Stifel: The Knall/Cohen Group Market Commentary Second Quarter 2017 - - PowerPoint PPT Presentation

Market Commentary Second Quarter 2017 Stifel: The Knall/Cohen Group

6.4% 6.4% 4.5% 3.1% 2.5% 1.5% ‐5.5% ‐10.0% ‐8.0% ‐6.0% ‐4.0% ‐2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

MSCI Emerging Markets Index MSCI EAFE Index MSCI All Country World Index S&P 500 Index Russell 2000 Index Bloomberg Barclays U.S. Aggregate Index S&P GS Commodity Index

Index Returns: Second Quarter 2017

Sources: Zephyr StyleADVISOR; Bloomberg.

Equities

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International stocks outperformed the U.S. in the second quarter of 2017, while commodities lagged due to a decline in oil prices.

18.6% 14.2% 11.8% 9.3% 5.0% 2.3% ‐10.2% ‐20.0% ‐15.0% ‐10.0% ‐5.0% 0.0% 5.0% 10.0% 15.0% 20.0%

MSCI Emerging Markets Index MSCI EAFE Index MSCI All Country World Index S&P 500 Index Russell 2000 Index Bloomberg Barclays U.S. Aggregate Index S&P GS Commodity Index

Index Returns: 2Q17 Year‐to‐Date

Sources: Zephyr StyleADVISOR; Bloomberg.

Equities

2

Emerging market equities have gained nearly 19% this year, international developed markets were up 14% through the first six months, and the S&P 500 Index increased 9% year‐to‐date.

Low Volatility for the S&P 500 Index in 2017

2017 Has Been One of the Least Volatile Years We’ve Seen in Decades

• The S&P 500 Index was up on a total return basis in each of the first six months of
• 2017. The last two times this occurred was 1995 and 1996.
• The S&P 500 Index closed up or down at least 1% only four times during the first

half of the year. The last time that occurred was 1972, with only three instances. The record was 1964 with only one, and the most was in 1932 with 91.

• The largest pullback was only 2.8% (March 1 until April 13) and that was the

second‐smallest first‐half pullback ever (1995 at 1.7% is the record). The average first‐half pullback has been 9.0% since 1950.

Sources: LPL Research; Knall/Cohen Group.

Equities

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23% 35% 47% 60% 89% 97% 98% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2010 2011 2012 2013 2014 2015 2016

Passive Ownership of U.S. Stocks By Vanguard

Source: Zerohedge.com. 4

Due to growth in indexing strategies, Vanguard owns at least 5% of the outstanding float of 98% of the companies in the S&P 500 Index, up from 23% in 2010. In addition, Bank of America calculates the proportion of stocks in the S&P 500 Index now managed passively has nearly doubled since the 2008 crisis to 37%, while ETF trading accounts for about one‐fourth of the daily volume across U.S. exchanges. So when investors want to sell how much liquidity will there be? Who will be buying?

% of Stocks in S&P 500 Index Where Vanguard Owns > 5% of Company

Equities

17% 16% 11% 10% 9% 9% 8% 7% 6% ‐11% ‐13% ‐20.0% ‐15.0% ‐10.0% ‐5.0% 0.0% 5.0% 10.0% 15.0% 20.0%

Technology Health Care Consumer Discretionary Industrials Materials Utilities Consumer Staples Financials Real Estate Telecom Energy

S&P 500 Index Sector Returns: 2Q17 Year‐to‐Date

Source: Standard & Poor’s. 5

Equities

Growth stocks outperformed value thus far in 2017, led by Technology and Health Care, with Energy and Telecom lagging.

29% 25% 24% 21% 18% 16% 16% 13% 10% 10% 9% 9% 8% 3% ‐14% ‐20% ‐10% 0% 10% 20% 30%

Greece China Spain India France Germany Italy Portugal U.K. Japan U.S. Australia Ireland Brazil Russia

Country Returns: 2Q17 Year‐to‐Date

Sources: Zephyr StyleADVISOR; MSCI (Gross, U.S. dollars); Standard & Poor’s. 6

Equities

Emerging market countries were among the top performers with Greece gaining 29%, China 25%, and India 21%.

Government Bonds, Yield Curve

Sources: Bloomberg, Thomson One, July 10, 2017.; Knall/Cohen Group.

