Download The Election and Beyond

November 2016
INVESTMENT OUTLOOK
The Election and Beyond
"The basis of our political system is the right of the people to make and to alter their constitutions of government."
—George Washington
George Washington (1732-99) was a U.S. founding father, the commander in chief of the army in the American
Revolution, and later the first president of the United States. Born and raised in Virginia, Washington spent his early
career as a surveyor, later enjoying a long and storied military career. Following the Revolutionary War, Washington
presided over the Constitutional Convention in 1787. He was unanimously elected president by the Electoral
College in both 1789 and 1792, the only president to have won all electoral votes in a U.S. election. Washington
served as president from 1789 to 1797; he was the only nonpartisan president of the United States.
The 2016 election will be held November 8, not
news to anyone at this point. This election year has
been filled with media attention and public scrutiny.
From a market perspective, financial markets
typically do not favor uncertainty, and some volatility
entered the arena due to the fast-paced
developments of the 2016 U.S. presidential
campaign.
Polling has shown to be volatile throughout this
election cycle, and many have even come to
question the polling processes themselves—
different polls have shown dramatically different
results. Not surprisingly, markets have responded
to this election cycle in kind, with confusion and
sometimes volatile trading.
In our conversation about the election, it is not by
any means our intent to predict the outcome. For
that there has been much coverage by political
analysts, media, and other sources. But the
question we hear from investors is, "What happens
to the markets based on the outcome of the
election?"
In looking at past election data, there are many
factors that help determine how markets react to
which candidate or party wins an election. We hope
to present some of these findings here. Also we
remind investors that regardless of the outcome of
the election, there are many inputs to determining
how the U.S. government is run and what factors
impact the U.S. economy and financial markets.
In this month's Investment Outlook we discuss:
 financial markets and the election;
 the post-election market outlook;
 the U.S. economy; and
 market considerations.
Our 2016 U.S. outlook is for continued expansion of
the economy. PNC expects U.S. economic growth of
1.5% in 2016 and 2.3% in 2017. We expect markets
to continue to watch the Federal Reserve (Fed) for
signals of additional interest-rate increases, while
tracking policy actions from central banks
worldwide. Markets are tuned to the dynamics in
the oil industry, monitoring supply projections and
price moves. Currency movements are also key
factors. Finally, we believe geopolitical concerns
remain on the radar as among the biggest
perceived risks to markets.
We believe stock market volatility will be elevated in
the near term as the market continues to digest
economic data, outlooks, and unforeseen events.
While we acknowledge the difficulty for us, or
anyone, to predict with great accuracy the
short-term behavior of stocks, we feel investors
should continue to focus on their long-term goals,
working with their PNC advisors to focus on an
asset allocation that matches their risk and return
objectives.
PNC’s six traditional asset allocation profiles are
shown on the back page of this outlook.
The Election and Beyond
Election Market Implications
The media, polls, and political analysts have
covered this election with great interest and
attention. This election cycle is certainly one most
Americans would soon like to put in the rear view
mirror, in our view. A question we often hear from
clients is: "How does the stock market perform in
an election year?" A second question is typically:
"Does it matter to financial markets who wins?"
Volatility data are slightly different, particularly for
an incumbent party, which in this case is seeking
reelection in a slow recovery period. We would
expect market volatility could rise as the election
date draws closer, especially given the particularly
polarizing election 2016 is turning out to be.
The Election
In looking at past election data, there are many
factors that help determine how markets react to
which candidate or party wins an election.
Interestingly, looking at data since 1901 shows that
the market tends to prefer a mixed Congress, with
majorities in the two chambers held by different
political parties (Table 1).
The faceoff between the two major party nominees
in the presidential debates seemed to be a turning
point in this election. After the first presidential
debate, former Secretary of State Hillary Clinton
was able to recover ground lost following the muchtelevised fainting episode of September 11. Heading
into the final month of the race she had a slight lead
over Donald Trump.
One positive data point of note: election years tend
to be favorably correlated with market returns.
Since 1928 the median return of the S&P 500® in an
election year has been 9.0% and the return has
been positive 15 out of 21 times. All election years
have experienced a rally of at least 10% at some
point during the calendar year. The median
election-year rally has been 17.2%. Corrections
occurring during election years tend to be of the
magnitude of about -10.3%.
We would be cautious when looking at who won or
lost any of the debates as being a sure predictor of
the outcome of this election. In addition, polling has
been shown to be volatile through this election
cycle, and many have even come to question the
polling processes themselves; different polls have
shown dramatically different results. It is not
surprising, therefore, that markets have responded
to this election cycle in kind, with confusion and
sometimes volatile trading.
Table 1
Gains under Various Configurations of Party of President and Majority Party in Congress
March 4, 1901-August 7, 2012
Democrat President
Republican President
Democrat Congress
Republican Congress
Democrat President and Congress
Democrat President, Republican Congress
Republican President and Congress
Republican President, Democrat Congress
All Periods Buy/Hold
Stocks
(DJIA)
7.73%
2.95
6.01
3.57
7.26
9.63
1.62
4.32
5.13
Industrial
Production
5.26%
1.80
4.48
1.45
6.29
1.11
1.56
2.04
3.38
Inflation
(CPI)
4.44%
1.80
4.36
0.65
4.60
3.79
-0.37
4.01
3.01
Real Stock
Returns
3.14%
1.13
1.59
2.89
2.54
5.63
2.00
0.30
2.06
Long-Term
Gov’t Bonds*
3.84%
7.75
5.54
6.39
2.89
8.14
5.48
8.99
5.77
Fed
Dollar**
0.11%
-1.42
-1.11
-0.23
-2.24
4.00
-4.24
-0.56
-0.91
*Data since 1925
**Data since 1971
Note: Majority Party = Party with average control in House and in Senate greater than 50%
Source: PNC
2
The Election and Beyond
Chart 1
Third-Party Votes
E=estimate
Source: Strategas Research Partners, PNC
Many view Ms. Clinton’s campaign as reminiscent of
George H.W. Bush, whose run in 1988 was seen as
a symbolic third Ronald Reagan term. Ms. Clinton’s
numbers have been following Mr. Bush’s trajectory
from the convention forward, according to
Strategas Research Partners.
Strategas also believes this election will be a battle
for the vote of the college-educated white
demographic, and more specifically, the women
within that group. This group has overwhelmingly
favored Republicans in past elections.
When it comes time to vote on November 8, many
political strategists cite voter turnout and thirdparty candidates as possible game changers
(Chart 1). In this election, polls show that thirdparty candidates could receive the fifth-largest
share of support in 100 years. If support for them
were to drop off, it could consolidate support for
either of the two major-party nominees.
The Markets and the Election
Looking at the markets, history has shown that
stocks have exhibited some relative correlation with
the winner of an election. The directional return of
the S&P 500 has correctly predicted the outcome of
19 of the past 22 elections. For the three months
preceding the election, if stocks were positive the
incumbent party typically won the election (Table 2).
