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Quarterly Economic & Market Update2nd Quarter 2016

Prateek Mehrotra, MBA, CFA®, CAIA®

Chief Investment Officer

1

2

Important Information

Performance quoted is past performance and cannot guarantee comparable future results; currentperformance may be higher or lower.

Results shown assume the reinvestment of dividends.

An investment cannot be made directly in an index.

Investments with higher return potential carry greater risk for loss.

Investing in small companies involves greater risks not associated with investing in more establishedcompanies, such as business risk, significant stock price fluctuations and illiquidity.

Foreign securities have additional risks, including exchange rate changes, political and economicupheaval, the relative lack of information about these companies, relatively low market liquidity andthe potential lack of strict financial and accounting controls and standards.

Investing in emerging markets involves greater risk than investing in more established markets such asrisks relating to the relatively smaller size and lesser liquidity of these markets, high inflation rates,adverse political developments and lack of timely information.

Fluctuations in the price of gold and precious metals often dramatically affect the profitability of thecompanies in the gold and precious metals sector. Changes in political or economic climate for thetwo largest gold producers, South Africa and the former Soviet Union, may have a direct effect on theprice of gold worldwide.

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3

Stock Market record new highs driven by earnings turnaround following the anniversary of $USD surge and energy prices bottoming stocks are fully-, but not over-valued margins are likely sustainable Fed is accommodative inflation is tame lack of irrational exuberance

Point of ViewJuly 2016

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ValuationS&P 500 vs. 17X actual and estimated earnings

4

S&P 500

17X S&P 500 actual and estimated earnings

1988Q4

1989Q4

1990Q4

1991Q4

1992Q4

1993Q4

1994Q4

1995Q4

1996Q4

1997Q4

1998Q4

1999Q4

2000Q4

2001Q4

2002Q4

2003Q4

2004Q4

2005Q4

2006Q4

2007Q4

2008Q4

2009Q4

2010Q4

2011Q4

2012Q4

2013Q4

2014Q4

2015Q4

2016Q4

2017Q4

200

400

600

800

1000

1200

1400

1600

1800

2000

2200

2400

S&P

500

Inde

x

This is not a forecast or prediction.It’s simply a calculation of 17X actual and estimated S&P 500 earnings.

1 2015 (actual), 2016 (estimated) and 2017 (estimated) bottom-up S&P 500 operating earnings per share as of June 29, 2016: for 2015, $117.46; for 2016(e), $118.62; for 2017(e), $135.63. Sources: Yardeni Research, Inc. and Thomson Reuters I/B/E/S survey of consensus estimates. Standard and Poor’s for index price data through June 30, 2016; and actual earnings data through 2014.

5

Earnings recessionS&P 500 earnings and forecasts – with and without energy + materials

Source: Standard & Poor’s. Earnings estimates are based on the Capital IQ consensus forecast. Actual data through Q1 2016. Data as of June 30, 2016.

According to Standard & Poor’s forecasts, earnings are on a +12% growth trajectory through the end of 2017.

+12% might be too optimistic but just half of that would be fine.

S&P 500 earnings

Forecast

S&P 500 earnings ex-energy and …

Actual

+12% y/y trendline

$20.00

$22.00

$24.00

$26.00

$28.00

$30.00

$32.00

$34.00

$36.00

Dec-13

Feb-14

Apr-14

Jun-14

Aug-14

Oct-14

Dec-14

Feb-15

Apr-15

Jun-15

Aug-15

Oct-15

Dec-15

Feb-16

Apr-16

Jun-16

Aug-16

Oct-16

Dec-16

Feb-17

Apr-17

Jun-17

Aug-17

Oct-17

Dec-17

S&P

500

quar

terly

ope

ratin

g ea

rnin

gs ($

)

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6 Source: Federal Reserve major currencies index. Data through June 2016. Federal Reserve, Remarks by Chairman Alan Greenspan before the Economic Club of New York, March 2, 2004.

Economic dataU.S. Dollar index

$USD stabilization for over a year.

“… no model projecting directional movements in exchange rates is significantly superior to tossing a coin.”-- Alan Greenspan1

March 2015

60

70

80

90

100

110

120

130

140

150

1973-01

1975-01

1977-01

1979-01

1981-01

1983-01

1985-01

1987-01

1989-01

1991-01

1993-01

1995-01

1997-01

1999-01

2001-01

2003-01

2005-01

2007-01

2009-01

2011-01

2013-01

2015-01

$USD

Inde

x (M

arch

197

3 =

100)

+35%

+39%

+54%

7

Earnings recessionS&P 500 earnings & the $USD

Sources: Federal Reserve and Standard & Poor’s. Earnings estimates are based on the Capital IQ consensus forecast. Actual earnings data through Q1 2016; actual $USD data through Q2 2016.

2014-15 surge in the $USD was a key cause of the earnings recession.

With $USD stabilization and rising oil prices earnings are forecast to surge in 2016 and 2017.

y/y % change $USD(right axis)

S&P 500 operating earnings(left axis)

-15

-10

-5

0

5

10

15

20

25

$80.00

$90.00

$100.00

$110.00

$120.00

$130.00

$140.00

Dec-10

Mar-11

Jun-2011

Sep-11

Dec-11

Mar-2012

Jun-12

Sep-2012

Dec-12

Mar-2013

Jun-13

Sep-2013

Dec-13

Mar-2014

Jun-14

Sep-2014

Dec-14

Mar-2015

Jun-15

Sep-2015

Dec-15

Mar-2016

Jun-16

Sep-2016

Dec-16

Mar-2017

Jun-17

Sep-2017

Dec-17

y/y

% c

hang

e $U

SD (%

)

S&P

500

oper

atin

g ea

rnin

gs p

er sh

are

actual earnings estimated earnings

8

Market dataS&P 500

Source: Standard & Poor’s. data through July 11, 2016.