Fixed Income

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Yields remain low across the world with many countries having negative interest rates. Relative to Europe and Japan, interest rates in the U.S. are attractive to investors. Compared to the Spring of 2016, current interest rates in the countries shown have generally increased across the yield curve, except for the United Kingdom where interest rates have slightly declined due to concerns about a potential economic slowdown related to Brexit.

Country 2‐Year 3‐Year 5‐Year 7‐Year 10‐Year U.S. 1.4% 1.6% 2.0% 2.2% 2.4% United Kingdom 0.3% 0.4% 0.7% 1.0% 1.3% France ‐0.4% ‐0.3% 0.0% 0.4% 0.9% Germany ‐0.6% ‐0.5% ‐0.2% 0.1% 0.6% Japan ‐0.1% ‐0.1% ‐0.1% 0.0% 0.1% Switzerland ‐0.9% ‐0.7% ‐0.5% ‐0.3% 0.0% Maturity

As of July 10, 2017 As of April 12, 2016

Country 2‐Year 3‐Year 5‐Year 7‐Year 10‐Year U.S. 0.9% 1.2% 1.2% 1.5% 1.8% United Kingdom 0.4% 0.6% 0.8% 1.2% 1.4% France ‐0.5% ‐0.4% ‐0.2% 0.1% 0.5% Germany ‐0.5% ‐0.5% ‐0.4% ‐0.2% 0.2% Japan ‐0.3% ‐0.3% ‐0.2% ‐0.2% ‐0.1% Switzerland ‐1.0% ‐1.0% ‐0.8% ‐0.6% ‐0.4% Maturity

“Riskier” Debt Has Very Low Yields Too

Security Yield at Issue Date Debt Issue Date South Korea 50‐Year Government Bond 1.6% October 2016 Ireland 100‐Year Government Bond 2.4% March 2016 Italy 50‐Year Government Bond 2.9% September 2016 Spain 50‐Year Government Bond 3.5% May 2016 Mexico 100‐Year Government Bond 4.2% April 2015 Argentina 100‐Year Government Bond 7.9% June 2017

Sources: The Wall Street Journal, June 20, 2017; Bloomberg; Knall/Cohen Group.

In June, the Argentine government raised $2.8 billion by issuing 100‐year maturity bonds at a yield of 7.9%. This was the first time a junk‐rated government sold century bonds. At the start

• f 2016, Argentina was effectively barred from international bond markets, the result of an $80

billion default in 2001. Argentina has defaulted on their debt eight times since 1827.

Fixed Income

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Growth in ETF Yield Product Over the Past Decade

Source: WSJ’s The Daily Shot, June 28, 2017. 9

Due to low interest rates, a “thirst for yield” by investors has led to demand for income assets, such as corporate debt, REITs, emerging market bonds, MLPs, and dividend stocks.

Fixed Income

Impact of Higher Interest Rates on Bond Returns

6/30/17 Price Impact if 1% U.S. Treasury Yield Rise in Interest Rates 2‐Year 1.4% ‐1.9% 5‐Year 1.9% ‐4.7% 10‐Year 2.3% ‐8.4% 30‐Year 2.8% ‐17.7% Indices Barclays U.S. Aggregate Index 2.6% ‐5.9% Barclays Municipal Index 2.2% ‐6.0% Barclays U.S. Corp. High Yield Index 5.6% ‐4.0%

Source: JP Morgan, Guide to the Markets, June 2017.

Fixed Income

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Global Central Bank Balance Sheets

Source: WSJ’s The Daily Shot, June 12, 2017. 11

The amount of money printing by the major global central banks has been massive, but it is forecasted to hit a plateau soon at approximately $16 trillion, up from less than $4 trillion in 2007.

Fixed Income

26 15 17 17 14 16 0.0 5.0 10.0 15.0 20.0 25.0 30.0 Mar‐00 Oct‐07 Dec‐16 Jun‐17 10‐Year Average 25‐Year Average

S&P 500 Index Forward P/E Multiple

Sources: FactSet Research; JP Morgan.

Valuation

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The current forward price‐to‐earnings multiple for the S&P 500 Index at 17x is slightly above the 25‐year average of 16x, but well below the 2000 bubble at 26x earnings.

