March 15, 2018 2018 SGV Economic Forecast Summit
March 15, 20182018 SGV EconomicForecast SummitGlobal & National ForecastChristopher Ainsworth, Managing Director
Disclaimer
The CIO “Bulls Eye”An succinct and objective perspective on new developments during the quarter and key ongoing macro drivers.Recent DevelopmentsRepublican tax plan signed into law, handing President Trump a major legislative achievementJerome Powell chosen as next Federal Reserve Chairman, seen as a continuation of accommodative monetary policyU.K. and the European Union agree to separation financial bill, setting up talks for future trade relationshipRepublican electoral defeats potentially signal shift in political windsQuantitative Easing Roll Off (QERO) begins in U.S. while global central banks tiptoe towards tightening monetary policyAngela Merkel, recently elected Chancellor of Germany, finds it difficult to form a governmentNorth Korea, categorized as state-sponsor of terrorism, fires another ICBM*Bitcoin futures begin trading on the Chicago Board Options Exchange and Chicago Mercantile ExchangePositive FactorsOn WatchBroad global synchronized recovery drives earnings growthGeopolitical and trade tensions (protectionism)Monetary policy worldwide remains accommodativeChina’s deleveraging campaign and economic transitionHealthy consumer and job growth drives U.S. economyQERO and FOMC** compositionGrowth of European economy reduces political riskItalian elections (March 4th) / Identity PoliticsSource: Chief Investment Office. Data as of December 31, 2017. *Intercontinental ballistic missile; **Federal Open Market Committee1
2018 Outlook: The Next Great OdysseyWe see 2018 as a year of continued transition.The progression from the prolonged period of secular stagnation and extraordinarily low interest rates to risingeconomic growth, enhanced by secular forces, and rising interest rates may generate episodes of concern, which couldeventually set the stage for a new upcycle.Our outlook of expected dynamics to drive the new upcycle can be seen through a 5 by 5 prismExpected growth sourcesNew demographic & inflation dynamics expected to allow Capital investment via repatriationCentral banks to normalize large balance sheetsMillennial housing cycleTapering of central bank bond-buying programsEmerging market middle-class consumersA nudge higher in interest ratesSecond wave of an innovation cycleTrillions of dollars to fade to positive rate structureGlobal infrastructure redevelopmentDebt servicing costs to remain at acceptable levels, as growthhovers at or above trend levelsSource: GWIM Investment Strategy Committee (ISC) as of December, 2017.2
U.S. GDP Quarterly % Change3
Manufacturing SurveyCurrent General Business ConditionsSource: www.philadelphiafed.org/manufacturing-BOSSource: Research.stlouisfed.org4
Leading Economic Indicator5
Tight Labor MarketA tight labor market supports faster wage growth.Unemployment rate has declined, which may pressure wage growthWage Growth Tracker: Overall:3-Mo Moving Avg of Median Wage Growth Non-Seasonally Adjusted, %17.5715.0612.5510.0Percentage (%)Percentage (%)Broader Measure of Unemployment*, SA, %Civilian Unemployment Rate: 16 yr , SA, 2013*Broader measure of unemployment: Total unemployed plus all marginally attached workers, plus total employed part time for economic reasons as a percent of thecivilian labor force, plus all marginally attached workers. Source: (Left) Bureau of Labor Statistics/ Haver Analytics. As of December 15, 2017. (Right) Federal Reserve Bankof Atlanta / Haver Analytics. As of January 3, 2018. Shaded are recessions.Past performance is no guarantee of future results. Please refer to appendix for asset class disclosures and index definitions.62016
Inflation Expectations are SoftInflation running below policy target adds to the case for a cautious Fed tightening cycle. Coreinflation should return to trend over the medium term.Market-based inflation expectations are still historically low .a mood increasingly reflected by consumers.Calculated 5-Year Forward Inflation Rate EOP, %12 Month Expectations: Change in Prices: Median Increase, %5.253.04.502.01.5Percentage (%)Percentage (%)2.53.753.001.02.250.51.502004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Source: (Left) Federal Reserve Board /Haver Analytics. As of January 3, 2018. (Right) University of Michigan /Haver Analytics. As of January 3, 2018.Past performance is no guarantee of future results. Please refer to appendix for asset class disclosures and index definitions.7
