SVB Asset Management Economic Book Q3 2013


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SVB Asset Management is pleased to announce the release of the Q3 2013 Economic Booklet as a research piece summarizing the macro-economic and sector trends in the global market. The Economic Booklet is our reference tool for clients. Displaying graph and chart views of the global economy, this piece guides clients through factors that impact their business.

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SVB Asset Management Economic Book Q3 2013

  1. 1. SVB Asset Management Q3 Quarterly Economic Report 2013
  2. 2. Table of Contents Thoughts from our CIO CIO 03 Overview 04 Overview 04 Domestic Economy Economy 06 Federal Reserve Reserve 16 Markets & Performance Performance 21 Global Economy Economy 31 Regulatory 37 Regulatory 37 SVB Asset Management | Quarterly Economic Report Q3 2013 2
  3. 3. Thoughts from our CIO A Bit of a Head Fake There is no doubting the fact today’s economy is growing, but it is also clear that the quality of growth is subpar. Consumption, representing about 70 percent of the economy, has been growing – albeit at a slower pace – and has received some surprising help from the auto industry. Consumer outlooks, however, are shaky compared to the past two decades in light of uncertain fiscal and monetary policies. Employment growth is slowing and we remain far from “recovered” in this all-important measure of economic health. Lower participation in the workforce is not the ideal way to lower the unemployment rate and there is some sense the Fed will look deeper into the data to assess any potential improvement in the labor markets. The housing market has shown some heady price increases and rising housing starts are filtering through the economy to provide growth in many sectors. On the other hand, higher mortgage rates in the coming months will provide a solid headwind in fourth quarter. Our special topic this quarter looks at the changing make-up of the Federal Reserve where we’ll likely see a few more “hawks” but not enough to affect the decisions. We are hopeful the 2014 FOMC voters will have something to be hawkish about! The much discussed “great rotation” from bonds into equities took a pit stop in cash during the quarter, but our analysis of flow of funds data reveals that September inflows helped drive markets to new highs. On the regulatory front, we’ll be watching the SEC for further insight into money fund reform. I don’t expect any significant change to the industry given the outpouring of comment letters against such change. Should a move to floating NAV occur, I would anticipate a very long implementation period allowing investors to reevaluate and adjust their cash management tools. Looking ahead, I would expect a relatively calm quarter of activity with the Fed largely on the sidelines. The only wild card at press time is the debt ceiling debate. Compared to our experience in 2011, I would expect this to be only a moderate speed bump. Joe Morgan, Chief Investment Officer SVB Asset Management | Quarterly Economic Report Q3 2013 3
  4. 4. Overview Special Topic: The Fed It has been an interesting quarter for the Fed. Not only has there been a lot of chatter on the course of monetary policy, but the FOMC voting members will face significant turnover next year including a new chairman. With the potential changes, the Fed regime is shaping up to look less dovish, which may have implications for future monetary policy. Last quarter speculation regarding when the Fed would start to taper lead to volatility in the markets. The Fed’s September 18 announcement to hold off on tapering surprised markets, causing a rally across the curve. The question remains whether or not quantitative easing has been effective, especially for the broader economy. Domestic Economy Economic growth is slowly picking up despite headwinds stemming from fiscal policy. The consumer has started to pull back on spending showing that higher taxes and interest rates are having an effect. Improvement in employment has slowed with job growth struggling and labor force participation at 30+- year lows. Inflation has been running below the 2 percent objective, although this is expected to normalize in the medium term. Monthly housing data has been mixed showing that the market is trying to balance higher mortgage rates with tight home supply. SVB Asset Management | Quarterly Economic Report Q3 2013 4
