morningstar markets observer...qmo5 equities s&p 500 russell 2000 msci eafe msci emerging markets 12...

Morningstar®Markets Observer2nd Quarter 2015Data as of March 31, 2015

Table of Contents

Market Overview 4

Equities 13

Fixed Income 21

Funds 26

Economic Indicators 36

Robert Johnson, CFA — Director of Economic Analysis

Timothy Strauts — Markets Research Manager

Alina Lamy — Senior Markets Research Analyst

Roland Czerniawski — Markets Research Analyst

Summer Bornman — Senior Production Designer

Morningstar® Markets Research Team

Mar

ket O

verv

iew

QMO5

Equities

S&P 500

Russell 2000

MSCI EAFE

MSCI Emerging Markets

12 Mo. Yield

U.S. Aggregate

U.S. Corporates

High Yield

Municipals

Emerging Markets

1.9

1.3

2.9

2.7

2.1

3.0

6.6

2.0

5.6

Bloomberg Commodity

Morningstar Commodity

YTD

1.0

4.3

4.9

2.2

1.6

2.7

2.5

1.0

2.0

–5.9

–6.0

3 Mo

1.6

2.7

2.5

1.0

2.0

–5.9

–6.0

1.0

4.3

4.9

2.2

1 Yr

5.7

7.1

2.1

6.6

5.6

–27.0

–33.2

12.7

8.2

–0.9

0.4

3 Yrs

3.1

5.5

7.5

4.1

5.4

–11.5

–12.1

16.1

16.3

9.0

0.3

5 Yrs

4.4

7.1

8.4

5.1

7.1

–5.7

–2.8

14.5

14.6

6.2

1.7

Return (%)

Broad Commodities

Fixed Income Curr. Yield

P/E

19.1

20.9

17.9

14.0

Brent Crude Oil

Gold

P/B

2.8

2.3

1.7

1.6

107

1,292

P/S P/C

Fundamental Measures

Interest Rates

Commodities

2 Yr Treasury

5 Yr Treasury

10 Yr Treasury

20 Yr Treasury

Prime Rate

Current

55

1,187

1.8

1.3

1.1

1.3

0.6

1.4

1.9

2.5

3.3

1 Yr Ago

11.8

11.9

9.4

8.4

0.4

1.7

2.7

3.6

3.3

Return (%)

> 20

10 to 20

0 to 10

–10 to 0

–20 to –10

< –20

5–Year ReturnValue Blend Growth

Sm

all

Mid

Larg

e

11.7

15.2

15.0

15.1

17.8

14.9

15.9

16.2

16.2

Return (%)

> 20

10 to 20

0 to 10

–10 to 0

–20 to –10

< –20

1–Year ReturnValue Blend Growth

Sm

all

Mid

Larg

e

5.6

9.2

9.3

12.0

15.4

9.4

20.1

15.7

10.5

3–Month ReturnValue Blend Growth

Sm

all

Mid

Larg

e

–1.4

1.7

2.4

–1.3

4.4

4.2

4.9

7.4

6.7

Return (%)

> 8

4 to 8

0 to 4

–4 to 0

–8 to –4

< –8

Market DashboardAll the major equity and fixed-income indexes posted positive returns so far in 2015. On the equity side, developed international stocks led the way, followed by U.S. small caps. Credit spreads tightened, which landed corporate and high-yield bonds in the top fixed-income spots. Commodities continued their downfall, and large-value and blend stocks were the only style box categories to suffer this past quarter.

Source: Morningstar Direct. U.S. Aggregate—Barclays U.S. Aggregate Bond Total Return, U.S. Corporates—Barclays U.S. Corporate 5-10 Year Total Return, High Yield—Bank of America Merrill Lynch U.S. High Yield Master II Total Return, Municipals—Barclays Municipal Total Return, Fixed Income Emerging Markets—JPMorgan EMBI Global Diversified Total Return, Gold—London Fix Gold PM Price Return. © 2015 Morningstar. All Rights Reserved. 5

1930’s 1940’s 1950’s 1960’s 1970’s 1980’s 1990’s 2000’s

0.1

1

10

5

Gray bars represent recessions

35 10

151 months

9 21 18

3749

1650.9%36.2%

44 months193.3% total return34.1% annualized

34 months–83.4%

6–21.8%

6–22.3% 19

–29.3%21–42.6%

3 –29.6%

25–44.7% 16

–50.9%

6785.9%11.7%

2124.0%13.1%

1214.6%14.6%

3656.6%16.1%

146697.7%18.6%

134434.5%16.2%

135523.2%17.7%

An Expansion measures subsequent market performance

from the end of the recovery until it reaches the next peak

level before another 20% decline.

A Recovery is represented as the number of months

from the bottom of a contraction to when the

market reaches the level of its previous peak again.

A Downturn is defined by a decline in the

stock market from its peak by 20% or more.

QMO6

U.S. Market Downturns, Recoveries, and ExpansionsThere have been 8 market downturns since 1926, the most severe one being, without doubt, the Great Depression. More recently, during the “lost decade,” two consecutive downturns with little to no expansion all but discouraged U.S. investors. However, the market returned an impressive 56.6% since the expansion started in March 2012 and, as the chart illustrates, there is ample potential for future growth.

Source: Stocks—Ibbotson Associates SBBI U.S. Large Stock Index. © 2015 Morningstar. All Rights Reserved.

6

Apr 2014 Jul 2014 Oct 2014 Jan 2015

• Developed-markets stocks ex US• U.S. bonds• U.S. stocks • Commodities• Emerging-markets stocks

–40

–20

–30

–10

0

10

20% Return

QMO1

Trailing 12-Month Performance of Major Asset ClassesDespite increased volatility, U.S. stocks performed well over the past year, substantially outperforming all other asset classes. Commodities posted a substantial loss over the last nine months, as oil prices registered a dramatic decline. International developed- and emerging-markets stocks had strong local-currency returns this past quarter, but a strong dollar limited the upside for unhedged U.S. investors.

Source: U.S. stocks—Morningstar U.S. Market Index. Developed-markets stocks ex-U.S.—Morningstar Developed Markets ex-U.S. Index. Emerging-markets stocks—Morningstar Emerging Markets Index. U.S. bonds—Morningstar Core Bond Index. Commodities—Morningstar Long-Only Commodity Index. © 2015 Morningstar. All Rights Reserved.

