Download CIO Thoughts 5/09

The Key to Investing in Markets Today May be in Knowing Who
You Are and What You Do…
Rick Rieder
CIO, Global Fixed Income
Trevor Slaven
Dez Desai
Annelise Eschmann
May 18, 2017
The opinions expressed are those of BlackRock as of 18 May 2017, and are subject to
change at any time due to changes in market or economic conditions.
This document contains general information only and does not take into account an individual’s financial circumstances. An assessment
should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a
professional adviser before making an investment decision. Reference to any security, holding or company is for discussion purposes only.
The issuers referenced are examples of issuers BlackRock considers to be well known and that may fall into the stated sectors. BlackRock
may or may not own any securities of the issuers referenced and, if such securities are owned, no representation is being made that such
securities will continue to be held.
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Dial-in information
• Date: May 18, 2017
• Time: 8:00am Eastern Standard Time*
• Conf. Call Name: Monthly Markets Call
• Passcode: 6474262
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Markets today have become incredible in their convergence of thought… Seemingly everyone
crowds into the same views and then watches those positions underperform due to lack of followthrough potential…
• For example, it is incredible that a select few do all the deep analysis in areas like oil such as
production capacity, technology innovation, political dynamics, etc. but everyone in the market has an
opinion on where oil is going…
• Markets seem to coalesce around one consensus view on complex subjects, and like to simplify the
key drivers within that view; e.g. ECB tightens and Euro rallies.
• Consequently, markets tend to converge toward one overriding principle or theme related to what the
experts have discerned, particularly in an era of media/social media ever-presence.
• Markets move up with the crowd, and then when they don’t have anyone else to sell their ideas to, they
go down, unless there is a secular theme which persists to drive the concept further, or the underlying
technical conditions within that concept are extraordinarily deep and durable…
• In other words, the consensus wins for a while and then ultimately loses, unless the secular and
technical factors overwhelm the crowding into one view.
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3
However, knowing who you are, and what the environmental conditions are, could ultimately drive
success in today’s unusual market conditions, and can prevent reacting to superfluous noise which
detracts from the objective at hand…
Today’s Call is organized to address three key drivers in the market:
1) Major secular trends and drivers that
persist over many years and are the
underlying foundation of long-term
investment direction…
2) Medium-term trends/cycles which
can determine prices and market
moves, and can tangibly drive returns
and profitability…
3) Short-term news or
noise which can
influence very shortterm market prices
but can easily
reverse
Investors
Major trends: important to build from
here given long-term return objectives
or liability-matching requirements
Medium-term cycles: critical to
evaluate effectively as they can be
major drivers of return… they vary in
length, but usually with two or three
main themes a year that drive annual
return proficiency…
News / Noise: require incredible
fortitude and conviction to ignore, or
scale in a very small way…
Speculators / Traders
Major trends: should generally not
be interested here
Medium-term cycles: these are
helpful for background…
News / Noise: there is money here
today still, but the era of
instantaneous information
dissemination, transparency, and
central-bank influence on volatility
make this difficult, requiring speed,
efficient scaling, and an ability to
quickly decipher news from noise…
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… we just had a full refresher on these exact concepts during the prior week…
Some of the recent Chinese data has turned down, but is
coming off of a heretofore surprisingly solid growth
trajectory which should remain intact in our view…
53.5
Last Thursday, the PPI data was strong, stoking the
“reflation” theme again, but then on Friday morning, the CPI
data was soft, invoking a “lack of inflation” theme again…
2.2%
55
53.0
2.0%
53
50
51.5
49
48
51.0
Yield
51
52.0
2.0%
1.8%
47
50.5
1.9%
1.6%
1.8%
Yield
GDP PMI
52
PMI Output Prices
52.5
50.0
2012
2.2%
PPI Surprises
Higher
2.1%
54
1.7%
1.4%
CPI Surprises
Lower
1.2%
1.6%
1.5%
46
2013
2014
2015
GDP Weighted PMI Headline
2016
45
2017
GDP Weighted PMI Output Prices (rhs)
1.0%
1.4%
US 3Y Breakeven
US 10Y Breakeven (rhs)
We believe in the title of our last monthly:
• “Investing Within a System that is Only ‘Flating’ During a Time of Increased Uncertainty and Historic Technical
Conditions”
• … and we agree with the FOMC’s recent assessment of the US earlier this month that “…inflation will stabilize
around 2 percent over the medium term…” And we believe that a lot of the inflation data released last week
was largely noise around what is a roughly stable dynamic…
• Hence, we think that investing today is all about focusing on:
1) The large secular themes as a foundational backdrop,
2) … married to some major intermediate cyclical dynamics that can drive a good deal of annual returns,
3) …as well as maintaining an incessant focus on separating the daily news from the noise…
Source: Bloomberg as of 5/15/2017
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1) Major secular trends – We still think that few appreciate how powerful they are in 2017, and in
virtually every month within it… Demographics and technology keep driving all the major market
moves…
The growth in demand for fixed income assets is
outpacing the supply of liabilities to generate the
cash flows 1
$150
Fixed Income: $89 trillion
Equity: $58 trillion
Growth of Supply and Demand for Global
Fixed Income
$2,500
USD Billions
$2,000
$1,500
$600 bn in annual interest
income to US households is 7x
higher than the $85 bn “cost” of
a 1% increase in mortgage rates
(and mostly only new
mortgages would be affected)
$1,000
$500
$0
USD Trillions
$6
$4
$2
2018
2017
2016
$8
$0
Demand-Supply Imbalance
Net G4 Issuance, Net of CB QE