flat 18 months

9/17/15 Fed defers

on rate hike

October 2014QE3 ends,

Fed rate hike jitters,global slowdown worries

-9.8%

12/11/15Third Avenue

suspends redemptions

-4.3%

7/8/16Strong June jobs report

1/29/14Fed begins QE taper -6.1%

April 2014Ukraine-4.4%

7/30/14Fed reaffirms

taper will conclude QE

by October 2014-4.3%

12/17/14Fed to be"patient"

raising rates

-5.1%

6/29/15Greek vote

8/24/15flash crash;

China devaluation, global slowdown

worries-11.2%

10/22/15ECB, China signal more

stimulus

12/16/15 Fed rate

hike

2/12/16China, global

slowdown worries, oil-12.0%

3/4/16Strong Feb jobs report,

oil rally

4/1/16 Strong Mar jobs report

6/24/16Brexit

-5.3%

1700

1750

1800

1850

1900

1950

2000

2050

2100

2150

2200

Dec-13

Jan-14

Feb-14

Mar-14

Apr-14

May-14

Jun-14

Jul-14

Aug-14

Sep-14

Oct-14

Nov-14

Dec-14

Jan-15

Feb-15

Mar-15

Apr-15

May-15

Jun-15

Jul-15

Aug-15

Sep-15

Oct-15

Nov-15

Dec-15

Jan-16

Feb-16

Mar-16

Apr-16

May-16

Jun-16

S&P

500

Stock market equilibriumS&P 500 total return

Source: Standard & Poor’s Corporation. Data through July 8, 2016. 1Total return includes dividends reinvested.

2015 and 2016-to-date have marked a leveling out in the stock market and two long-anticipated corrections following the extraordinary uninterrupted four-year recovery run.

The market’s relentless, low-volatility surge higher was driven by a post-recession reversion back to normal valuation.

See next slide.

Let’s put it into perspective.

August 2011-14% correction

1500

2000

2500

3000

3500

4000

Dec-10

Mar-11

Jun-11

Sep-11

Dec-11

Mar-12

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Sep-13

Dec-13

Mar-14

Jun-14

Sep-14

Dec-14

Mar-15

Jun-15

Sep-15

Dec-15

Mar-16

Jun-16

S&P

500

tota

l ret

urn

inde

x 2/16-13%

8/15-12%

8/11-16%

+77%+19% per year

9

10Sources: Standard & Poor’s Corporation. P/E ratio calculated on operating earnings. Stock price data through June 30, 2016. Latest data point: 2099 ÷ trailing earnings of $116.61 through 3/31/16 = 18.0X.

Stock market equilibriumValuation – S&P 500 P/E ratio

Post-recession, the stock market’s P/E ratio took three years to revert back to normal.

That sustained upward re-valuation pressure helps to explain the market’s relentless, low-volatility three-year surge higher.

With that re-valuation tailwind now past, the stock market has been more susceptible to volatility.

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0

30.0

2015Q4

2015Q1

2014Q2

2013Q3

2012Q4

2012Q1

2011Q2

2010Q3

2009Q4

2009Q1

2008Q2

2007Q3

2006Q4

2006Q1

2005Q2

2004Q3

2003Q4

2003Q1

2002Q2

2001Q3

2000Q4

2000Q1

1999Q2

1998Q3

1997Q4

1997Q1

1996Q2

1995Q3

1994Q4

1994Q1

1993Q2

1992Q3

1991Q4

1991Q1

1990Q2

S&P

500

P/E

Ratio

P/E ↑ from 12X

to 18X

11Sources: Standard & Poor’s Corporation and Thomson Reuters I/B/E/S earnings estimates, BEA. Stock price data through June 30, 2016; inflation data through Q1 2016. Top panel, latest data point: 2099 ÷ trailing earnings of $116.61 through 3/31/16 = 18.0.

ValuationS&P 500 P/E ratio vs. inflation

The S&P 500’s latest P/E ratio (6/30/16) on trailing 12-months operating earnings is 18.0X.

It is 15.5X on consensus bottom-up 2017 operating earnings.

Inflation(left axis)

S&P 500 P/E ratio(right axis)

17.9X

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

-1.0

4.0

9.0

14.0

19.0

24.0

12/31/196006/30/196212/31/196306/30/196512/31/196606/30/196812/31/196906/30/197112/31/197206/30/197412/31/197506/30/197712/31/197806/30/198012/31/198106/30/198312/31/198406/30/198612/31/198706/30/198912/31/199006/30/199212/31/199306/30/199512/31/199606/30/199812/31/199906/30/200112/31/200206/30/200412/30/200506/30/200712/31/200806/30/201012/31/20116/30/201312/31/20146/30/2016

S&P

500

P/E

Ratio

Pers

onal

Con

sum

ptio

n Ex

pend

iture

s Def

lato

r(y

/y %

cha

nge)

12

Stock market arithmeticTotal return = 7.0% earnings-driven price + 2.3% dividends reinvested

The 2011-2014 run higher put these two indices slightly above their long-term trajectories. Today they are in line.

+9.3% per year S&P 500 total return over the last 25 years is right in line with the stock market’s long-term returns going back to 1926, or back even further to 1871.3

Source: Standard and Poor’s. Data through July 8, 2016.1 Compound annual growth rate. 2 S&P 500 total return index. 3 per Professor Jeremy Siegel’s seminal Stocks for the Long Run, first published in 1994.

S&P 500 w/ dividends

reinvested2

S&P 500

+9.3%1 growth path

+7.0%1 growth path

0

100

200

300

400

500

600

700

800

900

Jul-91

Jul-92

Jul-93

Jul-94

Jul-95

Jul-96

Jul-97

Jul-98

Jul-99

Jul-00

Jul-01

Jul-02

Jul-03

Jul-04

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

Jul-13

Jul-14

Jul-15

Jul-16

S&P

500

Inde

x(6

/30/

91 =

100

)

This was a bubble.

13

Economy

Q1 GDP – weakness from “I” investment strong growth in: personal income, DPI, real DPI, real DPI

per capita, retail sales strong household balance sheets, savings rate and record

low household financial obligations ratio rising LEI, rebounding PMIs, strong hiring, record high job

openings, declining unemployment rate, record low weekly unemployment claims, strong car sales, rising housing starts

no inflation threat


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14 Source: Bureau of Economic Analysis, data through March 2016.