7

QMO4

0.8

5.1

1.3

–2.0

–2.2

7.7

U.S. Market

Basic Materials

Cons. Cyclical

Cons. Defensive

Energy

Financial Services

Health Care

Industrials

Real Estate

Technology

Utilities

–15% Return –10 –5 0 105 15 20 25 30

0.8

2.8

16.6

17.7

28.2

8.1

9.8

22.9

17.3

10.9

–12.3

4.6

1.5

–4.6

• Trailing quarter

• Trailing 1 year12.61.8

U.S. Sector PerformanceAfter the collapse of energy prices in the fourth quarter of 2014, the sector somewhat stabilized at the beginning of the year, but still posted a negative return. The health-care sector continued its winning streak, mainly driven by biotech and medical insurance companies. Real estate was another winner, while utilities suffered this quarter.

Source: Morningstar Sector Indexes. © 2015 Morningstar. All Rights Reserved.

8

QMO3

Europe

ex UK

UK Asia

ex Japan

Japan Developed

International

Middle East

& Africa

EM Asia Latin

America

Eastern

Europe

Emerging

Markets

Emerging MarketsDeveloped Markets

–25

10

–20

–15

–10

–5

15% Return

0

5

10.1

5.4

–9.8

• Trailing quarter

3.33.2

–0.5

• Trailing 1 year

5.1

–5.5

11.9

–21.0

–1.6

–5.5

10.6

5.4

–1.8

2.6 1.9

3.8 3.9

–19.0

International Stock Market PerformanceEurope’s QE finally pushed performance into positive territory in the first quarter, but strong local-currency returns were tempered by a strong U.S. dollar. An economy reliant on commodities and systemic problems such as corruption derailed Brazil over the last year. China continued to post strong performance, driven by local investors transferring assets from real estate into the stock market.

Source: Morningstar Indexes. © 2015 Morningstar. All Rights Reserved.

9

QHF1

Derivatives

Relative Value

Event

Directional

equity/debt

Morningstar MSCI Composite AW

Multistrategy

Global macro

Volatility

Systematic futures

Currency

Equity market neutral

Debt arbitrage

Convertible arbitrage

Diversified arbitrage

Merger arbitrage

Event driven

Distressed securities

Long/short debt

Asia/Pacific long/short equity

EM long/short equity

Europe long/short equity

U.S. small cap long/short equity

U.S. long/short equity

Global long/short equity

• Trailing quarter • Trailing 1 year

–15% –10 –5 0 5 10 15

2.6

–0.8

1.6

–4.0

3.5

–0.3

–3.2

–2.1

–6.1

–2.4

–0.4

–1.0

–3.8

–2.7

0.0

–0.5

–0.6

1.2

–0.8

–0.9

–13.1

–1.3

7.3

3.2

–12.7

2.8

–1.0

–1.7

–2.0

–3.9

–3.3

–8.0

–3.8

0.3

2.4

–8.8

–5.4

–0.9

–2.4

14.2

Hedge Fund Category ReturnsMost hedge-fund categories performed poorly in the first quarter. Systematic futures was the winner for the last three months and for the year, as this strategy probably took advantage of oil price volatility to boost returns. Despite increased volatility in both U.S. and global markets, it seems most hedge funds failed to capitalize on available opportunities.

Source: Morningstar Hedge Fund Database. Category returns as of February 2015. © 2015 Morningstar. All Rights Reserved.

10

QAA1

Lowest

return

Highest

return

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

• Intermediate-term government bonds• Intermediate-term corporate bonds

• International-developed stocks• Emerging-market stocks

• High-yield bonds • Moderate portfolio• Commodities• Large stocks

• Small stocks

EntirePeriod

2015 YTD

4.4

4.0

2.6

2.5

2.1

1.7

1.4

0.8

–6.0

9.3

7.5

7.5

6.7

6.0

5.8

5.7

4.0

3.5

42.2%

12.3

9.7

7.7

1.7

–5.9

–10.7

–11.4

–36.0

10.8

8.5

5.3

5.3

3.8

–2.5

–15.1

–20.5

–23.1

34.0

13.5

11.1

–1.4

–3.8

–6.7

–13.8

–20.4

–23.5

52.4

47.7

41.2

29.0

27.0

24.7

22.5

7.9

2.7

24.8

21.7

20.4

17.6

11.5

11.1

9.5

4.9

3.0

33.9

25.5

15.3

7.0

5.8

4.9

2.7

1.1

0.7

35.6

25.1

17.0

15.9

13.0

11.8

4.9

3.6

–0.2

38.3

31.8

12.1

10.3

8.6

6.7

6.0

1.9

–0.7

14.1

–3.2

–22.2

–26.2

–33.8

–36.1

–36.2

–43.4

–53.2

79.6

58.2

37.7

35.2

24.8

21.8

20.9

19.5

–1.4

28.4

23.6

21.1

15.1

13.4

12.3

11.2

8.5

7.1

9.4

5.2

5.0

2.6

0.6

–2.6

–5.3

–12.0

–18.8

19.0

17.4

16.5

16.0

15.8

12.0

11.2

3.7

2.5

37.9

31.8

22.0

14.3

7.4

0.6

–1.8

–2.7

–3.7

13.6

6.9

4.9

4.5

3.9

2.5

–0.8

–3.9

–24.4

Asset-Class Winners and LosersIn the first quarter, international developed- and emerging-market stocks more than bounced back from a poor 2014. In terms of USD-translated returns, these international categories landed in second and third place, but in terms of local-currency returns their performance was even stronger. Commodities didn’t show any signs of improving their dismal performance pattern of the last four years.

Source: Small stocks—Morningstar Small Cap Index. Large stocks—Morningstar Large Cap Index. International-developed stocks—Morningstar Developed Mkts ex-U.S. Index. Emerging-market stocks—Morningstar Emerging Mkts Index. Intermediate-term govt bonds—Morningstar Interm. U.S. Govt Bond Index. Intermediate-term corp. bonds—Morningstar Interm. Corp. Bond Index. High-yield bonds—Barclays U.S. High Yield Corp. Bond Index. Commodities—Morningstar Long-Only Commodity Index. © 2015 Morningstar. All Rights Reserved. 11

0

1

2

20142002 201120082005

QAA2

$3

1999

$2.83$2.75

$2.33• U.S. stocks• U.S. bonds

Conservative

80%

20%

Aggressive

95%

5%

Moderate

61%

39%

Conservative portfolio

Moderate portfolio

Aggressive portfolio

0.6

1.4

2.2

2.2

4.2

5.4

3.5

8.1

11.7

4.8

8.3

10.8

4.9

6.8

7.6

Trailing

Quarter

Trailing

1 Year

Trailing

3 Years

Trailing

5 Years

Trailing

10 Years

Total Return (%)

3.8

9.3

14.9

Risk

Performance of Risk-Based PortfoliosAs expected, an aggressive portfolio with a larger allocation to stocks was able to deliver superior returns than its moderate and conservative counterparts over all time periods analyzed. However, it did so while assuming a greater risk level. Nevertheless, a multi-asset portfolio may be a better idea than a single-asset portfolio that has no exposure to a diversifying asset class.