Checkable Deposits Savings Deposits
Net Demand, Global Fixed Income Assets ex. CBs
*Net Demand assumes Global Fixed Income Demand Base maturities of
approximately 7 years (in-line with the duration of Barclays Global Agg) and
coupon payments in-line with the five-year trailing yield (currently 2.0%)
A normalization of yields on household financial
assets (100-120bps higher) would equate to $500600 billion in additional interest income per year 2
2015
US Insurance
EU Corporates
JP Corporates
SWFs
US HF, PE, MF & ETF
2014
2016
2013
2014
2012
US Corporates
EU Households
JP Households
JP Insurance
Int. FX Reserves
2012
2011
2010
2010
2008
2009
US Households
US Pensions
EU Insurance + Pension
JP Pension
CBs
2006
2008
2004
2007
$0
2002
2006
$25
2003
$50
$10
2005
$75
$12
$14
$12
$10
$8
$6
$4
$2
$0
2004
$100
USD Trillions
USD Trillions
$125
Household deposits and money market fund
holdings exceed $11 trillion; A 1.0% increase in
the rate earned on cash assets equates to over
$110 billion of annual income 2
Money Markets
… hence the inflows in Fixed Income that
continue to press yields & spreads to very
aggressive levels 4
The demand for income from the aging global demographic is
stark, especially as an aging population tends to slow growth,
resulting in lower interest rates 3
• The amount of implicit demand for yielding financial assets
from retirees alone is incredible
500,000
400,000
Source: Census as of 12/31/16
1987
1997
2007
2017
2027
Population Ages 65+ (MMs)
% of the Total Population
29.6
12.2%
34.4
12.6%
37.8
12.6%
51.1
15.6%
69.5
19.7%
Yield: 50/50 Portfolio of TSY & HY
11.4%
7.3%
6.8%
4.0%
4.1%
Annual Interest Income Desired
Fin. Assets Req. to Generate
Income
$9,485
$13,276
$17,349
$20,000
$24,380
Agg. Fin. Assets Req. for 65+yr
300,000
200,000
100,000
0
-100,000
$83,315 $181,586 $253,955 $497,055 $589,408
-200,000
05/13
$ in BNs
HH Interest Income
USD, millions
There is nearly $150 trillion of liquid assets
seeking out yield around the world 1
$2,468
$6,247
$9,606
$25,377
$40,937
HH Interest Income @ 4.0% Yield
Source: 1) Barclays as of 9/30/16; 2) Federal Reserve as of 12/31/16; 3), Census as of 12/31/16; 4) EPFR, as of 5/10/17
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05/14
05/15
05/16
05/17
All Global Bond Mutual Fund Flows
North America Bond Mutual Fund Flows
20170517-160346-445949
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1.A.) Demographic influences continue (and will continue) to be one of the biggest forces driving this major
secular demand for yield… Central banks continue to use extreme policy to plug what is largely a demographicallydriven “lower potential growth” impact, consequently driving immense demand into Fixed Income/Rates markets…
4,500
350
4,000
300
3,500
250
3,000
2,500
2,000
1,500
14,000
10,000
150
100
50
Japan: Increm. Govt Debt
Eurozone: Increm. ECB B/S
Japan: Increm. BOJ B/S
… hence why Europe and Japan still have negative
net supply after taking the purchases of the ECB
and BOJ into account 2
Net G4 Issuance, Net of CB QE
BOJ Balance Sheet (USD)
2016
Fed Balance Sheet (USD)
However, $180bn of annual run-off could start in 2018 once the Fed begins
reducing its balance sheet, which is still moderate relative to the $60bn/mo
the ECB is still buying (albeit in smaller size next year)… 3
Balance sheet scenario
4,000
5.00
4.50
3,000
Size of B/S ($,trillion)
4.00
2,000
1,000
0
-1,000
USD
GBP
EUR
TOTAL
2016
2013
2010
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
-2,000
Total
MBS
100
Scenario assumptions for a
tapered runoff:
90
•
In H1 2018, allow 5bn Tsy
& 5bn MBS to run off per
month
•
In H2 2018, allow 10bn Tsy
& 10bn MBS to run off per
month
•
Starting in 2019, Allow full
runoff in MBS (i.e. fully stop
MBS reinvestment).
Continue to allow 10bn Tsy
to run off per month
•
In mid 2023, when Fed’s
SOMA holdings get down
to $2.8 trillion, start to net
buy Treasuries again (NY
Fed’s assumption)
80
Tsy
3.50
70
3.00
60
2.50
50
2.00
40
1.50
30
1.00
20
0.50
10
0.00
0
JPY
Source: 1) ECB, as of 3/31/17; 2) BlackRock, 5/2017; 3) Federal Reserve, as of 5/2017
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Monthly Run-Off ($, billion)
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
-
5,000
USD Billions
$ in
BNs
6,000
ECB Balance Sheet (USD)
SUPPLY DEMAND
Net Demand,
Net G4
Global Fixed
Gross G4 Net G4 Issuance,
Income
Issuance Issuance Net of CB
Assets ex.
QE
CBs
3,832
2,038
2,038
9,703
4,357
2,282
2,282
10,553
4,350
2,101
2,101
9,609
4,902
1,986
1,986
9,662
4,907
2,077
2,077
10,626
4,861
1,273
1,273
11,504
7,268
3,874
3,871
11,640
6,929
3,911
3,550
12,754
6,693
2,770
1,739
12,312
7,094
2,584
2,076
11,478
6,933
2,673
1,609
10,643
6,928
2,202
1,394
8,676
6,350
1,728
636
8,458
6,528
1,901
351
7,907
6,658
1,924
484
7,778
7,786
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
Eurozone: Increm. Govt Debt
Supply of fixed income is being
overwhelmed by demand,
especially when taking central
bank demand into account… 2
$3.2tr in
May 2007
2,000
2005
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
(100)
2006
-
2005
500
8,000
4,000
-
(50)
$13.2tr in
May 2017
12,000
200
1,000
An incremental $10 trillion in Central Bank assets have been
put to work  a number that is still growing… 2
US$ billions
Yen in Trillions
EUR in Billions
The ECB and BOJ have essentially bought all of the net issuance of their governments since
before the crisis 1
20170517-160346-445949
7
… the supply/demand imbalance could change significantly over the next two years (possibly led by Europe),
consequently taking some of the pressure off of US rates… And, the US paradigm of deficit spending and borrowing
could very well change over the next couple of years, but probably not for a bit of time…
2017 net supply estimates today – which will change quite a bit when the ECB tapers 1
Germany | net supply net of QE purchases
5
10
5
0
bns
bns
France | net supply net of QE purchases
11
-10
-20
-30
-11 -13
-12
-13
-16
-16
-17
-19
-23
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
20
10
0
-10
-20
-30
-40
15
bns
bns
1
-5
-9
20
0
-9
-10
-10 -9
-13
-15
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
-24
-28
6
4
1
2
0
-1
-5
-15
3
0
-3
-10
-20
-17
-23
-30
-40
-24
-32
-50
1
-60
0
-10
8
2
0
-19
5
0
-20
2
Italy | net supply net of QE purchases
5
-4
EMU-11** | net supply net of QE purchases
10
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
12
-10
11
-9
10
10
13
10