  5. 5. Overview Markets/Performance Global Economy The Fed’s decision not to taper led stocks and bonds higher and all sectors posting positive returns. Equities have become the asset class of choice among investors given the recent fund inflows. This has led to a significant outperformance of stocks versus bonds. Regulatory Europe: Expansion germinates, starting a discontinuous path to medium-term sustainability. China: Slowing exports underlie a downshift in overall growth; domestic retail consumption is increasingly imperative . Investors have tempered their appetite for bonds; however, with spreads range bound, credit still offers protection against higher future interest rates due to higher income. Global tensions in Syria and a slowdown in EM economies could lead to some short-term volatility in commodity prices. Irrespective of who is in office, debate on the debt ceiling continues, but we expect legislators to continue to raise the debt ceiling. The Comment period has ended for SEC MMF reform in the last quarter. Implementation is not expected within the year. Japan: Entrenching BOJ monetary easing and planned economic reforms are steadying the yen. European regulators introduced their version of MMF reform. Acceptance by various legislators is still required. U.S.: Dollar volatility to increase amid improving prospects in some G20 economies and pending Fed action. SVB Asset Management | Quarterly Economic Report Q3 2013 5
  6. 6. SVB Asset Management Domestic Economy Domestic Economy
  7. 7. GDP Struggling to Pick Up Momentum GDP Since the recovery started the U.S. has averaged just over 2 percent growth. 10.0% 5.0% Sequestration has caused growth to slow, especially given recent tax hikes and spending cuts. 0.0% Consumption is helping offset the reductions in government spending and driving the economy forward despite recent headwinds. -5.0% -10.0% U.S. GDP Q-o-Q Trailing 4-Quarter Average GDP and Components The second half of the year is projected to have better growth as the effects of sequestration have subsided and the Fed holds off on tapering for the time being. GDP Y-o-Y Growth 4Q Average – Long View 5.0% 8.0% 3.0% 6.0% 1.0% 4.0% -1.0% 2.0% 0.0% -2.0% Government Res Investment Inventories GDP Net Exports Bus Fixed Investment Personal consumption exp -4.0% Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter annualized. SVB Asset Management | Quarterly Economic Report Q3 2013 7
  8. 8. Consumption Restrained Growth Consumer Sentiment – University of Michigan Consumer sentiment as shown by the University of Michigan survey steadily declined in the third quarter with the latest reading at 76.8, a five-month low. This is below the 30-year average of 87, but still above the five-year average of 71. 120.0 100.0 80.0 Retail sales have been tested in recent months with signs of slower growth. Purchases rose only 0.2 percent in August, below expectations and the smallest gain in four months. Average 60.0 Higher mortgage rates, higher payroll taxes, and limited wage growth are some of the factors which seem to be limiting the consumer’s spending power. 40.0 Personal Consumption – % Change $450.0 $25.0 $400.0 $20.0 $350.0 $15.0 $300.0 $10.0 $250.0 $5.0 Ex Autos Vehicle Sales (Millions) Retail & Food Services Sales (Billions) Retail & Food Services Sales 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Vehicle Sales Source: U.S. Bureau of Economic Analysis (BEA),, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 8
  9. 9. Consumption Restrained Growth Personal Income Personal Savings as a % of Disposable Income 10.0% 2.0% 8.0% 0.0% 6.0% -2.0% 4.0% -4.0% 2.0% -6.0% Monthly Percentage Change 4.0% 0.0% Household Net Worth $80.0 Billions $60.0 $40.0 $20.0 $0.0 Personal incomes have been fairly muted in recent months, averaging just over 0.2 percent growth, while savings rates have been very steady for the majority of the year, hovering right around 4.5 percent. Although the consumer may have wavered a bit in terms of sentiment, household net worth continues to be on the rise supported by gains in the housing and equity markets. The last reading in Q2 showed that net worth rose $1.3 trillion during the quarter to $74.8 trillion. Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 9
  10. 10. Employment Slowing Down Full-Time Employment 15.0% 500.0 5.0% 0.0 -5.0% -500.0 -15.0% -1,000.0 Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS) Long Term Unemployment 125,000.0 10,000.0 120,000.0 8,000.0 115,000.0 6,000.0 110,000.0 4,000.0 105,000.0 2,000.0 100,000.0 0.0 Full Time Employment (LHS) Thousands Thousands 1,000.0 Thousands Employment Landscape Part Time for Economic Reasons (RHS) The unemployment rate has dropped to 7.3 percent, although the drop is partially due to less people participating in the work force. 50.0% Despite all the monetary support by way of quantitative easing, the pace of hiring has yet to accelerate. 40.0% 30.0% The pace of hiring has slowed since the beginning of the year and the quality of jobs is weak with more part-time than full-time jobs being added. 20.0% 10.0% 0.0% The number of long-term unemployed has declined since the peak, but is still at an unhealthy high level. Recession Period Unemployed 27 Weeks and Over Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months. SVB Asset Management | Quarterly Economic Report Q3 2013 10
