SVB Asset Management Economic Report Q4 2014

Quarterly Economic Report 2014SVB Asset Management

Q4

Table of Contents

Thoughts from the Desk 03

Overview 04

Special Topic: U.S. Return to Normal 06

Domestic Economy 13

Markets & Performance 22

Global Economy 30

Portfolio Management Strategy 36

2 SVB Asset Management | Quarterly Economic Report Q4 2014

Table of Contents

Last quarter’s varying economic performance across the globe was evidence of the tug-of-war dynamics weighing on investors as new factors and prolonged forces add to volatility in the market. We expect volatility to pick up in 2015, with an uptick in yields and continued domestic economic growth. Monetary policies from the Euro zone and Asia will be more accommodative as the countries attempt to reflate their economies.

After reaching a five-year low, crude prices flirted with a sub-50 dollars per barrel pricing as the Organization of Petroleum Exporting Countries (OPEC) bet that other oil drilling countries would be “crushed” by compressed prices so that OPEC could maintain its market share. So far, drillers are continuing to pump, but future capital expenditure plans are being reassessed. U.S. consumers are one of the biggest benefactors, while oil revenue dependent countries such as Russia and Venezuela are facing possible economic chaos. As a preventive measure, the Swiss National Bank imposed a 0.25 percent charge on bank deposits to minimize flight-to-quality currency trades resulting from the spillover of the Russian currency turmoil and impending quantitative easing programs from the European Central Bank (ECB).

With the exception of a few economic segments, the U.S. economy continues to lead the pack. Private sector hiring will likely average just below 275,000 per month for the quarter, lifting the monthly average to over 230,000 for the year — extending the positive trend from last year’s average of 197,000 per month. The improvement in labor markets and beginning of what appears to be a wage pick-up has resulted in consumer sentiment pushing new highs. This will likely carry over to other parts of the U.S. economy.

As such, the Fed quandary continues as it aims to meet its dual mandate of promoting maximum employment and long-term price stability. While core inflation is still well within the Fed’s stated tolerance of 2.5 percent, the Fed had judged that it “ can be patient in beginning to normalize the stance of monetary policy.” This has led market participants to expect the first rate hike to occur in the second half of next year. The good news is we will no longer have to wait for a “considerable time.”

2015 is shaping up to be an exciting year. We will continue to exercise our disciplined investment approach to ascertain investment opportunities and mitigate risks on your behalf.

Ninh Chung, Head of Investment Strategy and Portfolio Management

3

Thoughts from the Desk

SVB Asset Management | Quarterly Economic Report Q4 2014

Thoughts from the Desk

4

  Volatility was front and center this year as we have seen a “tug of war” between strong economic data domestically and concerns regarding growth and geopolitical tensions abroad. (p. 7)

  The general trend has been an upward trajectory in interest rates as the markets are preparing for a rate hike in 2015. (p. 7, 10-11)

  While the labor market continues to improve, there are still some metrics keeping the Fed on the sidelines in terms of raising interest rates, notably the historically low labor force participation rate and below-target inflation. (p. 8)

  Though most of the regulatory uncertainties dissipated in 2014, the financial industry is facing more deadlines within the next two years to comply with new standards. (p. 12)

Special Topic: U.S. Return to Normal

  The U.S. economy exhibited strong, broad-based growth in the past two quarters. This is in stark contrast to many other economies across the globe. (p. 14)

  Consumers are benefiting from an improving labor market and declining fuel prices. Sentiment is nearing an eight-year high. (p. 15)

  The Fed has noted reduced slack in the labor market, thanks to robust job growth in 2014. However, more improvement is needed before the Fed ends its accommodative policy. (p. 16-17)

  Activity in the housing sector has been volatile this year. At the same time, we are getting back to more sustainable levels. (p. 18-19)

  A decline in oil prices has brought inflation issues back to the forefront; however, the resulting stronger consumption should help to keep inflation expectations stable. (p. 20-21)

Domestic Economy

Overview


5

  A strengthening U.S. dollar and increased supply have slashed oil prices, which has benefited non-energy based equities. (p. 23)