Source: Conservative portfolio—Morningstar Conservative Target Risk Index. Moderate portfolio—Morningstar Moderate Target Risk Index. Aggressive portfolio—Morningstar Aggressive Target Risk Index. Returns for periods longer than 1 year are annualized. © 2015 Morningstar. All Rights Reserved.

12

Equi

ties

150% Overvalued

100

50

0

–50

–100 Undervalued

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

• 90–95 percentile• 75–90 percentile• 50–75 percentile• 25–50 percentile• 10–25 percentile

– Median– Fair Value

• 5–10 percentile

QQE1

Morningstar Price to Fair Value Distribution, U.S. EquityThe distribution of Price to Fair Value can yield a richer interpretation of market valuation than simple averages. At times, the median U.S. stock may be slightly overvalued, but the extent of the overvaluation can be substantial. Today, U.S. equities appear to be fairly valued on a median basis, with a narrow distribution by historical standards. However, the distribution has widened slightly in the last six months.

Source: Morningstar quantitative and analyst fair value data. © 2015 Morningstar. All Rights Reserved.

14

Total Market

Style Uncertainty

Value

< –10 –10 to –5 –5 to 0 0 0 to 5 5 to10 > 10

Blend Growth

Sm

all

Mid

Larg

e

1.1%

–0.3

6.1

2.5

–4.1

–5.9

0.7

–0.8

2.8

1.7

6.6

3.6

4.6

3.0

10.2

4.7

Low Medium High

Non

eN

arro

w

Wid

e

–0.6

4.0

–1.3

4.1

2.7

6.4

9.9

1.8

–1.2

6.9

0.0

–4.1

–11.3

–0.4

–4.3

Undervalued Fairly valued Overvalued

Moat

Siz

e

QQE4

Morningstar Price to Fair Value, U.S. Equity Style BoxesThe current market is fairly valued, at 1.1% on a market-cap weighted basis. The most undervalued opportunities appear to be in large and small value in the size/style box, and in high uncertainty across the board in the moat/uncertainty box. After a five-year bull market and with rising interest rates looming in 2015, investor sentiment seems to veer toward lower risk equities.

Source: Morningstar quantitative and analyst fair value data. Style boxes based on market-cap weighted data. © 2015 Morningstar. All Rights Reserved.

15

–45

–30

–15

0

30% Overvalued

15

0

25

50

100%

75

Basic

Materials

Comm

Services

Consumer

Defensive

Energy Financial

Services

Healthcare Industrials Real Estate Technology UtilitiesConsumer

Cyclical

• Overvalued

• Fairly valued

• Undervalued

Percentiles

90th

75th

25th

10th

Median

Market Cap Weighted Avg

QQE2

Morningstar Price to Fair Value Distribution by U.S. SectorAmong U.S. equity sectors, energy and healthcare were the two most undervalued at the median (basic materials also, but to a lesser extent). Market-cap weighted averages, however, can paint a different picture. In the healthcare sector, most large companies appear to be overvalued, pushing the market-cap weighted average up while the median stays low.


16

–40*

0

–20

North America Latin America UK & Ireland Africa India, Pak &

Middle East

Asia Pacific Australia &

New Zealand

Europe

20%Overvalued

*Undervalued

QQE3

Percentiles

90th

75th

25th

10th

Median

Market Cap Weighted Avg

Top 10 Most Undervalued Countries (Market Cap Weighted)

Country

Iraq

Greece

Bangladesh

Egypt

Nigeria

Saudi Arabia

Pakistan

Qatar

United Arab Emirates

Vietnam

Undervalued By (%)

–17.3

–11.8

–11.2

–10.6

–8.9

–7.6

–7.1

–4.5

–4.0

–3.9

UncertaintyRating

Very High

Very High

Very High

Very High

Very High

Very High

Very High

High

High

High

Number ofCompanies

43

59

267

158

70

156

326

39

47

231

Top 10 Most Overvalued Countries (Market Cap Weighted)

Country

China

Germany

Ireland

Italy

Finland

Denmark

Netherlands

Japan

Sweden

Norway

Overvalued By (%)

21.5

16.1

14.6

13.5

11.0

9.3

8.4

8.2

7.1

6.9

UncertaintyRating

High

High

Medium

High

High

High

Medium

High

Medium

High

Number ofCompanies

2,179

484

21

234

105

123

93

3,459

367

155

Morningstar Price to Fair Value Distribution by RegionThe strong stock-market rally in Europe, driven by the ECB’s QE efforts, pushed valuations into overvalued territory for most European countries. For example, Germany’s valuation increased to 16.1% from 4.4% last quarter. Strong equity-market performance (beginning to display worrisome bubble-like tendencies) maintained China at the top of the overvalued list.


17

QQE5

Overvalued/Undervalued (%)

Market Cap Weighted

>5.01.1 to 5.0 < –5.0

Undervalued Overvalued

Greater Asia 9.7

–5.0 to –1.1 –1.0 to 1.0

Fairly Valued

U.S. 1.1 Greater Europe 7.9

United States 1.1

Chile 0.8

Brazil 2.2

South Africa 3.9

Finland 11.0 Russia –0.7

Canada 4.4

Portugal 4.9

Norway 6.9

U.K. –0.7

Spain 0.6

China 21.5

Japan 8.2

South Korea 1.2

Vietnam –3.9

Thailand 1.9

India 3.4

New Zealand 2.5

Australia –2.4

Countries not highlighted

Mexico 4.8

France 6.8

Germany 16.1

Sweden 7.1

Morningstar Price to Fair Value by CountryThe U.S. stock market remained relatively tame during the first quarter, but most of the world has rallied. The rise in global equity markets might have gone unnoticed by many unhedged U.S. investors because of the rapid rise of the U.S. dollar at the same time. However, U.S. investors should be aware that most of the world now appears overvalued and does not present as many attractive opportunities.


18

2002 2004 2006 2008 2010 2012 2014

–25

–5

–10

–15

–20

0

25%

20

15

10

5

Excess Return of International Stocks versus U.S. Stocks, Rolling 12 Months • International stocks outperform • U.S. stocks outperform

QE4

International stocks

U.S. stocks

3.5

1.8

–1.0

12.6

7.1

16.4

TrailingQuarter

Total Return (%) Trailing1 Year

Trailing3 Years

U.S. Versus International Stock PerformanceFor most of the 2000–2010 “lost decade,” international stocks outperformed. However, U.S. stocks have retaken and maintained the performance lead since mid-2010. Over the past three years, U.S. stocks have outperformed by 9.3% on an annualized basis. This outperformance was caused by an improving U.S. economy, a strong U.S. dollar, and economic weakness in the rest of the world.