  11. 11. Employment Slowing Down Fewer Workers Supporting Greater Population Will the Recent Spike in Earnings Hold Up? 11.0% 65.0% 68.0% 5.0% 9.0% 63.0% 66.0% 4.0% 7.0% 61.0% 64.0% 5.0% 59.0% 3.0% 57.0% Unemployment Rate (LHS) Employment to Population Rate (RHS) 3.0% 2.0% 62.0% 1.0% 60.0% 0.0% Labour Force Participation Rate (LHS) Avg Hourly Earnings Growth (RHS) Hires and Quits Remain Depressed Workers as a percentage of the total population remain depressed. 5.0% 4.0% The labor force participation rate is at 35-year low, causing some of the drop in the unemployment rate to be driven by fewer participants rather than more jobs. 3.0% 2.0% Turnover, as measured by job hires and quits, remains depressed vs. recent growth trends. 1.0% Job Hire Rate Job Quit Rate Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 11
  12. 12. U.S. Housing Market On the Fence 9.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 8.0 7.0 6.0 5.0 4.0 3.0 Total Sales (new & existing) Home Supply (months) Home Sales (Millions) Home Sales & Supply Existing Home Supply 2,500.0 Housing Starts (Thousands) Sales of existing homes have continued to rise in the third quarter; however, new home sales have experienced more of a slowdown. Home prices reflect the same trend with double-digit, one-year increases, but levels remain below their prior peak reached in 2006. Home Prices – Indexed to 100 350.0 2,000.0 280.0 1,500.0 210.0 1,000.0 140.0 70.0 500.0 0.0 0.0 Housing Starts Population (Millions) Housing Starts Housing indices have been more volatile in recent months as the market has been balancing higher mortgage rates with continued tight home supply. U.S. Population 240 190 140 90 Case Schiller 20 City FHFA Purchase Median Home Price Source: National Association of Home Builders (NAHB),, S&P, and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 12
  13. 13. U.S. Housing Market On the Fence 70.0% 68.0% 66.0% 64.0% Housing Affordability Composite Index Affordability Index Homeownership Rate 250.0 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 200.0 150.0 100.0 50.0 0.0 62.0% Housing Affordability 30 Year Fixed Mortgage Rates Home Foreclosures - % of Total Loans 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Homeownership has held at 65 percent for the past two quarters. The sustained drop during the past decade indicates that this may reflect positive data in the future. Foreclosures appear to have turned the corner which implies some relief for the typical consumer. Home affordability has started to reverse the upward trend showing that the rise in mortgage costs is a significant factor. In the latest Fed announcement, policymakers cited a tightening of financial conditions as being one of the reasons for keeping the pace of monthly bond purchases. Source:, National Association of Realtors and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 13
  14. 14. Inflation Below the Line CPI Components 12-month Change Food & Bev. Housing Apparel less Footw ea Transportation Medical Care Recreation Educ. & Com . m Other 1.4% 2.2% 1.6% 0.0% 2.3% 0.4% 1.6% 1.6% Headline CPI 1.5% Energy Food -10.0% 1.4% Less: Core CPI Core PCE 2.8% 5.0% 41.1% 5.9% Housing 6.7% Transportation Food & Bev. 7.1% Medical Care Educ. & Comm. Recreation 14.2% Apparel less footwear 17.2% Other 8.0% 6.0% 4.0% 2.0% 0.0% Fed Target Monetary Policy Threshold Producer Price Index % change from prior year 15.0% 10.0% 5.0% 0.0% -5.0% CPI Ex Food & Energy 10.0% Core PCE 1.8% Consumer Price Index % change from prior year % change from prior year Component Distribution August 2013 CPI 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% PPI Ex Food & Energy PPI Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 14
  15. 15. Inflation Below the Line Wage Growth: Average Hourly Earnings Crude Oil – Spot & Futures $150.0 4.0% Price per barrel Annual % change 4.5% 3.5% 3.0% 2.5% 2.0% $100.0 $50.0 $0.0 1.5% Crude Oil Crude Oil Futures Univ. of Michigan Survey of Inflation Expectations At the recent Fed meeting, the Committee acknowledged that inflation has been persistently running below its 2 percent objective, but they expect this will revert over the medium term. 5.5% 4.5% Inflationary measures such as CPI and PPI have both been coming in very close to expectations and inflation continues to be a very low concern to many. 3.5% 2.5% We are still not seeing significant wage growth, which is needed in order to drive inflation. Furthermore, emerging markets demand has subsided which has stabilized commodity prices. 1.5% 1 Year Ahead 5-10 Year Ahead Source: U.S. Bureau of Labor Statistics (BLS), U.S. Energy Information Administration (EIA), University of Michigan / Thomson Reuters - Survey of Consumers and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 15
  16. 16. SVB Asset Management The Federal Reserve The Federal Reserve