If returns were negative, the incumbent party
usually lost. Uncertainty in the short run tends to
affect sentiment and seems to indicate that change
could be warranted. Conversely, if things are
positive, it seems to presage more of the same. In
the current election cycle, the three-month period
for returns preceding the election began on
August 8, 2016.
In a shorter timeframe, this correlation has shown
to be more pronounced. If you look at the one
month preceding the election, if returns have been
positive, the incumbent typically won (Chart 2,
page 4), while if negative the opposition won.
Further, in the one-month period preceding an open
election (with no candidate up for re-election), the
returns data are even more pronounced. In five of
the seven open elections since 1948, there were
negative returns and the opposition party won
(Chart 3, page 4).
Table 2
S&P 500 Performance 3 Months Prior to
Presidential Election
Year
1928
1932
1936
1940
1944
1948
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
Price
Return
14.91%
-2.56
7.92
8.56
2.29
5.36
-3.26
-2.58
-0.74
2.63
6.45
6.91
-0.09
6.73
4.80
1.91
-1.22
8.17
-3.21
2.16
-19.48
2.45
Incumbent
Party
Won
Lost
Won
Won
Won
Won
Lost
Won
Lost
Won
Lost
Won
Lost
Lost
Won
Won
Lost
Won
Lost
Won
Lost
Won
Correlation
to Result
Y
Y
Y
Y
Y
Y
Y
N
Y
Y
N
Y
Y
N
Y
Y
Y
Y
Y
Y
Y
Y
Source: Strategas Research Partners, PNC
3
The Election and Beyond
Chart 2
S&P 500: Percentage Change 1-Month Prior,
Incumbent versus Nonincumbent
1933-2012
As the election approaches, the down-ballot races,
including congressional races, are gaining more
attention. The Republicans currently control the
Senate; a net gain of five seats would be required
for the Democrats to take control. If the Democrats
were to gain four seats, then the Senate would be
divided 50/50 between parties, with the vicepresident’s party being the tie-breaker for control.
At the start of October, however, Cornerstone
Macro published a report indicating that investors
were beginning to question what would happen if
the Republicans lost control of both houses of
Congress. A shakeup in the control dynamics could
indeed send stocks selling off, at least initially.
Source: Strategas Research Partners PNC
Chart 3
S&P 500: Percentage Change 1-Month Prior, Open
Election Incumbent versus Nonincumbent
1948-2008
Source: Strategas Research Partners PNC
Congress Matters More
This presidential election has caused much media
attention, public scrutiny, and market reaction. But
what is more important to markets is what happens
within Congress in terms of party control. Polls this
past summer were showing the probability that
Republicans would retain control of the House;
control of the Senate looked to be up in the air.
The big question as it pertains to Congress is
whether the Republicans can retain their majority in
the Senate or House of Representatives. According
to Evercore ISI, there is a small but rising risk of a
Democratic sweep of both houses.
Table 3
Sectors Selected Industries and the Presidential
Election Cycle
Sectors
Consumer Discretionary
Consumer Staples
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Telecomm Services
Utilities
Select Industries
Alternative Energy
Aerospace/Defense
For-Profit Education
Housing
Insurance
Master Limited Partnerships
Municipal Bonds
Natural Resources
Real Estate Investment Trusts
Democrat Republican
+
+
+
+
+
-
+
+
+
+
+
+
+
+
+
+
-
+
Source: Cornerstone Macro, Strategas Research Partners,
PNC
4
The Election and Beyond
However, a Democratic clean sweep is not the most
probable outcome heading into the last weeks
before the election. Some current polling suggests
Congressional races favor a split House and Senate
which, when combined with either party in the
presidency, leads to an outcome that, as we have
outlined, is more conducive to the markets' appetite
for a balance of power.
On the other hand, if the Democrats were to take
complete control, one would not expect certain
sectors to do well, namely, Energy and Financials,
which are outperforming since the first debate in
September (Table 3, page 4)
To Brexit, or Not to Brexit?
Some analogies can be drawn between the tone in
the United Kingdom preceding the Brexit
referendum and that in the United States prior to
the presidential election. The most certain
conclusion, in our opinion, is that there is no certain
conclusion. No polling can predict with absolute
certainty the outcome of an election.
The day before the vote, the polls for Brexit showed
a 76% chance that the outcome would be to stay in
the European Union. Some comparison between
this and Ms. Clinton’s lead in the polls can be
drawn. As we noted earlier, the polling processes
have been challenged throughout this election
cycle.
perspective, is that across the variety of scenarios,
fiscal policy for next year could include the Fed
raising interest rates at a faster pace than the
market currently is predicting.
As we stated earlier, markets typically trade higher
if the incumbent party is viewed as the likely winner.
This makes sense. Markets don’t like change,
equating it to risk and unknowns. A change in party
could also upset the outlook for a Fed rate hike in
December, given some amount of uncertainty.
A so-called “gridlock,” where one party has majority
control of the Senate and the other has control of
the House, is typically rewarded by markets.
(Chart 4).
Historically speaking this seems to be in line with
recent data, which show that the highest rate of
turnover of seats in Congress in the past 70 years
has been since 2006. Senate seats have been
turning over since 2006 at an average of six seats
per two-year election cycle, levels not seen since
the post-Great Depression and post-World War II
years (Chart 5, page 6).
Chart 4
Equity Markets Reward Gridlock
1933-2015, Excluding 2001-02
Also, as we think about the comparisons between
the Brexit vote and the outcome of the U.S. election,
there is one huge difference. The Brexit vote was
majority rules, whereas the U.S. presidential
election is based on the Electoral College.
Looking Beyond
As the November 8 election day approaches, we
begin to look beyond it to what are some possible
scenarios for the economy and the markets
following the election. From an economic
perspective, the uncertainty of this election and the
probable implications in the outcome scenarios
could be leading some businesses to hold back on
investing. The top takeaway, from Evercore ISI’s
Source: Strategas Research Partners, PNC
5
The Election and Beyond
Chart 5
Average Change in Senate Seats
Chart 7
S&P Total Return by Presidential Cycle
1928-2014
Source: Strategas Research Partners, PNC
Source: Strategas Research Partners, PNC
Chart 6
Change in GDP
1949-2015
Source: Bloomberg L.P., PNC
Coinciding data would show that the United States
has been experiencing the slowest economic
growth period since those same decades following
the Depression and the two World Wars. This can
also be described as politically volatile (Chart 6).
Following any election, regardless of the outcome,
there is usually a relief rally. According to Strategas
Research, the fourth quarter of the fourth year of a
presidential election cycle shows the highest
quarterly performance versus any other quarter.
What normally follows in the first quarter of a
presidential term is often, not surprisingly, market
lows as markets try to assess the new political
landscape and its impact on Washington.