Spain | net supply net of QE purchases
20
8
4
bns
20
-70
-1
-67
-68
-80
-9
-12
-12
-13
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Positive Supply
-82
-90
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Negative Supply
90%
16
80%
14
70%
12
60%
10
50%
8
40%
6
30%
4
20%
2
10%
0
1945
1955
1965
Federal Govt
1975
1985
1995
2005
State & Local Govt
2015
0%
1975
Net Treasury Issuance vs. Federal Budget Deficit
$2,000
-$1,600
-$1,400
$1,500
USD Billions
18
-$1,200
-$1,000
$1,000
-$800
-$600
$500
-$400
2017 data is
-$200
LTM Net
$0
Issuance
$0
USD Billions, inverse
$ Trillions
U.S. government debt has been growing, but so have tax receipts… Yet, ultimately, entitlement-spending will likely overwhelm this in the coming years… 2
$200
-$500
1985
1995
2005
Federal Gov't Debt to GDP
$400
2015
Tsy Issuance
Federal Budget Deficit, rhs
Source: 1) ECB, as of 3/31/17; 2) Federal Reserve, as of 12/31/16; ** EMU = Economic and Monetary Union, EMU 11 refers to 11 initial European Countries in the EMU
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… in the meantime, the central bank “crowding-in” consequently drives huge demand for the
(meager) available supply of reasonable-yielding U.S. assets…
US trading partners are by far the largest holders of
TSY debt 1
And specifically, the amount held by foreign
investors in the 7 – 10 year point of the curve,
where rates are close to zero internationally, is
pretty amazing… 1
50%
FX Reserves: a source of demand for much
of the past decade, this became a source of
supply in 2015-2016… but is now stable 2
45%
$14
35%
$1.2 tn “net supply” since 9/30/14
$12
FX Reserves (USD tn)
30%
25%
20%
15%
10%
5%
0%
$10
$8
$6
$4
$2
2016
Saudi Arabia
US$ bn
2016
2015
2014
2013
2012
2011
2010
2009
50
China
Mar-17
Dec-16
Jun-16
2,600
Sep-16
-50
-100
Mar-16
2,800
Dec-15
Jan-17
Oct-16
Jul-16
Apr-16
Jan-16
Oct-15
Jul-15
Apr-15
Jan-15
Oct-14
400
100
0
Jun-15
450
3,000
Sep-15
500
3,200
Mar-15
550
150
3,400
Dec-14
600
200
3,600
Jun-14
650
250
3,800
Sep-14
FX Reserves (USD bn)
700
Cumulative Japanese net purchase of foreign bonds
by fiscal year ($bn)
$1tn peak to trough
4,000
Mar-14
$225bn peak to trough
Jul-14
2008
… while the Japanese have poured money into
foreign markets for 3 straight years… 3
4,200
750
Apr-14
2007
World
Pegged currencies and commodity producers were hit particularly badly over the past
couple of years… 2
Jan-14
2006
Mutual Funds
RoW
2005
2015
2014
2013
2012
2011
2010
2009
2008
Banks
Insurance
$0
2004
HHs
Pensions
Fed
2007
2006
2005
2004
2003
2002
2001
2000
-5%
FX Reserves (USD mm)
% holding of Tsy debt
40%
0
4
8 12 16 20 24 28 32 36 40 44 48 52
# of weeks from the start of each fiscal year in April
FY 2011
FY 2012
FY 2013
FY 2014
FY 2015
FY 2016
FY 2017 YTD
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… and companies are now also looking for yielding assets for their cash hoards, resulting in this \major
secular influence on markets (with demographics being at the core of this) ---> there aren’t enough
attractive assets for the organic demand in markets today…
Corporate debt has been growing and should continue to grow (not too much larger), and much of the
issuance has come, meaning record cash balances have themselves become a major source of demand
for yield, including back into credit-assets! 1
400
200
0
5.0%
4.0%
Cash / Assets
2016
200%
150%
100%
50%
0%
Brazil
Indonesia
India
Colombia
Turkey
South…
South Africa
Mexico
Thailand
China
Canada
U.K.
France
Spain
U.S.
Italy
Japan
Gross debt as a % of GDP
250%
2001
6.4x
2.2x
5.4x
2.0x
4.4x
1.8x
3.4x
213
200
110
96
100
29
0
2.4x
1.6x
1.4x
1.4x
-200
-1
-33
-41 -29
-95 -98
-129
-180
-300
2004 2006 2008 2010 2012 2014 2016
… particularly where yield is available in the 2017 “yield
vs. duration mess” 5
With reasonable valuations and only moderate
need for debt in much of EM, supply may not
meet the demand for EM bonds (and equities) 4
35,000
30,000
25,000
20,000
15,000
10,000
5,000
(5,000)
12/16
305 308
300
-100
Cash (rhs)
Sovereign leverage levels in EM are now lower
or still at low levels relative to debt in
developed markets 3
2.4x
$ in Billions
6.0%
7.4x
2017: Yield vs. Duration, Returns from 7/31/2016 to 5/15/2017
12%
Returns from 7/31/20165/15/2017
10%
LatAm Sov & Gov't, $1,016,
+12.7%
8%
US HY, $1,122,
+8.9%
6%
01/17
EM Bond
02/17
03/17
04/17
EM Equity
US IG, $4,461, -0.4%
EM Corp, $569,
+4.7%
Yield
800
600
7.0%
400
2.6x
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
8.0%
Securitized Net Issuance
2.8x
IG ex Fin Debt/EBITDA
(rhs)
8.4x
Cumulative Flows (USD
mm)
9.0%
3.0x
IG ex Fin Net Debt/FCF
9.4x
Debt/EBITDA
1,400
1,200
1,000
10.0%
10.4x
Net Debt/ FCF
1,800
1,600
11.0%
S&P 500 Cash ($ in BNs)
S&P 500 Cash / Assets
12.0%
In securitized markets, regulatory change in the
US and Europe would be required for more
securitized asset supply, but this market could
grow in the coming years, albeit not for a while 2
UK Sov & Gov't,
$1,339, -1.3%
EUR HY, $353,
+6.6%
4%
MBS, $5,268, -0.5%
2%
EUR IG, $1,411, -0.7%
Conclusions here: we believe that developed market rates will move higher, but maybe not for a
few more months (especially given the noise becoming news in Washington), so we like Emerging
Market rates better… We like Securitized assets until the supply technicals really change (not for a
while)… And ultimately, DM rates will be driven higher by monetary policy-evolution in Europe, and
further by deficit-financed government borrowing in the US…
0%
-2%
US Sov & Gov't,
$7,422, -1.3%
2
3
Euro Sov & Gov't, $6,843, -4.1%
4
5
6
Source: 1) CapIQ, as of 12/31/16; 2) Bloomberg, as of 5/2017; 3) Datastream, as of 12/31/16; 4) Bloomberg, as of 5/15/17; 5) Barclays, as of 5/15/17
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Not for Public Distribution – Please Read Important Disclosures
Japan Sov & Gov't, $7,228, -2.7%
7
8
9
10
Duration
20170517-160346-445949
10
1.B.) The Second Secular Influence (Technology) – Playing out in May 2017 (and in every month of 2017)…
We showed these remarkable charts on last month’s call. They played out again in a major way this past
month… Charts below are repeats from last month.
Historically, technology has proved to be
deflationary
105
200
90
190
85
180
170
80
160
150
Headline CPI
140
500
80
400
60
300
IT Subcomponenets(rhs)
20
0
2013
2014
Disruptor
Energy Comm.
Fracking
Tech-Disrupted Sectors
(excluding Energy)
0.0%
Audio Equip.
Streaming, smartphones
Sports Equip.
Amazon
Photographic Equip.