Global Profit OutlookSynchronized global earnings expansion is expected to continue.Earnings growth has been synchronized across regions, atrend expected by analysts to continue.Analyst earnings revisions are headed higher across mostregions.2.040USAJapanAsia Pac ex-Japan28.2301.61.42016.41.2YoY, (%)# Stock Upgraded / # d Markets-200.2Emerging 2011201220132014201520162017E2018E2019ESource: (Left) BofA Merrill Lynch Global Research. Data as of November 30, 2017. Source: (Right) FactSet consensus estimates. Data as of January 4, 2017.Past performance is no guarantee of future results. Please refer to appendix for asset class proxies and index definitions.8
Inside the Global Synchronized Economic PickupMore country economies have been growing at faster rates, while those contracting have fallen to acycle low.Countries growing above 2% and below 0%Share of all countries100%90%Countries growing above 2%80%Countries growing below 0%Cycle high70%60%50%40%30%20%Cycle ce: International Monetary Fund. Data as of 2017.Past performance is no guarantee of future results. The economic and market forecasts presented are for informational purposes as of the date of this report. Therecan be no assurance that the forecasts will be achieved. Please refer to appendix for asset class proxies and index definitions.9
Global Economic Policy UncertaintyPolicy uncertainty is off its highs post-French election, while financial stress remains benign.Policy uncertainty has declined, financial stress is lowGlobal Economic Policy Uncertainty Index (EPU)350(January 1997 to November 2017)Using data for 17 countries that account for2/3 of global GDP300BofA Merrill Lynch Global Financial Stress Index (GFSI)U.S. Elections &Political developmentsin Brazil, China, France,South Korea, and theU.K.Levels greater/less than 0 indicate more/less financial market stress1.00.8Brexit200150Asian &RussianFinancialCrisis9/11Gulf War IIGlobalFinancialCrisisEurozone Crises, U.S.Fiscal Fights, ChinaLeadership 2-0.450Global EPU, Current Price GDP Weights00.6BofAML GFSI250-0.6201220132014201520162017Source: (Left) www.policyuncertainty.com. Data as of December 14, 2017. (Right) Bloomberg and Chief Investment Office. Data as of December 14, 2017.Notes: Global EPU calculated as the GDP-weighted average of monthly EPU index values for U.S., Canada, Brazil, Chile, UK, Germany, Italy, Spain, France, Netherlands, Russia, India,China, South Korea, Japan, Ireland, Sweden, and Australia, using GDP data from the International Monetary Fund (IMF) World Economic Outlook Database. National EPU indexvalues are from www.PolicyUncertainty.com and Baker, Bloom and Davis (2016). Each national EPU Index is renormalized to a mean of 100 from 1997 to 2015 before calculating theGlobal EPU Index.Past performance is no guarantee of future results. fees or expenses. It is not possible to invest directly in an index.Please refer to appendix for asset class proxies and index definitions.10
Global Economy ImprovingThe synchronized global growth upturn that began last year continues and has broadened.Global aggregate economic data continue to improveOECD & Major Six Non-Mem: Original Series:Gross Domestic Product (Year/Year % Change)5.5Global Wave suggests continued outperformance for equitiesand cyclical rotation5.0GDP (YoY % Change)China/EM Slowdown4.54.0Dollar-Oil 17The Global Wave quantifies trends in global economic activity and is anamalgamation of seven macroeconomic and market components.***Organization for Economic Co-operation and Development. **Components of Global Wave: Global Industrial Confidence (Output), Global Consumer Confidence (Demand), GlobalCapacity Utilization (Investment), Global Unemployment Labor (Market), Global Producer Prices (Prices), Global Credit Spreads (Bond Market) and Global Earnings Revision Ratio(Equity Market). Source: (Left) OECD /Haver Analytics. As of December 2017. (Right) BofA Merrill Lynch Global Quantitative Strategy, MSCI, IBES, Bloomberg, OECD, IMF. As ofDecember 2017. Past performance is no guarantee of future results. There can be no assurance that the forecasts will be achieved. Economic or financial forecasts are inherentlylimited and should not be relied on as indicators of future investment performance. Please refer to appendix for asset class disclosures and index definitions.11
CIO U.S. Recession IndicatorChanges in economic gauges we track are aggregated into the CIO U.S. Recession Indicator. At itscurrent reading, the risk of recession in the U.S. appears to be currently low.100RecessionElevated recession risk 25%Recession Indicator*Extreme recession risk 50%9080Probability (%)7060504030201001970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016Source: GWIM Chief Investment Office, Bloomberg, National Bureau of Economic Research. *Logistic regression of six macroeconomic variables (initial claims,housing starts, industrial production, domestic vehicle sales, 10yr-3m yield curve, commercial bank loans and leases) against recessionary and non-recessionaryperiods since January 1970. The start of past recessions has generally been contemporaneous with increases in the indicator above 50%. Data as of November 2017.Past performance is no guarantee of future results. Please refer to appendix for asset class proxies and index definitions.12