Source: U.S. stocks—Morningstar U.S. Market Index. International stocks—MSCI ACWI ex-U.S. Index. © 2015 Morningstar. All Rights Reserved.

19

• Buyback yield • Dividend yield • Total yield• Buybacks • Dividends paid

20142003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0

200

400

600

800

$1000 bil

0

2

4

6

8

10%

Yield

S&P 500 Dividends and Buybacks, Trailing 12 months

QE5

Total Yield of S&P 500 Close to 5%Companies can reward investors by paying out dividends or—an option sometimes forgotten—buying back their own stock. Dividend yield has been fairly stable over time at about 2%. Buyback yield has fluctuated a lot more because companies are not compelled to maintain buybacks during tough economic times. The buyback yield has been accelerating over the last year and a half and currently stands at 2.8%.

Source: Morningstar Equity Data. © 2015 Morningstar. All Rights Reserved.

20

Fixe

d In

com

e

4.0%

0

0 years 5 20 301510

3.5

3.0

2.5

2.0

1.5

1.0

0.5

25

Current 1 year ago

1–Year Return

Barclays US Aggregate Bond Index 5.7

10 Year US Treasury Bonds 8.9

20+ Year US Treasury Bonds 23.3

US Corporate Bonds 6.5

US High Yield Bonds 2.0

US Mortgage Bonds 6.0

USD EM Bonds 4.4

Local Currency EM Bonds –8.6

%

QFI6

Long-Term Interest Rates Declined Over the Past YearDuring the past year, the U.S. Treasury yield curve steepened at the short end and flattened at the long end, reflecting investors’ expectations that short-term rates will rise and that inflation will stay below average in the long term. In the first quarter, long-term rates continued to decline, despite expectations to the contrary. Long-duration, low-credit-risk bonds posted the strongest returns.

Source: 10-Year US Treasury Bonds—Barclays US Treasury 7-10 Year Bond Index. 20+ Year US Treasury Bonds—Barclays US Treasury 20+ Year Bond Index. US Corporate Bonds—Morningstar Corporate Bond Index. US High Yield Bonds—Barclays US Corporate High Yield Bond Index. US Mortgage Bonds—Morningstar Mortgage Bond Index. USD EM Bonds—Morningstar EM Composite Bond Index. Local Currency EM Bonds—Barclays EM Local Currency Broad Bond Index. © 2015 Morningstar. All Rights Reserved. 22

8% Yield

7

4

3

6

5

2

1

0

2005 2007 2009 2011 2013 2015

FranceJapanGermany

Italy

QFI10

U.S.

Last quarter

Last 1 year

Last 3 years

–0.7

–2.1

–3.8

–0.2

–0.7

–0.1

–0.4

–1.6

–2.4

–0.4

–1.3

–1.6

0.1

–0.2

–0.6

ItalyYield Difference U.S. France Germany Japan

World 10-Year Government Bond YieldsSince the European Central Bank began implementing quantitative easing measures, interest rates have collapsed across European countries, with Germany’s rates now plunging below Japan’s. The U.S., on the other hand, is dialing back its stimulus efforts, which may result in rates climbing in the near future. Comparatively higher rates will make U.S. Treasuries more attractive for international investors.

Source: OECD, investing.com, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

23

20%

5

10

15

0

2005 2007 2011 20132009 2015

Corporate Credit Spreads

AAA

BBB

High Yield

0.7%

1.8

4.8

0.8

2.1

5.8

Current

0.0

–0.2

–0.2

Change OverLast Quarter

Average

QFI9

Corporate Credit SpreadsAll corporate credit spreads spiked in 2007–2009 during the financial crisis, but have generally been on the decline since then. All spreads are still below their long-term averages, but not by much. After increasing last year in the fourth quarter, spreads tightened slightly in the first quarter of 2015.

Source: Federal Reserve, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

24

QFI8

Lowest

return

Highest

return

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

• Intermediate-term gov’t• Long-term gov’tBonds:

2014

• Long-term corp • Short-term

• Municipal • International

• Emerging-market • High-yield

• Bank loans• Aggregate

19.2%

14.4

12.3

11.8

11.7

9.7

8.6

4.9

–1.3

–5.9

11.7

9.1

8.5

8.5

5.3

5.2

5.1

4.2

1.4

–3.0

24.8

16.7

13.5

13.1

10.8

10.4

9.6

7.3

1.9

–1.4

29.0

25.7

18.7

10.2

10.0

5.3

4.0

3.2

2.7

2.4

14.6

11.7

11.1

8.0

6.9

5.2

4.5

4.5

3.0

1.5

10.7

5.1

5.0

3.5

2.7

2.7

2.5

1.6

1.1

–7.3

11.8

9.9

6.8

6.7

4.8

4.3

4.1

4.1

3.6

2.2

10.8

10.3

9.9

7.4

7.3

6.3

4.3

3.4

2.1

1.9

20.7

14.1

10.3

7.6

5.0

–2.5

–3.5

–10.9

–26.2

–29.1

58.2

51.6

28.2

20.2

12.9

4.6

4.2

4.2

–1.4

–9.2

15.1

12.0

11.1

10.1

9.4

7.1

6.3

5.8

3.5

2.4

22.7

11.8

10.7

9.4

8.5

8.0

6.9

5.0

2.3

1.5

18.5

15.8

13.4

9.7

6.8

4.4

3.9

3.5

2.5

1.7

7.4

5.3

0.6

–1.9

–2.6

–2.7

–4.5

–4.5

–6.6

–9.9

18.2

12.8

9.1

6.1

5.5

3.9

2.5

2.0

1.6

1.0

EntirePeriod

2015 YTD

3.4

2.8

2.5

2.1

2.1

1.7

1.6

1.0

0.7

–3.2

9.4

8.1

7.9

7.5

5.9

5.7

5.5

5.5

5.1

4.0

Fixed-Income Winners and LosersInterest rates rose in 2013, so short duration categories like high-yield, bank loans, and short-term bonds posted the only positive returns. In 2014, interest rates declined, so the longer duration categories were the top performers. In the last quarter, long-duration categories performed best because of declining interest rates, and high-credit-risk categories performed well because of tightening credit spreads.

Source: Long-term gov’t—Morningstar LT U.S. Gov’t Bond Index. Intermediate-term gov’t—Morningstar IT U.S. Gov’t Bond Index. Long-term corp—Morningstar LT Corp Bond Index. Short-term—Morningstar Short-Term Core Bond Index. Municipal—Barclays Municipal Bond Index. International—Citigroup WGBI Non-USD 5+ Year Bond Index. Emerging-market—JPM EMBI Global Bond Index. High-yield—Barclays U.S. Corp High Yield Bond Index. Bank loans—S&P/LSTA Leveraged Loan Index. Aggregate—Morningstar Core Bond Index. © 2015 Morningstar. All Rights Reserved.