In addition, by looking strictly at performance of the
stock market, there is some correlation to the year
of the presidential term. The first two years tend to
have the lowest absolute performance. The best
year for markets tends to be the third year, which is
a pre-election year (Chart 7). This also tends to be
the year when presidential candidates begin to
focus on approval ratings ahead of campaigning.
History has shown that bonds tend to perform
better in the first half of an election term than the
second half. But we have seen this shift with the
best being the first quarter, and the worst the third
quarter.
A Word on the Economy
While the election is certainly at the front of
everyone's mind at the moment, we remind
investors that there are many factors affecting the
U.S. government, the U.S. economy, and the
financial markets. We look back at the Financial
Crisis and Global Recession of 2008-09 as one not
easily forgotten, remembering the swift and severe
market response. The U.S. economy, with the
assistance of extraordinary monetary policy
6
The Election and Beyond
implemented by the Fed, did eventually recover, in a
cycle that began in July 2009. The financial markets
have recovered as well, and the S&P 500, at its
current level of approximately 2,150, is more than
three times higher than the depths reached in
March 2009. The S&P 500 has returned more than
200%, including the reinvestment of dividends,
since those lows.
With the economic recovery having recently crossed
the seven-year mark, some investors may question
if this is perhaps a signal of some sort, by which the
tide could turn in the other direction. Certainly in
2015 and 2016 markets have experienced periods of
greater market volatility due to a wide variety of
global risk factors.
Investors have been focusing on the timing and
trajectory of interest rate changes. The Fed made
the decision in late 2015 to raise interest rates for
the first time since the zero-interest-rate policy
began in 2008. We remind investors that the Fed
began raising rates for the right reason—the
extraordinary measures effected by the Fed during
the crisis and subsequent recovery were no longer
necessary when the U.S. economy found firm
footing with strengthening economic indicators. In
2016, uncertainty as to when the Fed will raise rates
a second time continues to spark volatility from
time to time. Economic data, Brexit, and China
market worries topped the list this year of factors
the Fed could consider in its decision. PNC expects
one additional rate hike in 2016, at the upcoming
December Federal Open Market Committee (FOMC)
meeting.
Economy
PNC expects U.S. economic growth for 2016 of 1.5%
year over year, accelerating to 2.3% in 2017.
Second-quarter 2016 GDP slipped to a
disappointing 1.4% due to a drop in inventories and
fixed investment, and the first reading for thirdquarter GDP reflected a jump to 2.9% growth. PNC
economists expect a rebound in the second half of
2016 and an acceleration in 2017 in GDP growth.
Following a recession, GDP growth usually
accelerates as a result of pent-up consumer
demand for goods and services. After the initial
jump, growth tends to settle into a more
sustainable level. In the last stage of an expansion,
GDP growth slows further until it collapses. The
current U.S. recovery is a bit unusual in that there
was not an initial surge in growth. Quarter-overquarter annualized real GDP growth has trended at
about 2% since the recovery began.
While GDP growth has been far from robust, and
there have been quarters of slow growth from time
to time, there remains little evidence to suggest an
absolute trend lower. As we noted earlier, economic
growth in the second quarter of 2016 was a
slower-than-expected 1.4%, which was the slowest
pace in three years, and lower than the 1.6% growth
in first-quarter 2016. As PNC economists expected,
the first reading for third-quarter 2016 GDP
reflected a rebound.
We note in our discussion of GDP that the data are
not typically available as quickly as some other
indicators. The initial estimate is not released until
a month after the quarter ends. Even though this
initial number is highly anticipated and closely
tracked, it often fails to accurately reflect economic
performance. The GDP estimate is revised at least
twice in subsequent months. These revisions can
seriously alter perceptions of the economy. Below
we give a few highlights of some other economic
indicators.
Labor Market
The labor market is much improved since the dark
days of the recession. Often times a slowdown in job
creation suggests the late stages of an expansion.
The three-month moving average for monthly
payroll growth has been 178,000 ending in
September, slightly slower than the levels of 2014
and 2015. September’s number was 156,000
(Chart 8, page 8). Total nonfarm employment
surpassed its prerecession peak in 2014. A
conclusion on this factor alone puts the labor
market expansion at just about two years old.
7
The Election and Beyond
Chart 8
Payroll Growth
As of September 30, 2016

the decline in the labor force participation
rate. Participation has fallen from a
prerecession peak of 66.4% to 62.9% today—
around the lowest level since the 1970s.
There are indications of a high number of
underemployed people. This includes both
workers accepting jobs below their skill sets
as well as workers taking part-time work
even when seeking full-time employment.
Inflation
Source: Bloomberg L.P., Bureau of Labor Statistics, Bureau of
E
i A l i PNC
The labor market in general, and more specifically,
payroll growth, tend to be lagging indicators of the
business cycle. Current payroll creation tends to
reflect economic trends three to six months in the
past. Thus, it has less value in predicting the
present state of the business cycle. PNC
economists characterize the labor market to be in
good shape, and expect it to move toward full
employment in 2017.
The nonaccelerating inflation rate of unemployment
(NAIRU) is the rate of joblessness below which a
tightening labor market induces inflation. Generally,
when the unemployment rate matches NAIRU, the
economy is considered at full employment and any
further labor market tightening is harmful to broad
economic health. Unfortunately, an exact value for
NAIRU is unknown. The FOMC puts it somewhere
between 5.2% and 5.5%, but the range of estimates
is even broader, from 5% to 6%. The unemployment
rate, currently at 5.0%, is now below that range,
suggesting the labor market might be hovering
around its potential.
But there are a couple of reasons to believe the
labor market is not as tight as the unemployment
rate would suggest.
 A significant share of the improvement in
the unemployment rate can be attributed to
In traditional business cycle models, inflation
accelerates at the peak of the business cycle and
slows, or even stalls, at its nadir. Inflation is both a
symptom of a strained economy and a cause of the
subsequent recession. Inflation accelerates at the
peak of the business cycle because a tight labor
market or tight production, among other possible
factors, pushes prices higher. This, in turn, stresses
both corporate and consumer purses, ultimately
spelling cutbacks in spending.
So far in this recovery, inflation has been of little
concern. In fact, for a time, economists were more
concerned about deflation, despite broader
economic growth. Many factors are helping to keep
price pressures low. A loose labor market means
little price pressure from wage growth. The
unexpected and deep fall in oil prices in 2015,
however, has been the biggest driver of low
inflation.
Growth in the Consumer Price Index (CPI) has been
modest and is not likely to rise precipitously
anytime soon. In fact, CPI growth recently clocked
in at 1.5% year over year. PNC economists forecast
1.2% growth in 2016 and 2.2% growth for 2017. Both
are well in line with the 2% rate that the FOMC has
established as its long-term target rate-run goal.
Excluding food and energy, core CPI was 2.2% year
over year. Rising core personal consumption
expenditures (PCE)—the Fed-preferred measure of
prices—are even milder. The year-over-year
increase is just 1.6% (Chart 9, page 9).
