SVB Asset Management Economic Report Q2 2014


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The SVB Asset Management Economic Report, Q2 2014, is a review of and outlook on economic and market factors that impact global markets and business health. Our most recent Q2 edition highlights Global Central Bank Monetary Policy as the special topic, as well as detailed content on the components of the domestic and global economy, investment performance, portfolio strategy and a number of other topics. In addition to the report, you may also refer to an online infographic which highlights the major concepts in the book.

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SVB Asset Management Economic Report Q2 2014

  1. 1. Quarterly Economic Report 2014 Q2
  2. 2. Table of Contents Thoughts from our CIO 03 Overview 04 Domestic Economy 06 Special Topic: Central Banks 16 Markets & Performance 20 Global Economy 27 Portfolio Management Strategy 33 2SVB Asset Management | Quarterly Economic Report Q2 2014
  3. 3. A new set of risks entered the investment framework this quarter as continued disruption in Ukraine was joined by significant tribal clashes in Iraq which led to a dissolution of the government. Talk arose of coordination between the U.S. and Iran who oddly find themselves with a similar point of view — at least for now. Geopolitical risk emanating from Ukraine is one thing, but potential disruption of the second largest oil exporter in the region should significantly affect the markets. However, aside from a modest 4 percent rise in energy prices, it hasn't, thus far. Instead, risk markets in nearly all regions continue to rise on the back of a perceived improving economy. Indeed, the beat goes on. There is plenty of evidence to support the view of growing activity in the U.S., regardless of the first quarter's horrid GDP print. Personal consumption underperformed in the first quarter, but signs of a consumer rebound are solid in the second quarter including impressive numbers for retail sales. Full-time job growth has totaled 1.4 million so far this year, nearly as much as the 1.5 million new full-time jobs gained in all of 2013. Home prices continue to rise, though at a slower, more sustainable pace, while overall inflation continues to bound along at low, uninteresting levels. Our special topic looks at central bank activity around the world which is being held responsible for high returns and low volatility in risk assets. If central bank support truly deserves this reputation, continuing pullbacks by the Federal Reserve and the Bank of England will be interesting to watch. In the equity markets, rotation from high-performing sectors such as technology into less exciting sectors such as energy and utilities were the main story. As U.S. equities continue to gain new highs, institutional investors seemed to have rebalanced their portfolios, positioning for further gains. European markets continue to enjoy sovereign yields trading at recent lows while stocks float at near post-crisis highs. The region's bank stress tests later this year will help set the stage for lending activity going forward. In Japan, initiation of an aggressive sales tax in April does not seem to have stopped the consumer. The Abenomics experiment continues forward to phase three: creating a set of structural reforms designed to raise the country's long-term potential growth rate. Looking ahead, the markets appear to be in calm waters with many volatility measures holding steady. But concerns of unintended consequences from global monetary stimulus combined with worries over Putin's end game as well as Iraq's fate, leave us skeptical. Markets will remain calm and rising as long as the beat continues. But the herd mentality that defines market turning points will arise again. In the meantime, as is always the case, a diversified approach focusing on long-term goals is the best way forward. Joe Morgan, Chief Investment Officer 3 Thoughts from our CIO ...And the Beat Goes On SVB Asset Management | Quarterly Economic Report Q2 2014
  4. 4. 4   Economic growth experienced a strong pullback in the first quarter due to harsh weather conditions; however, more recent readings point to stronger growth for the remainder of the year. (p.7)   Likewise, personal consumption is set to rebound as greater job gains are boosting confidence and spending. Rising home values and equity prices also continue to bode well for the consumer. (p.8-9)   The labor market has been a strong point in the economic recovery this year with large monthly job gains and a current unemployment rate at 6.1 percent. (p.10)   A broader look at the labor force participation rate, wage growth, and hires and quits, shows more progress is necessary. (p.11)   The housing sector has experienced a volatile year having