Economic data Contributions to GDP growth: C + I + G + Net Exports

% c

hang

e at

ann

ual r

ate

Don’t be surprised if we get a +3.0% quarter this year.

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0 2

003-

I 2

003-

IV 2

004-

III 2

005-

II 2

006-

I 2

006-

IV 2

007-

III 2

008-

II 2

009-

I 2

009-

IV 2

010-

III 2

011-

II 2

012-

I 2

012-

IV 2

013-

III20

14-II

2015

-I20

15-IV

Personal consumptionexpenditures

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

200

3-I

200

3-IV

200

4-III

200

5-II

200

6-I

200

6-IV

200

7-III

200

8-II

200

9-I

200

9-IV

201

0-III

201

1-II

201

2-I

201

2-IV

201

3-III

2014

-II

2015

-I

2015

-IV

Gross private domestic investment

average = 0.7%

3-quarter inventory correction

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

200

3-I

200

3-IV

200

4-III

200

5-II

200

6-I

200

6-IV

200

7-III

200

8-II

200

9-I

200

9-IV

201

0-III

201

1-II

201

2-I

201

2-IV

201

3-III

2014

-II20

15-I

2015

-IV

Government consumption and gross investment

recovering

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

200

3-I

200

3-IV

200

4-III

200

5-II

200

6-I

200

6-IV

200

7-III

200

8-II

200

9-I

200

9-IV

201

0-III

201

1-II

201

2-I

201

2-IV

201

3-III

2014

-II

2015

-I

2015

-IV

Net exports of goods and services

Q1 ∆GDPConsumption +1.0%Investment -0.3%Government +0.1%Net Exports +0.2%Total +1.1%

15 Source: Bureau of Economic Analysis, monthly data through May 2016. 1Compound annual growth rate.

Economic data – consumer spendingConsumer income, spending and saving

Nominal DPI drives spending, spending drives GDP and corporate earnings.

The savings rate (5.3%) has recently run higher and has remained substantially higher than it was pre-crisis.

Disposable Personal Income

(left scale)

Personal Outlays(70% of GDP)

(left scale)

Personal Saving (right scale)

Shaded bands represent recession.

0

500

1,000

1,500

2,000

2,500

3,000

1,000

3,000

5,000

7,000

9,000

11,000

13,000

15,000

1995-Jan 1995-Jul 1996-Jan 1996-Jul 1997-Jan 1997-Jul 1998-Jan 1998-Jul 1999-Jan 1999-Jul 2000-Jan 2000-Jul 2001-Jan 2001-Jul 2002-Jan 2002-Jul 2003-Jan 2003-Jul 2004-Jan 2004-Jul 2005-Jan 2005-Jul 2006-Jan 2006-Jul 2007-Jan 2007-Jul 2008-Jan 2008-Jul 2009-Jan 2009-Jul 2010-Jan 2010-Jul 2011-Jan 2011-Jul 2012-Jan 2012-Jul 2013-Jan 2013-Jul 2014-Jan 2014-Jul 2015-Jan 2015-Jul 2016-Jan

$ bi

llion

s SAA

R

DPI 7/02-7/07

+5.3%1

DPI 5/15-5/16

+4.1%

Personal outlays

5/15-5/16+3.7%

16 Source: Bureau of Economic Analysis, monthly data through May 2016. 1Compound annual growth rate.

Economic data – consumer spendingReal consumer income and spending

Growing faster than pre-recession.

Income stagnation is a fiction

Real Disposable Personal Income


Real Personal Outlays

6,000

7,000

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

1995-Jan 1995-Jul 1996-Jan 1996-Jul 1997-Jan 1997-Jul 1998-Jan 1998-Jul 1999-Jan 1999-Jul 2000-Jan 2000-Jul 2001-Jan 2001-Jul 2002-Jan 2002-Jul 2003-Jan 2003-Jul 2004-Jan 2004-Jul 2005-Jan 2005-Jul 2006-Jan 2006-Jul 2007-Jan 2007-Jul 2008-Jan 2008-Jul 2009-Jan 2009-Jul 2010-Jan 2010-Jul 2011-Jan 2011-Jul 2012-Jan 2012-Jul 2013-Jan 2013-Jul 2014-Jan 2014-Jul 2015-Jan 2015-Jul 2016-Jan

billi

ons (

$) S

AAR

Real DPI 7/02-7/07

+2.8% CAGR1

Real DPI 5/15-5/16

+3.2%

17Source: Bureau of Economic Analysis, quarterly data through March 2016. 1Compound annual growth rate. 2Surge in compensation paid prior to 2013 tax hike.

Economic data – consumer spending Real per capita purchasing power

Real per capita after-tax income is growing faster than pre-recession.

Income stagnation is a fiction.

Shaded bands represent

recessions.

24,000

26,000

28,000

30,000

32,000

34,000

36,000

38,000

40,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Real

Disp

osab

le P

erso

nal I

ncom

e pe

r Cap

ita(c

hain

ed 2

009

dolla

rs)

Real DPI per Capita (2)

+2.5% y/y

+1.8% CAGR1

2002-2007

18

Eco

nom

ic d

ata

Reta

il sa

les

Source: The Wall Street Journal, June 15, 2016.

Dismal comp store sales for Neiman, Macy’s, Nordstrom, Kohl’s, Gap … but, overall retail sales are booming.

Major retail channel shift continues.

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19

Economic data Retail sales

Source: U.S. Census Bureau. Data through May 2016.

Services (44% of total GDP)

Government Consumption(18% of total GDP)

Investment(17% of total GDP)

Booming trend in retail sales growth.

Despite soft comp-store sales at Macy’s, Nordstrom, Kohl’s, Gap and more.

10/06-10/07+3.1%

Shaded band represents recession.