Compare these trends with the last business cycle
peak. In 2008, year-over-year CPI growth peaked at
5.6%, a rate not seen since 1990, concurrent with
the peak of that business cycle. The less-volatile
8
The Election and Beyond
Chart 9
Core Personal Consumption Expenditures
As of August 31, 2016
Bureau of Economic Research (NBER) for about a
year after the contraction begins, a sharp dip in the
PMI can generally give a fairly accurate early
indication of the status of the overall economy.
The current ISM manufacturing PMI of 51.5
suggests the manufacturing sector and the broader
economy are both in expansion territory (Chart 10).
Even though the index is below its post-recession
peak, it remains in expansion.
Industrial Production
Source: Bloomberg L.P., PNC
Core CPI at 2.2% is consistent with its long-term
trends. PCE is performing similarly.
Institute for Supply Management™ (ISM) Indexes
We have found the PMI constructed by ISM to be
among the most timely and accurate economic
indicators available. PNC’s proprietary analysis
shows that a PMI value below 43.2 would indicate a
contracting economy (these findings are consistent
with ISM and academic research). Since recessions
are typically not officially announced by the National
Chart 10
ISM Manufacturing Index
As of September 30, 2016
Source: Bloomberg L.P., PNC
Industrial production is one of the most-tracked
indicators of the goods-producing side of the
economy. Underscoring its importance, industrial
production is one of the headline indicators the
NBER uses when dating recessions. Broadly,
industrial production can be viewed as a timely
alternative to GDP—the lag to reporting is just a few
weeks compared with GDP’s months-long lag.
Further, industrial production exhibits many of the
business cycle patterns of GDP: contraction, postrecession surge, settling to sustainable growth, and
then a waning period.
Unlike GDP, industrial production did experience a
post-recession surge, maxing at 8.7% year-overyear growth in early 2010. After that, growth settled
around 3%, consistent with historical trends
(Chart 11). This suggests to us that industrial
Chart 11
Industrial Production
As of September 30, 2016
Source: Bloomberg L.P., PNC
9
The Election and Beyond
production has moved beyond the early stage of the
business cycle.
Housing Market
As one of the root causes of the Great Recession, it
is especially necessary to keep an eye on the
housing sector. Usually, the housing sector is a
source of stability during recessions and, therefore,
does not really experience a recovery. However,
given the severity of the decline during the housing
bust, some cyclicality can be expected in real
estate.
The housing market has been slower to recover,
and is certainly location specific. However, we
believe overall housing should continue to perform
well in 2016 (Chart 12).
Chart 12
New and Existing Home Sales
Monthly, January 1990-September 2016
continues to emphasize it expects subsequent rate
hikes to be gradual.
Given the Fed’s multifaceted response to the past
recession, looking at only the federal funds rate
ignores many of the central bank’s other policies.
While the Fed has yet to tighten traditional
monetary policy, it has already ceased some of its
less orthodox policies, such as quantitative easing,
implemented during the feeblest stages of the
recession. Such actions would suggest the business
cycle has advanced into the later stages of recovery.
Current market expectations place a greater than
68% probability that the Fed will raise interest rates
for the second time in December 2016.
Yield Spreads
When investors begin to expect a significant slowing
of growth, the spread between shorter- and longerterm interest rates generally shrinks. When
investors begin to suspect contraction, future
expectations of short-term rates tend to fall more
dramatically and the yield curve inverts.
Historically, the inversion of the yield curve has a
very high success rate at predicting recessions
13-24 months in advance. This generally holds true
no matter what combination of short- and longterm Treasuries is used. Since 1953, there has not
been a recession in the United States without the
Source: National Association of Realtors®, Bloomberg L.P.,
PNC
Chart 13
10-Year to 30-Year Treasury Yield Spread
Weekly, 1/6/78 through 10/21/16
Federal Funds Rate and Fed Policy
The federal funds rate is frequently used by
analysts as a signpost of where the economy stands
in the business cycle. Generally, falling rates
correspond to recession, and increasing rates to
periods of expansion. By this standard, the current
federal funds rate implies it is still in the earlier
phases of recovery. The Fed raised short-term rates
in December 2015, for the first time since zero
interest rate policy began in 2008. The Fed
Source: Bloomberg L.P., PNC
10
The Election and Beyond
10- to 30-year yield curve inverting no less than one
year before the start of a recession.
The 10- to 30-year yield curve has averaged just
over 70 basis points in September and October
(Chart 13, page 10). While these numbers have
pulled back from the 140-basis-point spreads seen
in 2011, that is no cause for concern. The spread in
2011 was an almost record high, making a
narrowing almost certain as rates normalized.
Retail Sales
Retail sales provides a good indicator of PCE, a
component of GDP. There is a direct correlation
between strong retail sales and GDP. Retail sales
have been somewhat flat as of late (Chart 14).
Despite recent softness, consumer spending is
leading the U.S. economy in mid-2016. The
fundamentals for consumers are good: more jobs,
accelerating wage growth as the labor market
tightens, low interest rates, and solid home and
stock values. Consumer spending rose 4.2% at an
annual rate in the second quarter after inflation, the
clear standout in an otherwise disappointing GDP
report, and slowed to 2.1% in the third quarter.
Consumer spending growth will likely be slower in
the second half of 2016 versus the first half, but
with solid drivers we think consumers should
Chart 14
Retail Sales
As of August 31, 2016
continue to lead U.S. economic growth through the
rest of this year.
Markets
Investors sometimes look to market corrections as
a sign of economic conditions. Our research has
shown this is not the case. Using data from 1900 to
2014, we analyzed whether stock market
corrections (in this case bear markets) can
accurately predict a recession. Our results show
that stock price declines do not do a good job of
predicting recessions. We used the Dow Jones
Industrial Average (DJIA) in this example rather
than the S&P 500 to take advantage of the longer
history of data available, but we would not expect
the results to change materially if we were to use
the other index.
In this example, we are defining a bear market as a
20% market correction over a several-month
period. Since 1900, there have been 33 bear
markets and 22 recessions. Overall, bear markets
have predicted 5 of 22 recessions. This is a success
rate of less than 23%. Most often, bear markets
have given false alarms. Using a less-stringent 15%
decline in stock market prices does not improve the
predictive power and significantly increases the
number of false alarms.
Further, there is little evidence that a bear market
has any lasting consequences for economic growth.
GDP growth during the quarter when the 20%
threshold is crossed and in the following two
quarters does not show any definitive movement in
either direction across recessions.
Looking at it another way, we consider the effect
economic contractions have on the stock market,
not to predict the economic cycle but to better
understand market moves under economic duress.
What we find by looking at data for the S&P 500
dating back to the 1940s and calculating peak-totrough declines is that the median decline through
all recessions was 21-22% (Table 4, page 12). The
median is shown including and then excluding a few
outliers—the severe recessions of 1974-75 and
2007-09 and the technology bubble.