been hit by a harsh winter. We expect to see a normalization this year as the market balances home supply, house values, and interest rates. (p.12)   While there has been some uptick in consumer prices, inflation remains well contained causing no immediate cause for concern. (p.14) Domestic Economy   Unconventional monetary policies are still in play globally but with benign inflation and excess capacity; central banks will exercise caution when removing support. (p.17)   The ECB recently announced additional stimulus to combat deflation and provide lift to otherwise fragile recovering economies. (p.17)   The Fed is in the lead in removing loose monetary policies as it announced an additional scale back of $10 billion per month of asset purchases. Despite clear rhetoric that they are not on a pre-set course, if the economy continues to improve, tapering will conclude before year-end. The pace of treasury and agency mortgage-backed securities currently total $35 billion per month after the June FOMC meeting. (p.18)   The Federal Reserve and Bank of England are expected to raise rates more rapidly than their peers, although the risk of prematurely stalling out the recovery with tighter policies could force them to keep target rates low for a ‘considerable time.’ (p.19)   Despite three rounds of QE, the BoE’s balance sheet pales in comparison to the Fed’s. The BoE is expected to shift from its forward guidance policy to macroprudential policy to slow the heated housing market. (p.19) Special Topic: Central Banks Overview SVB Asset Management | Quarterly Economic Report Q2 2014
  5. 5. 5   Money funds continue their decline in assets while equity flows level and bond flows begin to pick up the pace. (p.21)   From a total return perspective, credit investors are rewarded for the risk taken. (p. 22-24)   Income return is still the primary source of return as bond investors continue to dive into credit despite bond spreads trading at all-time lows. (p.25)   Credit will be stable for the next quarter as strong fundamentals offset near-term challenges such as consolidation, muted economic environment and shareholder-friendly activities. (p.26) Markets & Performance   Europe: The ECB is attempting to deflate the euro but battling a strong current account surplus. The GBP is priced for a rate hike after the BoE warns of intention to act early but slowly on higher rates. (p.28-29)   China: The yuan is stabilized by monetary and fiscal intervention to support growth target. A limited reserve ratio cut may be followed by a wider rate cut. (p.30)   Japan: The yen is range-bound by growth prospects after adjusting to a tax hike. Economic activity is stronger than expected but slow-flation may be re-established without additional actions. (p.31)   U.S.: The dollar is awaiting the timing of a rate hike before there is upside movement. The Fed may reconsider its plan to end balance sheet reinvestments before hiking rates, which would boost the USD. (p.32) Global Economy Overview SVB Asset Management | Quarterly Economic Report Q2 2014
  6. 6. Domestic Economy
  7. 7. GDP Speed Bump GDP 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. GDP and Components GDP Growth 4Q Average – Long-Term   As expected, harsh weather conditions earlier this year led to a pullback in economic activity during the first quarter. Q1 GDP showed a contraction of 2.9 percent, the worst reading since Q1 2009.   Markets largely shrugged off the weak reading in light of stronger economic data in Q2, indicating the pullback will likely prove temporary.   Expectations for 2014 annual GDP range from 2.0-2.5 percent.   Weakness in growth was pervasive — consumer spending, inventories, business investment, and net exports were all lower in Q1. 7SVB Asset Management | Quarterly Economic Report Q2 2014 -10.0% -5.0% 0.0% 5.0% 10.0% U.S. GDP Q-o-Q Trailing 4-Quarter Average -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% -1.0% 1.0% 3.0% 5.0% Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP
  8. 8. Consumption Poised for a Rebound Consumer Sentiment – University of Michigan Source: U.S. Bureau of Economic Analysis (BEA),, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management. Retail & Food Services Sales Personal Consumption – % Change   Personal Consumption rose 1.0 percent in Q1, the lowest in almost five years; extraordinary weather conditions and a drop in healthcare spending played a part.   We should see a rebound in the second quarter as greater job gains and higher equity prices boost confidence.   Consumer sentiment, as shown by the University of Michigan index, averaged 82.8 in the second quarter, up from 80.9 in the first quarter.   Retail sales show gradual improvement with a couple of months of impressive data this year. 8SVB Asset Management | Quarterly Economic Report Q2 2014 40.0 60.0 80.0 100.0 120.0 UniversityofMichigan Index Average $5.0 $10.0 $15.0 $20.0 $25.0 $250.0 $300.0 $350.0 $400.0 $450.0 VehicleSales(Millions) Retail&FoodServices Sales(Billions) Ex Autos Vehicle Sales -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
