svb asset management economic book q4 2013
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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
SVB Asset Management | Quarterly Economic Report Q4 2013
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)
SVB Asset Management | Quarterly Economic Report Q4 2013
-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.
7 SVB Asset Management | Quarterly Economic Report Q4 2013
-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.
8 SVB Asset Management | Quarterly Economic Report Q4 2013
-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.
9 SVB Asset Management | Quarterly Economic Report Q4 2013
-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.
10 SVB Asset Management | Quarterly Economic Report Q4 2013
-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.
11 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
12 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
13 SVB Asset Management | Quarterly Economic Report Q4 2013
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
14 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
15 SVB Asset Management | Quarterly Economic Report Q4 2013
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
17 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
18 SVB Asset Management | Quarterly Economic Report Q4 2013
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
19 SVB Asset Management | Quarterly Economic Report Q4 2013
$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
20 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
22 SVB Asset Management | Quarterly Economic Report Q4 2013
-$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.
24 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
SVB Asset Management | Quarterly Economic Report Q4 2013 25
-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
SVB Asset Management | Quarterly Economic Report Q4 2013 26
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.
27 SVB Asset Management | Quarterly Economic Report Q4 2013
$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.
28 SVB Asset Management | Quarterly Economic Report Q4 2013
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
SVB Asset Management | Quarterly Economic Report Q4 2013 29
$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
SVB Asset Management | Quarterly Economic Report Q4 2013 30
$0.0
$500.0
$1,000.0
$1,500.0
$2,000.0
Issu
ance
($ in
Bill
ions
)
Leverage I-Grade Other
70
75
80
85
90
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
SVB Asset Management | Quarterly Economic Report Q4 2013 32
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
SVB Asset Management | Quarterly Economic Report Q4 2013 33
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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.
34 SVB Asset Management | Quarterly Economic Report Q4 2013
6
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Y/U
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.
35 SVB Asset Management | Quarterly Economic Report Q4 2013
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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
SVB Asset Management | Quarterly Economic Report Q4 2013 36
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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
38 SVB Asset Management | Quarterly Economic Report Q4 2013
$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.
39 SVB Asset Management | Quarterly Economic Report Q4 2013
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.
SVB Asset Management | Quarterly Economic Report Q4 2013
European Money Markets The EU Speed bump
41 SVB Asset Management | Quarterly Economic Report Q4 2013
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 jschnitz@svb.com
Chief Investment Officer
Joe Morgan, CFA jmorgan@svb.com
Head of Credit Research
Melina Hadiwono, CFA mhadiwono@svb.com
Portfolio Managers
Eric Souza esouza@svb.com Paula Solanes psolanes@svb.com Renuka Kumar, CFA rkumar@svb.com Jose Sevilla jsevilla@svb.com
Credit and Risk
Sook Kuan Loh, CFA sloh@svb.com Tim Lee, CFA tlee@svb.com Kyle Balough kbalough@svb.com
Silicon Valley Bank Partners
Susan Winters Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman
Head of Portfolio Management
Ninh Chung nchung@svb.com
SVB Asset Management | Quarterly Economic Report Q4 2013
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
43 SVB Asset Management | Quarterly Economic Report Q4 2013
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