  There were minimal flows in equity funds and slightly more volatile fund flows in bond funds in the latter part of the year. Money market mutual fund assets have grown in late 2014, increasing the demand for high quality assets in the short-end of the curve. (p. 24)

  Credit spreads continue to hover near all-time lows despite recent volatility and moderate spread widening. (p. 25-27)

  Credit sectors continue to exhibit positive total returns, as income returns have cushioned the impact of negative price performance over the past quarter. (p. 25-27)

  Benign catastrophic events and steady interest rates assisted insurance companies throughout 2014 and restructurings weighed on the Healthcare sector. Solid credit performance is anticipated in the Services sector while Energy is likely to lag behind in early 2015, due to volatile oil prices. (p. 28-29)

Markets & Performance

  Europe: The ECB’s stimulus measures have proven insubstantial. New asset purchase programs are expected in early 2015. (p. 32)

  United Kingdom: Falling inflation has been overwhelming solid underlying economic fundamentals in the country’s rate hike decision. The first rate hike may be delayed until middle of 2015. (p. 33)

  China: Decelerating growth, weak inflation and a firm yuan support further rate cuts. (p. 34)

  Japan: The Bank of Japan took action to reinforce its commitment to inflation generation. We expect fiscal and monetary stimulus to continue in 2015. (p. 35)

Global Economy

Overview


SVB Asset Management

Special Topic: U.S. Return To Normal

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Perc

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2 Year Treasury Yield 1 Year Treasury Yield

U.S. Return to Normal Year in Review


Source: Bloomberg and SVB Asset Management. Data as of 12/18/14.

1-year Treasury Bill: Yields experienced little movement for the majority of the year and saw a pickup beginning in November: started the year at 0.11% and is currently at 0.19%. 2-year Treasury Note: Yields further out on the curve experienced greater volatility for much of the year: started the year at 0.37% and is currently at 0.68%.

Q1 Q2 Q3 Q4

Economics: U.S. economic data disappoints and signs of a slowdown in China emerge. Monetary Policies: FOMC removed the 6.5% target on the unemployment rate and Fed Chair Yellen noted that “6 months” is considered a “considerable time” to keep rates low. Geopolitical Events: Tension between Ukraine and Russia are present.

Economics: U.S. economic data shows an improvement in the labor market, but the Q1 GDP print disappoints with a 2.1% contraction. Monetary Policies: ECB announced negative rates on deposits. Others: Treasury short covering on delayed Fed rate hike and further rate declines exacerbated by bond scarcity.

Economics: U.S. economic data showed a rebound in Q2 GDP to +4.6%. Data in the E.U. showed that growth in Germany is decelerating while Italy braced for a 3rd recession. Monetary Policies: FOMC raised its end-of-year 2015 target level on Fed funds. Geopolitical Events: Malaysian airline tragedy refueled tensions between Ukraine and Russia. Additionally, headlines centered around the Gaza strip, Iraq and ISIS.

Economics: U.S. data was generally all positive; however, IMF cut world growth estimates. Additionally, there was an affirmation of a euro-area slowdown. Monetary Policies: Fed QE program ended with market consensus showing a mid-2015 rate hike. The Fed will "be patient" with policy normalization. Geopolitical Events: Headlines centered around ISIS and the Ebola outbreak. Others: Oil prices plummet to at least a five-year low, Treasury short covering was prevalent, and Dodd-Frank rulings were set into motion to limit banks’ ability to be market-makers.

Source: Bloomberg and SVB Asset Management. Data as of December 30, 2014.

U.S. Return to Normal Yellen’s Dashboard


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 best time to exit accommodative monetary policy.

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% 3.3%

Nonfarm Payrolls (3-month average) 161.8K -826K 278.3K

Unemployment Rate 5.0% 10.0% 5.8%

Hires Rate 3.8% 2.8% 3.6%

Quits Rate 2.1% 1.3% 1.9%

U-6 Underemployment Rate 8.8% 17.2% 11.4%

Long-term Unemployed Share 19.1% 45.3% 30.7%

Labor Force Participation Rate 66.1% 62.7% 62.8%

Target Threshold Current Level

Inflation (Core PCE) 2.0% 2.5% 1.6%


U.S. Return to Normal The Fed’s Exit Strategy


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  Treasury and MBS bond purchases, which contributed to the immense growth in the Fed’s balance sheet, came to a halt in October. The Fed now solely continues to reinvest principal payments into longer-term securities at sizable levels.