25

Fund

s

Jan 2013 Apr 2013 Jul 2013 Oct 2013 Jan 2014 Apr 2014 Jul 2014 Oct 2014 Jan 2015

Cumulative Flows Since January 2013

–100

100

0

$400 bil

200

300

Total Net Asset Distribution as of March 2015

Total net assets: $13,638 billion

• International equity

• Allocation

• U.S. equity

• Alternatives + Commodities

• Bond

QFF6

45%

17%

26%

9%

2%

International-Equity Funds Most Popular Category Since January 2013In terms of cumulative flows, investors pooled the largest sums into international-equity funds, attempting to take advantage of lower valuations and faster growth opportunities outside the United States. In the last quarter, bond and international-stock flows accelerated, and U.S. equity flows flatlined.

Source: Morningstar Direct. © 2015 Morningstar. All Rights Reserved.

27

$600 bil

200

400

0

–200

2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD

• Alternatives + Commodities • International equity • Allocation • Bond • U.S. equity

QFF1

Annual Asset FlowsFrom 2009 to 2012, fixed income got the great majority of investor money. That trend switched in 2013 and 2014, as U.S. and international stock categories received strong investor flows. So far in 2015, investors preferred bonds and international stocks while avoiding U.S. stocks.

Source: Morningstar Direct. Funds analyzed include U.S. open-end mutual funds and ETFs. © 2015 Morningstar. All Rights Reserved.

28

–200

–100

0

100

200

300

$400 bil

1994 1997 2000 2003 2006 2009 2012 2015

• Taxable bond • U.S. equityRolling 12-Month Fund Flows

QFF2

Bond Versus Equity Fund FlowsInvestor behavior is tied to market performance, but the timing may not always be right. In 2009, as the stock market hit bottom, investors should have been buying cheap stocks, but bond funds received massive flows instead. In 2013, there was a sharp reversal in stock and bond flows as the market expected interest rates to rise. In 2014, the trend reversed one more time, with stock inflows down and bond inflows up.

Source: Morningstar Direct. Funds analyzed include U.S. open-end mutual funds and ETFs. © 2015 Morningstar. All Rights Reserved.

29

–20

–10

0

10

20

$30 bil

Jan 13 Apr 13 Apr 14Oct 13 Jan 14Jul 13 Jul 14 Oct 14

–20

–10

10

0

$20 bil

Taxable Bond Active Versus Passive Fund Flows, 3-Month Average

U.S. Equity Active Versus Passive Fund Flows, 3-Month Average • U.S. Equity, Active • U.S. Equity, Passive

Jan 15

• Taxable Bond, Active • Taxable Bond, Passive

QFF5

Flows into Passively-Managed Funds on the RiseIn recent years, passively-managed funds have become increasingly popular and started attracting a larger portion of investor money than their actively-managed counterparts, especially in the U.S.-equity category. Investors now appear to display a marked preference for passive, lower-cost mutual funds and ETFs.


30

QFF8

• Index funds

$350 billion

300

250

200

150

100

50

0

(50)Equity

U.S. Cross-border Europe Asia

Fixed

Income

Equity Fixed

Income

Equity Fixed

Income

Equity Fixed

Income

• Non-index funds

2014 Global Flows, Active Versus PassiveIn the U.S., passive flows dominated active flows in both the equity and the fixed-income space. The passive investing trend for equity funds is just starting to catch on in Europe and Asia as well, although the flows are much smaller. One would expect the passive investing trend to begin in equity and then shift toward fixed income a few years down the road. Right now, Europe and Asia appear to follow this pattern.

Source: Morningstar Direct. Funds classified as cross-border are domiciled in tax havens such as Luxembourg and Ireland and are distributed in many markets, primarily in Europe, but also in Asia, Latin America and the Middle East. © 2015 Morningstar. All Rights Reserved.

31

20

40

60

80

10020% of Assets Rated

4 Stars or Better

4030 50 60 70 80 90

More highly rated fundsFewer highly rated funds

More expensive

Less expensive

QMF3

100% Share Classes

Below Average Fee Level

Oppenheimer

Fidelity

JP Morgan

Franklin Templeton

Janus Lord Abbett

BlackRock

MFS

John Hancock

Wells Fargo Advantage

Invesco

Columbia American Century

American Funds

DFAVanguard

T. Rowe Price

PIMCO

Principal Funds

Dodge & Cox

Top 20 Mutual Fund Companies by AssetsThere is a clear relationship between fees and performance. Firms with high fees have below-average performance and are located in the bottom-left-hand side of the chart. Firms with low fees have a higher likelihood of above-average performance, but it isn’t guaranteed. The two best firms, by these metrics, are Dodge & Cox and Vanguard.


32

0% 20 40 60 80 100 120

In terms of trailing-12-month organic growth rate,

the top 10 fund families among the 100 largest

Category Assets ($billion)

Metropolitan West

Baird

WisdomTree

Schwab ETFs

First Trust

DoubleLine

Parnassus

PrimeCap Odyssey

Guggenheim

Dodge & Cox

Intermediate-Term Bond


Europe Stock

Large Blend

Consumer Cyclical


Large Blend

Large Blend

Large Blend


63.9

8.1

17.3

4.9

2.4

45.6

12.1

4.3

11.2

43.5

TTM Organic Growth Rate

Top fund for

each family

Metropolitan WestTotal Return Bond

Baird Core Plus Bond

WisdomTree EuropeHedged Equity ETF

Schwab U.S. BroadMarket ETF

First Trust ConsumerDiscret AlphaDEX ETF

DoubleLine TotalReturn Bond

Parnassus Core Equity

PrimeCap Odyssey Stock

Guggenheim S&P 500®

Equal Weight ETF

Dodge & Cox Income

110

95

65

63

50

48

37

31

29

23• Contribution of top-flowing fund

QFF7

Fastest-Growing Fund FamiliesWithdrawals from PIMCO Total Return fund drove most of the inflows within the intermediate-term bond category. The beneficiaries included MetWest, Baird, DoubleLine, and Dodge & Cox. ETF firms are growing rapidly, with WisdomTree, Schwab ETFs, First Trust, and Guggenheim all in the top ten.


33

Allocation

Commodities

International Equity

U.S. Equity

U.S. Sector Equity

Taxable Bond

Municipal Bond

–0.3

–0.4

–0.2

–0.1

–0.6

–0.7

–0.5

–7.6

–3.3

–8.4

–7.9

–6.5

–7.3

–5.5

8.2

3.8

4.8

7.3

7.1

7.7

5.5

1

0

0

0

0

0

0

19,649

2,934

20,732

27,825

47,443

78,278

64,421

70%

0%

31%

34%

77%

87%

97%

1.9

–1.2

2.5

1.2

–1.0

2.2

1.7

5.0

–12.6

2.7

6.5

3.0

3.8

12.5

3 Year Z-

Statistic

Broad

Category

Current

Avg.

