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2013 Outlook: Second Quarter (Q2) Update S omewhat fondly recalling the days when the U.S. Federal Reserve (the Fed) played its cards close to the vest, during the last month or so, we have witnessed the impact of the Fed’s new “transparency” as U.S. and global markets react (or overreact?) to what the Fed said or meant to say or should have said. Nonetheless, the problem for the U.S. is unchanged: a tortoise economy unable to stand on the pillars of corporate investment and consumption, with a Fed torn by the need to be supportive yet cognizant of the long-term effect of continuing the printing presses, as well as the potential to choke even slow recovery if interest rates rapidly increase. It is difficult to tell if the best descriptor for this economy is “cautiously optimistic” or “nervously positive,” but we can certainly say it is uncertain and investors are skittish. Although for every favorable indicator there appears to be an offsetting negative and a resulting weakness in most measures of Americans’ sentiment, the U.S. is still the proverbial hare compared to many other developed economies. Europe, by contrast, has pulled its head and legs into its shell and seems This is the second quarterly update to content to let time pass by in hopes of a safer environment before continuing. Segal Rogerscasey’s 2013 Investment This approach, austerity, may have merit eventually, but in the meantime, Outlook, which can be accessed by Segal Rogerscasey is concerned about rising discord as the spread beclicking on the image above or the tween the have and have-not eurozone economies widens. There will be following link: http://www.segalrc.com/ bright spots, as there are a number of strong and attractive companies in pubs/outlook/2013.pdf the eurozone, some of which may be cheaper due to the overall perception of the region, but, on average, the more attractive valuations could be occurring with good reason. In Japan, the first two arrows of “Abenomics”1 had seemingly convinced the markets that performance-enhancing drugs injected into the tortoise would cause a magical transformation to Gamera, the iconic flying turtle of sci-fi fame. More recently there has been a significant pullback, as the depth of the issues and caution about the unknown result of the pending third injection have combined to blunt the previous unbridled optimism. The much-anticipated global winner of the race, emerging markets, has stopped to take a nap, at least as far as investors are concerned, and suddenly went from everyone’s favorite to an apparent long shot. Segal Rogerscasey continues to believe that the truth lies somewhere in between (neither unbridled speed nor sleeping in the tall grass) and structural change accompanied by currency stability is likely to favor these economies over the long term even though this hare is prone to unpredictability and inconsistency with the resulting impact from investors who quickly back other contestants whenever these characteristics manifest. 1 This term refers to Prime Minister Shinzo Abe’s three-pronged plan for improving the economy, which includes monetary policy, fiscal stimulus and structural economic reforms. Updated Equity, Interest Rate and Fixed-Income Graphs Segal Rogerscasey has updated many of the equity, interest rate and fixed-income graphs from the 2013 Investment Outlook to include data as of June 30, 2013. Those graphs are available on the following page of the Segal Rogerscasey website: http://www.segalrc.com/pubs/outlook/Q22013updatesupp.pdf Q2 Update to 2013 Investment Outlook This update to Segal Rogerscasey’s 2013 Investment Outlook includes a summary of the global environment and a revised summary of views. It also includes observations on the investment outlook for Canada, contributed by experts at Segal Rogerscasey Canada, and for Australia, contributed by Frontier Advisors Pty Ltd, Melbourne, Australia. We want to welcome Fiona Trafford-Walker, Director of Consulting, Frontier Advisors, to the team of senior professionals that develops this Investment Outlook. Frontier Advisors joins Segal Rogerscasey as part of the recently formed Global Investment Research Alliance. (Information about the Alliance can be found on the following pages of the Segal Rogerscasey and Frontier websites: http:// www.segalrc.com/news-and-events/press-releases/?id=896 and http://www.frontieradvisors. com.au/documents/GIRAPressReleaseMay2013.pdf.) The material contained herein is intended as a general market commentary for distribution to investment professionals and fiduciaries only. This is not intended for retail use or distribution. It is for informational purposes only and is intended solely for the person to whom it is delivered by Segal Rogerscasey. Opinions expressed herein are those of