  9. 9. Personal Finances Steady as it Goes Personal Income Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management. Personal Savings as % of Disposable Income Household and Nonprofit Organizations Net Worth   Monthly change in personal income has been minimal. While we saw a steady increase in Q1 from +0.3 percent to +0.5 percent, readings since have been between +0.3 percent and +0.4 percent.   Savings rates as a percentage of disposable income have ranged from 4 to 5 percent in recent quarters with the latest reading at 4.8 percent. The average for the past five years has been 5.3 percent, higher than the five-year average before the financial crisis.   Household net worth continues to rise benefitting from job gains, higher home values and rising equity prices. In the first quarter, household net worth rose by almost $1.5 trillion. 9SVB Asset Management | Quarterly Economic Report Q2 2014 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% MonthlyPercentage Change $0.0 $15.0 $30.0 $45.0 $60.0 $75.0 $90.0 Billions
  10. 10. 0.0 200.0 400.0 600.0 800.0 1000.0 1200.0 1400.0 Thousands Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months. Employment Gaining Momentum Employment Landscape Full-Time Employment   Monthly job growth has averaged 214K in the first five months of the year. The economy has finally regained the number of jobs lost during the recession.   The unemployment rate has held at 6.1 percent the past two months and is down from 6.6 percent at the beginning of the year.   The labor market is certainly showing signs of improvement with both the number of employees that are part-time for economic reasons and the declining number of discouraged workers not in labor force. 10SVB Asset Management | Quarterly Economic Report Q2 2014 Discouraged Workers Not in Labor Force -15.0% -5.0% 5.0% 15.0% -1,000.0 -500.0 0.0 500.0 1,000.0 Thousands Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS) 0.0 5,000.0 10,000.0 - 50,000.0 100,000.0 150,000.0 Thousands Thousands Full Time Employment (LHS) Part Time for Economic Reasons (RHS)
  11. 11. Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management. Employment Gaining Momentum U.S. Labor Force Participation Rate Average Hourly Earnings YoY Hires and Quits Remain Depressed   With the Fed dropping the 6.5 percent threshold for the unemployment rate, it is now looking at a broader range of statistics including the labor force participation rate, the “quits” rate, and wage growth.   The labor force participation rate at 62.8 percent is the lowest in over 30 years and there has been no significant pickup in the hires and quits rates.   Wage growth has been soft; however, when adjusting for relatively low inflation, purchasing power appears better off.   Looking at these metrics in total, there is still improvement that must be made in the labor market. 11SVB Asset Management | Quarterly Economic Report Q2 2014 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% Job Hire Rate Job Quit Rate 61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%
  12. 12. Source: National Association of Home Builders (NAHB),, S&P, and SVB Asset Management. U.S. Housing Market Regaining Ground Home Sales & Supply Housing Starts Home Prices – Indexed to 100   Home sales, both new and existing, have been incredibly volatile this year with declines in the first quarter and coming in stronger than expected in the second quarter.   Purchases of new homes rose in May by the most in over 20 years as the industry rebounds from the harsh winter.   Home prices continue to rise in double-digits as shown by the S&P/ Case-Shiller index; however, the increase is at a slow pace as home affordability is a limiting factor. 12SVB Asset Management | Quarterly Economic Report Q2 2014 0.0 5.0 10.0 15.0 3.0 5.0 7.0 9.0 HomeSupply(months) HomeSales(Millions) Total Sales (new & existing) Existing Home Supply 0.0 100.0 200.0 300.0 400.0 0.0 500.0 1,000.0 1,500.0 2,000.0 2,500.0 Population(Millions) HousingStarts (Thousands) Housing Starts U.S. Population 90 140 190 240 Case-Shiller 20-City FHFA Purchase Median Home Price
