2017 market outlook - u.s. equity

U.S. EQUITY

Larry Puglia, CFA, CPA

Portfolio Manager

November 17, 2016

2017 Global Market Outlook Press Briefing

2

U.S. Equity Outlook

ENVIRONMENT

Stock valuations are reasonable relative to 25-year averages for many measures—

current forward price-to-earnings (P/E) is 16.8x

Stocks have overcome significant periods of volatility and large intra-year declines

Value has outperformed growth, especially in small-/mid-cap area

Dividend yield is near an all-time high relative to 10-year Treasury yield

Growth relative to value commands a smaller-than-average premium among large-caps

Balance sheets, buybacks, and dividends remain quite strong, but leverage is increasing for many small-caps

LOOKING AHEAD

Rising interest rates can be accompanied by rising stock prices, especially when yields are less than 5%

Defensive low-volatility sectors (utilities, telecom and consumer staples) have outperformed, but this trend

may be changing

Russell 1000 Growth, Russell Midcap Growth, and Russell 2000 Value appear to have the most attractive valuations

Information technology and health care are the industry sectors with the most attractive valuations

S&P 500 earnings should rebound in 2017 and 2018, reflecting a sharp improvement in energy; however, analyst

projections have not been accurate, so some caution is warranted

Earnings dispersion by industry is notable, with information technology and health care screening well

As of September 30, 2016

Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark

of Russell Investment Group.

3

8x

10x

12x

14x

16x

18x

20x

22x

24x

26x

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

S&P 500 Valuation Measures


Sources: FactSet, Federal Reserve Board, Robert Shiller, Standard & Poor’s, and J.P. Morgan Asset Management.

Price-to-earnings ratio is price divided by consensus analyst estimates of earnings per share (EPS) for the next 12 months. Shiller’s P/E uses trailing 10 years of

inflation-adjusted earnings as reported by companies. Dividend yield is calculated as the next 12-month consensus dividend divided by most recent price. Price-to-

book ratio is the price divided by book value per share. Price-to-cash flow ratio is price divided by NTM (next 12 months) cash flow. Earnings yield (EY) minus Baa

yield is the forward earnings yield (consensus analyst estimates of earnings per share over the next 12 months divided by price) minus the Moody’s Baa seasoned

corporate bond yield. Standard deviation over-/undervalued is calculated using the average and standard deviation over 25 years for each measure.

*Price/Cash flow is a 20-year average due to cash flow data availability.

S&P 500 INDEX: FORWARD P/E RATIO

+1 Std. dev.: 19.1x

25-year average: 15.9x

-1 Std. dev.: 12.7x

16.8x

Valuation

Measure Description Latest

25-Year

Avg.*

Std. Dev. Over-

/Undervalued

P/E Forward P/E 16.8x 15.9x 0.3

CAPE Shiller’s P/E 26.6 25.9 0.1

Div. Yield Dividend yield 2.2% 2.0% -0.4

P/B Price-to-book 2.6 2.9 -0.3

P/CF* Price-to-cash flow 11.7 11.4 0.1

EY Spread EY minus Baa yield 1.7% -0.4% -1.1

4

Market Volatility


Past performance cannot guarantee future results.

Sources: FactSet, Standard & Poor’s, and J.P. Morgan Asset Management; (Bottom) Chicago Board Options Exchange. Drawdowns are calculated as the prior peak

to the lowest point. Guide to the Markets—U.S. Data are as of September 30, 2016.

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2010 2011 2012 2013 2014 2015 2016

MAJOR PULLBACKS DURING CURRENT MARKET CYCLE

S&P 500 Stock Index

10

20

30

40

50

2010 2011 2012 2013 2014 2015 2016

Jul. 2, 2010:

-16.0%

Oct. 3, 2011:

-19.4%

Jun. 1, 2012:

-9.9%

Jun. 24, 2013:

-5.8%

Oct. 15, 2014:

-7.4%

Aug. 25, 2015:

-12.4%

Feb. 11, 2016:

-13.3%

2010 2011 2012 2013 2014 2015 2016

2010 2011 2012 2013 2014 2015 2016

Jul. ’10:

Flash Crash,

BP oil spill,

Europe/Greece

Oct. ’11:

U.S. downgrade,

Europe/periphery

stress

Jun. ’12:

Euro double dip Jun. ’13:

Taper Tantrum

Oct. ’14:

Global

slowdown

fears, Ebola

Aug. ’15:

Global slowdown

fears, China, Fed

uncertainty

Feb. ’16:

Oil, U.S.

recession

fears, China

VIX

’08 Peak

Average

Latest

LEVEL

80.9

18.1

13.3

VOLATILITY

VIX Index

5

Annual Returns and Intra-year Declines



Sources: FactSet, Standard & Poor’s, and J.P. Morgan Asset Management.

Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. Returns shown are calendar year returns from 1980 to 2015, except for 2016, which is year-to-date. Guide to the Markets—U.S. Data are as of September 30, 2016.

S&P 500 INTRA-YEAR DECLINES VS. CALENDAR-YEAR RETURNS

Despite average intra-year drops of 14.2%, annual returns positive in 27 of 36 years

26

-10

15 17

1

26

15

2

12

27

-7

26

4 7

-2

34

20

31

27

20

-10 -13

-23

26

9

3

14

4

-38

23

13

0

13

30

11

-1

6

-17 -18 -17

-7

-13

-8 -9

-34

-8 -8

-20

-6 -6 -5

-9

-3

-8 -11

-19

-12

-17

-30

-34

-14

-8 -7 -8 -10

-49

-28

-16 -19

-10

-6 -7

-12 -11

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

1980 1985 1990 1995 2000 2005 2010 2015

6

U.S. Markets: Small-Cap Growth

Leads in Q3



Sources: FactSet, Russell Indexes, and Standard & Poor’s.

3.5% 3.9% 4.6%

16.2% 15.4% 13.8%

4.4%

4.6% 17.3%

11.2%

8.9% 9.0% 9.2% 18.8% 15.5% 12.1%

THIRD QUARTER ONE YEAR

RUSSELL 1000 VALUE S&P 500 RUSSELL 1000

GROWTH RUSSELL 1000 VALUE S&P 500 RUSSELL 1000

GROWTH

RU

SS

EL

L M

IDC

AP

GR

OW

TH

RUSSELL 2000 VALUE RUSSELL 2000 RUSSELL 2000

GROWTH RUSSELL 2000 VALUE RUSSELL 2000 RUSSELL 2000

GROWTH

<-10% -5% to -10% 0% to -5% 0% to +5% +5% to +10% >+10% SCALE:

RU

SS

EL

L M

IDC

AP

VA

LU

E

7

U.S.: Dividend Yields Relative to Bond

Yields Have Reached Extreme Levels



Sources: FactSet, Standard & Poor’s, and T. Rowe Price.

The S&P 500 dividend yield is currently 1.28 times as large as the 10-year U.S. Treasury yield. This is the

eleventh-largest ratio in the history of our data set, which goes back to March 1990. A ratio of greater than

one (i.e., S&P dividend yield >10-year U.S. Treasury yield) has only occurred in 9.2% of the observations.

7

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Yie

ld R

ati

o

Range of Observations March 1990 to September 2016

S&P 500 DIVIDEND YIELD/

10-YEAR U.S. TREASURY YIELD

Sep. 30, 2016:

1.28

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1990 1993 1996 1999 2002 2005 2008 2011 2014Y

ield

S&P 500 DIVIDEND YIELD VS.

10-YEAR TREASURY YIELD

March 1990–September 2016

S&P 500 Dividend Yield

10-Year U.S. Treasury Yield

8

U.S.: Large-Cap Growth Stocks Are Commanding a

Smaller-Than-Average Premium


Chart is shown for illustrative purposes only and does not represent the performance of any specific security.

Source: FactSet and Russell Indexes.

-10%

10%

30%

50%

70%

90%

110%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

VALUATION PREMIUM: GROWTH VS. VALUE

Based on One-Year Forward P/E Ratio, January 2005‒September 2016

Russell 1000 Growth/Value Long Term Median

Russell 2000 Growth/Value Long Term Median

9

U.S.: Leverage Has Increased



Sources: FactSet and Standard & Poor’s.