Source: U.S. Census Bureau, Bloomberg L.P., PNC
11
The Election and Beyond
Table 4
Recession Declines
S&P 500 Level
Recession
Peak
Trough
1948-49
17
14
1953-54
27
23
1957-58
50
39
1960-61
61
52
1969-70
108
69
1974-75*
111
62
1980
118
98
1981-82
141
102
1990-91
369
295
2001*
1,527
777
2007-09*
1,565
677
Mean
Median
Excluding *Outliers
Change
-20.6%
-14.8
-21.6
-13.9
-36.1
-44.1
-17.1
-27.1
-19.9
-49.1
-56.8
-29.2
-21.6
-21.4
Source: National Bureau of Economic Research, Bloomberg
LP, PNC
The S&P 500 appears to have caught up with the
strong earnings corporations reported in the years
following the recession, reflected in its trading
multiples. From a long-term perspective, the
S&P 500 appears neither overvalued nor
undervalued. We believe investors should focus
primarily on valuation and fundamental factors,
keeping in mind their longer-term expectations,
goals, and risk tolerance when making asset
allocation decisions.
Considering different inflation scenarios, market
valuations look reasonable to us. We also recognize
that central bank actions around the globe are
seeming to push everyone out on the risk
continuum.
Table 5
Historical Returns
January 1, 1926-September 30, 2016
Real
S&P 500
6.92%
Long-Term Government Bond 2.69
30-Day T-Bill
0.47
Inflation
NA
Nominal
10.02%
5.66
3.39
2.90
Source: Ibbotson Associates, Morningstar, PNC
While volatility has been low relative to history, we
believe market events could result in increased
volatility. Market declines are not predictable, so
trying to time them is an unreliable tactic. What is
known is that over the long term, stocks have
tended to produce significant positive real returns—
returns after inflation (Table 5). We believe now, as
always, it is important for investors to be
comfortable with their long-term asset allocation,
given risks and volatility expectations, in
consultation with their advisor, considering their
goals and risk tolerance.
Conclusion
What is certain is the new president of the United
States will be faced with some large tasks. From a
fiscal perspective, the next president is facing a
fiscal drag of 0.5% in 2017 (Chart 15). Congress will
be faced with the task of addressing fiscal policy
next year, as the new fiscal policy enacted in 2016
largely borrowed against next year; it is not
surprising in a fourth-year presidential term that
Congress “kicked the can down the road.”
Government spending has been a positive for GDP
growth in the past seven quarters and whether this
continues will be an issue for the new government.
Tax revenues this year from corporations have been
lower, given lower corporate profits. Government
Chart 15
Fiscal Policy of New President
E=estimate
Source: Strategas Research Partners, PNC
12
The Election and Beyond
spending has increased at the same time. As a
result the federal budget deficit has increased by
28% or $115 billion in the past five months
according to Strategas.
Other places the market is hoping the government
will contribute to the economy is in infrastructure
spending and tax reform. But even if a plan was
enacted next year, funds would not enter the
economy until 2018, and most estimates show this
adding to GDP only modestly.
On the tax reform front, we believe most would
argue that a solid reformation is much overdue and
very necessary. The last effective fiscal policy was
probably that of 2003, in our view. In addition, we
think a repatriation holiday is seen as possibly in
play for a new president, particularly at a time in
history when corporations have record amounts of
cash on balance sheets. See our August 2014
Market Update, Tax Inversions. Health care is
another mammoth topic under debate. With so
many unknowns, we are certain to revisit these
topics when we at the very least have clarity as to
the makeup of the Oval Office and new Congress of
2017.
For the sake of due diligence, we hoped in this
paper to include a discussion of what seems to
matter most to investors at this moment in time:
the election, the economy, and the financial
markets.
Our research has shown that economic expansions
typically cease from an atypical overheating, or an
external shock versus old age. At just over seven
years, or 84 months, the current recovery is longer
than the average historical recovery—but not by
much. And if you consider the more recent
recoveries, there have been more than a few that
have gone on much longer: 1970 at 106 months;
1991 at 92 months; and 2001 at 120 months.
It is our conclusion that while there is often a
discussion as to where we are in this recovery cycle,
we believe the most important thing to note is that
expansions do not end naturally. There is typically
an event that brings the cycle to an end, for
example, tighter monetary policy or some other
exogenous shock, such as oil. In the last recession
it was the massive leveraging and deleveraging of
the housing market as the causal factor, in the prior
it was the technology bubble build and bust.
The outcome of this election is not likely to be a
shock to the system by this definition, however we
do expect the election and its outcome to bring
great amounts of uncertainty, which in turn tends to
bring market volatility. We will be closely following
the election outcomes and the possible
implications.
We invite you to join us for our post-election Webinar
on November 9—toll free at 800-832-0736,
international toll at 303-330-0440, room number
*3333584#.
PNC Current Recommendations
PNC’s recommended allocations continue to reflect
our positive view regarding the durability of the
economic expansion while considering the
continued downside risks inherent in the market
and economic outlook:
 a baseline allocation of stocks relative to
bonds;
 a preference for high-quality stocks;
 a tactical allocation of 52% value and 48%
growth within U.S. large-cap stocks;
 a tactical allocation to smart beta/core
strategies;
 a tactical allocation to real estate
investment trusts (REITs);
 a tactical allocation to Europe focused
equities—FX hedged within the international
equity component;
 a tactical allocation to Japan focused
equities—FX hedged within the international
equity component;
 an allocation to emerging markets within
the international equity component;

a tactical allocation to global dividendfocused stocks;

a tactical allocation to Treasury
Inflation-Protected Securities (TIPS) within
the bond allocation;
13
The Election and Beyond




a tactical allocation to leveraged loans
within the bond allocation;
a tactical allocation to absolute-returnoriented fixed-income strategies within the
bond allocation;
a tactical allocation to global bonds within
the bond allocation; and
an allocation to alternative investments for
qualified investors.
Baseline Allocation of Stocks Relative to Bonds
Since one cannot accurately determine the shortterm movement of stocks, we believe investors
should focus on what is knowable and controllable.
The one thing investors can truly control is asset
allocation reflective of their needs and risk
tolerance. PNC’s six baseline asset allocation
models are shown on the back page of this Outlook.
 foreign growth;
 valuation; and
 yield-curve slope—
continue to support an overweight to U.S. large-cap
value style relative to growth.
We focus on the yield-curve slope because results
of our analysis show that a steep curve is supportive
of value style outperformance relative to growth. It
is not a concrete rule that value always outperforms
Chart 16
2-Year to 10-Year Treasury Yield Spread
Weekly, 1/6/78 through 10/21/16
Preference for High-Quality Stocks
Any relapse to stressed capital markets or to
another credit crunch from a financial crisis likely
poses a higher threat to lower-quality and highly
leveraged companies. Companies with weak
balance sheets and less-robust business models
have a much higher risk to their survival.
