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Market Snapshot Liz Ann Sonders Senior Vice President Chief Investment Strategist Charles Schwab & Co., Inc. March, 2015 Global central banks’ massive QE programs ECB Monetary Base BoJ Monetary Base 4.5 480 4.0 430 3.5 380 3.0 330 2.5 280 2.0 230 1.5 180 1.0 130 0.5 2008 80 2010 2012 2014 BoJ (¥, trillions) Fed ($, trillions) & ECB (€, trillions) Fed Monetary Base 2016 As of 1/15. Dotted lines represent projections (2/15-12/16). Source: Bank of Japan (BoJ), Bloomberg, European Central Bank (ECB), FactSet, Federal Reserve. 1 Divergences in QEs’ sizes are notable Ratios of QE to Bond Issuance 3.0 ECB QE 2.5 2.0 BoJ 2014 1.5 BoJ 2013 1.0 0.5 Fed QE2 Fed QE3 0.0 2016 Projected Monetary Base as % of Nominal GDP 100 BoJ 80 60 40 Fed ECB 20 0 As of 1/15. QE=quantitative easing. QE3=1/13-10/14. QE2=10/10-6/11. ECB QE=3/15-9/16. Source: Bank of Japan (BoJ), Bloomberg, European Central Bank (ECB), FactSet, Federal Reserve, GavekalDragonomics, International Monetary Fund (IMF). 2 Global economic surprises tilting toward non-US Citigroup Economic Surprise Index US Eurozone China Japan 75 50 25 0 -25 -50 -75 -100 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 As of 2/27/15. The Citigroup Economic Surprise Index measures the amount that economic activity surprised or disappointed relative to analyst expectations. It’s defined as weighted historical standard deviations of data surprises (actual releases vs Bloomberg survey median). A positive reading of the Economic Surprise Index suggests that economic releases have on balance beating consensus. The index is calculated daily in a rolling three-month window. Source: FactSet. 3 (0215-1604) US GDP slows down … temporarily? % of real GDP 2Q14 annualized Q/Q % change 3Q14 annualized Q/Q % change 4Q14 annualized Q/Q % change Consumer spending 68.2% 2.5% 3.2% 4.2% Government spending 17.8% 1.7% 4.4% (1.8%) (0.9%) 9.9% (7.5%) 3.4% 1.1% 2.0% (0.3)* 0.8* (1.2)* Federal: 6.9% State/local: 10.9% Net exports of goods & services (2.9%) Exports: 13.0% 11.1% 4.5% 3.2% Imports: (15.9%) 11.3% (0.9%) 10.1% 9.5% 7.7% 4.5% Fixed investment 16.4% Nonresidential: 13.3% 9.7% 8.9% 4.8% Residential: 3.1% 8.8% 3.2% 3.4% 1.4* 0.0* 0.1* 4.6% 5.0% 2.2% Change in private inventories -Real GDP 2.3% (“new normal”) = average real GDP since June 2009 recession end 3.2% (“old normal”) = average private sector real GDP since June 2009 recession end As of 4Q14. *Represents contribution to percent change in real GDP. Numbers may not add up to 100% due to rounding. Source: Bureau of Economic Analysis, FactSet. 4 (0215-1604) Closer to “escape velocity” than recession in US “Escape Velocity” level Key recession level Current level NDR Recession Probability Model 5 50 0.3 Breadth of Philly Fed State Leading Indexes 95 52 98 NDR Economic Timing Model 17 0 20 NDR Composite Leading Model 3.4% -2.6% 3.3% National Financial Conditions Index -0.7 0.9 -0.7 350,000 500,000 294,500 Conference Board’s Consumer Confidence Index 98.2 63.2 96.4 Conference Board’s Business Confidence Index 61 43 60 ISM Manufacturing Index 55.0 48.0 52.9 ISM Non-Manufacturing Index 55.2 51.4 56.7 Indicator Initial unemployment claims (4-week average) Escape velocity refers to economic growth returning to potential after a recession, and activity is self-sustaining, i.e., it no longer needs the support of fiscal/monetary accommodation *As of 3/2/15. Green means indicator is above “escape velocity” level. Lighter green means indicator is getting close to “escape velocity” level. ISM=Institute for Supply Management. Source: Ned Davis Research (NDR), Inc. Further distribution prohibited without prior permission. Copyright 2015(c) Ned Davis Research, Inc. All rights reserved. 5 (0215-1604) Inflation rates converging to sub-target? US Inflation Japan Inflation Eurozone Inflation 2% Target Inflation Rate 6 y/y % change 4 2 0 -2 -4 2008 2009 2010 2011 2012 2013 2014 2015 As of 1/15. US Inflation=Consumer Price Index (CPI). Eurozone Inflation= Eurostat Eurozone Core Monetary Union Index of Consumer Prices. Japan Inflation=Consumer Price Index (CPI). Source: FactSet. 6 Inflation risk low while velocity remains low Monetary Base ($, billions) 4,500 3,500 Fed flooded system 2,500 1,500 500 2007 2008 2009 2010 2011 2012 2013 2014 2015 M2 to Monetary Base Ratio 10 8 But “velocity” of money remains depressed 6 4 2 2007 2008 2009 As of 2/15. Source: FactSet, Federal Reserve. 