6% 6% 7% 0% 0% 10% 12% 0.0% 5.0% 10.0% 15.0%

2012 2013 2014 2015 2016 2017F 2018F

S&P 500 Index Earnings Growth

Sources: FactSet Earnings Insight, July 7, 2017; Knall/Cohen Group.

Valuation

After mid‐to‐high single digit earnings growth in 2012 through 2014 and no earnings growth in 2015 and 2016, the companies in the S&P 500 Index are forecasting double digit earnings gains in 2017 and 2018.

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Tech Valuations Not Far Off from Broad Market

Source: WSJ’s The Daily Shot, June 13, 2017. 14

Although technology companies have been among the top performing stocks this year, their valuations are not far

• ff from the overall market (S&P 500

Index). Valuation multiples during the Tech bubble of March 2000 were unusually high, but that is not the case today.

Valuation

Equity Fundamentals Are Stronger Than Prior Peaks

Sources: Lazard Asset Management; Knall/Cohen Group. 15

Equity fundamentals are stronger than the prior peaks of 2000 and 2007 due to higher cash flow generation and less debt.

March 27 October 11 July 3 2000 2007 2017 S&P 500 Index Price 1,527 1,576 2,429 Trailing Earnings per Share $53 $85 $113 Trailing P/E Multiple 29x 19x 22x Free Cash Flow Yield 2.6% 2.3% 4.7% Net Debt/EBITDA 4.1x 4.5x 1.5x 10‐Year U.S. Treasury 6.2% 4.6% 2.4%

Valuation

18 15 16 13 15 15 13 12 5 10 15 20 25 30 S&P 500 MSCI Europe MSCI Japan MSCI Emerging Markets

Global Equity Market Valuation

Sources: Lazard Asset Management (July 4, 2017).

Valuation

16 Current Median (July 2017) 10‐Year Median

Forward Price‐to‐Earnings Multiples

Similar to the U.S., valuation multiples outside the U.S. are slightly above their historical averages.

High Yield Bond Market Seems Priced for Perfection

Sources: Stifel Research Brief, June 28, 2017; Bloomberg, Knall/Cohen Group. *OAS: Option Adjusted Spread 17

The high yield bond index has a yield below 6%, while the spread above U.S. Treasuries is approaching a multi‐decade low. This indicates that high yield bonds are generally not cheap.

Valuation

U.S. Economic Expansion Cycles

Source: WSJ’s The Daily Shot, June 27, 2017. 18

Outlook

The current economic expansion is now the third longest since World War II. Many economists give it another two years. What will be the catalyst to usher in the next recession?

Long‐Term Forecasted Returns

Sources: GMO, Research Affiliates (assumes 2% inflation), Wellington, Zephyr StyleAdvisor, and Knall/Cohen Group. Themes

• Returns from U.S. equities are forecasted to be lower than their long‐term historical average.
• Non‐U.S. equity returns are projected to be higher than U.S. stocks. Emerging market equities are forecasted to

have the highest returns.

• Bond returns will be low, in the 1%‐to‐3% range.

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Outlook

GMO Research Wellington Vanguard Actual 7‐Yr. Affiliates 10‐Yr. 5‐Yr. 10‐Yr. 25‐Year Index Forecast Forecast Forecast Forecast Annualized Date of Forecast June 2017 June 2017 January 2017 December 2016 NA Firm AUM $80 billion $180 billion $1 trillion $4 trillion NA U.S. Equity ‐1.8% 2.5% 7.0% ~6% 9.6% Non‐U.S. Equity ‐ Developed 1.2% 6.9% 7.5% ~8% 6.4% Non‐U.S. Equity ‐ Emerging 5.3% 8.7% 8.5% ~8% 7.5% U.S. Investment‐Grade Bonds 1.0% 2.1% 2.6% ~2% 5.6%

U.S. Economic Outlook

Source: Bloomberg (July 11, 2017).

2015 2016 2017F 2018F Real GDP Growth +2.6% +1.6% +2.2% +2.3% Inflation +0.7% +2.1% +2.2% +2.2% Unemployment Rate 5.0% 4.7% 4.4% 4.2% 10‐Year U.S. Treasury 2.3% 2.5% 2.7% 3.1% Federal Funds Rate 0.50% 0.75% 1.50% 2.05% Key Observations

• Real GDP is forecasted to be 2% for 2017 and 2018.
• Inflation is projected to be in the 2% range in 2017 and 2018.
• The unemployment rate is forecasted to remain below 5%.
• Interest rates are projected to remain low relative to historical standards, but expectations are for

interest rates to rise.