Discount (%)

Avg.

Distribution

Rate (%)

Number of

IPOs in

2015

Total

Assets

($ mil)

% of

Funds Using

Leverage

3 Month

Total

Return (%)

1 Year

Total

Return (%)

–4

–2

0

2

3 Year Z-Statistic of Taxable Bond Universe

2012 20141990 1992 1994 1996 1998 2000 2002 2004 2006 20102008

Selling Opportunity

Buying Opportunity

QCEF1

Closed-End Funds Trading at Above Average DiscountsAll closed-end fund categories are currently trading below fair value, but discounts have tightened for bond categories and widened for equity categories during the last quarter. Taxable bonds and U.S. sector equity offer the most attractive opportunities, based on their 3-year z-scores. As you can see in the chart, buying below −1 and selling above 1 has historically been a good strategy.

Source: Morningstar Direct. The z-statistic result is the number of standard deviations away from the average discount over the time period measured. Z-statistic = (Current discount–Average discount)/Standard deviation of discount. © 2015 Morningstar. All Rights Reserved.

34

$10,000

1,000

100

10

1

0.10

1926 1936 1946 1956 1966 1976 1986 1996 2006

$5,317

$2

$80

$23

$135

$1,055

Growth of $1

QMF6

Stocks

Bonds

10.1

5.7

8.1

3.6

5.1

0.6

NominalCompound Ann Ret (%) After Taxes After Taxes & Inflation

U.S. Stocks and Bonds Before and After Taxes and InflationOver the long run (1926–2014), the adverse effect of taxes and inflation on investment returns can become especially pronounced. Investors lost approximately 5% annually to taxes and inflation, which can make a dramatic difference over time. A larger allocation to stocks, or tax-deferred investment vehicles, are possible options for investors seeking real long-term growth.

Source: Stocks—Ibbotson Associates SBBI U.S. Large Stock Index. Bonds—20-year U.S. government bond. Inflation—Consumer Price Index. Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $110,000 in 2010 dollars every year. © 2015 Morningstar. All Rights Reserved.

35

Econ

omic

Indi

cato

rs

GDP Breakdown: $16294.7 billion

–2.9% Net Exports

68.2% Consumption

17.0% Investment

17.8% Government

GDP Growth Contributions: 2.2% total growth

–0.4% Government

0.6% Investment

3.0% Consumption

–1.0% Net Exports

Mar 2012 Jun Sep Dec Mar 2013 Jun Sep Dec Mar 2014 Jun Sep–2

5%

4

3

2

0

1

–1

Quarterly Annualized GDP Growth

QEI7

Dec

Q4 2014

2.2%

Growth

Q4 2015 U.S. Real GDP Back to Trend, Not Down the DrainThe halving of the GDP growth rate from 5% in the third quarter to 2.6% in the fourth quarter was a reality check for those thinking that the economy had hit escape velocity with 3%–4% growth as far as the eye could see. The full-year U.S. real GDP has been trending in the 2.0%–2.5% range for the third straight year, and this trend is likely to continue in 2015.

Source: Bureau of Economic Analysis, Morningstar Calculations. Percentage breakdowns might not add up to their totals due to rounding differences. © 2015 Morningstar. All Rights Reserved.

37

3%

0

1

–2

–3

Employment Growth Since 2010, Year-Over-Year, 3-Month Average

2010 2011 2012 2013 2014

2

–1

• Total nonfarm• Private sector

QEI13

Despite Weak Results in March, Year-Over-Year Employment Growth Still HealthyDespite the disappointing monthly nonfarm payroll data in March (only 126 thousand jobs added), the year-over-year 3-month average for nonfarm employment growth remained at 2.3%, up from 2.1% recorded at year end. Over the past 12 months, the monthly jobs added averaged 261 thousand, a pace of job creation not seen since 2000.

Source: Bureau of Labor Statistics, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

38

2001 2003 2005 2007 2009 2011 2013 2015

• Quits• Job openings • Hires

1,000

2,000

3,000

4,000

5,000

6,000

Job Openings, Quits, and Hires, Seasonally Adjusted, Thousands of Workers

QEI26

Job Openings Still on the RiseThere were 5.1 million job openings as of February 2015, a new post-recession high. Job openings continue to rise rapidly, while hiring struggles to keep up with a wide array of new job postings. This has been the trend since early 2014, reinforcing our thesis that labor scarcity issues could begin to intensify in the near future.

Source: Bureau of Labor Statistics. © 2015 Morningstar. All Rights Reserved.

39

–8

–4

0

4

8%

Year-Over-Year Change, 3-Month Average

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2015 2014

Recession

• Consumption • Wages • Disposable income

QEI3

As Wages and Incomes Edge Higher, Consumer Spending Has FollowedIncreased employment and higher wages are slowly pulling up consumption. Accelerating employment data, low gasoline prices, and an unusually high savings rate should drive consumption higher. In the short-term, consumption is the biggest driver of the U.S. economy.

Source: Bureau of Economic Analysis, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

40

2015

–4

0

4

8

12

16%

1955

Average = 3.6%

Consumer Price Index, Year-Over-Year Change, 3-Month Average

1961 1967 1973 1979 1985 1991 1997 2003 2009

0 25¢ 50¢ 75¢ $1

2003

1983

1993

Inflation-Adjusted Value, Today, of $1 From…


QEI5

Inflation Rate Declines Amid Low Commodity PricesDespite the relative health of the U.S. economy, the year-over-year 3-month average inflation rate ticked down to -0.1% in March. The slower inflation rate is primarily due to the collapse of energy prices. The lower inflation rate, while temporary, should further aid U.S. consumers.

Source: Bureau of Labor Statistics, The National Bureau of Economic Research, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

41

100%

80

60

40

20

0

–20

–40

–60

–80

–100

2010 2011 2012 2013 2014 2015

QC3

Trailing QuarterTotal Return (%) Trailing Year

Energy

Livestock

Precious metals

Industrial metals

Grains

–8.2

–9.8

1.3

–5.3

–8.2

–46.6

–13.5

–10.4

–7.6

–28.3

Commodity Prices Stabilize After Trending Down for Four YearsOutside of the precious metals category, global commodity prices have extended their losing streak into the first quarter of 2015, but stabilized by quarter end. As worldwide growth and China in particular continued to slow down, the demand for commodities, especially energy and industrial metals, suffered. Stimulus measures and an improved European economy could limit the decline going forward.

Source: Morningstar Direct. Data represented by Bloomberg Commodity Indexes. © 2015 Morningstar. All Rights Reserved.