2

4

6

8

10

12

14

16

18

20

CASH AS % OF MARKET

CAPITALIZATION

January 1995–March 2016

S&P 500 Large Cap

S&P 600 Small Cap

50

60

70

80

90

100

110

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

TOTAL DEBT AS %

OF TOTAL EQUITY

January 1995–September 2016

S&P 500 Large Cap

S&P 600 Small Cap

As a result of historically low borrowing costs,

corporations have been increasing debt and buying

back stock.

Corporate management has favored returning cash

to shareholders through share repurchases and

dividends, but ample capital remains for capex and

merger-and-acquisition activity.

10

U.S.: Buybacks and Dividends

Remain Strong



0%

1%

2%

3%

4%

5%

6%

7%

8%

Div

ide

nd

an

d B

uyb

ac

k Y

ield

S&P 500 TRAILING 12-MONTH

DIVIDEND AND BUYBACK YIELD

January 2005–September 2016

S&P 500 Buyback Yield

S&P 500 Dividend Yield

25

30

35

40

15

20

25

30

35

40

45

50

Pa

yo

ut R

atio

(%)

Div

ide

nd

s P

er

Sh

are

(U

SD

$)

S&P 500 PAYOUT RATIO AND

DIVIDENDS PER SHARE

June 1995–September 2016

S&P 500 Dividends Per Share (L)

S&P 500 Dividend Payout Ratio (R)

Dividend yield plus buyback yield remains near 5%,

which is attractive relative to the yields available on

many fixed income securities.

Higher payout ratios and dividends suggest that

managements are choosing to return capital to

shareholders rather than reinvest.

11

0% 2% 4% 6% 8% 10% 12% 14% 16%

Interest Rates and Equities


Past performance cannot guarantee future results. Sources: FactSet, Standard & Poor’s, Federal Reserve Board, and J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Markers represent monthly 2-year correlations only. Guide to the Markets—U.S. Data are as of September 30, 2016.

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

Co

rre

lati

on

Co

eff

icie

nt

10-year Treasury Yield

CORRELATIONS BETWEEN WEEKLY STOCK RETURNS

AND INTEREST RATE MOVEMENTS

Weekly S&P 500 returns, 10-year Treasury yield, rolling 2-year correlation, May 1963–September 2016

When yields are below 5%,

rising rates have historically

been associated with rising

stock prices Positive

relationship

between

yield

movements

and stock

returns

Negative

relationship

between yield

movements and

stock returns

12

U.S. Sectors: Higher-Yielding Sectors

Give Back Some Gains in Q3



Sources: Standard & Poor’s, FactSet, and T. Rowe Price.

12

3.9

-5.6

12.9

3.7 4.1

2.3

-5.9

-2.6

0.9

2.9

4.6

15.4

26.8

22.8 22.2

19.7 19.0

17.4

15.8

10.7 9.6

7.4

-10

-5

0

5

10

15

20

25

30

Retu

rn (

%)

Quarter

One Year

Heath Care 15%

Telecom 3%

Discretionary 13%

Utilities 3%

Technology 22%

Staples 10%

Financials 13%

Materials 3%

Industrials 10%

Energy 8%

S&P 500 INDEX WEIGHTS

13

9

12

15

18

21

24

27

30

Russell 1000 Russell 1000Value

Russell 1000Growth

RussellMidcap

RussellMidcap Value

RussellMidcap Growth

Russell 2000 Russell 2000Value

Russell 2000Growth

Pri

ce

-to

-Ea

rnin

gs

Mu

ltip

le

FORWARD PRICE-TO-EARNINGS (P/E) RATIOS*

September 2001–September 2016

Current Average High** Low

U.S.: Valuations Appear Slightly

Elevated Relative to History

Sources: FactSet, Russell Indexes, and T. Rowe Price.

*P/E ratios are based on FactSet market aggregates.

