- US economic growth is expected to accelerate to over 3% in the coming years, helping boost stock prices and profits. This is unlike other forecasters who predicted too early an acceleration. - Long-term Treasury bonds are expected to underperform due to rising interest rates, making them unattractive investments. The 10-year Treasury yield is projected to reach 3-4% in the next 3 years. - While the US economy looks strong now, concerns are raised about the risks of the Federal Reserve raising interest rates too quickly by 2018, which could cause a recession. Careful monetary policy will be needed in the coming years.

1. SANDPOINTE 1
SandPointe Investment Perspective
Roger E. Brinner, PhD
Chief Market Strategist and Co-founding Partner
September 2014

2. SANDPOINTE 2
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist
The Fundamental Investment Strategy View from Our “One-Armed” Economist President Harry Truman famously asked for a one-armed economist so that he could get an unequivocal, fact-driven assessment, rather than hearing “on the one hand…., but on the other hand…” In this, SandPointe’s first Investment Perspective, you’ll get this treatment.

3. SANDPOINTE 3
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist and Bryce Quillin, Chief Economist
•
US equities will benefit from another year of profit growth and P-E ratio expansion
-
Real GDP growth in the US is shifting from 2% to 3+% real growth rates) unlike others who have prematurely predicted acceleration, I have waited until the fiscal policy corrections were digested and wealth had been rebuilt to make this call
-
Confounding pundits who have repeatedly, mistakenly projected an imminent peak in profit margins for years (just because the profit/GDP ratio was higher than “normal”), profits will rise more rapidly than GDP based on rising capacity utilization rates, price inflation still exceeding unit labor cost growth, and diminishing interest burdens
-
Even if, as we believe, the competing 10-year Treasury yield is headed toward 3.5% or more within three years, this would still easily align with a trailing PE ratio of 23-plus versus 19 currently. 23.5, for example, implies an earnings yield (the inverse of the PE) of 4 ¼% that would still exceed T-bonds, and then the equity investor also gets earnings growth and the bond investor gets nada
-
Another way of stating this is that the equity risk premium is still exceptionally, unjustifiably large and is taking its sweet time shrinking, even though the risk premia in bond markets are now at relatively low levels (e.g. the corporate Baa is 2.2% above the 10-yeaar Treasury versus 5.6% in 2008); Putin has scared the equity markets but they can rally strongly after his threats to Europe have been sized up and stabilized
•
Long-term Treasuries are “dead men walking” for the next 3 years: everyone should know the real after-tax return will likely be negative yet such bonds still sit prominently in portfolios
-
A year from now, the 10-year Treasury yield will be near 3% versus less than 2 ½% today, producing a 1 ½% total return with a capital loss of 1% offsetting the meagre coupon
-
Subtract 3% cost inflation and you’re underwater if you’re an endowment
-
Subtract 40% income taxes and 2% price inflation if you’re a consumer, so welcome to the investor scuba-diving team
-
Three years from now the federal funds rate will be at least 3% (2% inflation target plus 1-2% real return at cyclical peaks) and I judge the 10-year Treasury will be closer to 4%, thus more capital losses to offset historically abysmal coupons
-
Why would a prudent investor accept such returns when the implied bond-equivalent long-term equity return is at least 11%: the 5 ¼% current earning yield (i.e. 19 PE) plus sustainable earnings growth of 6%?

4. SANDPOINTE 4
Equity Prices Respond to Four Fundamentals
Absolute and relative performance of US and global regional equities
Earnings (Primarily Past 2 Years)
Competing Yield On “Risk-free” Sovereign Fixed Income
Perceived Risk/ Uncertainty of Earnings Due to Stage of Business Cycle
Additional Risks Due to Abrupt Changes in Regulations or Global Shocks

5. SANDPOINTE 5
Profit Growth, Plus a “Super-Rotation” from Risky Treasury Bonds to Equities, Continues to Bode Well for US Share Prices
-5051015 19811986199119962001200620112016 Bond Yield - Earning Yield 10-Year Treasury YieldS&P 500 Earnings Yield (E/P Ratio)
History Forecast
INCREASING RISK AVERSION
REVERSION TOWARD NORMAL RISK AVERSION
SPREAD WITH NORMAL RISK AVERSION
April 2013 Forecast for S&P 500 price increase to Q2 2014: +26.2% Actual gain: +25.5%