Retail sales ex-gasoline

5/15-5/16+3.7%Total retail sales

280,000

300,000

320,000

340,000

360,000

380,000

400,000

420,000

440,000

Jan-2005M

ay-2005Sep-2005Jan-2006M

ay-2006Sep-2006Jan-2007M

ay-2007Sep-2007Jan-2008M

ay-2008Sep-2008Jan-2009M

ay-2009Sep-2009Jan-2010M

ay-2010Sep-2010Jan-2011M

ay-2011Sep-2011Jan-2012M

ay-2012Sep-2012Jan-2013M

ay-2013Sep-2013Jan-2014M

ay-2014Sep-2014Jan-2015M

ay-2015Sep-2015Jan-16M

ay-16

Reta

il sa

les

($m

illio

ns)

20

Economic data Retail sales by category

Source: U.S. Census Bureau. Data through May 2016.

Services (44% of total GDP)

Government Consumption(18% of total GDP)

Investment(17% of total GDP)

motor vehicles and parts dealers

general merchandise incl. dept. storesfood and beverage storesfood services and drinking places +6.4% y/y

non-store retailers (internet retailers) +11.4% y/y

building materials and garden equip dealers +8.2% y/y

health and personal care stores +8.2% y/y

clothing and accessories storesdepartment stores -5.6% y/ymiscellaneous storeselectronics and appliance stores

sporting goods, hobbies, books and music stores

furniture and home furnishings stores

Dying retail format: Macy’s, Gap, Nordstrom, et al

gasoline stations


-5,000

5,000

15,000

25,000

35,000

45,000

55,000

65,000

75,000

85,000

95,000

Jan-2005

May-2005

Sep-2005

Jan-2006

May-2006

Sep-2006

Jan-2007

May-2007

Sep-2007

Jan-2008

May-2008

Sep-2008

Jan-2009

May-2009

Sep-2009

Jan-2010

May-2010

Sep-2010

Jan-2011

May-2011

Sep-2011

Jan-2012

May-2012

Sep-2012

Jan-2013

May-2013

Sep-2013

Jan-2014

May-2014

Sep-2014

Jan-2015

May-2015

Sep-2015

Jan-16

May-16

Reta

il sa

les

($ m

illio

ns)

Sources: Bureau of Economic Analysis, actual data through March 2016; The Wall Street Journal survey taken June 2016.

Consensus GDP forecastSteady expansion expected

The 70 economists surveyed in early June see an average +2.4% rate of quarterly GDP growth ahead, in line with the +2.5% actual two-year GDP growth.

Despite Q1 weakness it’s a Goldilocks forecast … healthy economic growth with benign inflation.

-7.0

-5.0

-3.0

-1.0

1.0

3.0

5.0

7.0

9.0

1997-I

1997-IV

1998-III

1999-II

2000-I

2000-IV

2001-III

2002-II

2003-I

2003-IV

2004-III

2005-II

2006-I

2006-IV

2007-III

2008-II

2009-I

2009-IV

2010-III

2011-II

2012-I

2012-IV

2013-III

2014-II

2015-I

2015-IV

2016-III(E)

Real

GDP

Q/Q

% c

hang

e(an

nual

ized)

Actual and Forecast

Q1 2011Japan

tsunami

3-quarter average +2.4%

Q1 2014 East Coast

winterQ4 2012 Hurricane

Sandy

Q1 2015 East Coast

winter, West Coast dock

strike

21

The Conference Board Leading Economic Index® (LEI) components: 1) average weekly hours worked, manufacturing; 2) average weekly initial unemployment claims; 3) manufacturers’ new orders – consumer goods and materials; 4) ISM index of new orders; 5) manufacturers’ new orders, nondefense capital goods; 6) building permits – new private housing units; 7) stock prices, S&P 500; 8) Leading Credit Index™; 9) interest rate spread; 10-year Treasury less fed funds; 10) index of consumer expectations.

Source: ©The Conference Board. Data through May, released June 23, 2016.

Economic dataU.S. index of leading economic indicators

22

The LEI ticked down in May but continues to trend higher, suggesting continued growth ahead.

This chart shows how the LEI has definitively rolled over well in advance of the last two recessions.

Shaded areas represent recession.

Economic data rest-of-worldWorld GDP growth forecasts – improving growth expected

Source: OECD, Economic Outlook, June 2016.

2013-2015Actual

2016-2017Forecast

-4

-2

0

2

4

6

8

Euro Area U.S. Japan China Brazil India

GDP

Gro

wth

(% C

hang

e Y/

Y)

23

24

Fed policy first rate hikes have signaled stock market strength the Fed manages the yield curve the Fed has created every recession since the 1950s twin mandate points to continued dovish policy for

now


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Federal Reserve policy… it’s the last rate hike that matters

Initial fed funds rate hikes have caused the stock market to stutter.

But, following the initial stutter stocks have continued higher even as the Fed has repeatedly hiked rates … until fed funds have approximated bond yields.

Sources: NBER, Federal Reserve and Standard & Poor’s. Data through July 11, 2016.

S&P 500


Fed Funds

0

2

4

6

8

10

12

14

0

250

500

750

1000

1250

1500

1750

2000

Jul-83

Sep-84

Nov-85

Jan-87

Mar-88

May-89

Jul-90

Sep-91

Nov-92

Jan-94

Mar-95

May-96

Jul-97

Sep-98

Nov-99

Jan-01

Mar-02

May-03

Jul-04

Sep-05

Nov-06

Jan-08

Mar-09

May-10

Jul-11

Sep-12

Nov-13

Jan-15

Mar-16

Fed

Fund

s (%

)

S&P

500

Inde

x

25

Federal Reserve policyFed’s key policy lever is the yield curve

Steep yield curves –high bond yields compared to Fed Funds rates – are consistent with strong GDP growth.

Flat or negative yield curves have preceded recessions.

Today the yield curve is positive but less than half as steep as immediately post-recession.

The Fed has been saying that rate hikes are likely to be very gradual from here.

Sources: NBER, Federal Reserve. Data through July 11, 2016. 1The differential between the interest rate on Fed Funds (short term) and the 10-year Treasury bond (long term).