Smartphones with cameras
Books
eBooks
Toys
Smartphones, tablets
PCs & Peripheral Equip. Smartphones, tablets
-0.1%
Contribution to YoY Change
Smartphones, tablets
-0.1%
-0.2%
-0.2%
-0.3%
Computer Software
App Store
Leased Cars & Trucks
Over supply, ride sharing
-0.3%
Netflix, digital media
-0.4%
Video Discs & Other
Media
Wireless Telephone
Serv.
Smartphones saturation, price
war
80
60
2016
2017
WTI(rhs)
2000
2005
2010
Toys
Appliances
Window, Floor Coverings, Linens
Photo Equipment
Personal Computers
IT Commodities
Sports Equiment
2015
Furniture & Bedding
Household Equipment
IT Hardware & Services
Audio Equipment
Video & Audio Products
Leased Cars & Trucks
Weakness in March 2017 CPI Report – driven by the introduction of “unlimited data”
Household Furnishings IKEA, Amazon
Televisions
2015
Production per Rig: Permian Oil
Tech-disrupted sectors contribution to CPI
Inflation Category
100
40
100
0
2012
120
40
200
75
160
100
Headline CPI
Core CPI
CPI Food
Food at Home
Food Away From Home (nsa)
CPI Energy
Energy Commodities
Fuel Oil (nsa)
Motor Fuel
Energy Services
Core CPI
Core goods
Apparel
New Vehicles
Used Cars and Trucks
Medical Care Commodities
Alcoholic Beverages
Tobacco & Smoking Products
Core Services
Shelter
Medical Care Services
Transportation Services
Recreation Services
Education & Communication
Wireless Telephone Services
MoM%
-0.29
-0.12
0.34
0.48
0.16
-3.20
-6.01
-0.76
-6.11
-0.29
-0.12
-0.33
-0.70
-0.30
-0.90
0.23
0.22
0.48
-0.06
0.12
0.12
0.36
0.19
-1.94
-6.98
YoY%
2.38
2.00
0.5
-0.9
2.4
10.9
19.8
24.9
19.9
3.4
2.0
-0.6
0.6
0.2
-4.7
3.9
1.1
3.6
2.9
3.5
3.4
3.8
3.5
-2.1
-11.4
Wireless Telephone
Services, Inflation NSA
1%
0%
-1%
-2%
-3%
-4%
-5%
-6%
-7%
-8%
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
210
180
600
MoM Change
95
200
120
Price Index
220
We can see this has taken root across a variety of products and
industries
WTI
Headline CPI - Index Level
100
230
700
IT Components – Index Level
240
bbl/day
250
And when technology starts seeping into or
disrupting traditional industries, this can put a lid
on prices and on historical drivers of inflation
Source: BLS, Bloomberg as of 5/12/2017. References to securities are shown for illustration purposes only and should not be construed as investment advice or recommendation.
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… wireless prices drop again  again having a major influence on the CPI readings…
… while PPI was very impressive and reflective of buoyant global growth, IP, exports, etc., the consumer impacts from wireless, and
obviously from food, apparel, etc., are truly incredible..
YoY%
2.20
1.88
2.4%
0.20
0.18
0.22
1.14
1.34
-0.33
1.20
1.19
0.95
0.07
-0.17
-0.25
-0.32
-0.25
-0.82
0.31
0.40
4.23
0.14
0.30
0.03
-0.16
0.04
0.50
-0.80
2.30
9.30
14.50
22.10
14.40
14.30
4.40
1.90
-0.60
-1.40
0.50
-1.40
2.60
1.30
-1.40
7.70
2.70
3.50
3.10
3.10
3.20
2.1%
-0.24
-2.40
-1.73
0.17
-12.90
3.20
2.3%
YoY
2.2%
2.14
2.06
2.0%
2.00
1.9%
1.90
1.8%
1.7%
1.6%
1.5%
2015
2016
2017
Core CPI (adjusted for wireless)
CPI: Wireless Services Price Index
2017
2016
2015
40
2014
50
2013
60
2012
70
2011
YoY
80
2010
90
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
2009
100
2008
2014
Core CPI
2007
2013
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
CPI Food
Food at Home
Food Away From Home
CPI Energy
Energy Commodities
Fuel Oil
Motor Fuel
Gasoline
Energy Services
Core CPI
Commodities less Food & Energy
Household furnishings
Apparel
Transportation Goods ex Fuel
Medical Care Goods
Alcoholic Beverages
Other Goods
Tobacco & Smoking Products
Services less Energy Services
Shelter
Medical Care Services
Transportation Services
Recreation Services
Education & Communication
Services
Wireless Telephone Services
Other Services
MoM%
0.17
0.07
Index
Headline CPI
Core CPI
CPI: Wireless Services YoY
… how could the technology influences in these sectors be any more dramatic? … and why would these ever slow down a Fed which is
focused more so now on financial conditions, given that the intermediate projection for inflation is around 2%?
Clearly, the next few data releases need to be considered, but we think that it would be irrational for this technology-influenced data
(which is generally beneficial to consumers and particularly for lower and middle
12 income families) to be considered as a negative for
the Fed (and slow down their path), unless the news in Washington becomes more concerning...
Source: BLS, Bloomberg as of 5/12/2017
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… especially with these dynamics below… We think that the trends below are some of why the Fed’s focus has
shifted and will likely result in the Fed proceeding down its pre-ordained normalization path for 2017 and 2018,
assuming there is no major shock to the system……
Household Net Worth as % US Nominal GDP 1
Index
0.5
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2017
2012
2007
2002
1997
1992
0.4
1952
2017
2012
2007
2002
1997
1992
1987
1982
1977
1972
1967
1962
1957
1952
400%
0.8
0.6
1987
450%
0.9
0.7
1982
500%
1.0
1977
550%
1.1
1972
Ratio
Ratio
600%
1.2
1967
650%
SPX Market Cap / US Nominal GDP 1
500%
480%
460%
440%
420%
400%
380%
360%
340%
320%
300%
1962
700%
1957
Household Net Worth as % Disposable Income 1
Household Net Worth as % of US Nominal GDP
Household Net Worth as % of Disposable Income
S&P Market Cap/ US Nominal GDP Indexed
… the recovery in consumers’ balance sheets has somewhat supported the solid pace of consumption, and to reiterate on technology’s influence on inflation
(and growth), the deflationary impacts are largely sector specific and are in no way reflective of a negative demand shock (hence the Fed’s ability to maintain
its course)… in fact, quantities are very strong while prices are in full-on deflation (actually a sign of innovation, lower production costs, and a good thing for
consumers’ quality of life)… These charts below couldn’t be any more profound today in depicting technology’s influence on certain sectors…
As we have noted, it is important to look below the hood on headline growth numbers… Goods sector
quantities have been very strong, with weakness driven by prices… 2
30%
8%
25%
6%
20%
2%
0%
-2%
Video and Info Processing Equipment”
(beneficiaries of tech-led deflation)
10%
-5%
• In that time, prices have come down by 80%
-10%
• Relative to 1985, Americans are consuming
-6%
-20%
1985
2000
Goods: Quantity
2005
2010
Goods: Prices
2015
over 10% growth since 1985, a 27x increase
0%
-15%
1995
• Recreational Goods quantities have averaged
5%
-4%
-8%
1990
annual consumption on a real basis, or 37%
of all Durable Goods consumption
• And 2/3rd of Recreational Goods is in “Audio,
15%
4%
YoY Change
YoY Change
10%
• Recreational Goods accounts for $600bn of
1990
1995
2000
2005
2010
PCE Goods: Recreational: Quantity YoY Change
PCE Goods: Recreational: Price YoY Change
2015
27x more Recreational Goods at 1/5th the
price/unit
• BUT WE STILL USE OLD, HISTORIC GDP
DATA
Data source: BEA as of 4/30/2017
Source: 1) Bloomberg, as of 12/31/16; 2) BEA, as of 4/30/17
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We were absolutely blown away by these charts that we showed last month, and now we have witnessed this evolution
pick up speed again this month… This is a secular evolution that is playing out at light-speed every single day…
For example, the auto industry (which has enormous macro implications for the US and global economies) is beset by some very unique
trends…
PCE: Motor Vehicle 1
Hertz stock price 2
30%
$150
25%
Average new vehicle sales incentive by
passenger car 3
Used car prices YoY 2
Hertz
14%
15%
30%
10%
$0
2007
-5%
2013
2016
…down another 50% this month???