  17. 17. Federal Reserve A New Fed Regime Talk of a new Fed chair was persistent throughout the third quarter until Larry Summers made the surprise announcement that he was withdrawing from consideration. At the time of print, Janet Yellen appears to be the lead candidate to succeed Mr. Bernanke when his term expires at the end of January 2014. An announcement from the Obama administration is expected in the coming weeks. With 18 Fed policymakers, each with divergent viewpoints, arriving to a policy consensus is difficult. To the right is a breakdown of the current assembly and how that may change. The bottom line is that it looks like the regime may be less dovish next year. Current Camp Ben Bernanke (Chair) Janet Yellen (Vice Chair) Daniel Tarullo Sarah Bloom Rakin Jeremy Stein Jerome Powell Eric Rosengren William Dudley Charles Evans James Bullard Sandra Pianalto Dennis Lockhart Narayana Kocherlakota John Williams Esther George Charles Plosser Jeffrey Lacker Richard Fisher Dove Dove Dove Dove Dove Dove Dove Dove Dove Dove Dove Dove Dove Dove Hawk Hawk Hawk Hawk Voting (2013) Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes No No No No Yes No No No Voting (2014) No – term ends at the end of January Likely dependent on Fed Chair decision Yes No – leaving the board of governors Yes No – term ends at the end of January No Yes No No No – announced retirement No Yes No No Yes No Yes SVB Asset Management | Quarterly Economic Report Q3 2013 17
  18. 18. Federal Reserve Is Q.E. Working? Are Record Low Mortgage Rates Helping? $11.5 6.0% $11.0 5.0% 4.0% Billions $10.5 3.0% $10.0 2.0% $9.5 1.0% 0.0% $9.0 Mortgages Outstanding (LHS) 10 YR Treasury (RHS) 30 YR Treasury (RHS) Will the Wealth Effect be Sustainable? The question that many are asking, including the Fed, is whether quantitative easing is helping the broader economy. Mortgage rates are at record lows; however, mortgages outstanding have been on the decline for the last five years. Home prices have finally stabilized and are rising in many areas. Meanwhile, equities are rising with the S&P 500 hitting an all-time high in September. However, the fundamentals are not supporting the increase, an indication sustainability will be difficult. The unemployment rate, which is a Fed target, has been dropping but largely due to a drop in the participation rate. There is also concern that the quality of the jobs added is weakening. Low Participation Rate Impacts the Unemployment Rate 250 1,800 67.0% 12.0% 230 1,600 66.0% 10.0% 1,400 65.0% 8.0% 1,200 64.0% 6.0% 1,000 63.0% 4.0% 800 62.0% 2.0% 600 61.0% 0.0% 210 190 170 150 S&P 500 (RHS) Home Prices (LHS) Labor Force Participation Rate (LHS) Unemployment Rate (RHS) Source: Bloomberg and SVB Asset Management SVB Asset Management | Quarterly Economic Report Q3 2013 18
  19. 19. Federal Reserve Still Growing, For Now The sell-off triggered by the anticipation of tapering created a lot of volatility in markets and significant increases to interest rates. The rise in interest rates might have unnerved the Fed given the fragile state of the U.S. recovery. In the last FOMC meeting of the quarter the Fed stated that there has been “growing underlying strength in the broader economy” but wants to “await more evidence that progress will be sustained before adjusting the pace of its purchases.” Recent Balance Sheet Trends $4.0 Other Fed Reserve Assets Central Liquidity Swaps $3.5 Other Aurora $3.0 Maiden Lane III Maiden Lane II $2.5 Trillions The third quarter was a volatile one as investors tried to predict the pace of tapering that was hinted at back in May. The big surprise was on September 18 when the Fed announced it would hold off on tapering and gave no clear indication of when tapering would take place. Maiden Lane I TALF $2.0 AIG Seasonal Credit $1.5 Secondary Credit Primary Credit $1.0 Other Loans Treasury Currency Outstanding $0.5 Special Drawing Gold Stock $0.0 MBS Federal Agency Debt Securities U.S. Treasury Securities Source: Federal Reserve and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 19
  20. 20. Federal Reserve Mixed Signals The Fed continues to monitor economic data and is using the unemployment rate and inflation rate as metrics to monitor the need for monetary policy. The unemployment target is set at 6.5 percent and looser monetary policy will continue as long as inflation remains below 2.5 percent. Targeting Unemployment and Monitoring Inflation 12.0% 3.0% U.S. Unemployment Target 6.5% 10.0% 8.0% 2.0% 6.0% However, in June Bernanke mentioned that an unemployment rate of 7 percent could warrant the end of quantitative easing. While the unemployment rate is headed in that direction, it is propelled by a very low labor force participation rate. In the last meeting, Bernanke said the unemployment rate is not necessarily a great measure of the state of the labor market. Core PCE Threshold 2.5% 1.0% 4.0% 2.0% 0.0% 0.0% Core PCE (LHS) Core PCE Thresholds (LHS) U.S. Unemployment Rate (RHS) U.S. Unemployment Thresholds (RHS) Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 20
  21. 21. SVB Asset Management Markets & Performance Markets & Performance
  22. 22. Funds Flow Injecting Fuel Into Equities Equity Flows & Stock Performance $20.0 Flows into equity funds have recently exceeded performance driven by a dovish fed and lackluster top-line revenue growth. $0.0 With the decision to continue Quantitative Easing, the recent trends in equity and bond flows could persist. Millions There were large flows out of bond funds during the month of June and large flows into equity funds in September. -5.0% -$20.0 -15.0% -25.0% Net New Cash Flow (LHS) Total Return on Equities (RHS) Money Market Fund Flows $80.0 $2.7 Trillions $40.0 Billions 5.0% -$40.0 Money market funds have started to normalize in anticipation of the SEC decision regarding the recent proposals. Net New Fund Flows 15.0% $0.0 -$40.0 $2.6 $2.6 $2.5 $2.5 $2.4 -$80.0 Total Equity Total Bond MMF AUM Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 22