Yield Curve1

-1.5

-0.5

0.5

1.5

2.5

3.5

Jul-83Jul-84Jul-85Jul-86Jul-87Jul-88Jul-89Jul-90Jul-91Jul-92Jul-93Jul-94Jul-95Jul-96Jul-97Jul-98Jul-99Jul-00Jul-01Jul-02Jul-03Jul-04Jul-05Jul-06Jul-07Jul-08Jul-09Jul-10Jul-11Jul-12Jul-13Jul-14Jul-15Jul-16

10-y

ear T

reas

ury

Yiel

d -F

ed F

unds

(%)

26

Federal Reserve policyDual mandate, dovish Fed

See footnotes in the notes to the slide.

Fed’s dual mandate: full employment 2% inflation

With inflation still well below 2% the Fed might stay very dovish for awhile yet. It may take until well into 2017 to regain full employment.


PCED

+0.9%

June 2016 forecast (solid)

2011 forecast(dotted)

Core PCED

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Jan-04Jun-04N

ov-04Apr-05Sep-05Feb-06Jul-06Dec-06M

ay-07O

ct-07M

ar-08Aug-08Jan-09Jun-09N


ay-12O

ct-12M

ar-13Aug-13Jan-14Jun-14N


ay-17O

ct-17M

ar-18Aug-18

Pric

e In

dex

for P

erso

nal

Cons

umpt

ion

Expe

nditu

res

12-m

onth

per

cent

chan

ge (%

)

Fed’s central tendency forecasts

U-3

4.9%

U-6

9.6%

2

4

6

8

10

12

14

16

18

Une

mpl

oym

ent r

ate

(%)

27

28

Inflation PCED headline +1.1%, more in the core but

still far from the Fed’s +2% target employment costs steady and still tame productivity and declining unit labor costs how you experience inflation depends on

what you consume


www.EndowmentWM.com

InflationPCE – headline and core

Headline inflation (PCE) has plunged and partially recovered with the plunge in gasoline, diesel and fuel oil prices.

Inflation ex-food and energy (core PCE) is higher than core but still below the Fed’s 2% target.

Source: NBER, Federal Reserve Bank of St. Louis. Data through May 2016.

2% target

+1.5% core

+0.9% headline

Shaded bands represent recessions.

Core PCE

PCE

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Jan-95O

ct-95Jul-96Apr-97Jan-98O






ct-13Jul-14Apr-15Jan-16

Pric

e In

dex

12-m

onth

per

cent

chan

ge (%

)

29

How you experience inflation depends on what you consume.

InflationInflation by expenditure category

Food

Airfare

Medical care

Education

Information technology

CPI

1%

Housing2%

3%

4%

-4%

60

70

80

90

100

110

120

130

140

150

160

Jan-06

Jun-06

Nov-06

Apr-07

Sep-07

Feb-08

Jul-08

Dec-08

May-09

Oct-09

Mar-10

Aug-10

Jan-11

Jun-11

Nov-11

Apr-12

Sep-12

Feb-13

Jul-13

Dec-13

May-14

Oct-14

Mar-15

Aug-15

Jan-16

Inde

x(Ja

n. 2

005

= 10

0)

TransportationApparelRecreationNew and used vehicles

Source: BLS. Data through April 2016. Dotted lines indicate compound annual growth rate trajectories at rates indicated. 30

31

Bond Yields forecasts have grossly missed forecast for steady rise to 3.35% real yield suggests nominal yield could be higher pressure on yields from declining federal deficit pressure on yields from ECB’s QE capping euro

bond yields value in munis


www.EndowmentWM.com

Source: Federal Reserve. Data through July 8, 2016.1 Average of economists’ forecasts from The Wall Street Journal ‘s monthly surveys taken November 2011, January 2014, September 2014, January 2015 and December 2015.

Bond yields Much lower than expected bond yields

Forecasts have been consistently and horribly wrong.

Where yields go from here depends on the inflation data and supply and demand for bonds.

Inflation is very low and apt to remain so. The rate of net new supply of U.S Treasury bonds will be close to flat. The ECB is in the driver’s seat with its QE.

QE 1 QE 2

3/2/11: Bill Gross: with the end of QE2, bond yields are likely to go "higher, maybe even

much higher."

1.43%

QE 3

1.37%

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Jan-08Apr-08Jul-08O

ct-08Jan-09Apr-09Jul-09O









ct-17

10-y

ear U

.S. T

reas

ury

Bond

Yie

ld (%

)

32

33 Source: Federal Reserve. Data through July 5, 2016.

Bond yields – why so low? U.S. Treasury bond yields – nominal and TIPS

Quantitative easing (QE) has driven bond yields steadily lower.

Although the Federal Reserve is no longer purchasing bonds (QE), the ECB is, having a like effect on U.S. bond yields.

See next chart.

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2003-012003-052003-092004-012004-052004-092005-012005-052005-092006-012006-052006-092007-012007-052007-092008-012008-052008-092009-012009-052009-092010-012010-052010-092011-012011-052011-092012-012012-052012-092013-012013-052013-092014-012014-052014-092015-012015-052015-092016-012016-05

Yiel

d (%

)

U.S. Treasury Bond Yields10-year Maturity

Recession QE Nominal Yield TIPS Yield

34 Source: The Wall Street Journal. Data through July 6, 2016.

Bond yields – why so low? U.S. Treasury bond yield vs. German bund yield

Yields moving in lock-step.

The ECB is in control of U.S. Treasury yields.

The ECB plans to continue their QE program until further notice.

-0.2

0.3

0.8

1.3

1.8

2.3

2.8

7-Apr

21-Apr

5-May

19-May

2-Jun

16-Jun

30-Jun

14-Jul

28-Jul

11-Aug

25-Aug

8-Sep

22-Sep

6-Oct

20-Oct

3-Nov

17-Nov

1-Dec

15-Dec

29-Dec

12-Jan

26-Jan

9-Feb

23-Feb

8-Mar

22-Mar

5-Apr

19-Apr

3-May

17-May

31-May

14-Jun

28-Jun

Yiel

d (%

)

German bund yield U.S. Treasury bond yield

35

Market dataMunicipal bonds

Source: Federal Reserve, bond buyer GO 20-bond municipal bond index. Data through June 2016.