  13. 13. Source:, National Association of Realtors and SVB Asset Management. U.S. Housing Market Regaining Ground Homeownership Rate Housing Affordability Composite Index Home Ownership and Foreclosures 13SVB Asset Management | Quarterly Economic Report Q2 2014 0.0% 5.0% 10.0% 15.0% 0.0 50.0 100.0 150.0 200.0 250.0 AffordabilityIndex Housing Affordability 30 Year Fixed Mortgage Rates 62.0% 64.0% 66.0% 68.0% 70.0% 0.0% 2.0% 4.0% 6.0% 60.0% 65.0% 70.0% Homeownership Quarterly Rate Foreclosures as a % of Total Loans   An uptick in housing supply and stabilizing price gains, combined with a continued low rate environment and greater job gains, has been a positive for housing affordability and demand.   Home ownership continues to fall, dropping 0.4 percent in the first quarter to 64.8 percent.   Correspondingly, home foreclosures continue their decline and are currently at 2.7 percent of total loans vs. 4.6 percent at its peak in 2010.   Factoring out the weakness in Q1, most signs point to a strengthening housing sector in 2014.
  14. 14. Source:, National Association of Realtors and SVB Asset Management. Inflation Still Contained Component Distribution Core PCE – % Change from Prior Year Consumer Price Index – % Change from Prior Year Producer Price Index 14SVB Asset Management | Quarterly Economic Report Q2 2014 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% %changefromprioryear Core PCE Fed Target Monetary Policy Threshold -5.0% 0.0% 5.0% 10.0% 15.0% %changefromprioryear CPI Ex Food & Energy CPI -10.0% -5.0% 0.0% 5.0% 10.0% 15.0% %changefromprioryear PPI Ex Food & Energy PPI CPI Components 12-month Change Food & Bev. 2.4% Housing 2.6% Apparel less Footw ea 1.2% Transportation 1.8% Medical Care 2.8% Recreation 0.4% Educ. & Comm. 1.5% Other 1.8% Headline CPI 2.1% Less: Energy 3.3% Food 2.5% Core CPI 2.0% 41.2% 16.8% 14.9% 7.5% 7.0% 5.8% 2.8% 3.3% Housing Transportation Food & Bev. Medical Care Educ. & Comm. Recreation Apparel less footwear Other
  15. 15. 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. Inflation Still Contained Wage Growth – Average Hourly Earnings Crude Oil Univ. of Michigan Survey of Inflation Expectations   Core PCE remains below the Fed’s target of 2 percent and is currently at 1.5 percent.   CPI ticked up in April and May of this year. CPI in May experienced the largest increase in consumer prices in over a year at 2.1 percent.   The Fed reiterates that longer-term inflation expectations remain stable and they will continue to monitor inflation developments carefully in search of evidence that inflation will move towards its target. 15SVB Asset Management | Quarterly Economic Report Q2 2014 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% Annualpercentagechange 1.5% 2.5% 3.5% 4.5% 5.5% 1 Year Ahead 5-10 Year Ahead $0.0 $30.0 $60.0 $90.0 $120.0 $150.0 Priceperbarrel
  16. 16. Special Topic: Central Banks
  17. 17. SVB Asset Management | Quarterly Economic Report Q2 2014 Central Bank Current Policies 17 US Scaling back accommodative policies Will announce or implement new stimulus tools No policy change Further Rate cuts CA UK EU CHN BR JP AU
  18. 18. Source: National Association of Home Builders (NAHB),, S&P, and SVB Asset Management. Federal Reserve Tapering Almost Complete Are Record Low Mortgage Rates Helping? Will the Wealth Effect be Sustainable? Low Participation Rate Impacts the Unemployment Rate   Mortgage rates are at very low levels; however, they have been climbing the last year. Mortgages outstanding have been fairly steady.   The stock market continues to soar to new highs driven by continued loose monetary policy.   As the Fed moves towards ending the stimulus, the markets will pull back; however, high demand for fixed income is likely to keep levels from rising too quickly.   The unemployment rate has dropped, but largely due to a decrease in the participation rate. The participation rate peaked in 2000 and has yet to find a new normal. 18 Thousands SVB Asset Management | Quarterly Economic Report Q2 2014 -3.0% 2.0% 7.0% $9.0 $9.5 $10.0 $10.5 $11.0 $11.5 Billions Mortgage Outstanding (LHS) 10 YR Treasury (RHS) U.S. Home Mortgage 30 Year Fixed National Average (RHS) 600 800 1,000 1,200 1,400 1,600 1,800 2,000 $150 $170 $190 $210 $230 $250 Home Prices (LHS) S&P 500 (RHS) 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 62% 63% 64% 65% 66% 67% 68% Labor Force Participation Rate (LHS) Unemployment Rate (RHS)
  19. 19. SVB Asset Management | Quarterly Economic Report Q2 2014 Balance Sheet Evolution 19 $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0 Trillions Fed Balance Sheet (USD) BoE Balance Sheet (USD)
  20. 20. Markets & Performance
  21. 21. Funds Flow Deceleration Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management. Equity Flows & Stock Performance Net New Fund Flows Money Market Fund Flows   While flows have been marginally positive in both equity and bond funds, bond funds have seen the majority of those flows within the last few months.   With stock indices reaching records, valuation apprehension reduced equity fund flows in favor of bond funds.   Money market fund flows have continued their decline as short end rates remain low and inch closer to zero percent. 21SVB Asset Management | Quarterly Economic Report Q2 2014 -$80.0 -$40.0 $0.0 $40.0 Billions Total Equity Total Bond -20.0% -10.0% 0.0% 10.0% 20.0% -40.0 -20.0 0.0 20.0 40.0 Billions Net New Cash Flow (LHS) Total Return on Equities (RHS) $2.4 $2.5 $2.6 $2.7 Trillions MMF AUM