2010 2011 2012 2013 2014 2015 7 Low inflation generally bullish for US stocks Reuters CRB Continuous Commodity Index (y/y % change) 3-week moving average 200 180 160 140 High Inflationary Pressures (Bearish) 120 100 80 Low Inflationary Pressures (Bullish) 60 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 1/19/1968-2/20/2015 We are here Reuters CCI index DJIA annualized gain > 108.2 -0.9% 96-108.2 7.2% < 96 15.5% As of 2/20/15. The Reuters CRB (Commodity Research Bureau) Continuous Commodity Index (CCI) represents a geometric average of 17 commodity futures prices. DJIA=Dow Jones Industrial Average. Source: FactSet, Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2015(c) Ned Davis Research, Inc. All rights reserved.). 8 Unemployment saying Fed’s too patient? Unemployment Rate, 1Y % point difference (left-inverted scale) Fed Funds Target Rate, 1Y % point difference (right) -3 4 0 0 3 -4 6 1985 -8 1989 1993 1997 2001 2005 2009 2013 Yellow-shaded areas indicate Fed tightening periods As of 1/15. Source: FactSet, High Frequency Economics, Ltd. 9 Lower US unemployment leads higher wages Unemployment Rate Average When Wages Bottomed 10 9 8 7 6.6 6 5 5.6 5.4 4 3 1986 1990 1994 1998 2002 2006 2010 2014 y/y % change, 3m moving average Average Hourly Earnings of Production & Nonsupervisory Employees 5 4 3 2 1 1986 As of 1/15. Source: Department of Labor, FactSet. 1990 1994 1998 2002 2006 2010 2014 10 US job openings have surged Job Openings (JOLTS) - thousands 5,500 Average nonfarm payroll employment change = +267k 5,000 4,500 4,000 3,500 3,000 Average nonfarm payroll employment change = +122k 2,500 2,000 2004 2006 2008 2010 2012 2014 As of 12/14. Job Openings and Labor Turnover Survey (JOLTS) is a monthly survey of private nonfarm establishments and local government entities which provides information on the total number of job openings, hires, and separations (voluntary quits and layoffs/discharges). Source: Department of Labor, FactSet, ISI Group LLC. 11 Long-term US unemployment has plunged Long-Term Unemployment Rate (more than 27 weeks) Short-Term Unemployment Rate (less than 5 weeks) 5 4 3 2 1 0 1948 1958 As of 1/15. Source: Department of Labor, FactSet. 1968 1978 1988 1998 2008 12 Market’s expectations way under Fed’s September 2014 Median FOMC Fed Funds Rate Projections December 2014 Median FOMC Fed Funds Rate Projections Fed Funds Futures Rate (market expectations) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2014 2015 As of 2/15. FOMC=Federal Open Market Committee. Source: Bloomberg, Federal Reserve. 2016 2017 13 Volatility up across all asset classes Average Daily Move in 10-Year Treasury Yield (bps) Average Daily Move in S&P 500 (%) 8.5 2.0 7.5 1.6 6.5 1.2 5.5 4.5 0.8 3.5 0.4 0.0 2011 2.5 2012 2013 2014 2015 1.5 2011 2012 2014 2013 2015 JPM Global FX Volatility Index Average Daily Move in WTI Crude Oil Price (%) 30 3.5 3.0 25 2.5 20 Asian financial crisis/Russia default Mexican peso crisis Global financial crisis Peak of euro crisis 2.0 15 1.5 10 1.0 5 0.5 0.0 2011 2012 2013 2014 2015 0 1992 1995 1998 2001 2004 2007 2010 2013 As of 2/27/15. Average Daily Move=50-day moving average of absolute daily change. bps=basis points. WTI=West Texas Intermediate. JPM Global FX Volatility Index is an index of global foreignexchange volatility that tracks options on currencies of major and developing nations in percentage points. Source: Bespoke Investment Group (B.I.G.), Bloomberg. 14 Big lag from 1st hike to trouble historically Fed tightenings ahead of US bear markets and recessions Date of 1st Fed rate hike Bear market start # months to bear market Recession start # months to recession start 4/15/1955 8/2/1956 16 8/1957 28 9/12/1958 12/12/1961 39 4/1960 19 7/17/1963 2/9/1966 31 n/a n/a 11/20/1967 11/29/1968 12 12/1969 25 1/15/1973 1/11/1973 0 11/1973 10 8/31/1977 n/a n/a 1/1980 29 9/26/1980 11/28/1980 2 7/1981 10 9/4/1987 8/28/1987 -1 7/1990 34 2/4/1994 n/a n/a n/a n/a 6/30/1999 3/24/2000 9 3/2001 21 6/30/2004 10/9/2007 40 12/2007 42 Mean 16 Mean 24 Median 12 Median 25 Bear market defined as 20+% drop in S&P 500. See last slide for definition of recession. Source: Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2015(c) Ned Davis Research, Inc. All rights reserved.). 15 US stocks tend to rally into/after initial rate hike S&P 500 Around Starts of Fed Tightening Cycles 112 110 Average of 13 cases since 1928 108 106 104 102 100 Start of Tightening Cycle 98 -6 -5 -4 -3 -2 -1 0 1 2 3 Months Prior | Months Post 4 5 6 1928-2014. Source: Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2015 (c) Ned Davis Research, Inc. All rights reserved.) 