  There is over $2 trillion of excess reserves on banks’ balance sheets, which could pose a threat to inflation in the long term. To mitigate potential shocks to the economy, the Fed has been discussing tools to exit the unprecedented stimulus created in recent years.

  In order to drain excess reserves, the Fed has been discussing the following options: -  Increase the interest paid on bank reserves

(IOER). -  Halt reinvestments on securities. -  Engage in outright asset sales. -  Pursue reverse repurchase agreements. -  Offer interest-bearing term deposit facilities. -  Raise the Fed funds target rate.


U.S. Return to Normal Market Outlook


Source: Federal Reserve, European Central Bank, National People’s Congress of the People’s Republic of China, Bank of Japan. Data as of December 18, 2014.

2014 2015 2016 2017 Longer Run Economic Projections, United States Change in Real GDP 2.3 – 2.4 % 2.6 – 3.0 % 2.5 – 3.0 % 2.3 – 2.5 % 2.0 – 2.3 % Unemployment Rate 5.8 % 5.2 – 5.3 % 5.0 – 5.2 % 4.9 – 5.3 % 5.2 – 5.5 % PCE Inflation 1.2 – 1.3 % 1.0 – 1.6 % 1.7 – 2.0 % 1.8 – 2.0 % 2.0 % Core PCE Inflation 1.5 – 1.6 % 1.5 – 1.8 % 1.7 – 2.0 % 1.8 – 2.0 % Interest Rate Projections, United States Federal Funds Target Rate 0 – 0.25 % 1.125 % 2.5 % 3.625 % Economic Projections, Euro Area Change in Real GDP 0.8 % 1.0 % 1.5 % CPI Inflation 0.5 % 0.7 % 1.3 % Unemployment Rate 11.6 % 11.2 % 10.9 % Economic Projections, China Change in Real GDP 7.5 % CPI Inflation 3.5 % Unemployment Rate 4.6 % Economic Projections, Japan Change in Real GDP 0.4 % 1.5 % 1.2 % CPI Inflation 3.2 % 2.4 % 2.8 %

Central Bank Economic Projections:

U.S. Return to Normal Fed Rate Projections


Source: Federal Reserve as of December 17, 2014. Chart references median forecasted Fed rates at the end of each period.

Regulatory Environment What is Coming

SVB Asset Management | Quarterly Economic Report Q4 2014 12

Source: BIS, SEC, Federal Reserve, ECB and SVB Asset Management.

Domestic EconomySVB Asset Management

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

10.0%

GDP Separating From The Pack GDP

GDP and Components GDP Growth Trailing 4-Quarter Average

  Both second and third quarter GDP came in strong at +4.6 percent growth and +5.0 percent growth, respectively, a significant rebound from the contraction of 2.1 percent in the first quarter when harsh weather conditions stifled growth.   Growth was broad-based with positive contributions from consumption, business spending, government spending, exports and residential investments. This was partially offset by a negative contribution from private inventory investments.   Estimates for Q4 GDP call for growth of approximately 2.5 percent. For the year of 2014, GDP is expected to grow by 2.3 percent, mirroring the growth for the past two years.

14

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.


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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

Consumption Heightened Optimism Consumer Sentiment – University of Michigan

Retail and Food Services Sales Personal Consumption – % Change

  Consumer sentiment, as indicated by the University of Michigan index, showed immense strength this year. December’s preliminary reading of 93.6 was the highest level in almost eight years and reflected an improved outlook of the U.S. economy.   Retail sales have been somewhat volatile this year, but are poised to end the year on a strong note. November’s reading of +0.7 percent was the largest gain in eight months.   This heightened optimism and strong spending is directly attributable to lower fuel prices and a strengthening labor market. The bump in wage growth we saw last month was a welcome advance.

