Regional and Sector Strategy: Monthly Update

2016 Outlook. After a cautious outlook for 2015, we now expect modest gains inglobal equity markets in 2016. Moderate economic growth is likely to continue inmost Developed Markets and to resume in some Emerging Markets. As for valuations,P/E multiples seem unlikely to contract materially. A combination of stable P/Es and5-10% earnings growth would support modest gains in global equities in 2016.

Upgrade Two Sectors with Exposure to Global Growth. Reflecting attractivevaluations and improving earnings momentum, we upgrade the ConsumerDiscretionary and Information Technology sectors to Overweight from Neutral.These two sectors should benefit from global economic growth. Japan, the soleOverweight in our regional strategy, has the largest exposure globally to theConsumer Discretionary sector.

Strategy Remains Selective. We are Underweight the Energy, Materials andIndustrial sectors, in large part because of the absence of robust global growth.In terms of regions, we don’t favor areas with heavy exposure to commodities:Latin America (Underweight), South Africa and Russia (both ranked Neutral).

©doomu/Crystal Graphics

Michael Geraghty Global Markets Strategist

+1 (212) 874 - 7400

Figure 1: Regional Over- and Underweights Figure 2: Sector Over- and Underweights Arrows Indicate Change vs. Last Month

Source: Cornerstone Capital Group Source: Cornerstone Capital Group

Global Markets Strategy November 2, 2015

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Please see important disclosures at the back of this report.

2016 Outlook: Modest Gains for Equity Markets

In aggregate, global equity markets have been relatively flat in 2015, with the MSCI All Country World Index (ACWI) down 1.4% year-to-date in dollar terms. (Of course, some equity markets have been quite strong — Russia +11% — and others quite weak — Brazil -38%.) As outlined below, our proprietary “Investment Clock,” which has had a cautious outlook for equities in 2015, now suggests modest gains for equity markets in 2016. In addition, an analysis of earnings fundamentals also supports a more constructive outlook.

Earnings Fundamentals: Positive

Figure 3 illustrates that, through Q3 2015, six sectors representing 57% of the MSCI ACWI had negative year-on-year earnings growth: Consumer Staples, Energy, Financials, Industrials, Materials, Telecommunication Services. Moreover, two of those sectors experienced double-digit declines in earnings: Energy, Materials.

Figure 3: Earnings Before Extraordinary Items Index: 1/2012 = 100

Source: Cornerstone Capital Group

Obviously, weakness in oil and commodity prices weighed on the Energy and Materials sectors. While it is beyond our purview to speculate about such matters, a modest rebound in oil and commodity prices would clearly be a positive for these two sectors. That said, price stabilization would by itself be material to the earnings of the two sectors given that earnings comparisons are fairly easy, reflecting the 55% decline in the earnings of the Energy sector in 2015, and the 24% decline in the earnings of the Materials sector.

Tepid global demand contributed to weakness in oil and commodity prices in 2015. Figure 4 illustrates that it is expected that the world’s major economies will continue to grow (albeit slowly) in 2016, while some Emerging Markets that were in recession in 2015 are expected to return to growth in 2016—e.g., Latin America, Russia. And, while much has been made about the “slowing” of China’s economy, it is still expected to grow almost three times as fast as North America in 2016.

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Please see important disclosures at the back of this report.

Figure 4: Expected Real GDP Growth: 2015, 2016

Source: Bloomberg

In sum then, there are grounds to believe that 2016 will be a year of continued earnings growth in the Consumer Discretionary, Information Technology, Health Care and Utilities sectors, and renewed earnings growth in the Consumer Staples, Financials, Industrials and Telecom Services sectors, which experienced just single-digit declines in earnings in 2015. Moreover, as noted above, even a stabilization in oil and commodity prices would be beneficial to the earnings of the Energy and Material sectors. For these reasons, aggregate earnings growth of 5-10% seems plausible.

Separately, concomitant with modest growth in earnings, P/Es seem unlikely to contract materially. Globally, inflation will likely remain low, the major central banks seem reluctant to hike interest rates aggressively and, reflecting the “global savings glut,” there is a surplus of capital searching for returns. This combination of stable P/Es and 5-10% earnings growth supports an outlook for modest gains in global equities in 2016.

The Global Equity Strategy Investment Clock

In a January 9, 2015 report, we introduced the Global Equity Strategy Investment Clock. As we explained in the report, the clock is a useful rule-of-thumb. We also acknowledged that, in a complex global economy characterized by asynchronous economic cycles and monetary policies, this stylized model is overly simplistic. However, it is useful in helping determine the relative attractiveness (or unattractiveness) of stocks.

The concept is that we visualize the global investment cycle in terms of the face of a clock — see Figure 5.

12 o’clock is the peak of the investment cycle.

6 o’clock is the trough of the cycle.

When the hands of the clock are at 3 or 9, either the trough of the cycle is nearing (3), or the peak of the

cycle is being approached (9).

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Please see important disclosures at the back of this report.

Figure 5: The Global Equity Strategy Investment Clock

Source: Cornerstone Capital Group

Plotting our sector and regional equity recommendations on the face of this clock helps determine the relative attractiveness (or unattractiveness) of stocks. So, in January we wrote that:

There is currently a defensive tilt in both our sector (Overweight Health Care, Underweight Energy,

Materials) and regional (Underweight CEEMEA, Latin America) recommendations. This defensive tilt,

which is driven by bottom-up factors, suggests that the biggest gains for equity markets in the current cycle

may be behind us.

As outlined below, we are upgrading the Consumer Discretionary and Information Technology sectors to Overweight while maintaining our Overweight in Japan, which is consistent with a more positive outlook for equities as outlined in our January 9, 2015 report — see Figure 6.

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Please see important disclosures at the back of this report.

Figure 6: A Stylized Scenario Favoring “Soft Cyclicals” — Consistent with a Positive Outlook on Equities

Green = Overweight, Orange = Neutral, Red = Underweight

Source: Cornerstone Capital Group

To be sure, our expectation for gains of 5-10% in global equities in 2016 are relatively modest, and are not inconsistent with the view expressed earlier this year that the biggest gains for equity markets in the current cycle may be behind us.

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Michael Geraghty is the Global Markets Strategist for Cornerstone Capital Group. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.

michael.geraghty@cornerstonecapinc.com

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