16 Longer-term US performance during rising rates Economic & market performance during rising interest rate periods (based on Fed tightening cycles) % Gain per annum Coincident index 3.0% Nonfarm payrolls 2.5% Start date 4/30/1955 Fed rate 1.75% End date 7/31/1957 Fed rate 3.00% S&P 500 total return 15.1% 9/30/1958 2.00% 8/31/1959 3.50% 24.8% 13.8% 3.9% 7/31/1963 3.50% 11/30/1965 4.00% 16.2% 5.4% 3.8% 11/30/1967 4.50% 3/31/1969 5.50% 9.2% 4.4% 3.6% 1/31/1973 5.00% 3/31/1974 7.50% -13.9% 2.2% 3.0% 8/31/1977 5.75% 1/31/1980 12.00% 12.6% 3.5% 3.8% 9/30/1980 11.00% 4/30/1981 13.00% 15.5% 2.7% 2.1% 9/30/1987 6.00% 1/31/1989 6.50% -2.4% 4.0% 3.3% 2/28/1994 3.25% 1/31/1995 5.50% 3.6% 4.6% 3.6% 6/30/1999 5.00% 4/30/2000 6.00% 8.3% 4.2% 2.6% 6/30/2004 1.25% 5/31/2006 5.00% 7.6% 2.6% 1.7% Median 9.2% 4.0% 3.3% Mean 8.8% 4.6% 3.1% Gain per annum over entire history 11.3% 2.5% 1.7% Tightening cycle defined as at lest 3 consecutive rate increases without an intervening easing cycle. Source: Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2015(c) Ned Davis Research, Inc. All rights reserved.). 17 Higher US rates more a positive than negative Demand Deposits at Commercial Banks 1,200 $, billions 1,000 800 600 400 200 1990 1995 2000 Household Interest Income 2005 2010 2015 Household Interest Expense 1,600 $, billions 1,200 800 400 0 1990 1995 2000 2005 2010 2015 As of 1/15. Demand Deposits are funds held in an account from which deposited funds can be withdrawn at any time without any advance notice to the depository institution. Source: Bureau of Economic Analysis, Cornerstone Macro, FactSet, Federal Reserve. 18 Disclosures The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. We believe the information obtained from third-party sources to be reliable, but neither Schwab nor its affiliates guarantee its accuracy, timeliness, or completeness. The views, opinions and estimates herein are as of the date of the material and are subject to change without notice at any time in reaction to shifting market conditions. Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. ©2015 Charles Schwab & Co., Inc. All rights reserved. Member SIPC 19 Index definitions Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in directly. The Breadth of Philly Fed State Leading Indexes are produced monthly by the Federal Reserve Bank of Philadelphia, and designed to predict the 6-month growth rate of each state's coincident index. The components of the leading indexes are: state coincident indexes, state-level building permits, state initial unemployment insurance claims, delivery times from the ISM manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury note. The Business Confidence Index is a quarterly survey by the Conference Board of approximately 100 CEOs in a wide variety of industries, details Chief Executives' attitudes and expectations regarding the overall state of the economy as well as their own industry. The Chicago Fed's National Financial Conditions Index (NFCI) provides a weekly view of U.S. financial conditions in money markets, debt and equity markets, and the traditional and "shadow" banking systems. ©2015 Charles Schwab & Co., Inc. All rights reserved. Member SIPC 20 Index definitions Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in directly. The Conference Board's Coincident Economic Index (CEI) is a composite average of four individual economic indicators (employees on nonagricultural payrolls, personal income less transfer payments, industrial production, and manufacturing and trade sales) designed to capture turning points in aggregate economic activity better than any individual component. The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future. The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. The Institute for Supply Management (ISM) Non-manufacturing Index is an index based on surveys of more than 400 non-manufacturing firms by the Institute of Supply Management. The ISM Non-manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. ©2015 Charles Schwab & Co., Inc. All rights reserved. Member SIPC 21 Index definitions Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in directly. The S&P 500 Index is a capitalization-weighted index of 500 stocks from a broad range of industries. The component stocks are weighted according to the total market value of their outstanding shares. (0315-1739) ©2015 Charles Schwab & Co., Inc. All rights reserved. Member SIPC 22