15

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


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Ex Autos Vehicle Sales

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

Employment Back on Track Employment Landscape Full-Time vs. Part-Time

  Monthly job growth has averaged north of 240,000 in the first 11 months of the year. November’s reading of 321,000 was the largest number of monthly jobs created in almost three years and the economy has added over 230,000 private sector jobs on average per month.   The unemployment rate has fallen to 5.8 percent, a six-year low, but the labor force participation rate remains at a 30-plus year low. While the Fed has noted there is less slack in the labor market, it would also like to see more improvement before initiating a shift in monetary policy.

16

Discouraged Workers Not in Labor Force

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.


-15.0%

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Full-time Employment (LHS) Part-time for Economic Reasons (RHS)

Employment Back on Track U.S. Labor Force Participation Rate Hires and Quits Remain Depressed

Average Hourly Earnings YoY   With the Fed dropping the 6.5 percent threshold for the unemployment rate earlier this year, it is now looking at a broader range of statistics including the labor force participation rate, the “quits” rate and wage growth.   At 62.8 percent, the labor force participation rate is the lowest in over 30 years and has been below 63 percent since April of this year. Hires and quits have started to pick up which is a positive for the Fed’s labor market dashboard.   On a year-over-year basis, wage growth has been essentially keeping up with inflation at 2.0-2.1 percent; however, last month we saw an increase in average hourly earnings of 0.4 percent. This was the greatest gain since June of last year and is reflective of the persistent job growth we have been seeing.

17

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

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Job Hire Rate Job Quit Rate

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5.0%


U.S. Housing Market Uneven Ground Home Sales & Supply

Housing Starts Home Prices – Indexed to 100

  The housing market continues to make progress with homebuilder confidence hovering near a nine-month high. However, we have seen some volatility this year, as the recovery has been uneven.   Housing starts declined 1.6 percent in November, which was the first drop since August. New home sales showed modest improvement in October rising only 0.7 percent as constrained inventory weighed on sales, and existing home sales saw the strongest reading in over a year at 1.5 percent.   Home prices, as shown by the S&P/Case-Shiller index, have been more muted during the second half of the year, rising by 4-7 percent on a year-over-year basis. This compares to price increases of 8-13 percent seen in the first half of the year.

18

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Housing Starts U.S. Population


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

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Case Schiller 20 City FHFA Purchase Median Home Price

U.S. Housing Market Uneven Ground Homeownership Rate Housing Affordability Composite Index

Foreclosures vs. Mortgages Outstanding

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  Housing affordability has continued its decline this year, but it is still high by historical standards. A continued low-rate environment combined with stabilizing price gains is helping to support affordability.   The homeownership rate continues to fall as well and is currently at 64.4 percent, down from its peak of 69.2 percent in 2004. Foreclosures, as a percentage of total loans, are at 2.4 percent, down from a peak of 4.6 percent in 2010.   Homeownership has come down to a more sustainable level with mortgages outstanding and foreclosures following suit. The health of this sector is arguably stronger post-crisis as lending standards have been more stringent.


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

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Core PCE Fed Target Monetary Policy Threshold

Inflation On Watch Component Distribution Core PCE – % Change from Prior Year

Consumer Price Index – % Change from Prior Year Producer Price Index


Source: Census.gov and SVB Asset Management.

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7.6%

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2.7% 3.3% Housing

Transportation

Food & Bev.

Medical Care

Educ. & Comm.

Recreation

Apparel less footwear

Other

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Ann

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Inflation On Watch Wage Growth – Average Hourly Earnings NYMEX Crude Oil Generic Futures Contract

Univ. of Michigan Survey of Inflation Expectations   Declining oil prices have caused some disinflationary concerns in recent months; however, stronger consumption as a result should help to keep inflation expectations stable. Nonetheless, there has been an increased watch on inflation.   Core PCE remains below the Fed’s target of 2 percent and is currently at 1.6 percent. Both CPI and PPI remain under 2 percent on a year-over-year basis after briefly rising above that level earlier in the year.   The Fed reiterates that longer-term inflation expectations remain stable and it will continue to monitor inflation developments carefully in search of evidence that inflation will move towards its target.