  23. 23. Bond Sector Spreads Stuck in a Range? Spread Performance by Asset Class 250 Uncertainty at the Fed and in Congress has contributed to the recent volatility in the market. Corporate bond performance was boosted by increased demand for new issues, characterized by a flurry of new deals this year. In addition, the Fed's decision not to taper has boosted demand for riskier assets which should help credit spreads. 200 Spread (bps) Despite the recent chatter, credit spreads have been resilient and will likely trade within their respective ranges for the near term. 150 100 50 0 Inv. Grade Corporates U.S. Agency MBS ABS 800 300 -200 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 23
  24. 24. Bond Market Where’s the Alpha? The Fed’s decision to delay tapering led the majority of the U.S. bond sectors to post positive excess returns. Excess Return % YTD GOVERNMENT & CORPORATE SECTOR Year-to-date, high grade corporate sectors, such as Insurance and Financial Services, led the way posting 3.3 percent and 2.0 percent in excess returns. The Verizon downgrade to BBB is part of the reason for Telecom underperformance YTD. Meanwhile, CMBS and ABS sectors have provided the alpha in the securitized space. Telecommunications -1.2 Basic Industry -1.1 Media -0.9 US AGENCY -0.3 Energy 0.1 US TREASURY 0.1 Consumer Non-Cyclical 0.3 Healthcare 0.5 Capital Goods 0.6 Consumer Cyclical 0.7 Technology & Electronics 0.9 Services 1.1 Banking 1.7 Automotive 1.9 Financial Services 1.9 Insurance 3.3 SECURITIZED SECTOR CMBS 0.6 MBS -0.3 ABS 0.4 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 Source: Bloomberg, BoAML and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 24
  25. 25. Equity Markets Directional Indicators VIX is the Directional Indicator for Equities (VIX - inverse scale) Index Strength in S&P 500 Co. Fundamentals Reduce Risk & Improve Performance Index 1750 10 1700 12 1650 14 1600 16 1550 18 1500 20 1450 1400 22 1350 24 S&P 500 (LHS) Source: Bloomberg and SVB Asset Management VIX (RHS) Source: Bloomberg and SVB Asset Management SVB Asset Management | Quarterly Economic Report Q3 2013 25
  26. 26. Commodities U.S. Politics Driving Price Crude Futures – Per Barrel $110.0 $100.0 $90.0 $80.0 Gold Prices – An Ounce Commodities, such as crude oil, have been tied to combat potential in the Middle East, the value of the U.S. dollar and expectations of the economy. Oil prices had been rising because of the Syria crisis, yet recently dipped again on news of easing tension and a U.S.Russia deal in Geneva. The lack of tapering has given other commodity inflation hedges, like gold, an added pop. The weakening of the U.S. dollar will strengthen those investments. Iron Ore Futures – Per Ton $1,800.0 $165.0 $1,600.0 $140.0 $1,400.0 $115.0 $1,200.0 $90.0 Source: Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 26
  27. 27. Investment Performance Where’s the Horsepower? Benchmark Performance 3Q 2013 2013 YTD 2012 2011 2010 2009 2008 2007 G0O1 SBMMCD3 G0O2 SBMMCD6 G0O3 0.018 0.051 0.063 0.067 0.126 0.058 0.153 0.154 0.203 0.227 0.111 0.307 0.171 0.488 0.204 0.103 0.289 0.268 0.389 0.496 0.126 0.310 0.365 0.437 0.792 0.207 0.822 0.579 1.611 0.813 2.057 3.442 3.582 3.756 4.746 5.004 5.448 5.607 5.459 5.948 G1O2 G2O2 0.294 0.683 0.298 -0.567 0.434 1.577 1.554 6.229 2.348 5.695 0.785 -0.672 6.609 12.153 7.317 9.836 B110 B210 0.376 0.891 0.414 -0.376 1.188 3.077 1.527 5.479 2.641 5.925 2.766 2.958 5.184 6.174 6.981 8.324 G1P0 G2P0 0.304 0.832 0.270 -0.585 0.847 2.588 1.536 5.290 2.338 4.900 2.189 3.223 7.034 8.971 6.735 8.261 U1AF U2AF 0.409 0.987 0.577 0.095 0.520 1.539 1.800 4.951 0.923 2.087 3.189 5.345 5.875 7.992 4.710 5.390 R0U0 0.460 0.407 2.291 1.689 3.077 14.845 -0.682 5.723 INDU SPX CCMP MXWO CRY 1.033 4.123 9.810 6.878 2.749 15.484 18.769 26.350 16.064 -2.904 7.257 13.405 15.906 13.184 -3.372 5.544 2.110 -1.799 -7.615 -8.264 11.023 12.783 16.910 9.262 15.430 3.116 23.454 43.888 27.283 23.563 -33.762 -38.486 -40.541 -42.081 -39.450 6.432 3.530 9.812 7.093 16.679 Ticker Short Benchmarks 3-Month Treasury Bill 3-Month Citi/Salomon CD 6-Month Treasury Bill 6-Month Cit/Salomon CD 1-yr Treasury Bill Treasury 1-3 yr Treasury 3-5 yr Treasury Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt 3-5 yr Corp/Govt Agencies 1-3 yr Agencies 3-5 yr Agencies Municipals - Tax Exempt 1-3 yr Pre-refunded 3-7 yr Pre-refunded Auto Asset Backed Securities ABS, Autos, Fixed Rate, (1.45yrs) Other Indices Dow Jones Industrial Average S&P 500 NASD MSCI World Index CRB Index (Commodities) Source: Bloomberg, BoAML, Morgan Stanley. SVB Asset Management | Quarterly Economic Report Q3 2013 27
