Historic Lows

�  Credit spreads have fallen since the 5.6 percent peak during the financial crisis in January 2009, but remain higher than the sub- two percent levels seen pre-crisis.

�  Economy is expected to be on an upswing in 2014. As companies look to grow organically or via acquisition, 2014 will see a pick-up in M&A and LBO deals, though refinancing may still dominate as long as interest rates remain low.

�  Secondary loan pricing have remained steady at above par levels indicating stability in the secondary loan market.


January 2009 5.6%

0.0%

2.0%

4.0%

6.0%

10 YR BBB Yield - 10 YR Treasury Yield

November 2013 2.7%

0.0%

2.0%

4.0%

6.0%

3 Month LIBOR

November 2013 0.28%

65.0

75.0

85.0

95.0

105.0

LPC LCDX (Secondary Loan Price Index - Par = 100)

High Yield Market Fundamentals High Yield Funds Dip Notably in June

Source: Thomson Reuters Loan Pricing Corp., Lipper FMI and SVB Financial Group

�  Thanksgiving week ended at a muted pace with only $1.4 billion priced over four deals. However, a total of $11.2 billion of HY bonds priced the week of December 2, bringing YTD volume to $316.6 billion, close to 2012’s record annual issuance volume of $326.7 billion.

�  Senior secured high yield bond issuance fell to $3 billion in November from $4 billion in October. So far this year, $53.7 billion of senior secured bonds have been issued, 19 percent less than in the same period last year.

�  Bond-for-loan takeout volume ($87.4 billion) has been the biggest use of bond proceeds so far in 2013. Bond-for-loan takeout volume amounted to $6.2 billion in November. Next is bond redemptions at $53.2 billion and M&A (excluding LBO) activity at $29.8 billion. LBO volume is at $17 billion.

�  According to the Bank of America Merrill Lynch HY Master II Index, corporate HY bond spreads are the tightest since October 2007, before the financial crisis. During the week of December 2, HY spreads declined to just 416bp over comparable Treasuries.

High Yield Take-Outs of Bank Debt


$0.0 $10.0 $20.0 $30.0 $40.0 $50.0 $60.0

Issu

ance

($ in

Bill

ions

)

$0.0

$100.0

$200.0

$300.0

$400.0

Net

Ass

ets

($ in

Bill

ions

)

Loan Funds HY Bond Funds

Overall Loan Market Overview Historical Syndicated Loan Volumes

Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group

�  The Federal Reserve has indicated that it will start tapering its historic bond buying in the new year's first month. This tapering, a few months earlier than widely expected, introduced more certainty to markets that have been highly focused on pinpointing the timing and degree of the Fed's retreat from unprecedented monetary stimulus.

�  The primary market remains highly active. Following the

busiest November on record with $71.3 billion in U.S. institutional issuance, over 60 percent of the institutional calendar is comprised of refinancing and re-pricing transactions, with Cumulus Media, Chrysler Group LLC, and American Airlines coming to market to reduce pricing on over $7 billion of debt.

�  Given the lack of new money deals, lenders have put money

to work on opportunistic re-financings, re-pricings and dividend recap deals.

�  The core issues in 2014 will be refinancing and re-leveraging. Refinancing activity will remain strong amid record low rates and re-leveraging related activity to finance LBOs should continue to increase.

DXY USD Index


$0.0

$500.0

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$2,000.0

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ance

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ions

)

Leverage I-Grade Other

70

75

80

85

90

Global Economy SVB Asset Management

Global Economy


Euro Zone Expectation of Economic Growth

Source: Eurostat, Zentrum fuer Europaeische Wirtschaftsforschung GmbH, Bloomberg and SVB Asset Management.

�  Discontinuous growth is transitioning to steadier growth, albeit at marginal levels. Austerity phasedown, easing credit standards, and rising confidence levels support a continued recovery.

� Economist and investor sentiment reached a seven-year high in December, portending to better GDP ahead. Current situation sentiment remains highly negative, but is improving.

� While consumer sentiment increased throughout 2013, a stubbornly severe unemployment situation is inhibiting a more robust recovery.

� Euro zone services are trending upwards. New services business orders suggest the sector will begin to contribute positively in the near future.

� High unemployment aided a CPI reading of 0.7 percent in October, which stimulated deflation fears and incited the ECB to an unanticipated rate 25 basis point rate cut at its November meeting.

Euro Zone Unemployment Rate


Europe Ending Discontinuous Growth

-10.0%

-5.0%

0.0%

5.0%

-100 -50

0 50

100

ZEW Expectation (LHS) Eurozone GDP Change (RHS)

0 2 4 6 8

10 12

Europe Euro and Pound Remain Firm Currency Performance

Source: Eurostat, Bloomberg and SVB Asset Management.