Unfortunately, the economic outlook continues to
be subject to continued downside risks in the wake
of the financial crisis.
We favor a preference for high-quality stocks as a
method of risk control against unexpected shocks
to the economic system. This is also consistent with
our explicit allocation to dividend-focused stocks.
Source: Bloomberg L.P., PNC
Chart 17
10-Year to 30-Year Treasury Yield Spread
Weekly, 1/6/78 through 10/21/16
Overweight of U.S. Large-Cap Value Stocks
Relative to Growth 1
We believe the majority of the seven components of
our decision framework—
 earnings growth;
 interest-rate level;
 inflation;
 volatility;
Source: Bloomberg L.P., PNC
The March 2011 Investment Outlook, Quest for Value, provides details about the value style recommendation.
1
14
The Election and Beyond
growth in a steep yield curve, but it is an indication
of higher probability. Though recent Fed activities
have flattened them to a degree, both the 2- to
10-year (Chart 9) and 10- to 30-year (Chart 10)
Treasury slopes remain historically steep and
supportive of a value overweight.
We continue to monitor the possibility that the
typical impact of the steep yield curve might be
derailed by:
 the credit cycle;
Chart 20
U.S. Bank Core Capital Ratio
Quarterly, 1Q84 through 2Q16
Chart 18
U.S. Banks’ Willingness to Make Consumer Loans
(percentage more willing minus percentage less willing)
Quarterly, 1Q00 through 2Q16
Source: Federal Deposit Insurance Corporation,
Bloomberg L.P., PNC


Source: Federal Reserve, Bloomberg L.P., PNC
Chart 19
U.S. Delinquency Rates for Loans
Quarterly, 1Q91 through 2Q16
capital constraints; or
lack of loan demand.
Bank loan data seem to be past their worst levels,
and we believe there are reasons for cautious
optimism.
 Banks are showing a greater willingness to
extend consumer loans (Chart 11, page 15).
 Bank loan quality has continued to improve,
implying a tailwind to bank earnings and a
possible turn in the deleveraging cycle
(Chart 12).
 Bank capital ratios have more than
recovered, which should allow for loan
growth and likely help prevent relapse of
financial crisis within the banking industry
(Chart 13).
Our value allocation has underperformed in the
market downturn, given its more cyclical exposure.
We believe it will perform better as global growth
concerns fade.
Allocation to Smart Beta/Core Strategies
See the contents of this Investment Outlook for full
discussion of the smart beta/core strategies.
Source: Federal Reserve, Bloomberg L.P., PNC
Within the smart beta strategies, there is the option
to utilize the PNC STAR strategy, which uses
exchange-traded funds to systemically apply
15
The Election and Beyond
Chart 21
10% PNC STAR/90% S&P 500 Combination Total
Return
Monthly, 10/90 through 9/16
Chart 22
FTSE NAREIT All Equity Index versus S&P 500
Daily, 6/20/00 through 9/23/16
Source: Bloomberg L.P., PNC
Source: Bloomberg L.P., PNC
momentum exposure to industries, size, and
international factors. The PNC STAR strategy may
help a portfolio increase return without increasing
risk and, with small allocations, marginally reduce
risk (Chart 14).
In backtests, PNC STAR has produced excess
returns with a volatility level similar to the
benchmark S&P 500, resulting in a higher Sharpe
ratio. In addition, the analysis has shown that the
strategy has handled periods of crisis better than
the S&P 500 and was generally quicker to recover.
While past performance is not indicative of future
results, historically this model has produced
outperformance of just under 0.40% per month. In
addition, the drawdown analysis has shown that the
strategy has handled periods of crisis better than
the S&P 500 did and was generally quicker to
recover.
Momentum performance has dipped since the
financial crisis, but appears to be regaining some
momentum (to turn a phrase). If momentum
continues to work in the future as it has historically,
the strategy may lead to excess returns that should
help improve the tactical allocation portfolios.
Allocation to REITs
The strategic rationale for including REITs in the
portfolio rests on expanding the opportunity set for
income investors. REITs are required to distribute
at least 90% of income to shareholders in the form
of dividends. Given the nature of the dividend model,
we believe REITs fare better with investors not
aiming for quick capital gains but for dividend
income and modest price appreciation. Over a long
investment holding period, REITs have tended to
outperform the S&P 500 on a total-return basis
(Chart 15). The total-return perspective is unique
for REITs in that it has historically kept pace with or
exceeded the broader market, with the additional
benefits of:
 modest correlation with stocks;
 less market price volatility; and
 higher current returns.
REITs provide steady current-income-producing
dividend yields competitive with investment-grade
bonds, with the potential for increases in dividend
and share price.
REITs allow shareholders to invest in commercial
real estate while remaining liquid and leaving the
management to professionals. REITs historically
have had lower correlations versus other stocks,
providing diversification benefits. Given the complex
nature of the interrelated economics and industry
fundamentals, leaving the investment in real estate
to the professionals and buying for the long term
into strong companies is a standing argument for
16
The Election and Beyond
Chart 23
REIT Dividend Growth versus CPI
Source: NAREIT®, Department of Labor, PNC
long-term investing versus market timing. We
believe the asset class should bring some
diversification benefits in spite of the correlation
tightening with the S&P 500.
REITs are not so much interest-rate sensitive as
dependent on economic growth. Dividend growth
rates have outpaced inflation over the past decade
(Chart 16).
Allocations to Europe- and Japan-Focused
Foreign-Exchange-Hedged Equities
Our tactical allocation within the international
allocation focuses on Europe-based and Japanbased holdings. Stabilizing recoveries in both
Europe and Japan, relative valuations, improving
corporate earnings, and low energy prices are a few
of the dynamics that support strength of equities in
the regions. Equities in both regions have
underperformed in recent years, but we believe the
aggressive monetary policy actions by both the
Bank of Japan and European Central Bank are
supportive of financial assets (Chart 17). Our view is
these asset purchases should support their
economies and function to continue to make
equities in their respective countries more
attractive relative to fixed-income assets and to
bolster equity valuations.
Chart 24
FX Hedged Europe and Japan
Monthly, 4/30/08 through 8/31/16
International Equities
International equities offer geographic
diversification and open the opportunity set to invest
in firms worldwide. Beyond the benefits of
diversification and exposure to many of the world’s
leading companies, there are other potential
benefits to investing outside U.S. borders, including
unique opportunities in Asia and Europe. Within the
international equity component we recommend an
allocation to emerging markets.
It is reasonable to assume that the United States
and other developed markets have similar longterm expected returns. Much of the difference is
likely to come from currency gains or losses. We
remain mindful of the currency risk inherent in
international investing. While at times the weaker
dollar makes international investing look more
attractive than underlying fundamentals might
dictate, the reverse is true when the strong dollar
punishes U.S. investors' international returns.