  28. 28. Loan Market Fundamentals The New Normal? Credit Spreads Less than Half of 2009 Peak Credit spreads have fallen since the 5.6 percent peak during the financial crisis in January 2009, but remain higher than the sub-2.0 percent levels seen pre-crisis. In August 2013, spreads fell further to 2.7 percent. 6.0% LIBOR continues to remain at historic lows as the Fed continues its accommodative bond-purchasing policy. While inflation is expected to rise over the coming quarters, the tapering has been deferred until more solid evidence of an economic recovery is presented. 2.0% LPC LCDX (Secondary Loan Price Index - Par = 100) 105 95 85 75 65 August 2013 2.7% 4.0% 3.0% 1.0% 0.0% Since the trough in loan pricing in April 2009, prices have largely recovered and are ending 3Q 2013 above par after reaching peak levels in June 2013. Fundamentals Remain Steady January 2009 5.6% 5.0% 10 YR BBB Yield - 10 YR Treasury Yield 3-Month LIBOR Remains at Historic Lows 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% August 2013 0.28% Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q3 2013 28
  29. 29. High Yield Market Fundamentals Catching Up Net Assets ($ in Billions) High Yield Funds Dip Notably in June High-yield issuance volume dropped dramatically this summer due to issuer worries over higher interest rates and a lack of demand for the fixed rate asset class. $400 $300 $200 There was a notable pick up in the fall as September priced over $22 billion of U.S. corporate high yield bonds in just 19 deals, surpassing issuance volumes of the last three months and making it the third busiest September on record. In comparison, June priced nearly $14 billion over 30 deals, July $20 billion over 47 deals, and August $13 billion over 35 deals. $100 $0 Loan Funds HY Bond Funds High Yield Take-Outs of Bank Debt Volume (Billions) $15.0 Sprint Corp. was the first to come to the market after Labor Day with its $6.5 billion high yield deal for general corporate purposes. Since then, five more billion-plus deals have hit the high yield bond market, including T enet Healthcare’s $4.6 billion two-part deal to finance the acquisition of Vanguard Health Systems. In comparison to September, the first two months of 3Q 2013 priced 82 deals with a much smaller average deal size of just $410 million versus September’s average of over $1 billion. $10.0 $5.0 Companies are likely to take advantage of the breather provided by the Fed to go into the market prior to the holiday season. $0.0 Bank-Loan Paydown Source: Thomson Reuters Loan Pricing Corp., Lipper FMI and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q3 2013 29
  30. 30. Overall Loan Market Overview Powering Through Historical Syndicated Loan Volumes The overall loan market held steady for the third quarter of 2013 on loans to back mergers and acquisitions, but was absent of notable movements given the traditionally slow summer season. Issuance (Billions) $2,000 $1,500 This trend is a turnaround from a year marked mostly by repricings and refinancings. $1,000 $500 The leveraged loan market added another $61 billion of issuance in August, bringing August year-to-date issuance to $736 billion, up from $387 billion in the same period last year, as market participants reported continued strong demand for floating-rate products. $0 Leverage I-Grade Other Leveraged loan volume (Billions) Institutional Lending Exceeded Pro Rata Loans $160.0 $140.0 $120.0 $100.0 $80.0 $60.0 $40.0 $20.0 $0.0 Banks have remained disciplined in their approach in 3Q 2013, but have been receptive to lending both up and down the grade. Leveraged loan issuances through mid-September have already nearly matched 2012 volume (614 deals compared to 664 in 2012). Over $20 billion of institutional loans came to market the week of September 9, continuing the heavy flow of new money issuance following the Labor Day holiday. The proportion of loans related to M&A or LBO issuance rose to roughly 54 percent as of September 13, versus about 19 percent YTD. Investors cautiously awaited the outcome of the September 18 Fed meeting on the tapering after recent mixed economic data left questions about the magnitude of the Fed’s program. Pro rata Institutional Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q3 2013 30
  31. 31. SVB Asset Management Global Economy GlobalEconomy
  32. 32. Europe Discontinuous Growth Manufacturing PMI Manufacturing PMI Growth is germinating within the eurozone, though fluctuation will continue over the next year before it takes root. Supporting the recovery will be a moderation of tight credit standards for retail and enterprise borrowers. 60 50 Manufacturing activity is improving. Germany and Italy are leading growth, while France is lagging. Expansion occurred for the first time in two years in Spain. Exports were key in lifting manufacturing in the eurozone, as well as in the U.K. 40 30 Eurozone Germany France Italy As fiscal and regulatory reforms continue, expect growth to be inconsistent over the next year. The ECB will likely intervene when necessary, but will not introduce additional extraordinary programs to boost growth. We don’t anticipate a rate cut near-term, absent financial market stress. Services PMI Services PMI (>50 Expansion) While trailing manufacturing activity growth, eurozone services are trending upwards, with recent expansion strongest in Ireland. Stabilization of new services business orders suggests services will begin to contribute positively in the near future. 60 50 40 30 Eurozone Germany France Italy Source: MarkIt, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 32