-20%
1985
1990
1995
2000
2005
2010
2015
PCE Goods: Motor Vehicle: Quantity YoY
Change
PCE Goods: Motor Vehicle: Price YoY
Change
Share Price
-15%
04/12/17
-5%
2%
-15%
04/19/17
YTD Price Change
2025
Electric
04/26/17
05/03/17
05/10/17
-10%
2005 2007 2009 2011 2013 2015 2017
YoY Growth Rate (rhs)
Passenger Car Incentive/Market Value (lhs)
Technology performance vs. autos is incredible in what has happened this month, and obviously this year… 5, 6
0%
Hybrid
0%
$12
$10
20%
Regular
6%
$14
Forecast
2020
5%
0%
-5%
60%
2015
10%
8%
-10%
$16
80%
2010
15%
4%
100%
40%
5%
$18
Global car sales by engine type, 2010-2030 4
% of Global Auto Sales
2010
Precent
$50
0%
-10%
20%
10%
2030
20%
50%
10%
40%
0%
-10%
01/17
02/17
S&P
03/17
S&P Auto
04/17
05/17
Nasdaq 100
2%
0%
YTD Price Change
5%
12%
YoY Change
10%
25%
$100
MTD Price Change
YoY Change
15%
YoY Change
Share Price
20%
30%
20%
10%
0%
-10%
-2%
-20%
01/17
-4%
5/3/17
5/6/17
5/9/17
5/12/17
5/15/17
02/17
S&P
03/17
04/17
S&P Auto
05/17
Tesla
Maybe prices have overshot, but this secular influence can’t be close to finished in terms of technology’s influence on the economy/markets…
Source: 1) BEA as of 3/31/2017; 2) Bloomberg, as of 4/17/2017; 3) Wells Fargo as of 1/2017; 4) BII, LMC Automotive as of 4/2017; 5) Bloomberg, as of 5/2017; 6) Tesla Media Reports, as of
4/2017. Securities referenced for illustrative purposes only and should not be construed as a recommendation to buy or sell any security.
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14
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Visually this becomes even more profound to look at… We can spend hours on these charts, and where they are headed… Yet, the ultimate
conclusion will be that they will, in some combination relative to size and growth today, depict future cash-flow dynamics which represent a
very intense consolidation of those cash flows going forward which has major ramifications for debt and equity markets…
S&P 500 Consumer Discretionary Info Graphic (size relative to rank)
Market capitalization
Revenue
#1 rank in market cap – 16% of cons disc sector market cap
#3 rank in revenue – 7% of cons disc revenue
Sales per employee
Source: Bloomberg, as of 5/2017. Reference to the names of each company mentioned in this communications is merely for explaining the investment strategy, and should not be construed
as investment advice or investment recommendation of those companies.
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2) Medium-term trends/cycles – They can vary in length, but there are usually two or three main
themes a year that pivot off of these and can drive annual return potential…
# of Misses
6
6
9
5
Avg Miss Std Dev
0.94
0.76
0.39
0.58
Core CPI
Q1
Q2
Q3
Q4
# of Misses
3
3
5
4
Avg Miss Std Dev
0.74
0.45
0.53
0.45
GDP QoQ Ann.
Q1
Q2
Q3
Q4
# of Misses
2
1
0
2
Avg Miss Std Dev
0.44
0.05
0.00
0.08
Avg. Qtrly
GDP Since
1988 (%)
Avg. Qtrly
GDP Since
2010 (%)
1st quarter
1.72
1.00
2nd quarter
2.50
2.50
3rd quarter
2.51
2.51
4th quarter
2.40
2.36
GDP QoQ Growth… Q1 was very weak, which we think will
bounce back significantly in the 2nd quarter… 1
US GDP QoQ
5.0%
4.0%
10.0%
QoQ growth
1.0%
2.0%
1.0%
0.0%
Q1
2015
2017
Q3
Q4
Contributions to YoY Capex Equipment Growth
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%
5.0%
0.0%
-5.0%
World GDP in USD
2015
2012
2009
2006
2003
2000
1997
1994
1991
1988
1985
1982
-2.0%
2013
Q2
And there is a broad-based recovery in capital
investment that is building momentum… 2
-10.0%
2011
Since 2010
3.0%
0.0%
-1.0%
Since 1988
4.0%
20.0%
15.0%
2.0%
Since 1948
5.0%
In fact, we think the global economy will
stabilize in or around these growth levels… 1
6.0%
3.0%
6.0%
Real GDP QoQ
Retail Sales
Q1
Q2
Q3
Q4
We talked last month about weakness in Q1 data bringing in to
question the state of the US economy… and sure enough, the Q1
GDP print was the lowest in 12 quarters… however, we think 2017
and 2018 could likely be very fertile growth environments... 1
Q1 growth has been oddly
weak relative to other quarters
despite being seasonally
adjusted… This is not entirely
a post-crisis event as the
pattern holds from at least
1988 1
YoY
Data "Misses" vs. Survey since 2013 1
Headline NFP
# of Misses Avg Miss Std Dev
Q1
7
0.98
Q2
4
0.71
Q3
10
0.54
Q4
5
0.57
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
2013
Energy
Source: 1) Bloomberg, as of 5/17/2017; 2) BEA, Goldman Sachs as of 5/17/17
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
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2014
Transportation
2015
2016
Information Processing
20170517-160346-445949
'17
Industrial
16
The backdrop for growth generally is fairly good… On a YoY basis, DXY strength is muted, trade is much
better (especially EM), commodities are higher (although with recent weakness), and inflation is better
(more stable at higher levels) than we’ve seen in recent years…
Supportive environment for growth 1
EM : Export Nominal
20.0%
50%
15.0%
YoY
10.0%
25%
5.0%
0.0%
0%
-5.0%
-10.0%
-25%
01.14
-15.0%
2009
2010
2011
2012
2013
2014
2015
07.14
01.15
2016
07.15
01.16
07.16
01.17
Last Month
EM Export Nominal (USD) SA 3m/3m annualized
Broad USD YoY
Export Nominal (USD) NSA yoy
Top-line growth has been stagnant for several years
now… 2
20%
6%
50.0%
15%
5%
40.0%
10%
20.0%
10.0%
3%
5%
2%
0%
1%
-5%
0.0%
0%
-10.0%
-10%
-1%
-20.0%
-15%
1995
-2%
-30.0%
2009
2010
2011
2012
2013
2014
2015
2016
40%
4%
2000
2005
Revenue
S&P RevGrowth
Growth
2010
YoY Change
30.0%
MS Leading Earnings Indicator
1.70
20%
-0.30
0%
-20%
-2.30
-40%
-4.30
2015
CPI YoY (rhs)
Actual S&P 500 LTM EPS Growth
MS Leading Earnings Indicator, Leading 1yr (rhs)
Industrial CRB
Source: 1) Bloomberg, as of 5/17/2017; 2) Barclays, BLS, as of 5/2017; 3) Morgan Stanley, as of 3/31/17
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20170517-160346-445949
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Index
YoY Change
60.0%
And while we see this dynamic improving this year and
in to next, we believe M&A is still potentially an
attractive avenue for growth for many… 3
YoY
YoY Change
Commodities have been much softer recently (which we
will discuss) but are still elevated relative to the
trajectories of 2014-2015 1
And we’ve talked about better growth weighing on the rates markets over the coming months...