Source: Bloomberg L.P., PNC
The hedged currency recommendations reduce
currency risk for our U.S.-based investors who have
most, if not all, of their liabilities denominated in
dollars.
Allocation to Global Dividend-Focused Stocks
A global dividend-focused allocation expands the
opportunity set to invest in high-quality dividendpaying stocks, where in some cases companies
have exhibited faster dividend growth, essentially
17
The Election and Beyond
Chart 25
Dividends and Dividend Growth around the World
1995 to 9/23/16
Allocation to Treasury Inflation-Protected
Securities
The Treasury yield curve is anchored at the short
end due to continued accommodative U.S. monetary
policy, while longer-maturity yields are being pulled
lower largely by the term premium in light of global
concerns and ongoing central bank easing. We
think inflation expectations will rise as surveybased measures used by the Fed have remained
relatively flat, commodity prices have stabilized, and
wages have trended higher as the United States
moves closer to full employment.
Source: Société Général S.A.; MSCI; BlackRock, Inc.; PNC
opening up the opportunity to invest in firms outside
the United States, including emerging markets. In
addition, focusing on the combination of dividends
and dividend growth has historically been a winning
combination.
The reinvestment of dividends greatly enhances an
investor’s return and is a large component of the
dividend-focused strategy. Over time, the
compounding of dividends drives the total return. As
an investor’s investment holding period increases,
dividends typically comprise a larger portion of
return. As a reference point, from 1926 to 1959
dividends contributed more than 50% to total
returns for the S&P 500.
We believe the global dividend-focused allocation is
positioned to take advantage of global opportunities
and diversify across countries and sectors
(Chart 18, page 19). A globally generated income
stream is inherently more diverse than one from a
single country or region. This can help to avoid
concentration in terms of end markets, which may
drive sales and revenues. A global dividend
allocation may also allow an investor to invest in
sectors perhaps underrepresented by a particular
country.
Treasury Inflation-Protected Securities (TIPS) can
be a favorable alternative to conventional
Treasuries; TIPS provide both a comparable yield
and the credit quality of Treasury notes, while also
furnishing protection against the risk of higher
inflation. In addition, since TIPS return the greater
of the face value or the inflation-adjusted principal
at maturity, these securities would increase in real
value even during a deflationary period. With
commodity prices finally finding some footing
following a volatile period recently, TIPS are indirect
beneficiaries due to the CPI adjustment. While not
our base case in the near term, we think TIPS are
likely the best defense against stagflation because
high inflation coupled with low growth provide the
optimal environment for TIPS performance.
From both a valuation and goal-based methodology,
TIPS are likely a good addition to many portfolios. In
particular, tax-deferred and tax-exempt accounts
are likely beneficiaries of TIPS allocations. In our
opinion, TIPS provide some measure of insurance
against the risk of inflation and reduced real
purchasing power, while protecting against severe
deflation. This seems especially true for investors
holding excess cash or nominal Treasuries.
Allocation to Leveraged Loans within Bonds 2
We believe an allocation to leveraged loans within
the bond portion of a portfolio should help defend
against higher interest rates. Since leveraged loans
are adjustable-rate instruments tied to short-term
The March 2010 Investment Outlook, Shakespeare for Primates, provides details about leveraged loans.
2
18
The Election and Beyond
Chart 26
3-Month LIBOR
Daily, 1/1/10 through 10/24/16
Source: British Bankers’ Association, Bloomberg L.P., PNC
interest rates (typically the 3-month LIBOR), we
believe holders should benefit from rising rates
(Chart 19). If longer-term interest rates rise, we
expect the shorter duration of leveraged loans
should result in much better performance relative
to longer-duration fixed income, such as the
Barclays U.S. Aggregate Bond Index.
This allocation could be characterized as lowering
the portfolios’ interest-rate risk while raising their
credit risk and correlation with equities. We believe
it accomplishes this without a large impact on
portfolio income. In our opinion, this correlation
with equities, which we have noted since
recommending the allocation, has become more
apparent in the recent stock market downturn,
allowing investors an attractive entry point.
Allocation to Absolute-Return-Oriented Fixed
Income within Bonds 3
We believe an allocation to an absolute-returnoriented fixed-income strategy within the bond
portion of a portfolio has several benefits, including:
 defending against higher interest rates;
 further expanding the opportunity set for
fixed income; and
 increasing exposure to credit.
Given our belief that the economy will continue to
improve, strategies that help protect against the
risk of rising rates will become increasingly
important. While we do not believe interest rates
will necessarily move markedly higher in the near
term, rate volatility has certainly increased, and we
expect that the downside risk to holding excessive
duration will increase the longer rates remain low.
We believe it makes sense to further hedge against
this risk while maintaining the ability to participate
in upside credit potential. This is also consistent
with our current tactical allocations to global bonds
and leveraged loans.
We believe the Fed will continue to support the
economy as necessary until the economy can grow
and function without additional monetary policy
accommodation. This should lend itself to further
credit spread tightening over the short to
intermediate term. Even with spreads at relatively
attractive levels compared with historical
standards, we admit the absolute low level of yields
increases the difficulty of adding alpha within
spread sectors. This is one aspect in which we
believe an absolute-return long-short approach can
add value. Absolute-return strategies have the
ability to exploit mispricing via both long and short
positions and also expand the opportunity set of
strategies typically not accessible to traditional
long-only managers. Typical trading strategies
include, but are not limited to, capital structure
arbitrage, convertible arbitrage, event driven, and
pairs trading.
Allocation to Global Bonds within Bonds
The strategic rationale for including global bonds in
the portfolio rests on expanding the opportunity set
within the investible bond universe. The Barclays
Capital Global Aggregate Index, our proxy for highquality global bonds, contains less than 40% U.S.
issues (Chart 20). (For further details of our view on
global bonds, see the July 2011 Investment Outlook,
Pulling the Fourth Lever.) We believe investors who
decline to look outside the United States may be
The July 2013 Investment Outlook, Breaking the Bonds, provides details about absolute-return-oriented fixed income.
3
19
The Election and Beyond
Chart 27
Barclays Capital Global Aggregate by Country
As of 9/26/16
Chart 28
Barclays Capital Global Aggregate Excluding United
States, Unhedged, Correlation with Dollar
Monthly, 1/29/93 through 9/30/16
Source: Barclays Capital, PNC
Source: Bloomberg L.P., Barclays Capital, PNC
missing opportunities for diversification and
enhanced returns.
A primary motivation for allocating to global bonds
is to introduce currency exposure to a portfolio.
Although currency adds another level of volatility to
a portfolio’s fixed-income allocation, it provides for
investors a natural hedge against devaluation of the
dollar, which traditional domestic fixed-income
asset classes cannot offer (Chart 21, page 20).