  22. 22. Ticker Q2 2014 2013 2012 2011 2010 2009 2008 2007 Short Benchmarks 3-month Treasury Bill G0O1 0.005 0.073 0.111 0.103 0.126 0.207 2.057 5.004 3-month Citi/Salomon CD SBMMCD3 0.017 0.204 0.307 0.289 0.310 0.822 3.442 5.448 6-month Treasury Bill G0O2 0.019 0.180 0.171 0.268 0.365 0.579 3.582 5.607 6-month Cit/Salomon CD SBMMCD6 0.022 0.272 0.488 0.389 0.437 1.611 3.756 5.459 1-yr Treasury Bill G0O3 0.053 0.277 0.204 0.496 0.792 0.813 4.746 5.948 Treasury 1-3 yr Treasury G1O2 0.316 0.358 0.434 1.554 2.348 0.785 6.609 7.317 3-5 yr Treasury G2O2 1.118 -0.913 1.577 6.229 5.695 -0.672 12.153 9.836 Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt B1A0 0.393 0.705 1.478 1.562 2.818 3.835 4.693 6.872 3-5 yr Corp/Govt B2A0 1.270 -0.158 3.817 5.415 6.231 6.400 4.577 7.846 Agencies 1-3 yr Agencies G1P0 0.323 .0.424 0.847 1.536 2.338 2.189 7.034 6.735 3-5 yr Agencies G2P0 1.015 -0.531 2.588 5.290 4.900 3.223 8.971 8.261 Municipals - Tax Exempt 1-3 yr Pre-refunded U1AF 0.222 0.807 0.520 1.800 0.923 3.189 5.875 4.710 3-7 yr Pre-refunded U2AF 0.811 0.952 1.539 4.951 2.087 5.345 7.992 5.390 Auto Asset Backed Securities ABS, Autos, Fixed Rate, (1.45 yrs) R0U0 0.319 0.802 2.291 1.689 3.077 14.845 -0.682 5.723 Other Indices** Dow Jones Industrial Average INDU 1.896 23.591 7.257 5.544 11.023 3.116 -33.762 6.432 S&P 500 SPX 3.803 26.390 13.405 2.110 12.783 23.454 -38.486 3.530 NASD CCMP 2.601 34.198 15.906 -1.799 16.910 43.888 -40.541 9.812 MSCI World Index MXWO 3.182 21.478 13.184 -7.615 9.262 27.283 -42.081 7.093 CRB Index (Commodities) CRY 3.361 -5.837 -3.372 -8.264 15.430 23.563 -39.450 16.679 Benchmark Performance Investment Performance Where’s the Horsepower? 22SVB Asset Management | Quarterly Economic Report Q2 2014 Source: Bloomberg, BoAML, Morgan Stanley. * Past performance is not a guarantee of future results. ** Analyzed returns
  23. 23. Bond Sector Spreads Tightening Risk Premiums 23 Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management. Spread Performance by Asset Class Liquidity conditions provided by accommodative global central banks have lowered tail risks, so it is reasonable to expect benign volatility in all asset classes. The Fed’s tapering and eventual monetary policy tightening has bond investors looking to the short end as a safe haven to hedge the risk of higher interest rates. Short-end yields continue to be anchored on the low end as bond spreads (over U.S. Treasuries) continue to trade at the bottom end of their respective ranges. SVB Asset Management | Quarterly Economic Report Q2 2014 0 50 100 150 200 250 300 350 0 10 20 30 40 50 60 1-3yr IG Corps 1-3yr Agency US MBS US ABS Volatility 49.28 9.19 34.41 45.19 High (RHS) 330.49 37.70 223.20 271.55 Low (RHS) 42.15 2.49 53.19 36.20 5yr Average 108.12 14.54 144.77 85.68 6/30/2014 46.67 5.49 63.76 41.36 Spread(BPS) Volatility(BPS) Volatility High (RHS) Low (RHS) 5yr Average 6/30/2014
  24. 24. Sector Heat Map Where the Returns Have Been 24SVB Asset Management | Quarterly Economic Report Q2 2014 Total Return % (Fixed Income Sectors) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD Telecommunications 2.16 5.11 6.50 4.17 11.45 3.48 2.44 2.49 1.00 1.02 Services 2.58 5.16 6.08 7.66 10.82 3.82 1.81 2.23 1.46 0.99 CMBS 2.06 4.71 6.20 -0.29 16.31 5.65 3.12 3.51 0.94 0.95 Real Estate 1.90 5.18 5.86 -7.12 26.55 6.47 1.36 6.24 1.73 0.86 Media 1.50 5.01 5.97 0.79 9.47 3.59 2.14 1.64 1.01 0.85 Insurance 2.04 4.09 6.83 -2.55 14.29 5.22 1.99 3.06 1.45 0.84 Banking 1.94 4.56 5.34 -2.66 13.62 4.81 0.66 6.38 1.82 0.82 Utility 1.89 4.71 6.48 3.91 8.45 4.33 2.47 2.47 1.09 0.81 MBS 2.15 4.64 6.95 5.27 5.98 5.42 3.15 1.61 0.91 0.81 Basic Industry 1.94 4.32 6.86 0.99 9.74 3.96 2.33 2.03 1.01 0.78 Energy 1.94 4.51 6.67 4.40 9.15 3.58 2.84 2.11 0.93 0.76 Capital Goods 1.87 4.37 6.77 3.89 9.53 3.84 2.29 1.80 1.00 0.76 Automotive 1.86 4.34 5.68 -3.76 18.44 4.17 2.12 2.95 1.25 0.74 Financial Services 1.97 4.74 5.75 -8.06 10.73 4.65 2.27 3.09 1.51 0.72 Consumer Non-Cyclical 1.76 4.37 6.45 3.66 8.36 3.75 2.17 1.50 0.74 0.62 Technology & Electronics 1.83 4.58 6.64 5.52 7.66 3.33 1.82 1.48 0.56 0.62 ABS 2.60 4.73 4.84 -1.22 13.78 3.35 1.49 1.88 0.78 0.57 Consumer Cyclical 1.90 4.64 7.03 5.43 6.71 3.35 2.31 1.30 0.77 0.55 Healthcare 2.18 4.63 6.59 2.98 9.85 3.52 2.54 1.66 0.93 0.54 US Agency 1.72 4.46 7.12 7.78 2.23 2.68 1.60 0.89 0.43 0.36 US Treasury 1.67 3.96 7.32 6.61 0.78 2.35 1.55 0.43 0.36 0.29 Yearly Average 1.97 4.61 6.38 1.78 10.66 4.06 2.12 2.42 1.03 0.73 Source: BoAML and SVB Asset Management. * Past performance is not a guarantee of future results.