42

$4.30

3.30

3.80

2.80

2.30

1.80

1.30

0.80

1991 1995 1999 2003 2007 2011 2015

National Average Gasoline Prices

2012 88.25

2013 97.89

2014 65.00

2015Q1 48.68

Light Crude Oil Prices at

Period Ending ($)

QEI28

Tumbling Gasoline Prices Pushed Down U.S. InflationGasoline accounts for about 5% of the Consumer Price Index. Falling gasoline prices, down 29% year-over-year in March, have taken more than a full percentage point off the index. Falling fuel prices are particularly beneficial to low-income consumers who spend a higher proportion of their incomes on gas. However, low oil prices have already had detrimental effects on oil and oil-related manufacturing industries.

Source: U.S. Energy Information Agency, Morningstar Direct. Oil data—Brent crude spot price. © 2015 Morningstar. All Rights Reserved.

43

Pacific8.2

Mountain6.5

East North Central4.8

East South Central5.7

South Atlantic4.1

MiddleAtlantic1.7

New England2.9

WestNorth Central3.3

United States5.1%

WestSouth Central7.2

Annual Price Change (%)

• Less than 0

• 0 to 2

• 2 to 5

• 5 to 10

• Greater than 10

QEI2

FHFA Home Prices Approach Goldilocks TerritoryAccording to the FHFA, U.S. home price growth stood at 5.1% year-over-year in January. It appears that the decline in the rate of home price appreciation has stopped, with prices moving back up from a low reading of 4.5% in October. We estimated home price growth in 2015 at 4%–6%. Recent inventory data and price trends suggest that the high end of this range is now more likely.

Source: Federal Housing Finance Agency. © 2015 Morningstar. All Rights Reserved.

44

5

0

10

15

20%

Sep 13 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Building Permits Versus Housing Starts—Year-Over-Year Growth, 3-Month Average • Building permits • Housing starts

Dec Jan Feb Mar 15

0

500

1,000

1,500

2,000

2,500

Housing Starts—SAAR, Thousands of Units

2000 2002 2004 2006 2008 2010 2012 2014

Housing Starts

Breakdown,

March 2005

15%

33%

67%

85%

Housing Starts

Breakdown,

March 2015

• Single-family • Multi-family

QEI8

After a Disappointing 2014, Housing Market Set to Accelerate in 2015Low affordability, stagnant income growth, large student loans, and tight lending standards held back housing market growth in 2014. Higher incomes, accelerated employment growth, and less-stringent lending standards should provide fuel for further improvement in 2015 and beyond.

Source: Census Bureau, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

45

30

35

40

45

50

55

60

65

1990 1993 1996 1999 2002 2005 2008 2011 2014

PMI Composite Versus Recessions, 3-Month Average

Reading Over 50 Indicates an Expansion

Reading Below 50 Indicates a Contraction


QEI10

Danger Zone

2014 Banner Year for U.S. Manufacturing; A Slowdown Has BegunThe ISM Purchasing Manager Index has been declining since late 2014. That weakness is now clearly visible in the month-to-month industrial production data, too, that is now down a few months in a row. The strong U.S. dollar and the weakening of the oil and gas related industries are responsible for the slowdown, but a better housing market could get the manufacturing data humming again.

Source: Institute for Supply Management, The National Bureau of Economic Research. © 2015 Morningstar. All Rights Reserved.

46

0.2

0.6

0.4

0.8

1.0

1.2

2005 2007 2009 2011 2013

8.0

13.0

18.0

23.0

Monthly Domestic Auto Sales (Millions of Units)

Auto Industry Recovery • Sales• Production • Employment

1 Equals full recovery, based on 2005 high, 3-month average

QEI4

Auto Recovery Beginning to Show Its AgeAutos are an example of a manufacturing sector with production and sales already approaching pre-recession highs, while employment growth remains stagnant. As production and sales reach previous levels, growth has slowed for the past two years and is expected to slow even further in 2015.

Source: The Federal Reserve, Bureau of Economic Analysis, Bureau of Labor Statistics, Morningstar Calculations. © 2015 Morningstar. All Rights Reserved.

47

• 2015 forecast • 2014 forecast • Year-over-year growth

0.0

2.0

4.0

6.0

8.0

10.0

12.0 millions of barrels/day

U.S. Oil Production

1995 2000 2005 2010 2015

–10

0

–5

5

10

15

20%

QC2

306

128 157

274

Oil rigs

591

984

13571539

760

U.S. Oil Production ShrinksThe 2010 oil boom has helped the U.S. economy in a number of ways. It spurred job creation, contributed to the reduction in the trade deficit, and helped to keep inflation under control. Going forward, U.S. oil production will not be as big of a contributor as it was in the past, as the growth is likely to plateau much sooner than previously expected, especially after the recent collapse in oil prices.

Source: Energy Information Agency, Morningstar Estimates. © 2015 Morningstar. All Rights Reserved.

48

6.0%

5.0

4.0

3.0

2.0

1.0

0.0

2.0%

1.8

1.6

1.4

1.2

1.0

0.8

1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013

Population Growth Versus Real GDP Growth, Trailing 5-Year Averages • Population growth (lagged 5 years) • Real GDP growth

QEI19

Demographics Will Limit Long-Term Economic GrowthGDP growth generally trends 1%–2% above population growth rates. With population dropping from 1.8% in the 1960s to 0.7% currently, theoretical economic potential growth has dropped from 2.8–3.8% to just 1.7%–2.7%. Lower fertility rates and tighter immigration policies could further limit potential economic growth.

Source: Census Bureau, Bureau of Economic Analysis. © 2015 Morningstar. All Rights Reserved.

49

20091909 1914 1919 1924 1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

QE131

2,000

3,000

3,500

2,500

4,000

4,500

5,000

Births of Demographic Cohorts, Thousands

DemographicSignificance

Age of Cohort Today

Births (thousands)

Direction of Deomgraphic Growth

Average LifeExpectancy

81

2,396

Positive

Social SecurityEligibility

62

3,959

Positive

Near HighestSpending Age

50

3,760

Negative

First-TimeHome Buyer

31

3,669

Positive

Enter theForce

22

4,000

Neutral

Birth Cohorts Drive Economic CyclesEconomic activities are strongly influenced by the number of people turning a certain age in a given year or over a few years’ period. People typically get married, have children and buy homes at similar ages over time. For example, the highest earning and spending cohort (50-year-olds) is now shrinking rapidly, potentially limiting economic growth.

Source: Census Bureau © 2015 Morningstar. All Rights Reserved.