the Segal Rogerscasey Investment Committee as of July 2013, when this update to the 2013 Investment Outlook was written. These opinions are subject to change and may differ from those of other Segal Rogerscasey employees and affiliates. Past performance is not a guarantee of future results. Not all investment ideas referenced are suitable for all investors and each investor must consider their specific goals, objectives, liquidity, and risk preferences in making decisions regarding the applicability of these ideas to their own circumstances. Additional disclosures are provided at the bottom of the last page of this publication. n Page 2 Q2Q1 Update to to 2013 Investment Outlook Update 2013 Investment Outlookn nPage Page3 3 Summar y of the Global Environment The shaded cells in the table below indicate changes or additional information since the publication of the Q1 update to 2013 Investment Outlook, which included a similar table. 2013 Outlook Q2 Update United States Substantial uncertainty in economic direction Interest rates low, but future increases expected Federal Reserve seeking to lower unemployment U.S. housing market recovering College debt increasing Positive developments in North American energy Principally unchanged with marginal progress Unchanged, recent rapid rise and subsequent decline viewed as short term Unchanged, marginal progress and markets react poorly to Fed’s trial balloon of probing an exit to “quantitative easing2 infinity” Continues, issues outstanding, rate increases unfavorable to progress Continues to be long term concern especially due to recent rate increases Unchanged, environmental questions persist; some renewed focus on fracking Low inflation Unchanged, with even longer horizon Deleveraging with stronger balance sheet Most may be behind us now Some signs of uptick in autos and other consumer durables, but still modest Issues continue although some brightening in current accounts from sequester Consumption and spending muted Fiscal issues of budgets, debt ceiling, and taxes Developed Non-U.S. Europe problematic Chronic unemployment and concern for unrest, austerity vs. growth issues Overhang for European banks Unchanged New leadership in Japan Favorable stimulus, more expected, falling yen has commodity price impact Long-term growth prospects for Japan Fundamental issues are unchanged Developing Global slowdown impacts growth Unchanged Domestic consumption takes time Unchanged Growing middle class also long-term positive Unchanged China as the growth engine but has slowed Unchanged Additional Influences Rising level of instability in the Middle East Civil unrest and generational issues related to youth unemployment 2 Quantitative easing is a government monetary policy that increases the money supply to stimulate the economy. Q2Q1 Update to to 2013 Investment Outlook Update 2013 Investment Outlookn nPage Page4 4 Summar y of Views The shaded cells in the table below indicate changes or additional information since the publication of the 2013 Investment Outlook, which included a similar table. Broad Asset Class Sub Asset Class Absolute Relative Equities U.S. Slightly Favorable Favorable vs. Non-U.S. Developed Equities Non-U.S. Developed Slightly Favorable Unfavorable vs. U.S. Equity Equities Emerging Favorable Slightly Favorable vs. Developed Fixed Income U.S. Core Neutral Strongly Favor Active Management Fixed Income Non-U.S. Core Slightly Unfavorable Strongly Favor Active Management Fixed Income Emerging Market Debt Slightly Favorable Favor Local over External Debt Fixed Income High Yield Slightly Favorable Strongly Favor Active Management Fixed Income Bank Loans Slightly Favorable Strongly Favor Active Management Fixed Income TIPS Appropriate for Longer-Term Inflation Hedge Fixed Income Alternative Fixed Income Favorable Favor Direct Lending and Structured Credit Fixed Income Long Bonds Appropriate for Liability Hedging Support for Hedging Purposes Alternatives Hedge Funds Support Allocation to Best in Class Hedge Funds Favor Discretionary Global Macro/ Multi-Strategy Alternatives Private Equity Support Allocation to Best in Class Private Equity Favor Middle Market, U.S., Growth Equity and Emerging Alternatives Real Estate Support Real Estate over the Long Term Favor Value Added and Opportunistic Alternatives Other Hard Assets Infrastructure Cautiously Positive over the Long Term Global, Favor High Quality Core Managers Alternatives Other Hard Assets - Timber Positive Global Alternatives Other Hard Assets - Farmland Positive Cautious of U.S. Centric Approach Alternatives Energy Positive Favor Infrastructure, MLPs and Exploration and Production Assets Alternatives Commodities Consider Role in Portfolio for Inflation Protection Active Management, but Hard to be Positive in the Near Term Q2Q1 Update to to 2013 Investment Outlook