�  The GBP has been buoyed by accelerating macroeconomic improvements in the second half of 2013, while low inflation, relative political stability, and a persistent trade surplus have prevented the EUR from falling.

�  Economic growth quickened towards the end of 2013 in the UK, with PMI manufacturing and services indices reaching highs not seen since 2011. The BOE advanced its forecast to Q3 2015 for when the unemployment rate would hit its seven percent threshold.

�  Despite an unexpected rate cut by the ECB and a reduction by the Federal Reserve to its QE program, the EUR remained firm as the euro zone continues to run a positive current account. Consumption recovery will be slow enough to keep imports muted.

�  Anticipate the GBP and EUR to remain within the trading ranges of 2013, as the recent pace of economic activity in the UK steadies, and the Eurozone balances a low inflationary, low growth environment vis-à-vis faster U.S. growth. Downside is limited, as the Fed will not raise rates until at least 2015.

Euro Zone Trade Balance


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1.2 1.3 1.4 1.5 1.6

1.4

1.5

1.6

1.7

EU

R /

US

D

GB

P/U

SD

GBP EUR

China Steadying Growth

Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management.

Chinese Renminbi

Exports GDP

�  Though growth is structurally drifting lower, the PBOC has allowed the Yuan to appreciate at a steady pace, in part to control inflation and support macro policies to expand domestic consumption.

�  The Yuan touched a 20-year high in December, propelled by record export levels and increasing foreign investment.

�  The Yuan is poised to waft higher in 2014, though government leaders may reduce 2014’s growth target to seven percent from 2013’s 7.5 percent target.


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6.2

6.3

6.4

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SD

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Asia Inflation Desired and Despised Declining – Yen Continues, Rupee Moderates

Source: Japan Ministry of Internal Affairs and Communications, India Central Statistical Organisation, Bloomberg and SVB Asset Management.

India Industrial Production Lacks Growth

Japan Nationwide Consumer Price Index Rises �  Japan: The Bank of Japan (BOJ) affirmed its commitment to the

‘Quantitative-Qualitative Easing’ (QQE) program at its December meeting, which is scheduled to double the BOJ’s balance sheet by the end of 2014. A slow decline in the Yen should persist, as the BOJ may add a time commitment for the program, while the FED reduces balance sheet growth.

�  India: The Reserve Bank of India (RBI) refrained from increasing interest rates at its December meeting, after hiking the repo rate 25 bps each time during its previous two meetings. Rupee volatility may decline in the near-term if inflation eases, but soft economic growth will prevent any substantial appreciation.


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The U.S. Dollar Stability Ahead U.S. Treasury Curve

Source: Bloomberg and SVB Asset Management.

�  The Federal Reserve’s modest reduction in the pace of its bond purchase program will be supportive of the USD, as it will slow the expansion of the Fed’s balance sheet at a pace that will not hinder macroeconomic growth.

�  Longer term interest rates trended higher while short and medium-term rates remain anchored due to the Fed’s commitment not to raise interest rates immediately after the unemployment rate reaches 6.5 percent.

�  Inflation remains benign and below the Fed’s preference of two percent. A stronger housing market may buoy inflation but will be offset by softer energy prices.

�  The federal funds rate is expected to remain unchanged until the second half of 2015, which will prevent any substantial appreciation in the USD.

DXY USD Index


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Regulatory SVB Asset Management

Regulatory


U.S. Debt Grapevine Ahead

The U.S. debt burden has increased irrespective of who is in office. This may be due to macroeconomic conditions which have required a higher reliance on debt funding in recent years.

After much debate in October, the debt ceiling is currently suspended until February 7, 2014.

Continued payments from Fannie and Freddie together with the sequester and other tax measures have eased pressures on the debt ceiling.

We expect another heated discussion about the debt ceiling in late Q1 2014 or early Q2 2014 when the Treasury exhausts its extraordinary measures.

Source: Bloomberg, SVB Asset Management

Outstanding Treasury Securities and U.S. Statutory Debt Limit


$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

$14.0

$16.0

$18.0

Trill

ions

Outstanding Treasury Securities Democrat Republican US Statutory Debt Limit

Volcker Rule Tightening the Reins

�  953 pages, with much of the details yet to be determined by regulators.

�  Determination of “reasonably expected near-term demands of customer” for underwriting and market making related activities.

�  Unintended consequence of creating a “safer” banking environment.