Outlook

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U.S. Crude Oil Output Keeps Rising

Source: WSJ’s The Daily Shot, June 22, 2017. 21

While OPEC is trying to cut oil production to decrease the supply of oil, U.S. oil producers continue to expand production. U.S. oil production is over 9 million barrels a day, up from about 6 million barrels a day in 2012, or a 50% increase.

Miscellaneous

U.S. Household Debt at Record High

Source: WSJ’s The Daily Shot, June 7, 2017. 22

U.S. household debt is at record levels driven by student loan and auto loan growth since the 2008 recession.

Miscellaneous

Foundation and Endowment Asset Allocation

Source: 2016 NACUBO‐Commonfund Study of Endowments (dollar‐weighted). 23

Miscellaneous

Asset Under $25 to $50 $51 to $100 $101 to $500 $501 to Over $1 Class $25 Million Million Million Million $1 Billion Billion Total U.S. Equity 44% 38% 33% 26% 20% 13% 16% Non‐U.S. Equity 15% 17% 19% 20% 18% 19% 19% Private Equity/Venture 1% 3% 4% 7% 11% 19% 17% Total Equity 60% 58% 56% 53% 49% 51% 52% Fixed Income/Cash 27% 22% 20% 15% 13% 8% 10% Hedge Funds/Asset Allocation 7% 9% 14% 21% 26% 24% 23% Real Assets 2% 5% 6% 7% 8% 15% 13% Other 4% 6% 4% 4% 4% 2% 2% Total 100% 100% 100% 100% 100% 100% 100%

On average, foundation and endowments maintain equity exposure in the 50% to 60% range. Larger foundations hold less in bonds with a higher allocation to alternative strategies (private equity, hedge funds, and real assets).

This document does not constitute an offering to sell securities. It is meant only to provide a broad overview for discussion purposes. All information provided herein is subject to potential changes. Any statistics contained in this presentation have been obtained from sources believed to be reliable but are not necessarily complete and cannot be guaranteed. They are provided for informational purposes only. Any performance information provided in this presentation is historic and should not be taken as any indication of future performance. There can be no assurance that the investment opportunity will achieve comparable results, be able to implement its investment strategy, or avoid losses. Any comparison to a single market index is imperfect because some investment opportunities described in this presentation may contain options and other derivative securities, may include margin trading and other leverage. No part of this presentation is intended as a recommendation of any firm or any security. Factual information contained herein about investment opportunities and their returns, which has not been independently verified, has generally been collected from the firms themselves. Any investment performance figures described in this presentation are net of all fees and commissions unless otherwise indicated. Any management fees shown in this presentation exclude any commissions Stifel may receive from the execution of security transactions with an investment manager. In addition, the management fees exclude any compensation Stifel may receive from an investment manager for marketing and/or administrative services provided to Stifel clients. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Sector funds, because of their narrow focus, can exhibit greater volatility. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have a greater credit risk than higher quality bonds. Treasury bonds are backed by the U.S. government. Other investments do not have this backing and therefore may have higher risk. High-yield bonds have greater credit risk than higher quality bonds. CDs are insured by the FDIC and may provide fixed yields, whereas alternative investments’ principal and yield will fluctuate with changes in market conditions and may not be insured. Hedge funds often engage in leverage, short-selling, arbitrage, hedging, derivatives, and other speculative investment practices that may increase the investment loss. They are highly illiquid, often charge high fees that can erode performance, and may involve complex tax structures and delays in distributing tax information. They are not required to provide periodic pricing or valuations information to investors, and are not subject to the same regulatory requirements as mutual funds. The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains.

Investing in real estate involves the risk that trends unfavorable to real estate, such as tax law changes or rising interest rates, could have a negative impact on a real estate investment.