  33. 33. Europe Euro & Pound Rebound $1.7 $1.6 $1.6 $1.5 $1.5 $1.4 $1.7 $1.6 $1.5 $1.4 $1.3 $1.2 $1.1 GBP Eurozone Trade Balance Billions € 150.0 € 100.0 € 50.0 € 0.0 EUR Recent indications of strong growth in the U.K. and emerging signs of expansion in the eurozone have lifted the GBP and EUR. EUR / USD GBP/USD Currency Performance An acceleration in U.K. manufacturing and services growth, as well as a strengthening housing market and falling jobless claims propelled recent gains in the GBP. With the U.K. unemployment rate at 7.7 percent, above the 7 percent threshold set by the BOE for initiating a change in monetary policy, further gains will not hasten. Eurozone trade balance has declined after reaching a record high in March 2013, as weak domestic demand reduced imports. A solidly positive trade balance is proving support for the EUR. With the eurozone seeking to export its way to growth, trade balances will remain positive. The eurozone experienced its first quarterly expansion in the second quarter in almost two years. While the majority of national budgets have improved year over year, further fiscal and regulatory reform remain ahead. On the balance, this will contribute to a range-bound euro. -€ 50.0 -€ 100.0 Source: Eurostat, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 33
  34. 34. China Balancing Act Aggregate Financing Macroeconomic policies continue to focus on rebalancing from investment led consumption towards household consumption. 2,500.0 2,000.0 ¥ BIllions Despite efforts by the authorities to control credit growth, the trend remains robust with non-bank financing channels complicating policy and presenting downside risk to the economy. 0.0 Retail Sales % Change Year- over -Year % Change Year -over -Year 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% 1,000.0 500.0 Though trade surpluses and currency reserve accumulation persist, slowing exports increases the importance of retail sales to maintain growth. Export Activity 1,500.0 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 34
  35. 35. Asia Battling Inflation & Deflation India Inflation Uncontained 100.0 60.0 90.0 50.0 80.0 40.0 INR/USD 70.0 70.0 INR JPY JPY/USD Yen & Rupee Weaken 130.0 120.0 110.0 100.0 CPI Combined (2010 = 100) Japan Labor Market Improving Japan: The BOJ upgraded its assessment of the economy to “recovering moderately”, as public spending, home sales, and the labor market have improved since the start of its ‘Quantitative-Qualitative Easing’ (QQE) program. Increased political stability and comfort with expansionary policies will keep JPY/USD range-bound, with weakening bias in the medium to long term. India: Incoming RBI Governor Rajan raised the repo rate 25bps while simultaneously reducing the Marginal Standing Facility by 75 basis points at his first RBI meeting in September. The dual moves reflect the dilemma in fighting inflation without impairing growth. Continued INR weakness is possible in the medium term, as the limits to Rajan’s resolve to contain inflation is undetermined. Source: Ministry of Health, Labor, and Welfare, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 35
  36. 36. U.S. Dollar Short-Term Uncertainty Ahead U.S. Treasury Curve The Federal Reserve’s September decision to maintain the pace of its bond purchase program flattened the strength of the USD. Emerging market currencies, as well as high-yielding G-10 currencies, benefitted. USD weakness may continue in the nearterm before modestly strengthening. 5.0% Rate % 4.0% 3.0% 2.0% 1.0% 0.0% Sept 20 2013 Jan 2005 DXY USD Index Index Level 90.0 85.0 80.0 75.0 70.0 Jan 2013 Jan 2003 Jan 2008 The U.S. economy continues to grow faster than most developed countries, though recent higher interest rates and near-term political uncertainty may temporarily slow the growth pace. Manufacturing is recovering from a second quarter slowdown, while service activity is showing robust growth. Longer-term interest rates continued to trend higher through the third quarter, though a protraction of the Fed’s QE program has put a temporary lid on rates. With the possibility the Fed may not alter its current bond purchase program until the beginning of 2014, expect medium and long-term rates to remain steady. Volatility should increase near term due to ambiguous Federal Reserve policy direction and be range-bound medium term as growth re-emerges outside the U.S.. The USD may modestly move higher over the long-term on fiscal and political resolutions and normalization of interest rate policies in late 2015. Source: Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 36
  37. 37. SVB Asset Management Regulatory Regulatory