50

4%

2

–2

–4

–6

–8

–10

–12

1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016 2022 2028 2034

Budget Deficit as a Percentage of GDP

0

QEI12

Budget Problems Reappear as Baby Boomers RetireThe federal budget deficit fell from 9.8% of GDP in 2009 to 2.8% in 2014. The improvement was driven by a better economy and budget agreements that limited spending. Longer-term expenditures on Social Security and Medicare benefits will rise as baby boomers retire. However, lower interest rates, lower inflation, and muted medical spending have substantially reduced the worst-case scenario.

Source: The Congressional Budget Office. © 2015 Morningstar. All Rights Reserved.

51

250%

0

Brazil China India Italy Japan UnitedStates

GreeceGermany

200

150

100

50

Spain UnitedKingdom

• 2005

• 2015*

• 2020*

Government Debt as a Percentage of GDP

QEI15

Government Debt Projection Stable for U.S., Still Very High for JapanHigh debt-to-GDP ratios make it more difficult to pay down debts and, in the long-term, may cause creditors to demand higher interest rates. Since 2004, the major developed economies have all seen their debt-to-GDP ratios increase, while emerging countries like Brazil, India, and China currently have some of the lowest ratios among the nations analyzed.

Source: International Monetary Fund, World Economic Outlook Database. © 2015 Morningstar. All Rights Reserved.

52

2011 2012 2013 2014 2015* 2016*

Euro area

Japan

Australia

Brazil

Russia

India

China

Canada

United States

Advanced

Emerging

World

1.6

–0.5

2.6

2.7

4.3

6.6

9.3

2.5

1.6

1.7

6.2

4.1

% –0.7

1.5

3.6

1.0

3.4

4.7

7.7

1.7

2.3

1.2

5.1

3.4

–0.5

1.6

2.3

2.7

1.3

6.9

7.8

2.0

2.2

1.4

5.0

3.4

0.9

–0.1

2.8

0.1

0.6

7.2

7.4

2.5

2.4

1.8

4.6

3.4

1.5

1.0

2.9

–1.0

–3.8

7.5

6.8

2.2

3.1

2.4

4.3

3.5

1.6

1.2

3.0

1.0

–1.1

7.5

6.3

2.0

3.1

2.4

4.7

3.8

*These figures are IMF estimates

World GDP Growth Rates

QEI16

World Growth Rates ConvergeWorld growth rates have dropped from 4%–5% in the early 2000’s to just 3%–4% during the current recovery. A slowing Chinese growth engine, unfavorable demographics, and falling commodity prices have all contributed to the reduced growth potential. The most recent forecast shows a higher growth estimate for Europe, a lower one for the U.S., and an unchanged outlook for China.

Source: International Monetary Fund, World Economic Outlook Database. © 2015 Morningstar. All Rights Reserved.

53

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

QEI30

IMF China GDP Growth Forecast Since 2010

6.0

8.5

6.5

9.0

9.5

10.0

10.5%

8.0

7.0

7.5

• 2010 Outlook

• 2011 Outlook

• 2013 Outlook

• 2012 Outlook

• 2014 Outlook

• Jan 2015 Outlook

China’s Slowdown More Dramatic Than Once ExpectedChina has been unable to regain the heady 10% growth rates of ealier this decade, as demographics and increased competition have put a lid on growth. Increased emphasis on the internal consumption engine and less on exports and fixed investment have increased long-term stability and reduced inflation at the expense of higher growth.

Source: International Monetary Fund. © 2015 Morningstar. All Rights Reserved.

54

1.0% 0.00.5 –0.5 –1.0 –1.5 –2.0

Unemployment Trends in G7 Nations

2

4

6

8

10

12

12-month difference in unemployment rate

Unemployed

(mil)

Germany

Japan

Italy

United States

Canada

United Kingdom

France

14%

Current unemployment rate

QEI18

3.2

3.1

2.0

1.3

2.3

1.88.7

Eurozone Unemployment Rates Still Elevated; U.S., U.K. See Biggest Improvements The employment situation in G7 nations remains mixed as Italy and France experience double-digit unemployment rates. The first batch of QE countries, namely the U.S. and the U.K., have seen their unemployment rates improve significantly over the past year. The QE in Europe has stimulated the financial markets, but those results have not yet translated into labor-market improvements.

Source: Eurostat, Japan Statistics Bureau, Statistics Canada, Bureau of Labor Statistics. © 2015 Morningstar. All Rights Reserved.

55

The U.S. has stopped expanding its balance sheet because employment data and economic growth have improved. Japan has boosted equity markets but hasn’t yet seen improvement in its economy so the country is continuing its massive bond purchases. Europe is only just starting its QE program after several years of contracting its balance sheet.

U.S. and European Monetary Policy Going in Opposite Directions

2006 2012 20132010 20112008 20092007 2014

• European Central Bank • Bank of Japan• US Federal Reserve

0

10

40

30

20

50

60%

Central Bank Balance Sheets as Percentage of GDP

QEI25

US Federal Reserve

European Central Bank

Bank of Japan

17.7 tril USD

10.4 tril EUR

490 tril YEN

4.5 tril USD

2.2 tril EUR

320 tril YEN

Economy Size

Central Bank

Balance Sheet

Source: Federal Reserve, European Central Bank, and Bank of Japan. © 2015 Morningstar. All Rights Reserved.

56

2004 2012 20132010 20112008 200920072005 2006 2014 2015

• M3

• Loans to non-financial corporations

• Loans to private sector (NSA)

• Loans to households

–5

0

5

10

15%

Eurozone Money Supply and Lending Growth

QEI24

Easier Monetary Conditions Raise Hope for More Bank Lending in EuropeWhile very modest improvements have taken place in recent months, year-over-year growth in business and consumer lending is still negative. Although the ECB is increasing money supply growth, banks are still keeping a lid on lending. New, more restrictive capital requirements have generally kept banks sidelined despite greater reserves.

Source: European Central Bank. Year-over-year growth. Loans to private sector are not seasonally adjusted. © 2015 Morningstar. All Rights Reserved.

57

1.3

1.2

1.1

1.0

0.8

0.9

0.7

0.6

2007 2008 2009 2010 2011 2012 20142015 2015

QEI27

Foreign Exchange Rates, Rescaled to $1 in 2007

U.S. / Euro

U.S. / Japan

12.7

0.1

YTDPerformance (%)

28.5

15.9

1 Year

24.1

46.0

3 Years

U.S. Dollar Continues to Trend Higher The movements of the U.S. dollar against the yen and the euro have been even more dramatic than the 17% move in the dollar trade weighted exchange rate over the last three years. Given that U.S. exports to Europe and Japan are tiny, it is mainly corporations that must compete against Japan and Germany on the world stage, and ultimately they will be the ones to bear the brunt of the higher value of the dollar.

Source: The Federal Reserve. © 2015 Morningstar. All Rights Reserved.

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