Tax Reform in a Global ContextTax reform aims to make American firms more competitive and spark a capital expenditure cycle.This along with household tax cuts are ingredients for stimulating growth in the U.S.Headline national corporate tax rates, excluding regional or state levies (%)454035U.S. (previous)France302520Corporate tax rates around theworld have been trending lowerfor years. We believe tax reformhelps realign the U.S. with othermajor economies.JapanU.S. (new)U.K.1510GermanyCanadaIrelandWe believe tax reform, alongwith other pro-growth fiscaland regulatory policies, shouldstrengthen U.S. firms’ standingin the global economy.502000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Source: OECD. Data as of December 2017. The key on the right hand side of the chart classify the lines by country, while the top shows what the lines are. NeitherMerrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. Clients should consult their legal and/or tax advisors beforemaking any financial decisions. Past performance is no guarantee of future results. Please refer to appendix for asset class disclosures and index definitions.13
Repatriation: Over 1 Trillion to Return tothe U.S.?S&P 500 companies potentially returning over one-trillion dollars may boost earnings per share bytwo to three dollars on share buybacks. Tech and Health Care may benefit the most.Top 20 firms with overseas cash as a % ofmarket cap*Earnings per share impact by sector from repatriated cash used forbuybacksTechnology5.0Health Care2.1S&P ustrials0.7Materials0.6Telecom0.1Real Estate0.1Utilities0.00123Earnings per share impact (%)456CSCO Cisco Systems, Inc.GILD Gilead Sciences, Inc.NTAP NetApp, Inc.QCOM QUALCOMM IncorporatedAMGN Amgen Inc.ORCL Oracle CorporationAAPL Apple Inc.WDC Western Digital CorporationNWS News Corporation Class BSTX Seagate Technology PLCWAT Waters CorporationMSFT Microsoft CorporationXLNX Xilinx, Inc.LRCX Lam Research CorporationGE General ElectricRL Ralph Lauren Corporation Class ACA CA, Inc.CTXS Citrix Systems, Inc.JNPR Juniper Networks, Inc.VRSN VeriSign, : BofAML Global Research. Data on report published December 20, 2017. *For reference purposes only.Past performance is no guarantee of future results. Indexes are unmanaged and do not take into account fees or expenses. It is not possible to invest directly in an index.14
U.S.: Effective Corporate Tax Rates by IndustryRetail, Telecom, and Media companies may see the largest windfall from the recently passedRepublican tax plan.Small cap Russell 2000 corporate tax ratesEffective rateLarge cap Russell 1000 corporate tax ratesEffective rateRetailingTelecommunication ServicesTelecommunication h Care EquipmentAutomobiles & ComponentsDiversified FinancialsCapital GoodsMaterialsHealth Care EquipmentAutomobiles & ComponentsSoftware & ServicesCapital GoodsHousehold & Personal ProductsDiversified FinancialsHousehold & Personal ProductsDecreasingbenefit fromlower statutoryrateSoftware & ServicesSemiconductors & EquipmentSemiconductors & EquipmentPharma, Biotech & Life SciencesPharma, Biotech & Life SciencesEnergyEnergy0%5%10% 15% 20% 25% 30% 35% 40%Decreasingbenefit fromlower statutoryrateMaterials0%5% 10% 15% 20% 25% 30% 35% 40%Source: Credit Suisse, S&P Capital IQ/ClariFi, Compustat. Data as of 2016. Past performance is no guarantee of future results. The economic and market forecasts presented arefor informational purposes as of the date of this report. There can be no assurance that the forecasts will be achieved. Neither Merrill Lynch nor any of its affiliates or financialadvisors provide legal, tax or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions. Please refer to appendix forasset class disclosures and index definitions.15
Buybacks Reach 2nd Highest Amount Since 2009Corporate buybacks year-to-date, as of Feb. 6, in billions.Source: Birinyi Associates16