Municipals’ spread-to-Treasuries is attractive.

Municipal Bond Index

Muni spread over/under 10-year

Treasury

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1965-011966-041967-071968-101970-011971-041972-071973-101975-011976-041977-071978-101980-011981-041982-071983-101985-011986-041987-071988-101990-011991-041992-071993-101995-011996-041997-071998-102000-012001-042002-072003-102005-012006-042007-072008-102010-012011-042012-072013-102015-12016-4

Perc

ent (

%)


36

Crude oil price rebound with cut in global supply 22 consecutive oversupply months still 0.7 mmbpd supply/demand imbalance U.S. rig count collapse, production down

only slightly (so far)


www.EndowmentWM.com

37

OilWorld crude oil supply vs. consumption

Source: U.S. Energy Information Agency, Short-Term Energy Outlook, June 2016, data through May 2016. Includes condensate and natural gas liquids.

In 2014, 2015 and so far in 2016, global supply surged, outstripping demand growth, driving prices down.

Supply has now outstripped demand for 22 consecutive months.

0.7 mmbpd oversupply.

Supply(solid, left axis)

Consumption(dotted, left axis)

WTI(right axis)

0

20

40

60

80

100

120

140

160

180

200

85

87

89

91

93

95

97

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

Jan-13

Apr-13

Jul-13

Oct-13

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

WTI

pric

e pe

r bar

rel (

$)

Mill

ion

barr

els p

er d

ay

38

OilU.S. drilling plunge

Source: U.S. Energy Information Agency, Baker Hughes. Rig count through July 8, 2016. Crude oil production through July 1, 2016.

8.43 mmbpd production. Peaked at 9.61 mmbpd in June 2015.

351 rig count. Peaked at 1,609 in October 2014.U.S. crude oil

production(left axis)

U.S. oil rig count(right axis)

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

4.50

4.75

5.00

5.25

5.50

5.75

6.00

6.25

6.50

6.75

7.00

7.25

7.50

7.75

8.00

8.25

8.50

8.75

9.00

9.25

9.50

Jul-87Jul-88Jul-89Jul-90Jul-91Jul-92Jul-93Jul-94Jul-95Jul-96Jul-97Jul-98Jul-99Jul-00Jul-01Jul-02Jul-03Jul-04Jul-05Jul-06Jul-07Jul-08Jul-09Jul-10Jul-11Jul-12Jul-13Jul-14Jul-15

U.S.

oil

rig c

ount

U.S.

oil

prod

uctio

n (m

mbp

d)

39

Federal budget CBO’s March 2016 forecast looks good for a few years … … but the entitlements problem hasn’t

gone away rising debt/GDP ratio low U.S. tax burden allows flexibility to

solve long-term entitlements problem

DebtU.S. government debt

www.EndowmentWM.com

40

Medicare and Medicaid

Other Federal Noninterest Spending

Federal deficit and debtFederal revenues and outlays – a rising spending problem

Source: Congressional Budget Office, Updated Budget Projections: 2016 to 2026, dated March 2016.1 American Taxpayer Relief Act.

Widening, gap between outlays

and revenues through 2026.

Revenues

Forecast

Average Revenues1966 to 2015

(17.4%)

Outlays

Average Outlays1966 to 2015

(20.2%)

Actual13.0

15.0

17.0

19.0

21.0

23.0

25.0

1966196819701972197419761978198019821984198619881990199219941996199820002002200420062008201020122014201620182020202220242026

Perc

ent o

f GDP

(%)

The ATRA1 tax hikes of 2013 help push tax revenue up to 18% of GDP.

Federal deficit and debtFederal deficits % of GDP

CBO is projecting low growth in federal borrowing requirements through 2018.

Source: Congressional Budget Office, Updated Budget Projections: 2016 to 2026, dated March 2016.

Average 1966-2015

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

1966196719681969197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920102011201220132014201520162017201820192020202120222023202420252026

Perc

ent o

f GDP

(%)

---- projected ----

Federal Deficits % of GDP

41

42Source: IMF, World Economic Outlook Database, October 2014 and April 2016. Data for years (from left to right) 2011-2021. Actual (black) and forecast (red).


Social Security


Federal deficit and debtGovernment debt-to-GDP ratios (2011-2021)

0

20

40

60

80

100

120

140

160

180

Greece Japan Portugal Italy Ireland France UnitedKingdom

UnitedStates

Spain Germany Canada Australia

Debt

/ GD

P (%

)

2011-2021


Social Security


Federal deficit and debtProjected federal spending1 through 2050

Defense (+0.4%)

All other discretionary (+0.0%)

Entitlements are on autopilot and interest expense keeps growing as a share of total spending as the debt accumulates.

Source: Congressional Budget Office (CBO), The 2015 Long-Term Budget Outlook, June 2015. 1CBO’s 10-year and extended baselines are meant to serve as benchmarks for measuring the budgetary effects of proposed changes in federal revenues or spending. They are not meant to be predictions of future budgetary outcomes; rather, they represent CBO’s best assessment of how the economy and other factors would affect revenues and spending if current law generally remained unchanged.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

2015201620172018201920202021202220232024202520262027202820292030203120322033203420352036203720382039204020412042204320442045204620472048204920502051

Perc

ent o

f GDP

(%)

Stac

ked

Char

t

Interest Expense

Medicaid, CHIP and Exchange Subsidies

Medicare

Social Security

Defense and OtherDiscretionary

CBO’s latest 2015-26 projections, previous slides.

43


Social Security


Federal deficit and debtFederal debt % of GDP through 2040

Source: Congressional Budget Office (CBO), The 2015 Long-Term Budget Outlook, June 2015. 1CBO’s 10-year and extended baselines are meant to serve as benchmarks for measuring the budgetary effects of proposed changes in federal revenues or spending. They are not meant to be predictions of future budgetary outcomes; rather, they represent CBO’s best assessment of how the economy and other factors would affect revenues and spending if current law generally remained unchanged.