Update 2013 Investment Outlookn nPage Page5 5 Outlook for Canada Canada has been one of the world’s strongest economies in recent years, largely due to the boom in commodities and the country’s healthy financial condition relative to other countries. It escaped many of the ravages of the financial crisis of 2008-2009 due to its sound fiscal situation and the relative absence of toxic investments on the balance sheets of its major financial institutions. This strength has led the Bank of Canada to maintain its target for the overnight rate at 1 percent since January 2009, higher than the key interest rates of leading economies, such as the U.S. and the eurozone. However, the Canadian economy has slowed in recent months due to a decline in the general price and demand for commodities. This slowdown is reflected in local equity indices, which have been some of the worst-performing globally this year. In addition, while the Canadian dollar had traded above par with the U.S. dollar for much of the past several years, it is now questionable whether it can remain significantly above 90 cents in the next 12 months. Canada is a major oil producer, but the prospect of the U.S. also becoming a major player in the energy market in a few years will pose some difficulty for Canadian oil exporters. They will need to sell their oil to more distant markets, such as Asia. Like Australia (see “Outlook for Australia” on page 6), Canada has other industries that are not resource-driven — manufacturing, for instance — but its heavy concentration in the resources sector makes the economy susceptible to global swings that are dependent upon growth and expansion. Q2Q1 Update to to 2013 Investment Outlook Update 2013 Investment Outlookn nPage Page6 6 Outlook for Australia The Australian equity market, as measured by the industry standard S&P/ASX 300 Index, returned a total of 21.9 percent over the year ending June 30, 2013. As investors continued to favor quality or high-yielding stocks, three sectors led the gains: Financials, Telecommunications and Health Care. The market was also boosted by three separate cuts to official interest rates, totaling 0.75 percent, as the Reserve Bank of Australia sought to encourage other sectors of the economy to fill the gap left by the drop in resources-related capital expenditure. The Materials sector was the most notable underperformer over the 12-month period. It was the only sector to go backward over the past year. This underperformance characterized concerns regarding falling prices for bulk commodities, iron ore and coking coal in particular, and uncertainty surrounding the future likely path of Chinese economic growth. Toward the end of the 12-month period, concerns over the timing of a tapering in the U.S. Fed’s quantitative easing program and further uncertainty over China’s economy erased some of the market’s gains for the year. Looking to the year ahead, these current themes are likely to be key drivers of market performance. The timing, execution and circumstances surrounding any slowdown in the Fed’s quantitative easing program will likely play an outsized role in determining overall market performance. At the sector level, those sectors that have benefitted most from investors’ preference for yield over growth may be susceptible if this trend reverses. Moreover, the degree to which consumers and businesses respond to the multiple interest rate cuts is expected to drive the performance of domestic cyclical stocks. Investor confidence in the outlook for the Chinese economy is also expected to play a key role in determining the performance of mining and mining-related sectors. Q2 Update to 2013 Investment Outlook Questions? Contact Us. For more information about the market commentary discussed in this update to the 2013 Investment Outlook and how our views may help you to revise your investment strategy, contact your investment consultant, the nearest Segal Rogerscasey office (http://www. segalrc.com/about-us/contact-us-locations) or Tim Barron, Chief Investment Officer, at 203.621.3633 or [email protected] To receive each year’s Investment Outlook, quarterly updates and other Segal Rogerscasey publications as soon as they are available online, register your e-mail address via http://www.segalrc.com/register/ Segal Rogerscasey is a member of The Segal Group (www.segalgroup.net). Segal Rogerscasey provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Segal Rogerscasey’s second quarter update to the 2013 Investment Outlook and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Rogerscasey or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Of course, on all matters involving legal interpretations and regulatory issues, plan sponsors should consult legal counsel. Copyright © 2013 by The Segal Group, Inc. All rights reserved. n Page 7