U.S. Equity Fundamentals and ValuationsEquity valuations are full on an absolute basis, but more attractive versus fixed income. Earningsgrowth may be key for further equity upside.The normalized equity risk premium* usually undershootsduring bull markets1000bpEarnings momentum for the S&P 500 is forecasted to carry into 201820Financial crisisBAML EstimateChief Investment Office*18.1Actual unless specified (E)Chief Investment Office Range*18.21818Euro Crisis,Fiscal Cliff800bp15.81614400bpAverage (ex-Tech Bubble) 363 basis points (bp)YoY, (%)600bpEquity fearEquity optimism12.011.31212.811.5 2-200bp1987Tech 74Q17E1Q18E2Q18E3Q18E4Q18E2017E2018ENote: Specified (E) is the consensus expectation, an average of analysts’ forecasts surveyed by First Call.Source: (Both) BofA Merrill Lynch US Equity & US Quant Strategy. *Note: Normalized equity risk premium is the spread between normalized earnings per share (EPS) yield and thenormalized risk-free rate (RFR). Normalized EPS is based on a log linear regression of S&P 500 operating EPS. The normalized RFR is the difference between 1) the average of the30-year Treasury yield and the 5-year rolling average 10-year Treasury yield and 2) the 10-year TIPS spread and the 5-year rolling average CPI inflation rate. Data as of November30, 2017. (Right) Source: BofAML Global Research; Chief Investment Office. *The Chief Investment Office forecasts a S&P 500 2018 earnings per share (EPS) target range of 148– 158, which is depicted by the checkered box. E Estimate. Past performance is no guarantee of future results. Please refer to appendix for asset class proxies and indexdefinitions.17
Non-U.S. Equity ValuationsAcross the world, equity valuations relative to the U.S. appear appealing.Price-to-Book ratios versus the U.S. (MSCI indices)Price-to-Book of region versus Price-to-Book of U.S.1.0Current15 year average90th percentile10th ing1Markets1.5 Developed2 ex-U.S.2.53Europe3.54Japan4.5Source: Chief Investment Office, Bloomberg. Data as of December 29, 2017. Indexes are unmanaged and do not take into account fees or expenses. It is not possible to investdirectly in an index. Please refer to appendix for asset class proxies and index definitions.18
In Europe & Japan, Purchasing Power is KeyIn Japan, rising wages would increase consumer purchasing power and may be instrumental in defeating itspopulation’s “deflationary mindset.” In Europe, purchasing power would lift low margins off the mat,potentially boosting upside.The Japanese labor market is tight, which may result in risingwages as employers struggle to fill vacancies. Higher inflationmay boost attractive equity valuations.Profit margins are near a peak in the U.S. but sub-trend inEurope with room to expand.2.512MSCI US Profit Margin (12m Trailing)MSCI Europe Profit Margin (12m Trailing)1081.5%New Jobs to Applicants 052011201702003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Source: Chief Investment Office. MSCI, Bloomberg. (Left) Data as of November 30, 2017. (Right) Data as of December 29, 2017Past performance is no guarantee of future results. Please refer to appendix for asset class proxies and index definitions.19
Global Pickup May Favor Emerging MarketsIn our view, a rebound in global trade, along with the rise of the consumer are trends favoringEmerging Markets, particularly in Asia.Growth in global trade volumes have historically been atailwind for earnings in Asian Emerging Markets.On a relative price basis, Emerging Markets appear to have plentyof runway for appreciation if they lead global economic growth.EM Asia EPS growth140Global trade volume (rhs)8.07.01606040102000-20YoY, (%)2080EM GDP minus DM GDP (%)6.0100YoY, (%)180MSCI EM / MSCI DM 02001EM-DM Real GDP growth gap2003200520072009201120132015-202017-1.01996 1998 2000 2002 2004 2006 2008 2010 2012 2014 20166040A pickup in economic growth relative to Developed Markets suggests strength for Emerging Market equitiesNote: MSCI DM represented by MSCI World IndexSource: Chief Investment Office. IMF. Bloomberg, MSCI. (Left) Data as of September 30, 2017. (Right) Data as of December 29, 2017.Past performance is no guarantee of future results. Indexes are unmanaged and do not take into account fees or expenses. It is not possible to invest directly in anindex. Please refer to appendix for asset class proxies and index definitions.20MSCI EM / MSCI DM - Indexed to 10040160
Fixed Income Market TrendsThe disconnect between Federal Reserve projections and market expectations is something to watch,though it has narrowed. Negative policy rates continue to drive divergences in sovereign yields.Ex-U.S. global sovereign yields remain close to zeroGap between Fed and market rate hike expectations has narrowed3.00%3.0Market-implied rate path2.75%2.52.50%2.02.25%Yield (%)Projected Federal Funds RateFed-implied rate path2.00%10 Year Treasury1.510 Year German Bund1.01.75%10 Year Japanese Government 7Jun-17Sep-17In our view, the search for yield, the low supply of sovereign bond inventory, and the negative yield backdrop outside the U.S.,have all led to money flo
The Global Wave quantifies trends in global economic activity and is an amalgamation of seven macroeconomic and market components.** Global aggregate economic data continue to improve Global Wave suggests continued outperformance for equities and cyclical rotation
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