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.

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1 Year Ahead 5-10 Years Ahead


Markets & Performance

Oil Facing Headwinds

Source: Bloomberg, Energy Intelligence Group and SVB Asset Management.

Crude Oil Prices

USD and the Dow Jones Industrial Average World Supply vs. World Demand for Oil

  Oil hit the lowest price in five and one-half years in mid-December as a result of both reduced demand and increased supply.   World supply now exceeds world demand, according to the Energy Intelligence Group. Many attribute that to the increased use of fracking technologies and sustained production by OPEC.   Strengthening of the U.S. dollar against foreign currencies has had a substantially negative effect on the price of oil. As oil prices continued their decline, selected non-energy equities have rallied.   Many speculators have been exiting long positions, further exacerbating the fall in oil price.

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Fund Flows Mixed Results

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

Equity Flows & Stock Performance

Net New Fund Flows Money Market Fund Flows

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-12.0% -9.0% -6.0% -3.0% 0.0% 3.0% 6.0% 9.0% 12.0%

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

  Equities benefited from positive fund flows earlier in the year, while the latter half of the year was muted. In comparison, bond fund flows have been slightly more volatile.

  Stock returns have fluctuated within a band for the past two years. Much of the movement in 2015 will depend on future interest rates, the health of the global economy, any geopolitical risks and volatility in commodity prices.

  Money market fund assets are picking up as investors shift towards safer assets at year-end given the uncertainty in the future of the global economy.

-$70.0 -$50.0 -$30.0 -$10.0 $10.0 $30.0

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-12.0%

Bond Sector Spreads Nearing the Inflection Point

25

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

Spread Performance by Asset Class

QE was the factor behind driving credit spreads to its post-crisis lows this past summer. However, concerns about the expected end of QE is also the culprit behind spread widening in the second half of 2014. With tighter financial conditions, liquidity may become a concern if the Fed raises rates in 2015. Thus, with likely outflows in credit, other asset classes – ABS, MBS, and Agencies – should benefit as investor further diversify their portfolios in order to mitigate risks of credit spread widening.


Market Returns Softening the Price Volatility

Source: Bloomberg, BoAML and SVB Asset Management.


Sector Heat Map Law of Diminishing Returns



2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 CMBS 2.06 4.71 6.20 -0.29 16.31 5.65 3.12 3.51 0.94 1.30