Re-Print from last month: We have discussed recently the need to have some duration exposure over the next few months as
global growth could be impaired by uncertain news before it can ultimately stair-step a bit higher (albeit from very modest
levels)…
Historically, Real (and Nominal) Rates traded in-line with Real (and Nominal) Growth; yet, since the crisis, rates have continued to trade well below
fundamentals…
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0%
-1.0%
-1.0%
-2.0%
-2.0%
US 10Y - Core CPI
DE 10Y - Core CPI
US Real GDP
EU Real GDP
… this is in part due to central bank intervention but is also a reflection of the incredible technicals in the market, as well as a lingering pessimism on
underlying growth
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0%
-1.0%
-1.0%
-2.0%
-2.0%
UK 10Y - Core CPI
UK Real GDP
JP 10Y - Core CPI
JP Real GDP
We do believe that the bifurcation between growth and market rates today will ultimately evolve in the form of moderately higher rates, but we have to be
respectful of the incredible technicals at play and the timing of data/events, as well as the seasonal factors that are so profoundly influential today…
… and consequently, the timing of the duration reduction in 2017…
Source: Bloomberg as of 5/15/17
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The BlackRock Investment Institute has done some incredible analysis on these medium-term cycles of growth… Traditionally these have been
evaluated in terms of time; yet analyzing the economy more appropriately on a continuum from growth-trough to ultimate economic potential
suggests that these growth/inflation cycles have more to go in the US, as well as globally…
Aligned cycle comparisons: Output gap as % GDP
Avg 4Q (3 to 6)
Scaled to average length of 16 quarters (range 3 to 39)
NBER
Definition
6
Each dot
represents
a quarter
4
Output gap as % potential GDP
Avg 9 quarters (3 to 22)
2
0
Defined as
closest quarter to
when the output
gap crosses zero
-2
-4
NBER
Definition
Current positioning
based on forecast of
output gap closing
in Q4 2018
-6
-8
Prior
Trough
1953
1957
NBER
Definition
At Potential
1960
1969
1973
1981
1990
Peak
2000
2007
• We think that this work is incredibly powerful for investors in thinking about medium-term investment trends…
• The wide-ranging consensus view is that we are nearing the end of the business cycle, because of some mythical time-based series in history.
• Yet, it is amazing how consistent this recovery has been from a very deep recession, and how there appears to be plenty of room to run when analyzed
this way.
• Thus, we think that this analysis is an amazingly important foundation for understanding 2017 (and probably 2018), and what forces may drive returns.
Source: NBER, BEA as of 3/31/17
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The amazing pervasiveness of this cycle’s consistency can be depicted in numerous ways, and easily
transcends a daily focus on the noise which distracts investors from the core fundamental trends at play…
… such as the back and forth improving and deteriorating inflation releases, particularly with a reasonable wage trajectory underway as we go through a
natural full employment dynamic…
…especially in the face of tech-driven goods deflation
Real GDP, relative to pre-crisis peak
Price of Goods vs. Services, relative to pre-crisis peak
Core CPI, relative to pre-crisis peak
170
150
160
140
150
130
120
110
100
90
Prior
Peak
Trough
1953
1981
At Potential
1957
1990
1960
2000
1969
2007
Peak
1973
100
Relative price of non-energy
goods to services, peak = 100
160
CPI Core, prior peak = 100
GDP (pre-crisis peak = 100)
The trajectory of inflation is in-line with most historic trends, and will move modestly higher as output gaps close…
140
130
120
110
100
Prior
Peak Trough
1953
1973
At Potential
1960
2000
1957
1981
95
90
85
80
75
Prior Trough
Peak
Peak
1969
2007
1953
1981
At Potential
1957
1990
1960
2000
1969
2007
Peak
1973
Given these trends, long-term breakevens (TIPs) seem fair at levels just below 2%, given the liquidity discount for the product… A move closer to the mid-100’s should be
bought and anything well above 2% should be sold… and hiring will continue with somewhat higher wages, allowing the Fed to move and start reducing the balance sheet…
… wages will move moderately higher…
…on its way higher…
… especially for more skilled labor
Average hourly earnings (AHE) YoY%
Nonfarm Payrolls, relative to pre-crisis peak
NFIB firms reporting jobs hard to fill
10
140
8
130
40
25
20
15
110
2
10
100
0
Prior
Peak Trough
1981
30
120
4
At Potential
1990
2000
Peak
2007
90
Prior
Peak Trough
1953
1981
NFIB firms reporting 1 or more
jobs hard to fill, %
6
Nonfarm payrolls (pre-crisis
peak = 100)
Real average earnings % (3y
core CPI)
35
At Potential
1957
1960
1969
1990
2000
2007
Peak
1973
5
0
Prior
Peak Trough
1953
1957
1981
1990
At
1960 Potential 1969
2000
Pea
k 1973
2007
Takeaways:
• Rates can move moderately higher (with some timing to that).