Revolutionary WarLouisiana Purchase Civil War

WWI

GreatDepression

WWII

Rising Deficits1980s

Extended baseline

projection1

-10

10

30

50

70

90

110

130

179017951800180518101815182018251830183518401845185018551860186518701875188018851890189519001905191019151920192519301935194019451950195519601965197019751980198519901995200020052010201520202025203020352040

Perc

ent o

f GDP

(%)

ForecastActual

44

45Source: OECD, Revenue Statistics, 2015 Edition. 2014 data for all countries except 2013 data for Australia, Japan, Netherlands and Poland. Does not include non-OECD countries such as China, Brazil, India and Russia. Includes all forms of taxes: federal, state and local; income taxes, sales taxes, VAT taxes, estate taxes, property taxes, etc.


Social Security


While the U.S. has the highest corporate tax rate, the U.S. has one of the lowest total tax burdens among developed economies.

The U.S.’s comparatively low tax burden allows flexibility in solving its long-term entitlement spending problem.

TaxesTaxes % of GDP – comparison

0.0

10.0

20.0

30.0

40.0

50.0

ChileKoreaU

nited StatesSw

itzerlandAustraliaTurkeyIrelandJapanCanadaSlovak RepublicIsraelPolandN

ew Zealand

United Kingdom

EstoniaSpainCzech RepublicPortugalG

reeceG

ermany

SloveniaN

etherlandsLuxem

bourgHungaryIcelandN

orway

Sweden

AustriaItalyFinlandBelgiumFranceDenm

ark

Tota

l tax

reve

nue

as a

per

cent

of G

DP (%

)

46

Jobs job formation has not been “anemic” new jobs will be limited at full-employment good news in full-time employed record job openings strong relative U.S. job formation forecast

long-term strong real wage and income growth mean and median incomes bottomed myth: “… but we’re not creating good jobs”


www.EndowmentWM.com

Economic data - jobsNet new job formation and the unemployment rate

Source: Bureau of Labor Statistics. Data through June 2016.

Job growth stronger for longer in this recovery due to the depth of the last recession.

Job growth will decline as the unemployment rate sinks further.

287,000


4.9%

0

2

4

6

8

10

12

-850

-650

-450

-250

-50

150

350

550

Jan-95Sep-95M

ay-96Jan-97Sep-97M

ay-98Jan-99Sep-99M

ay-00Jan-01Sep-01M

ay-02Jan-03Sep-03M

ay-04Jan-05Sep-05M

ay-06Jan-07Sep-07M

ay-08Jan-09Sep-09M

ay-10Jan-11Sep-11M

ay-12Jan-13Sep-13M

ay-14Jan-15Sep-15M

ay-16

Une

mpl

oym

ent r

ate

(%)

Mon

thly

cha

nge

in to

tal n

onfa

rm p

ayro

lls (0

00)

47

48Source: U.S. Department of Labor, NBER. Data through April 2016, released June 8, 2016.

April job openings at record high.

Job growth is slumping as employers can’t find enough workers.

Economic data - jobsJob openings – record high

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15

Job

Ope

ning

sth

ousa

nds


49

Economic data - jobsLabor force participation rate1

Source: Bureau of Labor Statistics, Federal Reserve Bank of St. Louis. Participation rate data through June 2016. Working age population: aged 15-64, data through March 2015. 1Labor force participation rate: the proportion of the civilian noninstitutional population 16 years of age and older either at work or actively seeking work.(247.4 million).

Participation rate is in a structuraldecline driven partially by demographics.

Recessions drive cyclical slides in the participation rate.

61.0

62.0

63.0

64.0

65.0

66.0

67.0

68.0

Jan-77Feb-78M

ar-79Apr-80M

ay-81Jun-82Jul-83Aug-84Sep-85O

ct-86N

ov-87Dec-88Jan-90Feb-91M

ar-92Apr-93M


ct-99N

ov-00Dec-01Jan-03Feb-04M

ar-05Apr-06M


ct-12N

ov-13Dec-14Jan-16

Perc

ent (

%)

working age population ÷ total population

labor force participation rate

50

“Winning is crucial to my retirement plans.”

Saving and Investing for Retirement

www.EndowmentWM.com

51

Inve

stm

ent S

trate

gy

Wal

l Stre

et’s

sect

or c

alls

for 2

016

–sh

ould

you

take

thei

r adv

ice?

Source: Barron’s, December 14, 2015.

www.EndowmentWM.com

521 Published December 14, 2015.

Consumer Discretionary

Consumer Staples Energy Financials

Health Care Industrials

Information Technology Materials

Telecom Services Utilities

Federated Investors - + + + + -Blackrock - + + -Barclays Capital - - +Columbia Management + - -Goldman Sachs - - + + - -JPMorgan Chase + + - + - -Citi Research - + + - + -Morgan Stanley + - - + -Prudential + + - -BofA Merrill Lynch

Net (+/-) 0 -4 -2 +8 0 -1 +7 -5 -1 -5

Barron’s 2016 Forecast1

Survey of 10 stock market strategists’ sector picks and pans for 2016

Investment StrategyWall Street’s sector calls for 2016 – should you take their advice?

www.EndowmentWM.com

53

Investment Strategy S&P 2016 sector returns YTD – the strategists1 are a disaster

Source: Standard and Poor’s1 From Barron’s survey of 12 Wall Street strategists, published December 14, 2015.

Least favored

Neutral

Most favored

Most favored

Least favored

Least favored

Not favored

Neutral

Not favored

Not favored

-10.0 -5.0 0.0 5.0 10.0 15.0 20.0

Financials

Technology

Health Care

Consumer Discretionary

S&P 500

Industrials

Materials

Consumer Staples

Energy

Telecom Services

Utilities

S&P Sector Performance YTD thru 7-8-16 (%)

54

“The only value of stock forecasters is to make fortunetellers look good.” – Warren Buffet

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch

Investment Strategy Tactical asset allocation funds

Source: The New York Times, January 27, 2014. The Wall Street Journal, November 8-9, 2014.