Insurance 2.04 4.09 6.83 -2.55 14.29 5.22 1.99 3.06 1.45 1.24

Services 2.58 5.16 6.08 7.66 10.82 3.82 1.81 2.23 1.46 1.21

Financial Services 1.97 4.74 5.75 -8.06 10.73 4.65 2.27 3.09 1.51 1.18

Utility 1.89 4.71 6.48 3.91 8.45 4.33 2.47 2.47 1.09 1.16

Banking 1.94 4.56 5.34 -2.66 13.62 4.81 0.66 6.38 1.82 1.13

Telecommunications 2.16 5.11 6.50 4.17 11.45 3.48 2.44 2.49 1.00 1.11

MBS 2.15 4.64 6.95 5.27 5.98 5.42 3.15 1.61 0.91 1.09

Real Estate 1.90 5.18 5.86 -7.12 26.55 6.47 1.36 6.24 1.73 1.09

Media 1.50 5.01 5.97 0.79 9.47 3.59 2.14 1.64 1.01 1.09

Capital Goods 1.87 4.37 6.77 3.89 9.53 3.84 2.29 1.80 1.00 1.08

Automotive 1.86 4.34 5.68 -3.76 18.44 4.17 2.12 2.95 1.25 1.04

Technology 1.83 4.58 6.64 5.52 7.66 3.33 1.82 1.48 0.56 1.00

Energy 1.94 4.51 6.67 4.40 9.15 3.58 2.84 2.11 0.93 0.92

ABS 2.60 4.73 4.84 -1.22 13.78 3.35 1.49 1.88 0.78 0.89

Consumer Goods 1.90 4.64 7.03 5.43 6.71 3.35 2.31 1.30 0.77 0.87

Basic Industry 1.94 4.32 6.86 0.99 9.74 3.96 2.33 2.03 1.01 0.84

Healthcare 2.18 4.63 6.59 2.98 9.85 3.52 2.54 1.66 0.93 0.79

US Agency 1.72 4.46 7.12 7.78 2.23 2.68 1.60 0.89 0.43 0.73

US Treasury 1.67 3.96 7.32 6.61 0.78 2.35 1.55 0.43 0.36 0.60

Yearly Average 1.98 4.62 6.37 1.69 10.78 4.08 2.11 2.46 1.05 1.02

Performance YTD Returns vs. Credit Outlook

28

Best Performing Sector YTD based on Total Return Weakest Performing Sector YTD based on Total Return Insurance Healthcare   Pricing discipline and relatively benign catastrophic events supported P&C

credit profiles throughout 2014.   Barring CAT losses or a sudden inflationary spike, outlooks should remain

stable as disciplined underwriting, healthy P&C rates and benign claim losses will support credit despite muted investment income.   Receding economic headwinds, healthy capital markets and steady

interest rates should ease pressure on life insurance companies.   Higher fees from healthy asset prices and changing product mix help offset

muted net investment returns and low interest rates.

  The pharmaceutical industry is de-conglomerating via mergers, acquisitions and spin-offs, destabilizing certain credit profiles.   Solid long-term fundamentals should offset short-term volatility within

the market due to restructurings.   New government healthcare programs, law changes and

implementation present growth opportunities throughout the managed care subsector.   Product pipelines are robust and health insurance membership base

increases should continue due to regulation.



Performance YTD Returns vs. Credit Outlook

29

Top Sector based on Credit Outlook Weakest Sector based on Credit Outlook Services Energy   A shift towards online shopping will power volume growth for logistics

providers as brick and mortar shopping declines.   As oil prices remain low, cheaper transportation costs should assist

shipping company bottom lines. Performance should improve significantly this holiday season.   Some restaurants will benefit from better employment and lower energy

prices as consumers have more excess cash for higher quality dining.

  Persistently low oil prices are weighing heavily on the entire sector.   Spreads have widened significantly and are expected to continue to do

so until crude oil prices have bottomed out.   Differentiated companies can pull various levers to mitigate low oil

prices and remain credit stable, supported by strong cash flows.   Shareholder-friendly activities remain a credit concern for certain

issuers.   Be wary of M&A risk as companies take advantage of lowered valuation

and overextend to make acquisitions.



Global EconomySVB Asset Management

Central Banks Weak Inflation Influencing Policies

31

Source: Federal Reserve, European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, Bloomberg and SVB Asset Management.

United States United Kingdom Euro zone China Japan

Central Bank

Federal Reserve Bank of England European Central Bank People's Bank of China Bank of Japan

Benchmark Rate 0-0.25% 0.5% 0.05% 5.6% 0.1%

Current Policy

Stable Policy skewed to rate hike.

Balance sheet size stability to keep monetary conditions

favorable.

Stable Rate hike postponed due

to falling inflation. Maintain purchased assets.

Easing Negative deposit rate.

Balance sheet to further expand via increased

asset purchases beginning in January

2015.

Easing Declining oil prices & a weakening real estate

market provide scope for further rate cuts & policy

easing.

Easing Additional monetary

expansion possible in 2015 despite October’s action to increase asset purchases.

Inflation

Unemployment 5.8% 6.0% 11.5% 4.1% 3.5%

Analysis

Below 2% inflation to keep Fed from raising rates until

Q3 2015.

Disinflation overriding employment gains, pushing rate hike to

Q4 2015.

Feeble demand & fiscal stimulus

absence outweigh a weakening euro.

ECB will try to stoke loan demand.

GDP growth target may be lowered by

1% to 6.5% in 2015.

BOJ commitment to inflation target remains strong as it confronts

falling inflation. A tax hike, sinking yen

and fiscal stimulus expected in 2015.