• But inflation breakevens are fair here, and should be bought or sold around significant variances from today’s levels..
Source: NBER, BLS, BEA, NFIB, Federal Reserve, Bloomberg as of 3/31/17
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Inflation is running right on track, with goods-pricing declining faster, and services leading the way (consistent with
the technology secular framework)...
When you include R&D spend, business investment
may be moderately low (in lieu of equity buybacks),
but not grossly out of whack…
… the system doesn’t need more buildings or a major
plant and equipment spend like in the past…
Business Investment, relative to pre-crisis peak
Structures Investment, relative to pre-crisis peak
175
150
125
100
75
Prior Trough
Peak
1953
1981
At Potential
1957
1990
1960
2000
1969
2007
Peak
125
100
1973
Despite contained CapEx, corporate debt has boomed,
in part to buyback stock to capitalize on historically
low funding costs… Is there any question here that
the Fed has to continue to approach rate equilibrium
given financial condition easiness and the forward
risk attached to it?
US Corporate Debt as % of Revenues, relative to precrisis peak
5
0
-5
-10
Prior
Trough
Peak
1953
1957
1981
1990
At Potential
1960
2000
1969
2007
Peak
1973
50
Prior
Peak
1953
1981
Trough
At Potential
1957
1990
1960
2000
1969
2007
Peak
225
200
175
150
125
100
75
50
Prior
Peak
1953
1973
1981
Trough
1957
1960
At Potential
1969
1990
2000
2007
Peak
1973
… and the curve will flatten more from here…
UST 10s30s spread
150
Federal debt (% GDP), change from peak
50
Budget deficit (% GDP) change
since peak
Credit market debt as %
GVA, change
10
75
…but complicating the process for the Fed (and more
so the ECB and BOJ) is the need for deliberate
tightening given government leverage… Ultimately
though, deficit-financing will push US rates higher…
20
15
250
150
Business IP investment (precrisis peak = 100)
175
IP Investment, relative to pre-crisis peak
Spread (bp)
Business investment (pre-crisis
peak = 100)
200
Business structure investment (precrisis peak = 100)
225
IP spending is on a good path, and as we have
described in the past, it is actually multiples of this
because of the rapidly declining cost of that IP,
thereby making it cheaper to buy…
40
30
20
10
100
50
0
-50
0
-100
-10
Prior Trough
Peak
1953
1981
At Potential
1957
1990
1960
2000
1969
2007
Peak
1973
Prior Trough
Peak
1953
1957
1981
1990
At Potential
1960
2000
Peak
1969
2007
1973
Takeaways:
• CMBS supply should be muted, with some growth, but it still generally remains attractive…
• Consolidation of cash flows continues along the technology-innovation lines…
• Fed keeps moving albeit deliberately, especially with the balance sheet…
• Other developed market rates move higher but central banks try to mute those moves…
• Curves flatten…
Source: NBER, BLS, BEA, NFIB, Federal Reserve, Bloomberg as of 3/31/17
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
20170517-160346-445949
21
These other medium-cycle trends are incredibly profound… Households (consumers) are in great
shape, driving housing markets with it, and the banks have historic levels of dry-powder to promote
further velocity here (and elsewhere)…
FHFA House Prices, relative to pre-crisis peak
Residential Investment, relative to pre-crisis peak
170
150
House prices (pre-crisis peak = 100)
Business investment (pre-crisis peak = 100)
160
125
100
75
50
Prior
Peak
Trough
1953
1981
1960
2000
1969
2007
Interest and principal as % of typical household
income
130
120
110
100
90
80
Prior
Peak
Trough
1953
1981
1973
1957
1990
Construction employment (pre-crisis
peak = 100)
0.5
110
25
0.0
100
20
15
10
5
0Prior
Peak
1953
1981
Trough
At Potential
1957
1990
1960
2000
1969
2007
Peak
1973
1973
1.0
Risk ratio, change since cycle
peak
30
1969
2007
1.5
120
35
1960
2000
Change in risk ratio since start of cycle
130
40
Peak
At Potential
Construction employment, peak =100
45
Mortgage payments as % of typical
income
140
Peak
At Potential
1957
1990
150
-0.5
90
-1.0
80
-1.5
70
Prior Trough
Peak
1953
1981
At Potential
1957
1990
1960
2000
Peak
1969
2007
1973
Prior Trough
Peak
1953
At Potential
1957
1960
1969
Peak
1973
Takeaways:
• We are very comfortable with securitized assets focused around the consumer…
• We are comfortable with housing-related debt and equity, particularly non-agency mortgages.
• We are comfortable with Agency Mortgages, respectful of the supply-growth potential. While this will be muted somewhat by rate volatility, and we have to
keep an eye on the Fed, but we love buying these as an IG/credit substitute when they get cheap on Fed balance-sheet reduction fears.
Source: NBER, BLS, BEA, NFIB, Federal Reserve, Bloomberg as of 3/31/17
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
20170517-160346-445949
22
… although we are impressed with global growth, it clearly could moderate from here, but we believe it should
stabilize around generous levels of growth for the balance of the year, buoying equity valuations…
We have shown before how equities are not high until these bars invert like ‘06
and ‘07, which would require much higher rates, higher prices, or deteriorated
FCF… 1
2.5
Index Level
Present Value
S&P 500 Index Price
2,500
% Difference (rhs)
100%
2,000
50%
1,500
0%
1,000
-50%
500
2018 Est (1)
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
-100%
2003
0
To come back to
equilibrium:
1. S&P’s rally
25%
2. FCF drops 12.8%
3. 5yr TSY backs
up 98bps
4. Market valuewtd avg. IG/HY
spreads back
up 98bps
5. Some weighted
combination of
all of these.
REAL GDP GROWTH (%)
S&P 500 Index - Index FCF Discounted Using IG/HY Yield to
Worst
3,500
150%
3,000
Our internal indicators may be stabilizing, but still point
to decent global growth… 2
2.0
1.5
Jan 15
Jul 15
Jan 16
GPS
Jul 16
Jan 17
12m Forward Consensus
… while exports are moving smartly higher (but probably can’t hold this growth pace)… 3
EM : Export Nominal
40%
30%
20%
10%
0%
-10%
-20%
-30%
01.14
07.14
01.15
07.15
01.16
07.16
01.17
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
01.14
Asia : Export Nominal
70%
Latam : Export Nominal
50%
30%
10%
-10%
07.14
01.15
07.15
01.16
07.16
01.17
-30%
01.14
07.14
01.15
07.15
01.16
07.16
01.17
Last Month
Last Month
Last Month
EM Export Nominal (USD) SA 3m/3m annualized
Asia Export Nominal (USD) SA 3m/3m annualized
Latam Export Nominal (USD) SA 3m/3m annualized
Export Nominal (USD) NSA yoy
Export Nominal (USD) NSA yoy
Export Nominal (USD) NSA yoy
Takeaways:
• We like owning equity upside and are not worried that we are too high already today with growth being strong alongside a moderate central
bank tightening, and a strong bid for yield products (keeping the appropriate discount rate for equities low)… All of this also continues to
support our EM vs. DM rate-convergence forecast…
Source: 1) Bloomberg, as of 5/2017; 2) BlackRock BII, as of 5/2017; 3) Haver, as of 5/2017
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
20170517-160346-445949
23
… and with current volatility still being priced too low, why not own the beta risk in upside convexity instruments
(like equity calls), in case of exogenous downside shock, especially with such generous carry-availability still from
places like EM (while developed markets rates move moderately higher)...