�  Limit participation in private equity funds which have been spurring technological and biomedical developments.

�  Additional compliance and reporting requirements, leading to additional costs to the banks which would be passed on to their customers.

Source: SVB Asset Management

�  Prohibits banks from engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account.

�  Prohibits banks from owning and sponsoring hedge funds and private equity funds.

�  Five Main Exemptions: �  Government obligations including selected agencies,

municipal securities and FDIC obligations. Foreign sovereign debt allowed under certain conditions.

�  Clearly identified hedging activities. �  Market making activities. �  Underwriting. �  Foreign bank transactions that occur and are held outside

of U.S.

�  Final Rule is effective April 1, 2014 but banks are allowed conformance period up to July 21, 2015.


Details Challenges

Regulatory Environment Decisions, Decisions

40

Amendments to SEC 2a-7 rule have been in place since February 2010. Key changes included more restrictive maturity limits, higher credit quality standards, the establishment of new daily and weekly liquidity requirements as well as thorough stress testing and additional disclosures.

As of June 2013, two additional SEC proposals have been put forward, requiring public comments from the industry. After a 90-day comment period and review of the comments, the SEC will vote to implement either one or a combination of the two proposals described briefly to the right.

Regulatory action is subject to an implementation period estimated to span one to two years subsequent to the second vote.

Opt

ion

One

Floating NAV (Prime Institutional Funds Only)

�  Mark-to-market NAV valuation similar to other mutual funds with a NAV price rounded to the nearest 1/100th of a penny.

�  Exemption for Government and Retail Funds. Government funds defined as those holding 80 percent or more in cash, government securities or repurchase agreements collateralized by government securities. Retail funds are defined as having a $1 million limit on daily redemptions.

�  Pro: Daily pricing would reflect gains and losses fostering greater transparency.

�  Con: Causes a “first-mover advantage.”

Opt

ion

Two Liquidity Fees and

Redemption Gates (Optional for Government Funds)

�  If weekly liquidity drops below 15 percent of total assets, a 2 percent liquidity fee for redemptions could be imposed.

�  If weekly liquidity drops below 15 percent of total assets, a maximum 30-day suspension of redemptions could be imposed for any 90-day period,

�  Pro: The investor keeps the stability of a stable $1.00 NAV.

�  Con: In times of stress, when cash is crucial, access to funds could be delayed or subject to a fees.

�  Potential reforms could be a combination of the above proposals by the SEC �  Expect further actions from SEC in late Q1 2014

Potential Reform Proposals by the SEC as of June 2013

Source: SVB Asset Management.


European Money Markets The EU Speed bump


On September 4, 2013 the European Union released their own proposals to control the massive money market fund industry.

Rule implementation would require acceptance by all EU member states and pass Parliament. Parliamentary elections are scheduled for next Spring, which will have an impact on, not only the outcome, but the implementation timetable.

The new proposals were released in conjunction with added regulation on the so-called shadow banking sector. The rules would apply to money market funds domiciled in Europe.

Capital Buffer Money market funds that maintain a constant net asset value (CNAV) would require a 3 percent capital buffer to absorb potential losses and stabilize the fund during periods of high redemptions and decreasing asset values.

Liquidity Requirements MMMFs must have at least 10 percent of their portfolio maturing within one day and 20 percent within one week to protect investors from potential runs (Similar to SEC requirements of 10 percent/ 30 percent).

Concentration Limits Issuer concentration would be kept at 5 percent limit to prevent large undue weight on any particular issuer (similar to SEC requirements).

Our Team

42

Managing Director

Jeff Schnitz [email protected]

Chief Investment Officer

Joe Morgan, CFA [email protected]

Head of Credit Research

Melina Hadiwono, CFA [email protected]

Portfolio Managers

Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected]

Credit and Risk

Sook Kuan Loh, CFA [email protected] Tim Lee, CFA [email protected] Kyle Balough [email protected]

Silicon Valley Bank Partners

Susan Winters Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman

Head of Portfolio Management

Ninh Chung [email protected]


mailto:jschnitz%40svb.com?subject=Inquiry%3A

mailto:jmorgan%40svb.com?subject=Inquiry%3A

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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.

All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management 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 Asset Management. 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.

©2013 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB>Find a way, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. B_SAM-14-13207 Rev. 01-08-2014


SVB Asset Management


555 Mission Street, Suite 900 San Francisco, CA 94105

555 Mission Street, Suite 900San Francisco, CA 94105

SVB Asset Management


Date post:	06-May-2015
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SVB Asset Management Economic Book Q4 2013

Economy & Finance