6. SANDPOINTE 6
Central Banks Dominate Short-and Long-term Interest Rate Behavior, Responding to their Legislated Mandates to Control Inflation and Growth
Short-term interest rates
Job Growth
Core and Overall Inflation
Exchange Rate
“Quantitative Easing”
The Fed, the ECB, the Banks of England and Japan, and their Global Peers All React to National Conditions, with identifiable national sensitivities and timing/patience
Additional Forces Critical to Sovereign Bond Yields
Government Deficits
Potential Election Impacts
Special Crisis Situations
Long-term treasury rates

7. SANDPOINTE 7
-6-4-202468101214161820-6-4-202468101214161820 1960Q11962Q11964Q11966Q11968Q11970Q11972Q11974Q11976Q11978Q11980Q11982Q11984Q11986Q11988Q11990Q11992Q11994Q11996Q11998Q12000Q12002Q12004Q12006Q12008Q12010Q12012Q12014Q12016Q12018Q1 Fed. Funds Rate10-Year Treasury Note YieldPolicy Indicator: Job Growth+Inflation
The Economic Indicators Watched by The Fed Are Calling for Rate Increases and Bond Markets Began Responding Last Year
Bond Yield and Fed Funds Rate vs. Policy Indicator (Sum of Inflation and Employment Growth
(1960-2018)
Extraordinarily Low Funds Rate 2009-2014

8. SANDPOINTE 8
The Fundamental Investment Strategy View from Our “One-Armed” Economists (continued)
•
In dollar terms, commodities also shouldn’t offer any momentum plays to the investor
•
With the European Central Bank dropping euro interest rates as US rates rise, the dollar strengthens: it logically and empirically gains about 8% for each additional point of the US-Euro bond spread
•
Restrictive Japanese fiscal policy and Chinese growth targets also require easy monetary policy
•
Other things equal, within 6-12 months, each percentage point rise in the dollar against a currency basket cuts dollar- denominated commodity prices for industrial metals, farm products, chemicals, and energy by 7-9%
•
Gold and precious metals will be hard pressed to hold their value in a strong dollar, rising interest rate environment
•
Looking beyond mid-2015, there are reasons for concern
•
Know these two facts of postwar economics: 1) the US has never had a recession that wasn’t preceded by significant Fed tightening; and 2) the Fed has never raised the funds rate by 3% without causing a recession (classic declining real GDP recession or moderate “growth recession” with rising unemployment due to too-tepid GDP growth)
•
The Fed has announced it will raise rates beginning next year and continue until normal rates are established
•
The normal peak would be 4 ½% in that the inflation is targeted at 2% and the average funds rate when unemployment is under 6% (cyclical peak periods) is 2.6% above inflation; I expect a slightly lower 2018 peak in the 3 ½% to 4% range
•
As a result of this moderation, and the absence of a preceding overheated boom, I expect only a growth recession with 2% real GDP growth, slightly rising unemployment, and a brief profit retreat
•
In other words, 2016-2018 will be an extended balancing act by the Fed as it seeks to temper growth without reversing it; the mid-1990s are the best example of a successful maneuver of this type by the Fed
•
Both equity and bond returns are likely to be low and volatile in this future stretch until the Fed’s degree of success is learned
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist and Bryce Quillin, Chief Economist

9. SANDPOINTE 9
Global Economic Factors Drive All Commodity Prices, and Unique Supply Forces Impact Oil Prices in Particular
All Commodities: Farm, Metals, Plastics, Energy, Chemicals
Oil Prices
Global Growth
General Inflation (GDP Deflator)
Dollar Exchange Rate
OPEC Oil Production
Non-OPEC Oil and Gas Production
Common Demand Forces Affecting All Commodity Prices
Additional Supply Forces Affecting Oil Prices
New Technology for Oil and Gas
The “noise” of severe weather, strikes, catastrophes, and other crises is dominated by these discrete fundamentals when the investor prudently steps back from daily and weekly data