Not only is spot vol low, but longer-dated points on the vol curve are also historically low, meaning the market is
willing to offer cheap vol for longer-terms, in virtually all products…
80
70
40
35
30
50
Level
Level
60
40
30
25
20
20
15
10
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
2017
0
Minimum
Level
10yr Japan
10yr Germany
10yr France Spread
10yr Spain Spread
10yr Italy Spread
10yr Portugal Spread
10yr UK
10yr Canada
10yr Australia
10yr US
Munis
MBS OAS
US IG OAS
US Long Credit OAS
US HY OAS
Global EM
10yr Mexico
10yr Russia
10yr Indonesia
0.05%
0.38%
0.84%
1.56%
2.16%
3.21%
1.07%
1.45%
2.47%
2.22%
2.30%
0.23%
1.12%
1.61%
3.75%
4.17%
7.14%
7.58%
7.04%
5Y Percentile
18%
28%
28%
22%
42%
36%
7%
24%
15%
54%
59%
24%
13%
13%
12%
7%
91%
23%
26%
VIX 6-month
Median
EURUSD
USDJPY
AUDUSD
GBPUSD
USDBRL
USDSGD
USDKRW
USDCAD
3M Implied Vol Percentile – Today vs. Last 5
Years
0%
18%
1%
3%
2%
1%
13%
3%
2Y UST
5Y UST
10Y UST
30Y UST
10Y DE
10Y JP
2%
3%
0%
0%
0%
2%
1%
S&P 500
VIX
2%
0%
12.0
11.0
10.0
8.0
23%
0%
13.0
9.0
21%
15%
Oil
Eurostoxx
Nikkei
MSCI EM
14.0
Vol
VIX
10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
7.0
6.0
03/16
50%
100%
06/16
09/16
12/16
03/17
EURUSD 1m ATM Vol
Takeaways:
• Treasury vol is cheap to preserve some of the rate risk inherent in all of these trades, including holding some longer-end duration..
• Muni’s are priced ok, particularly with the ability to manage some of this duration risk with cheap rate-optionality.
• HY spreads seem full and global developed markets core rates are too low, but could stay that way for a bit of time, but it is a good deal of
beta to get the existing income……
Source: Bloomberg, as of 5/17/2017
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
20170517-160346-445949
24
3) Short-term news or noise – we think that it is news that the (scheduled) major vol events have passed (like the
French election), and that the focus now should be on following the cash-flow across the major secular and mediumterm trends in efforts to generate consistent return with contained levels of risk, with a very healthy respect for the
seriousness of the potential news out of Washington…
Short-term dynamics: most participants take risk down into events
(or don’t invest) and then pile-in after… like now… 1
… some of the best trades have been to fade the short-term noise being
promulgated through the market… 1
Headlines before French Election Round 2: “Buy the EUR &
European banks! The ECB will start raising rates once Macron
wins” [EUR / European banks subsequently trade lower]
150
1.10
Euro STOXX Banks Index
1.05
1.00
0.95
0.90
T-60
T-50
S&P (Election)
T-40
T-30
T-20
T-10
T
T+10
T+20
S&P (Election Overnight)
1.12
130
1.10
Headlines after Brexit: “Sell the
EUR & European banks! The
Eurozone can’t grow and is
slowly breaking up” [EUR /
European banks subsequently
trade higher]
120
110
100
1.04
Headlines before French Election Round 1: “Sell the EUR &
European banks! They are up 50% since Brexit, and not pricing in
election risk” [EUR / European banks subsequently trade higher]
80
1.00
4%
2%
0%
-2%
08/16
09/16
10/16
11/16
12/16
01/17
02/17
03/17
04/17
History does not always repeat itself, but the explosion in market cap in
tech seems to be following the cash flows… 1
Cash Flows
Structurally
Shrinking
3,500
Cumulative Free cash Flow
Population Growth through 2022E
6%
07/16
4,000
Cash Flows Structurally Growing
8%
06/16
Events
SX7E
EURUSD (rhs)
Euro STOXX Banks Index
12%
10%
1.02
70
CAC 40 (French Election)
Demographics tell us something about the sustainability of cash flows (growth) 2
1.06
90
05/16
FTSE (Brexit)
1.08
EURUSD
Index (1=Day of Event)
140
1.14
3,000
2,500
2,000
1,500
1,000
500
(500)
(1,000)
2012 Q1 2012 Q3 2013 Q1 2013 Q3 2014 Q1 2014 Q3 2015 Q1 2015 Q3 2016 Q1 2016 Q3
-4%
Consumer Discretionary
Financials
Information Technology
Utilities
Source: 1) Bloomberg, as of 5/2017; 2) World Bank, as of 12/31/16
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
Consumer Staples
Health Care
Materials
Energy
Industrials
Telecommunication Services
20170517-160346-445949
25
While on the surface it doesn’t look like reasonable returns can be generated in “fully-valued capital markets”, we
would argue that this isn’t true if you focus on who you are and what should be the drivers (long, intermediate, and
short-term) of your return toolkit…
Yield
7%
6%
5%
4%
3%
2%
1%
0%
-1%
1985
Real Risk-Free Yield (US 10Y - Core CPI)
1990
1995
2000
2005
2010
2015
No Term Premium
Yield per Unit of Duration
Yields vs. Risks Across Asset Classes
No Real Risk-Free Yield
Still Yield, Less
Beta, Some
Duration for Now
MBS
Muni
5%
APAC Credit
US Term Premium
US Agency
US IG
Int. TSY
Long TSY
S&P
German
10Y
4%
US HY
ABS
EM Hard FX
MSCI World
CMBS
EM Local
Russell 2000
Global Agg
France 10Y
Euro IG
Yield per Unit of 12mo Vol
Yield
3%
2%
1%
0%
-1%
1985
1990
1995
2000
2005
2010
2015
No Credit Premium
20%
HY OAS
Yield
15%
10%
5%
0%
2000
2005
2010
2015
Source: Bloomberg, as of 5/17/2017
For Professional, Permitted, Institutional, Qualified and Wholesale Investors/Professional Clients Only.
Not for Public Distribution – Please Read Important Disclosures
20170517-160346-445949
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Important Notes
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Index
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Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market
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Important Notes, cont.
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20170517-160346-445949