  25. 25. Market Returns Clipping Coupons Source: Bloomberg, BoAML and SVB Asset Management. 25SVB Asset Management | Quarterly Economic Report Q2 2014 -0.45 -0.70 -0.69 -0.90 -0.10 -0.50 -0.42 -0.72 -0.09 -0.49 -0.39 -0.59 -0.01 -0.90 -0.58 -0.69 -1.10 -1.48 -1.14 -0.88 -0.31 0.74 1.06 1.23 1.45 0.66 1.12 1.04 1.44 0.83 1.25 1.16 1.36 0.81 1.72 1.40 1.52 1.95 2.34 2.09 1.87 1.33 0.29 0.36 0.54 0.55 0.57 0.62 0.62 0.72 0.74 0.76 0.76 0.78 0.81 0.81 0.82 0.84 0.85 0.86 0.95 0.99 1.02 -2.00 -1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 2.00 2.50 3.00 US Treasury US Agency Healthcare Consumer Cyclical ABS echnology & Electronics Consumer Non-Cyclical Financial Services Automotive Capital Goods Energy Basic Industry MBS Utility Banking Insurance Media Real Estate CMBS Services Telecommunications YTD Sector Returns % Total Return % YTD Income Return % YTD Price Return % YTD
  26. 26. Performance Sector Credit Outlook 26SVB Asset Management | Quarterly Economic Report Q2 2014 Agency Consumer Non- Cyclical Energy Consumer Cyclical Healthcare Automotive Media Banking   With the quasi government status and support, returns will mirror that of the Treasury market.   Despite much talk, GSE status is expected to be preserved for the time being.   Volume growth difficult in highly competitive developed market.   Emerging markets remains source of growth, but velocity has decreased recently.   Steady oil prices contributing to performance, but volume fluctuations differentiates individual names.   Shareholder friendly activities a negative to select names.   Housing related products & services benefitting from strong real estate market   Shifting consumer lifestyles challenging restaurants.   Pharmaceutical industry de- conglomerating via M&A and spin-offs, destabilizing some credit profiles.   Healthcare law changes and implementation present growth opportunities.   Recovering global demand for improving fuel economy, additional content offering to small vehicles and increasing penetration in truck segment remains constructive of positive pricing trend.   Consolidation happening within the industry.   Sporting events and summer movie season adding to performance.   Stabilizing credit from healthier balance sheet and liquidity.   Banks poised to take opportunity of rising interest rates but offset by litigation and settlement risks. Capital Goods Technology & Electronics Financial Services Insurance Utility Tele- communications Real Estate Basic Industry   Healthy sentiment in global PMIs, lower energy cost and restructuring initiatives supporting credit profile.   M&A appetite may grow with strong cash flow and net debt position.   Cloud computing companies poised to perform well as consumers adapt.   Consumer PC market is weakening as consumption goes mobile.   Consolidation almost over with more steady returns expected from new framework.   Low volatility in the market hampering activity in the short term but should change with different rate environment.   Pricing discipline and relatively benign catastrophe event support P&C credit profiles.   Receding economic headwinds, healthy capital markets and steady interest rate eases pressure on Life Insurance’s profile.   Utilities within a favorable regulatory environment should stay consistent performers.   Generation companies heavily exposed to coal plants will be hurt by the proposed Obama’s EPA carbon rule regulation.   Companies are being acquisitive and should continue to do so.   European market continues to be a challenge as smartphone penetration remains low.   Low vacancy rates for multi-family and industrial buildings, with strength in select areas for office buildings. Hospitality properties stable.   Retail properties remain at risk due to shifting consumer lifestyles.   Uncertainty around China economic growth pose headwind in Metal and Mining.   Sluggish growth, high cash balance lead to activism for basic chemical   Improving construction support building materials and services
  27. 27. Global Economy
  28. 28. Source: MarkIt, European Central Bank, Bloomberg and SVB Asset Management. Euro Area Current Account   Euro area growth is set to continue, with increasing service activity poised to aid softness in manufacturing. Business activity in Italy, Spain, and other periphery countries inches forward while France lags.   Fiscal constraint, elevated unemployment, higher taxes, and debt reduction are some factors that inhibit domestic demand. The retail sector remains weak.   Weak domestic demand has prevented import growth and created dependence on exports for growth. This combination has led to a growing current account surplus, which has kept the euro lofty. In turn, this has contributed to ‘low-flation’ and hurt export competitiveness.   The standoff between Russia and Ukraine is creating geopolitical noise and higher oil prices, but the economic impact will be limited. A political solution is expected.   An upset in the banking sector could be a speed bump, as the EU banking stress test may reveal additional bad loans and push banks to raise significant additional capital. Eurozone Retail PMI SVB Asset Management | Quarterly Economic Report Q2 2014 28 Europe Slow Growing 40 42 44 46 48 50 52 >50=Expansion -€ 20.0 -€ 10.0 € 0.0 € 10.0 € 20.0 Billions