55

Asset allocation and diversification do not guarantee a profit or eliminate the risk of loss.Source: Riskglossary.com

Modern portfolio theory was introduced by Harry Markowitz with his paper “Portfolio Selection,” which appeared in the 1952 Journal of Finance.

Thirty-eight years later, he shared a Nobel Prize with Merton Miller and William Sharpe for what has become a broad theory for portfolio selection.

Modern Portfolio Theory

Diversify

Optimize

Rebalance

Investment StrategyModern Portfolio Theory = Asset Allocation

www.EndowmentWM.com

56

Investment StrategyAsset Allocation — An ExampleLet’s construct a global balanced portfolio using 7 asset classes …

Large U.S. Stocks

Small U.S. Stocks

Non-U.S. Stocks

Bonds

Cash

Real Estate

Commodities

Stocks (43%)

Bonds (14%)

Cash (14%)

Real Estate (14%)

Commodities (14%)

Source: ©2012 The 7Twelve ™ Portfolio powerpoint presentation, by Craig Israelsen. Used with permission. Indexes used in this illustration: Large-cap USequity represented by the S&P 500 Index. Small-cap US equity represented by the Ibbotson Small Companies Index from 1970-1978, and the Russell 2000Index starting in 1979. Non-US equity represented by the MSCI EAFE Index. Real estate represented by the NAREIT Index from 1970-1977 and the Dow JonesUS Select REIT Index starting in 1978.Commodities represented by the Goldman Sachs Commodities Index (GSCI). As of February 6, 2007, the GSCI became theS&P GSCI Commodity Index.U.S. Aggregate Bonds represented by the Ibbotson Intermediate Term Bond Index from 1970-75 and the Barclays CapitalAggregate Bond index starting in 1976. Cash represented by 3-month Treasury Bills.

www.EndowmentWM.com

57

Investment StrategyAsset Allocation — An Example

1Compound annual growth rate.Past performance is not a guarantee of future results. An investment cannot be made directly in the indexes used in this illustration.Source: ©2016 The 7Twelve ™ Portfolio powerpoint presentation, by Craig Israelsen. Used with permission. Indexes used in this illustration: Large-cap USequity represented by the S&P 500 Index. Small-cap US equity represented by the Ibbotson Small Companies Index from 1970-1978, and the Russell 2000Index starting in 1979. Non-US equity represented by the MSCI EAFE Index. Real estate represented by the NAREIT Index from 1970-1977 and the Dow JonesUS Select REIT Index starting in 1978.Commodities represented by the Goldman Sachs Commodities Index (GSCI). As of February 6, 2007, the GSCI became theS&P GSCI Commodity Index.U.S. Aggregate Bonds represented by the Ibbotson Intermediate Term Bond Index from 1970-75 and the Barclays CapitalAggregate Bond index starting in 1976. Cash represented by 3-month Treasury Bills.

S&P 500 CAGR1

= +10.3%

Diversified Portfolio CAGR1

= +9.8%

50

500

5000

19691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015

Inde

x (1

/1/7

0=10

0)(lo

garit

hmic

scal

e)

Large US Equity

Small US Equity

Non-US Equity

Aggregate US Bonds

Cash

Real Estate

Commodities

Equally Weighted DiversifiedPortfolio

REITs CAGR1

= +11.5%

58

Investment StrategyAsset Allocation — MPT has delivered

Large US Stocks

SmallUS Stocks

Non-USStocks

Aggregate US Bonds

Cash

Real Estate

Commodities

Equally Weighted Diversified Portfolio

4

5

6

7

8

9

10

11

12

0 5 10 15 20 25 30

Com

poun

d An

nual

Ret

urn

(%)

Standard Deviation of Annual Returns (%)

Risk vs. Return by Asset Class1970-2015

www.EndowmentWM.com

59

Source: Federal Reserve and ©2015 The 7Twelve ™ Portfolio powerpoint presentation, by Craig Israelsen. Used with permission.1 3-year average annual return of the U.S. Aggregate Bond index represented by the Ibbotson Intermediate Term Bond Index from 1970-75 and the Barclays Capital Aggregate Bond index starting in 1976. Annual data through 2015.

Investment StrategyDeclining bond returns

Fixed income returns can no longer boost portfolio total returns as they have over the last 40 years.

Expect very modest fixed income returns going forward.

3-year average annual return of just +1.5%

Bond Index Annual Return1

10-year U.S. Treasury Yield

0

5

10

15

20

25

19721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015

Perc

ent (

%)

Bonds’ shrinking contribution to

portfolio returns.

60

Inve

stm

ent S

trate

gyM

anag

ing

clie

nt e

xpec

tatio

ns

Source: The Wall Street Journal, September 5-6, 2015.

Pension funds are trimming their total return assumptions.

average target of 7.68%

New portfolio arithmetic?

60/40 stocks/bondsstocks: .6 X 8% = 4.8%bonds: .4 X 1.5% = 0.6%

5.4%

my back of the envelope figures:

61

All material presented is compiled from sources believed to be reliable and current, but accuracy cannotbe guaranteed. This is not to be construed as an offer to buy or sell any financial instruments andshould not be relied upon as the sole factor in an investment making decision. As with all investmentsthere are associated inherent risks. Please obtain and review all financial material carefully beforeinvesting.

The opinions expressed are those of the author, are based on current market conditions and are subjectto change without notice.

These materials may contain statements that are not purely historical in nature but are “forward-lookingstatements.” These include, among other things, projections, forecasts, estimates of income, yield orreturn or future performance targets. These forward-looking statements are based upon certainassumptions, some of which are described herein. Actual events are difficult to predict and maysubstantially differ from those assumed. All forward-looking statements included herein are based oninformation available on the date hereof and Fritz Meyer assumes no duty to update any forward-looking statement. Accordingly, there can be no assurance that estimated returns or projections can berealized, that forward-looking statements will materialize or that actual returns or results will not bematerially lower than those presented.

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