**In some cases, the 15-year high may be too extreme to appear on the chart.

PAST 15 YEARS

P/E Ratios (1-Year Forward)

by Russell Style Indexes

Current

September 30, 2016 Average High Low

Current Valuation to

15-Year Average

Russell 1000 17.03 15.58 23.42 10.81 9%

Russell 1000 Value 15.82 13.85 18.71 9.79 14%

Russell 1000 Growth 18.42 17.84 31.43 11.37 3%

Russell Midcap 18.12 16.44 22.30 10.48 10%

Russell Midcap Value 16.75 14.74 17.58 10.33 14%

Russell Midcap Growth 20.06 19.45 40.82 10.64 3%

Russell 2000 22.31 20.24 27.27 14.15 10%

Russell 2000 Value 17.53 16.57 22.89 12.21 6%

Russell 2000 Growth 30.51 27.44 78.91 16.77 11%

14

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Energy Materials ConsumerDiscretionary

Industrials InformationTechnology

Financials ConsumerStaples

Health Care Telecom. Utilities

Pri

ce

-to

-Ea

rnin

gs

Mu

ltip

le

Rela

tive

to

S&

P 5

00

RELATIVE FORWARD PRICE-TO-EARNINGS (P/E) RATIOS

September 1996–September 2016

Current

Average

High*

Low

PAST 20 YEARS

U.S.: Defensive Sectors Appear Expensive

Sources: FactSet, Standard & Poor’s, and T. Rowe Price. Chart is shown for illustrative purposes only and does not represent the performance of any specific security.

*In some cases, the 20-year high may be too extreme to appear on the chart.

P/E Ratios (1-Year

Forward) by Sector

Current

September 30, 2016

Relative to

S&P 500 Average High Low

Current Valuation to

20-Year Average

Energy 55.53 3.31 1.01 4.59 0.64 228%

Materials 16.70 1.00 0.98 1.72 0.43 1%

Consumer Discretionary 17.76 1.06 1.13 1.31 0.85 -6%

Industrials 16.61 0.99 1.02 1.19 0.80 -3%

Information Technology 16.96 1.01 1.27 2.10 0.94 -20%

Financials 12.20 0.73 0.78 1.16 0.53 -7%

Consumer Staples 19.95 1.19 1.17 1.44 0.74 2%

Health Care 15.11 0.90 1.08 1.47 0.75 -17%

Telecom 13.58 0.81 1.04 1.54 0.74 -22%

Utilities 17.24 1.03 0.87 1.25 0.49 18%

15

U.S.: Earnings Expected to

Rebound in 2017


Institutional Brokers’ Estimate System (IBES) estimate.


-1.8

32.4

25.1 18.6

12.7 7.1

-19.7

-39.2

75.5

17.4

4.5 4.0 6.7

-5.1

-1.2

13.2 11.9

-60

-40

-20

0

20

40

60

80

100

Pe

rce

nt

(%)

S&P 500 INDEX EARNINGS PER

SHARE GROWTH

2000–2018E

-1.5

4.4

10.6

13.1

11.3

7.3

9.0

-12.8

7.8

10.1

3.0 2.1

3.3

-2.4

2.0

5.8 5.4

-15

-10

-5

0

5

10

15

20

Pe

rce

nt

(%)

S&P 500 INDEX

REVENUE GROWTH

2000–2018E

Earnings growth is expected to remain in negative

territory in 2016, but a strong rebound is predicted

for 2017.

Analysts also expect revenue growth to recover, but

less dramatically.

16

U.S.: Earnings and Margin Weakness

Driven by the Energy Sector


EBITDA = earnings before interest, taxes, depreciation, and amortization.