1.6% 0.0% 1.0% 2.0%

1.0% 0.0% 1.0% 2.0%

0.3% 0.0% 1.0% 2.0%

1.4% 0.0% 1.0% 2.0% 3.0%

0.9% 0.00% 1.00% 2.00%


1.1

1.2

1.3

1.4

1.5

1.6

Eur

o pe

r U.S

. Dol

lar

Europe Too Slow, Too Low Euro

Source: Eurostat, European Central Bank, Bloomberg and SVB Asset Management.

Inflation Euro Zone Excess Liquidity

  Recent efforts by the European Central Bank (ECB) to ease monetary conditions have yielded marginal results, as demand for its latest lending program has been moderate.   With the ECB’s balance sheet growing too slowly to meaningfully support growth and inflation, it may expand asset purchases and move its deposit rate further into negative territory in early 2015.   The ECB’s stance has aided the weakening of the euro, which is set to fall further, though a persistent current account surplus will pace the fall.

32

0.0 1,000.0 2,000.0 3,000.0 4,000.0 5,000.0 6,000.0 7,000.0 8,000.0

Bill

ion

Eur

os

-1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

% C

hang

e Ye

ar o

ver Y

ear


United Kingdom Solid Growth, Soft Prices Markit/CIPS UK Composite PMI

Source: UK Office for National Statistics, Markit, Bloomberg and SVB Asset Management.

Retail Sales, Excluding Fuel Core Consumer Price Index

  Strong economic momentum continued through year-end, supported by household consumption. Retail sales have been solid, particularly in non-food stores and online sites, helped by rising wages.   Inflation remains soft, as retail prices fell 2 percent in November, paced by price drops in fuel, transport, and food & beverage.   Inflation deceleration dissuaded the Bank of England from raising rates in December. Inflation may stabilize, as higher labor costs offset falling energy prices, allowing for a rate hike in the second half of 2015.

33

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

% C

hang

e Ye

ar o

ver Y

ear

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

% C

hang

e Ye

ar o

ver Y

ear

48.0 50.0 52.0 54.0 56.0 58.0 60.0 62.0

PM

I Ind

ex (>

50 =

E

xpan

sion

)


China Managing Declines Chinese Renminbi

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

Gross Domestic Product Consumer Price Index

  The People’s Bank of China (PBOC) cut benchmark interest rates in November amidst declining inflation, slowing growth and a relatively strong currency.   Consumer prices drifted lower into the end of 2014, led by declines in food, transport costs, and housing costs. Fuel prices dropped over 8 percent in November, and will continue to fall into early 2015.   The PBOC is expected to cut rates further in 2015 to buttress export competitiveness and combat disinflation. China may lower its growth target by up to 1 percent in 2015 to 6.5 percent.

34

7.0

7.5

8.0

8.5

9.0

9.5

10.0

% C

hang

e Ye

ar o

ver Y

ear


0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

% C

hang

e Ye

ar o

ver Y

ear

Japan Preemptive Strike Japanese Yen

Source: Bank of Japan, Japan Chain Store Sales Association, Bloomberg and SVB Asset Management.

Japan Chain Store Sales

Nationwide CPI, ex Food & Energy   Worries over inflation expectations pushed the Bank of Japan (BOJ) to implement further easing in October, reinforcing its commitment to reach a 2 percent inflation target.   Despite a sinking yen, a substantial decline in oil prices and weak consumption demand after a sales tax hike could exert downward pricing pressure into early 2015.   Prime Minister Shinzo Abe and his political coalition won a two-thirds majority in December elections, preserving a rule that may include a corporate tax rate cut, a second sales tax hike and other fiscal stimulus measures in 2015.