The prospect of higher global economic growth
outside the United States is another motive for
allocating fixed income globally. As world
economies grow more quickly, international bond
investors may have the opportunity to reap the
benefits of tightening global credit spreads relative
to the United States. More importantly, currently
investors can take advantage of higher interest
rates abroad to gain higher yields. The addition of
the currency exposure that comes with an
unhedged global bond can act to help lower the
correlation with U.S. bond returns (Chart 22,
page 22).
In general, we suggest that active management
makes the most sense in this allocation. Global
bond index construction usually focuses on
allocating more assets to countries with more
outstanding debt. This may or may not be a good
thing. Larger and more stable economies are likely
to be able to support higher debt levels, but some
Chart 29
Barclays Capital Global Aggregate Excluding United
States, Correlation with U.S. Aggregate
Monthly, 1/29/93 through 9/30/16
Source: Bloomberg L.P., Barclays Capital, PNC
fundamental analysis is likely helpful. We also
believe that the current state of the global economy,
with the large dichotomy between most developed
and emerging economies, provides a possible
opportunity for active managers for exposure to
credit and foreign exchange.
In our opinion, it is likely that many managers’
allocations will differ greatly from the index. This
also affects risk metrics, typically to the upside in
terms of volatility, index tracking error, and
historical drawdowns. This was explicitly taken into
20
The Election and Beyond
exposure outside the dollar, make investing in the
global bond sector a viable complement to
traditional dollar-based fixed-income assets. This
allocation can be seen as adding to PNC’s defensive
posture on U.S. interest rates, with 10-year
Treasury rates now above 2% and our view that
yields will rise over time as the current economic
soft patch and the flight to safety fade (Chart 23).
We also see this as an opportunity to benefit from
higher bond yields elsewhere in the world.
Table 3 (page 21) illustrates the behavior of various
products on the PNC platform consistent with the
absolute-return-oriented fixed-income strategies
during periods of rising interest rates. The strong
relative performance in rising-rate environments is
notable and is consistent with our expectation.
Chart 30
10-Year Treasury Yields
Daily, 1/3/11 through 10/24/16
Source: Bloomberg L.P., PNC
consideration by the PNC Investment Policy
Committee (IPC) when it sized the recommended
allocation to global bonds.
Given the concerns regarding how the United States
will handle upcoming monetary and fiscal policy
decisions, as well as what effects those decisions
might have on the value of the dollar, we believe an
allocation outside traditional fixed-income bond
sectors is prudent. We believe the advantage of
higher global growth and diversification benefits,
along with the ability to benefit from currency
Table 6
Periods of Rising Rates
Begin
12/30/08
End
6/10/09
10-Yr Yield Begin
2.05%
10-Yr Yield End
3.95%
Change in 10-Yr Treasury (bps)
190
BAA Yield Begin
7.97%
BAA Yield End
7.75%
Change in BAA Yield (bps)
-22
Change in BAA Spread (bps)
-212
Total Return during Period:
BarCap U.S. Aggregate
-0.47%
Driehaus Active Inc (LCMAX)
13.08%
Blackrock SIO (BSIIX)
10.77%
MetWest Unconstrained (MWCIX) N/A
Western Asset
Unconstrained (WAARX)
12.01%
Allocation to Alternative Investments
We also believe alternative asset classes should be
considered for qualified investors because they may
provide an effective risk management tool for
portfolios. Our argument is that if alternative and
traditional investments are put on even footing with
regard to expected returns, then solely by virtue of
the two investments being different, the risk of the
overall portfolio is reduced without altering the
portfolio’s expected return. The risks may not be
less, but they are in some ways different, so we
10/8/10
2/8/11
2.39%
3.74%
135
9/22/11
10/27/11
1.72%
2.40%
68
1/31/12
3/19/12
1.80%
2.38%
58
7/25/12
8/16/12
1.40%
1.84%
44
12/6/12
3/11/13
1.59%
2.06%
47
5/2/13
12/31/13
1.63%
3.03%
140
5.62%
6.25%
63
-72
5.04%
5.46%
42
-26
5.07%
5.42%
35
-23
4.73%
5.09%
36
-8
4.55%
4.94%
39
-8
4.47%
5.37%
90
-50
-3.09%
4.65%
0.55%
N/A
-1.68%
2.26%
-0.20%
N/A
-1.18%
3.29%
1.22%
3.71%
-1.21%
0.48%
0.31%
1.75%
-1.01%
2.42%
1.73%
2.23%
-3.04%
1.27%
0.63%
0.70%
1.13%
0.14%
1.08%
0.32%
1.13%
-0.76%
Source: Bloomberg L.P., PNC
21
The Election and Beyond
believe this diversification may help manage overall
portfolio risk.
Every action (or inaction) involves risk, and we
believe investors should think about risk when they
consider alternative investments. However, our
research suggests that adding carefully selected
alternative investments to a diversified portfolio of
traditional investments may reduce the overall risk
(as defined by the volatility of returns) of that
portfolio without affecting expected returns. We
believe that, for qualified investors, alternative
investments should be considered as a tool for
managing portfolio risk, not for adding risk to
increase returns.
As an example of the possible value alternatives, in
particular hedge funds, can bring to a portfolio in
the current environment, look at the correlation
between the S&P 500 and the HFRX™ Macro Index
(Chart 24, page 22). Low correlation with stocks at
times when they are falling would be a distinct
positive in terms of reducing the downside. While at
times these two very different assets move nearly in
unison, the hedge funds do have exposure to other
factors than solely stocks and also might adapt to
the environment by changing exposures. In fact, the
HFRX Macro Index had significantly outperformed
the S&P 500 during previous downturns since late
April 2013 (Chart 25).
Given the current market environment, including a
number of factors (such as low returns on cash and
occasional spikes in macroeconomic concerns) that
could continue to result in increased volatility, we
believe alternative investments are worthy of
consideration for qualified investors. 4
4
Chart 31
HFRX Macro Index and S&P 500
Daily, 5/1/11 through 10/20/16
Source: HFR Asset Management, LLC; Bloomberg L.P.; PNC
Chart 32
HFRX Macro Index and S&P 500 Correlations
Daily, 5/1/11 through 10/20/16
Source: HFR Asset Management, LLC; Bloomberg L.P.; PNC
For more details, see our October 2009 Investment Outlook, Alternative Medicine, and our August 2009 white paper The
Science of Alternative Investments.
22
The Election and Beyond
Bill Stone, CFA®, CMT
Managing Director, Investment and Portfolio
Strategy
Chief Investment Strategist
Chen He, CFA
Senior Portfolio Strategist
Marsella Martino
Senior Investment Strategist
Rebekah M. McCahan
Investment Strategist
Katie S. Sheehan, CFA
Fixed Income Strategist
Paul J. White, PhD, CAIA®
Director of Portfolio Strategy
Michael Zoller
Investment Strategist
23
August 2016