  38. 38. U.S. Debt Navigating the Grapevine Outstanding Treasury Securities and U.S. Statutory Debt Limit The U.S. debt burden has increased irrespective of who is in office. This may be due to macroeconomic conditions which have required a higher reliance on debt funding in recent years. Recent payments from Fannie and Freddie together with the sequester and other tax measures have eased pressures on the debt ceiling but the extraordinary measures are predicted to last until mid-October by the Treasury. Expect further rhetoric debates in Congress to continue but the market believes the debt ceiling will be raised eventually due to budget deficiencies. $16.0 $14.0 $12.0 Trillions Treasury has been using extraordinary measures to avoid a default since the last increase in debt ceiling to $16.7 trillion in May 2013.# $18.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 Outstanding Treasury Securities Democrat Republican US Statutory Debt Limit # As of press time Source: Bloomberg, SVB Asset Management SVB Asset Management | Quarterly Economic Report Q3 2013 38
  39. 39. U.S. Regulatory Environment When Will We Cross The Finish Line? Potential Reform Proposals by the SEC as of June 2013 As of June 2013, two additional SEC proposals have been put forward. The 90-day comment period on those proposals ended September 23, and the industry is waiting for the SEC to deliberate. Should the SEC decide to proceed with one of the proposals, the implementation period is estimated to span a timeframe of one to two years from the announcement. Option One Mark-to-market NAV valuation similar to other mutual funds with a NAV price rounded to the nearest 1/100th of a penny Floating NAV (Prime Institutional Funds Only) Exemption for Government and Retail Funds. Government funds defined as those holding 80 percent or more in cash, government securities or repurchase agreements collateralized by government securities. Retail funds are defined as having a $1 million limit on daily redemptions Pro: Daily pricing would reflect gains and losses fostering greater transparency Con: Causes a “first-mover advantage” If weekly liquidity drops below 15 percent of total assets, a two percent liquidity fee for redemptions could be imposed Option Two Amendments to SEC 2a-7 rule have been in place since February 2010. Key changes included more restrictive maturity limits, higher credit quality standards, the establishment of new daily and weekly liquidity requirements as well as thorough stress testing and additional disclosures. Liquidity Fees and Redemption Gates (Optional for Government Funds) If weekly liquidity drops below 15 percent of total assets, a maximum 30-day suspension of redemptions could be imposed for any 90-day period Pro: The investor keeps the stability of a stable $1.00 NAV Con: In times of stress, when cash is crucial, access to funds could be delayed or subject to a fees Potential reforms could be a combination of the above proposals by the SEC Source: SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q3 2013 39
  40. 40. European Money Markets The EU Speedbump Capital Buffer Liquidity Requirements Concentration Limits Money market funds that maintain a constant net asset value (CNAV) would require a 3 percent capital buffer to absorb potential losses and stabilize the fund during periods of high redemptions and decreasing asset values MMMFs must have at least 10 percent of their portfolio maturing within one day and 20 percent within one week to protect investors from potential runs (Similar to SEC requirements of 10 percent/ 30 percent) Issuer concentration would be kept at 5 percent limit to prevent large undue weight on any particular issuer (similar to SEC requirements) On September 4, 2013 the European Union released their own proposals to control the massive money market fund industry. Rule implementation would require acceptance by all EU member states and pass Parliament. Parliamentary elections are scheduled for next Spring, which will have an impact on, not only the outcome, but the implementation timetable. The new proposals were released in conjunction with added regulation on the so-called shadow banking sector. The rules would apply to money market funds domiciled in Europe. SVB Asset Management | Quarterly Economic Report Q3 2013 40
  41. 41. Our Team Managing Director Portfolio Managers Credit and Risk Jeff Schnitz Eric Souza Sook Kuan Loh, CFA Chief Investment Officer Paula Solanes Tim Lee, CFA Joe Morgan, CFA Renuka Kumar, CFA Kyle Balough Head of Portfolio Management Jose Sevilla Ninh Chung Head of Credit Research Melina Hadiwono, CFA Silicon Valley Bank Partners Susan Winters Dave Bhagat Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman SVB Asset Management | Quarterly Economic Report Q3 2013 41
  42. 42. SVB Asset Management This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. ©2013 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB>Find a way, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. B_SAM-13-13087 Rev. 10-11-2013 0413-0042 SVB Asset Management | Quarterly Economic Report Q3 2013 42
  43. 43. SVB Asset Management 555 Mission Street, Suite 900 San Francisco, CA 94105 555 Mission Street, Suite 900 San Francisco, CA 94105
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