135.0 137.0 139.0 141.0 143.0 145.0 147.0 149.0

100.0

105.0

110.0

115.0

120.0

125.0

Yen

per E

uro

Yen

per U

.S. D

olla

r

-2.0

-1.0

0.0

1.0

2.0

3.0

% C

hang

e Ye

ar o

ver Y

ear

-6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0

10.0

% C

hang

e Ye

ar o

ver Y

ear

Portfolio Management StrategySVB Asset Management

Portfolio Strategy Tying It All Back

Short duration benchmark

(3, 6, 9 month)

Intermediate duration

benchmark (1 yr)

Long duration benchmark

(2+ yrs)

Duration Targets

Sector Overweights

Financial Corporate Bonds, Commercial Paper, MMFs

Financial & Industrial Corporate Bonds, Commercial Paper, Credit Card ABS, Bullet Agencies, On-the-run Treasuries

Short Maturity Financials, Long Maturity Industrials, Credit Card & Auto ABS, Bullet & Callable Agencies, On-the-run Treasuries

Sector Underweights

Treasuries, Agencies, Industrials

Short Treasuries and Agencies

Short Treasuries and Agencies

37

Portfolio Strategy Outlook As anticipated, the FOMC ended its large-scale asset purchase program in the fourth quarter, bringing an end to its monthly purchases of Treasury and mortgage-backed securities. At year-end, the market was focused on when the Fed will begin raising the Fed funds rate, which has been anchored at 0-0.25 percent since 2008. Market consensus is for a mid-2015 lift off.

In 2014, spread products outperformed Treasuries & Agencies with Credit and ABS leading the way. Within Credits, finance companies outperformed industrials, while credit card and auto ABS performed similarly.

Source: SVB Asset Management

-30% Neutral +30% -30% +30% Neutral +30% Neutral -30%


Treasuries & Agencies Corporate Bonds: Finance Sector

Corporate Bonds: Industrial Sector ABS

  We continue to anticipate a gradual rise of rates into year-end.

  On-the-run 2-year and 3-year Treasuries offer great total return range trades.

  Bullet & Callable agencies offer attractive yield pick-up over comparable Treasuries.

  Bullet Agency spreads are approximately 7 to 10 basis points over comparable Treasuries, while Callable Agency spreads are approximately 5 to 9 basis points over bullet Agencies.

  We prefer 2-year Callable Agencies that are trading at a slight discount dollar price.

  End of fourth quarter 2014 Approximate Yields: 2-yr Treasury: ~0.60% 2-yr Bullet Agency: ~0.70% 2-yr Callable Agency: ~.80%

  Banks and brokers offer the best value as both regulators and the industry are incentivized to build capital. Additionally, earnings continue to be strong.

  Over $1 trillion in corporate bonds were issued in 2014, of which approximately 40 percent were from the finance sector.

  Due to their attractive spread/yields and larger supply inventory base compared to industrials, we favor buying financials in the short end.

  End of fourth quarter 2014 spreads/yields: 2-yr A/A2 Finance: ~+50 / ~1.08 % 2-yr A-/A3 Finance: ~+70 / ~1.27 %

  Industrials continue to have strong balance sheets and positive earnings.

  Due to lack of supply in the short end and strong balance sheets, spreads over Treasuries are tight.

  We favor longer industrials for price performance stability.

  End of fourth quarter 2014 spreads/yields: 2-yr A/A2 Industrials: ~+30 / ~0.88 % 2-yr A-/A3 Industrials: ~+45 / ~1.02 %

  Strong fundamentals in the Auto and Credit Card ABS sectors.

  Very stable spreads.

  Active new issue and secondary markets.

  We favor Prime Auto ABS with durations two years and under and Credit Card ABS with durations between six months to one year. We like the soft-bullet maturity structure of Credit Card ABS as it offers the ability to receive principal back similar to a corporate bond.

  End of fourth quarter 2014 spreads/yields: 2-yr Auto & Credit Card ABS Spread: Swaps ~+25 / ~1.05%


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.

Our Team

39

Portfolio Managers

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

President, SVB Asset Management

Lauri Moss [email protected]

Head of Investment Strategy and Portfolio Management

Ninh Chung [email protected]

Head of Credit Research

Melina Hadiwono, CFA [email protected]

Credit and Risk

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

Silicon Valley Bank Partners

Maria Menard Priyanka Raju Girish Mallya


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.

©2014 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-14-13781 Rev. 01-05-2015.



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Date post:	12-Jul-2015
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SVB Asset Management Economic Report Q4 2014

Investor Relations