15

16

17

18

19

20

21

2014 2015 2016

EB

ITD

A M

arg

in (

%)

EBITDA MARGINS

January 2011‒September 2016

S&P 500

S&P 500 ex. Energy

S&P 500 Energy

4.01

6.69

-5.06

-3.75

7.50

8.38

0.36

2.80

-6

-4

-2

0

2

4

6

8

10

2013 2014 2015 YTD 2016

Cale

nd

ar

Ye

ar

EP

S G

row

th (

%)

EARNINGS PER SHARE GROWTH

As of October 7, 2016

S&P 500

S&P 500 ex. Energy

17

U.S.: Forward Earnings Estimates Have

Deteriorated Rapidly Amid Oil Weakness



2006

2007

2008

2009

2010

2011

2012

2013

2014 2015

2016

2017

$40

$60

$80

$100

$120

$140

$160

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Ea

rnin

gs

Pe

r S

ha

re

S&P 500 EARNINGS PER SHARE (EPS) AND ESTIMATE PATHS

2006‒2017, in U.S. dollars

Actual EPS Results

Estimate Paths, Odd Years

Estimate Paths, Even Years

Each line represents the path of earnings estimates for that calendar year at the date represented on the

horizontal axis. As indicated in the chart, forward estimates usually are revised downward as time passes.

This was particularly true during 2014, when oil prices fell sharply.

18

U.S.: Significant Dispersion by Sector



Sources: Standard & Poor’s and FactSet.

S&P 500

Sector

Annualized

5-Year

Return

Annualized

5-Year

Revenue

Growth

Trailing

12-Months

Dividend

Yield

12-Months

Forward

P/E Ratio

Consumer

Discretionary 20.10% 7.88% 1.45% 17.8

Health Care 20.02% 7.20% 1.63% 15.1

Information

Technology 18.08% 4.08% 1.45% 17.0

Industrials 17.54% 3.78% 2.20% 16.6

Financials 17.37% 4.26% 1.87% 12.2

Staples 15.42% 3.89% 2.57% 19.9

Materials 12.71% -1.08% 2.14% 16.7

Telecom 12.30% 1.16% 4.57% 13.6

Utilities 12.09% -2.37% 3.44% 17.2

Energy 5.96% -11.45% 2.90% 55.5

65%

43%

42%

34%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

200

8 Q

1

201

3 Q

2

201

3 Q

3

201

3 Q

4

201

4 Q

1

201

4 Q

2

201

4 Q

3

201

4 Q

4

201

5 Q

1

201

5 Q

2

201

5 Q

3

201

5 Q

4

201

6 Q

1

201

6 Q

2

201

6 Q

3 (

E)

201

6 Q

4 (

E)

201

7 Q

1 (

E)

201

7 Q

2 (

E)

201

7 Q

3 (

E)

201

7 Q

4 (

E)

Cu

mu

lati

ve

Gro

wth

in

Op

era

tin

g E

arn

ing

s P

er

Sh

are

EARNINGS GROWTH BY SECTOR

2010‒2017E

S&P 500 Health Care and Information Technology

S&P 500 Financials and Utilities

S&P 500 Consumer Discretionary and Consumer Staples

S&P 500 Energy, Industrials, and Materials

20

13

Q1

19

U.S. Equity Outlook

ENVIRONMENT

Stock valuations are reasonable relative to 25-year averages for many measures—

current forward price-to-earnings (P/E) is 16.8x

Stocks have overcome significant periods of volatility and large intra-year declines

Value has outperformed growth, especially in small-/mid-cap area

Dividend yield is near an all-time high relative to 10-year Treasury yield

Growth relative to value commands a smaller-than-average premium among large-caps

Balance sheets, buybacks, and dividends remain quite strong, but leverage is increasing for many small-caps

LOOKING AHEAD

Rising interest rates can be accompanied by rising stock prices, especially when yields are less than 5%

Defensive low-volatility sectors (utilities, telecom and consumer staples) have outperformed, but this trend

may be changing

Russell 1000 Growth, Russell Midcap Growth, and Russell 2000 Value appear to have the most attractive valuations

Information technology and health care are the industry sectors with the most attractive valuations

S&P 500 earnings should rebound in 2017 and 2018, reflecting a sharp improvement in energy; however, analyst

projections have not been accurate, so some caution is warranted

Earnings dispersion by industry is notable, with information technology and health care screening well


20

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The views contained herein are as of November 2016 and may have changed since that time.


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2017 market outlook - u.s. equity

Economy & Finance