Important Disclosures

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The S&P 500 Index is capitalization-weighted and is generally considered representative of the U.S. large capitalization equity market. The MSCI EAFE Index is a capitalization-weighted index that represents 23 developed markets outside North America, including Europe, Australasia, and the Far East. The MSCI World Index is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets. The MSCI Emerging Markets Index consists of 23 emerging market country indices and is designed to measure equity market performance in the global emerging markets. The MSCI Selected Countries indices are designed to measure equity performance within the specified country. The Dow Jones Industrial Average Index is an index that measures the performance of thirty large, publicly owned companies based in the United States. The Nasdaq Composite is an index that measures the performance of publicly traded stocks in the United States, which are primarily technology-related companies. The Bloomberg Barclays U.S. Aggregate Bond Index is designed to measure the performance of the U.S. investment-grade bond market. The Bloomberg Barclays 10-year U.S. Treasury Index is designed to measure the performance of the 10-year U.S. Treasury security. The Bloomberg Barclays 30-year U.S. Treasury Index is designed to measure the performance of the 30-year U.S. Treasury security The Bloomberg Barclays Corporate High Yield Index is designed to measure the performance of the U.S. non-investment-grade bond market. The Bloomberg Barclays U.S. MBS Index is designed to measure the performance of the mortgage-backed securities included in the Barclays U.S. Aggregate Bond Index. The Bloomberg Barclays U.S. Credit Index is designed to measure the performance of the investment-grade corporate bond market included in the Barclays U.S. Aggregate Index. The Bloomberg Barclays U.S. Government/Credit Index is designed to measure the performance of investment-grade corporate bonds and U.S. government bonds in the Barclays U.S. Aggregate Index. The Bloomberg Barclays U.S. Intermediate Credit Index is the intermediate component of the U.S. Credit Index. The Bloomberg Barclays 1-3 Year Government/Credit Index is designed to measure the performance of U.S. government and investment-grade corporate bonds with maturities between one to three years. The Bloomberg Barclays Municipal Index is designed to measure the performance of the U.S. municipal bond market. The Bloomberg Barclays U.S. Treasury Inflation Protected Securities Index (TIPS) consists of inflation-protection securities issued by the U.S. Treasury. The HFRI Fund of Funds Composite is an index of hedge fund strategies, specifically funds of hedge funds. The HFRI Fund Weighted Composite is an index of hedge fund strategies, excluding funds of hedge funds.

Important Disclosures

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The HFRI Equity Hedge Composite is an index of hedge funds that maintain both long and short equity positions (typically at least 50% exposure to equities). The MSCI AC World Index is designed to measure the equity performance of developed and emerging markets. The MSCI AC World ex U.S. Index is designed to measure the equity performance of the developed and emerging markets, excluding the United States. The Russell 1000 Index measures the performance of the 1,000 largest companies in the Russell 3000 Index. The Russell 1000 Growth Index measures the performance of those Russell 1,000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index measures the performance of those Russell 1,000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 2000 Growth Index measures the performance of those Russell 2,000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Value Index measures the performance of those Russell 2,000 companies with lower price-to-book ratios and lower forecasted growth values. The S&P GS Commodity Index represents the performance of diversified commodity futures. The S&P GS Gold Index is a sub-index of the S&P GS Commodity Index that measures the performance of COMEX gold futures. S&P 500 Growth: Represents stocks in the S&P 500 Index that are considered growth stocks based on sales growth, earnings valuation, and momentum. S&P 500 Value: Represents stocks in the S&P 500 index that are considered value stocks based on ratios of book value, earnings, and sales to price. The SPDR Gold Trust (GLD) is an exchange-traded fund that seeks to correspond to the performance of gold bullion. Oil (WTI) is spot price of West Texas Intermediate oil. The S&P CoreLogic Case-Shiller U.S. National Home Price Index is a composite of single-family home price indices for the nine U.S. Census divisions. The Index seeks to measure changes in the total value of all existing single-family housing stock. Index returns include the reinvestment of dividends but do not include adjustments for brokerage, custodian, and advisory fees. Indices are unmanaged and are not available for direct investment. The Knall/Cohen Group: David Knall, Managing Director; Jeff Cohen, Managing Director; Jamie Knall, Managing Director; Tom Pence, Managing Director; Mike Hall, Senior Vice President/Investments; Mike Aguirre, Senior Vice President/Investments Stifel, Nicolaus & Company, Incorporated Member SIPC & NYSE 600 East 96 Street Suite 575 | Indianapolis, Indiana 46240

Important Disclosures

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