  29. 29. Source: UK Office For National Statistics, Bloomberg and SVB Asset Management. Europe Euro & Pound Diverging Currency Performance   Sustained economic activity continues to push the GBP higher, while the EUR has been kept afloat by low inflation, improving financial stability, and a persistent current account surplus. Domestic consumption is largely driving economic activity in the UK, while the euro zone is more reliant on exports.   Employment improvements in the UK, as well as strong industrial and services activity, have influenced some members of the Monetary Policy Committee (MPC) to consider increasing interest rates if the recent pace of improvement sustains. The MPC reiterated its preference to avoid steep rises in rates, which compels them to begin raising rates temporarily to allow for rates to rise gradually.   The euro fell after the ECB cut rates at its June meeting and became the first major central bank in the world to implement a negative deposit rate. Though poised to pick up next year, inflation remains below target, and a lofty currency has frustrated growth efforts. A persistent current account surplus will compel the ECB to ease further in an attempt to dampen EUR strength.   The EUR skewed towards the downside due to ECB easing and a stronger U.S. economy. Conversely, the GBP risks drifting marginally higher in anticipation of a BoE rate hike late in the year. The BoE may refrain; however, if inflation remains below 2 percent due to economic slack. UK Unemployment SVB Asset Management | Quarterly Economic Report Q2 2014 29 1.25 1.30 1.35 1.40 1.45 1.50 1.55 1.60 1.65 1.70 1.75 EUR/USD GBP/USD GBP EUR 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50%
  30. 30. Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management. China Stimuli To Continue Chinese Yuan GDP – Year Over Year Change China Real Estate Climate   Chinese Premier Li Keqiang publically repeated the 2014 GDP target of 7.5 percent in June. The government has hastened infrastructure and other government budget spending.   Easing by the People’s Bank of China (PBoC) to support the GDP target will limit large upside move for the yuan. The PBoC implemented a targeted reserve ratio rate cut in June.   Modest inflation and a weak housing market provides scope for continued fiscal and monetary stimulus. Yuan is expected to remain within a 1 percent band. 30SVB Asset Management | Quarterly Economic Report Q2 2014 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% GDPChangeYoY 6.00 6.10 6.20 6.30 6.40 CNY/USD 85 90 95 100 105 110 115 120 >100=PositiveSentiment
  31. 31. Source: Bank of Japan, India Central Statistical Organisation, Bloomberg and SVB Asset Management. Asia Marginal Growth Ahead Volatility Declining India Current Account Balance Japan Tankan Business Conditions   Japan: A 3 percent sales tax increase implemented in April pushed inflation to a 32-year high while retail sales fell. The tax hike effects should wane towards year end and into 2015, with GDP to grow and remain positive after the tax hangover in Q2.   The Bank of Japan (BOJ) took no action at its June meeting, noting overseas economies are improving, the domestic economy will moderately recover, and confidence inflation will reach its 2 percent target. The Tankan survey shows Japanese industries remain upbeat, while consumer confidence is firming. Along with proposed fiscal reforms, the pressure to enact further monetary easing by the BOJ has moderately declined. Yen to be range-bound in the 100-105.   India: Growing exports and falling imports are helping India’s current account balance recover from recent record deficit levels. The Reserve Bank of India (RBI) kept the repo rate unchanged at its June meeting and emphasized inflation targets of 8 percent and 6 percent by 2015 and 2016, respectively. Moderating inflation and a decisive May election by the opposition bloc has helped stabilize the Rupee. 31SVB Asset Management | Quarterly Economic Report Q2 2014 -60 -40 -20 0 20 Net%Optimistic Responses Non-manufacturing Manufacturing -35 -30 -25 -20 -15 -10 -5 0 5 USDBillions 85 90 95 100 105 52 57 62 67 JPY/USD INR/USD INR JPY
  32. 32. *Convexity Unadjusted Source: Bloomberg and SVB Asset Management. The U.S. Dollar Interest Rate Watch Eurodollar Futures Pricing – 3-Month Libor Rate*   The Federal Reserve continued to reduce its bond purchase program at its June 2014 meeting. The pace of reduction is anticipated to be maintained throughout 2014, which will effectively end ‘QE3’ before year end.   Eurodollar futures have priced in a 25 basis point rise in rates by June 2015, with subsequent 25 basis point moves higher through 2016.   While the U.S. dollar has remained steady, it skewed to the upside as U.S. growth, within the context of moderate inflation, outpaces other developed countries, particularly the euro zone.   Look for the Fed to update its reinvestment policy, as recent comments and minutes suggest it may prefer to raise rates first before ending reinvestments, which would be supportive of the USD. DXY U.S. Dollar Index SVB Asset Management | Quarterly Economic Report Q2 2014 32 0 0.5 1 1.5 3MLiborRate% Dec-14 Jun-15 Dec-15 79 80 81 82 83 84 85
  33. 33. Portfolio Management Strategy
  34. 34. Portfolio Strategy Tying It All Back Short duration benchmark (3 & 6 month) Intermediate duration benchmark (1 yr) Long duration benchmark (2 yr+) Duration Targets Longer than benchmark Neutral to benchmark Shorter than benchmark Sector Overweights Financials, Commercial Paper, MMFs Financials, Industrials, Commercial Paper Short Maturity Financials, Long Maturity Industrials, ABS Sector Underweights Treasuries, Agencies, Industrials Treasuries & Agencies Agencies 34SVB Asset Management | Quarterly Economic Report Q2 2014 2014 Portfolio Strategy Outlook We anticipate that the FOMC will continue its tapering of Treasury and mortgage-backed securities purchases, bringing an end to the large scale asset purchases (LSAP) by the end of the year. As we head into year-end, the market views will shift focus from tapering to predicting the timing of the first federal funds rate hike. Strong credit fundamentals persist which will benefit the corporate bond market. There is strong institutional demand for corporate bonds even in a rising interest rate environment. Source: SVB Asset Management
  35. 35. Treasuries & Agencies Corporate Bonds: Finance Sector Corporate Bonds: Industrial Sector ABS   We anticipate a gradual rise of rates into year-end.   Agency spreads are still tight with spreads of + 1 to 2 basis points over comparable Treasuries, thereby not offering much incremental yield.   End of 2nd quarter 2014 Approximate Yields: 2 yr Treasury: ~0.45% 2 yr Agency: ~0.47%   Banks and brokers offer the best value as both regulators and the industry are incentivized to build capital. Additionally, earnings continue to be strong.   Active new issue market and very strong and liquid secondary market. For the first half of 2014, Finance new issues are approximately 40 percent.   In the short end, Financial companies account for approximately 35 percent of issues outstanding.   End of 2nd quarter 2014 spreads/ yields: 2 yr A/A2 Finance: ~+35 / ~0.80 % 2 yr A-/A3 Finance: ~+55 / ~1.0 %   Industrials continue to have strong balance sheets and positive earnings.   Due to lack of supply in the short end and strong balance sheets, spreads over Treasuries are tight.   We favor longer industrials for price performance stability.   End of 2nd quarter 2014 spreads/ yields: 2 yr A/A2 Industrials: ~+15 / ~0.60 % 2 yr A-/A3 Industrials: ~+30 / ~0.75 %   Strong fundamentals for the auto and credit card ABS sectors.   Very stable spreads.   Active new issue and secondary markets.   We favor prime auto ABS with durations under two years as they offer a yield pick-up over comparable AAA-rated securities and strong credit performance.   End of 2nd quarter 2014 spreads/ yields: 2 yr Auto & Credit Card ABS Spread: Swaps ~+15 / ~0.73 % 35SVB Asset Management | Quarterly Economic Report Q2 2014 Sector Overview Source: SVB Asset Management and Bloomberg Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
  36. 36. Quarterly Review Market Movers 36SVB Asset Management | Quarterly Economic Report Q2 2014 April 2014 May 2014 June 2014   At the beginning of the month expectations for better economic data caused treasuries to fall.   On April 2, the S&P 500 hit a monthly high propelled by strong factory orders and ADP data.   An expected resolution between Ukraine and Russia pushed investors out of safe havens and into riskier assets.   A weaker than expected jobs report ended speculation that the Fed would accelerate its tapering of the current stimulus program.   Fed minutes persuaded speculators to cool speculation that the central bank was planning to accelerate rate hikes.   Mid month the sell-off was initiated by a de-escalation in Ukraine and followed by some stronger than expected economic data (retail, Philly Fed, industrial production). Overall data was mixed during this period.   Treasuries ended their sell-off as tensions in Ukraine created a demand for the safe haven of U.S. Treasuries.   In the Fed meeting there were no meaningful changes and the pace of tapering stayed constant.   Fed Chair Yellen's rhetoric during this period emphasized that the economy was falling short of the Fed's goals and still needs help from the central bank. Yellen’s comments countered what she said back in March when she said that rates could rise mid next year.   At the end of the month a slowdown in the global economy caused a flight to quality.   On the 28th speculation that the U.S. economy grew at a slower pace than initially thought prompted a treasury rally   On May 30, the S&P 500 hit a record high driven by utility consumer staples.   Treasuries rallied as economists predicted that the European Central Bank would cut interest rates. On June 5th the ECB cut its deposit rate to -0.1%.   Treasuries sold off in anticipation of the FOMC announcement on June 18th.   Improvements in economic data and a jump in inflation numbers prompted investors to speculate that Yellen would propose an acceleration to the tapering plan or possibly an increase in interest rates.   The FOMC meeting and press announcement revealed that the Fed is staying on course and is not planning to accelerate the pace of tapering just yet.   Treasuries rallied slightly, but the range did shift upwards.   The S&P 500 hit new highs on June 20, thanks to additional improvements in economic data.   The S&P500 capped its longest sequence of quarterly gains since 1998. 0.30% 0.35% 0.40% 0.45% 0.50% 1780 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 April-14 May-14 June-14 S&P500 (LHS) 2 YR Treasury (RHS) S&PIndex 2-YearTreasury
  37. 37. Our Team 37 Managing Director Jeff Schnitz Chief Investment Officer Joe Morgan, CFA Head of Credit Research Melina Hadiwono, CFA Portfolio Managers Eric Souza Paula Solanes Renuka Kumar, CFA Jose Sevilla Credit and Risk Sook Kuan Loh, CFA Tim Lee, CFA Kyle Balough Silicon Valley Bank Partners Susan Winters Maria Menard Priyanka Raju Girish Mallya Sudhakar Pattabiraman Head of Portfolio Management Ninh Chung SVB Asset Management | Quarterly Economic Report Q2 2014
  38. 38. 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. ©2014 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-14-13488 Rev. 07-11-14. 38SVB Asset Management | Quarterly Economic Report Q2 2014
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