10. SANDPOINTE 10
Commodity Prices Have Cycled Massively, Consistent with Historical Patterns
•
All commodities are driven by three shared fundamentals:
−
Exchange rate of dollar vs. other currencies
−
Global economic activity
−
Trends in global GDP price
−
Note that in the graph, the simple sum of these 3 factors very closely matches the behavior of the average materials price index
−
Our econometric model creates a weighted sum that matches even better
Source: Global Insight, BLS, IMF
0.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.5 1988Q11989Q11990Q11991Q11992Q11993Q11994Q11995Q11996Q11997Q11998Q11999Q12000Q12001Q12002Q12003Q12004Q12005Q12006Q12007Q12008Q12009Q12010Q12011Q12012Q12013Q12014Q12015Q1All Prices Relative to 1990 Averages Indexed to 1990=1 GDP DeflatorExchange RateAverage Materials (Farm, Metals, Chemicals) excluding OilIndustrial Capacity UtilizationSimple Sum of 3 Factors
Drivers of Wholesale Materials Prices, 1988-2013

11. SANDPOINTE 11
Commodity Prices Move in Parallel, with the Exchange Rate Acting as a Dominant Common Force
Source: Global Insight, BLS, IMF
Historic U.S. Wholesale Prices of Key Crude Commodity Groups, 2001-2015
-30-20-10010203040% -90-60-300306090120120% 2001Q12002Q12003Q12004Q12005Q12006Q12007Q12008Q12009Q12010Q12011Q12012Q12013Q12014Q12015Q1Inflation vs. Year Ago Farm ProductsChemicalsOil Prices (Right Scale) Exchange RateMetals

12. SANDPOINTE 12
Looking Beyond Mid-2015, There Are Reasons For Investor Concern Because The Economy Responds Predictably, Logically Strongly To Policy Shifts
National Output, Employment, Interest Rates, Exchange Rates
and
Differentials versus Other Nations/Regions
“Business Cycles”
with predictable sequences of strength and weakness for each asset class
Monetary Policy
Fiscal Policy
Trade and Capital Policy
Regulatory Policy
If the wise investor looks beyond the noise of weekly data releases, trustworthy signals -- patterns based on good logic and theory-- are apparent and thoroughly investable
Technology and Entrepreneurial Zeal

13. SANDPOINTE 13
Monetary Policy is Particularly Important: In the Postwar Era, Recessions Are Nearly Perfectly Paired with Preceding Federal Funds Rate Increases
Source: Global Insight, BLS, IMF
Federal Reserve Rate Increases Always Precede Every Recession
0510152005101520 1959Q11962Q11965Q11968Q11971Q11974Q11977Q11980Q11983Q11986Q11989Q11992Q11995Q11998Q12001Q12004Q12007Q12010Q12013Q12016Q1 Unemployment RateFederal Funds Rate
The only rate increase not followed by a classic recession occurred in the mid-1990s

14. SANDPOINTE 14
The Case for the Long-Awaited Acceleration of US Growth Improvement From 2013 to 2014 -2015 Reflects Clear Major Forces

The range of bad events has been greatly reduced, encouraging employment, consumer spending and investment

Global growth struggled in 2013
o
The Euro-zone was in recession due to ultraconservative and late policy changes
o
The emerging nations felt the burden of higher bond rates and slow G-7 Growth

Fiscal policy was very restrictive in 2013, an adverse force equal to 2% of US GDP then but greatly moderated to only 0.5% now

2014 and beyond will see far higher growth
o
The extremely harsh winter grossly distorted Q1 in the US, but the loss is temporary, and the official Q1 data probably overstated the weakness
o
Rising asset and property values leading to substantially improved consumer spending and business investment & acquisitions
o
US housing legitimately, sustainably rising 10%+ per year
o
Europe is on the mend: positive growth soon to be aided by monetary policy stimulus
o
Asian growth will be fuelled by consumers as well as exports

15. SANDPOINTE 15
Fear/Uncertainty Greatly Reduced, First In North America And Then In Europe
Euro Will Collapse
US Fiscal Cliff
War with Iran
2nd Great Depression
0123456789102005Q12006Q12007Q12008Q12009Q12010Q12011Q12012Q12013Q12014Q12015Q12016Q1 Euro Periphery (PIIGS) Bond minus German BondCorp. BAA Bond minus 10-Year TreasurySum of Key Spreads
History Forecast
Bond Spreads, Reflecting Fears of Truly Bad Events, Now Markedly Lower
Stronger Hiring, Consumer & Capital Spending

16. SANDPOINTE 16
US Growth Strengthens as Fiscal Restraint Is Diminished and the Harsh Winter Effect Lapses
-4-2024% 20071.82008-0.32009-2.820102.520111.620122.220132.220142.220152.920162.3 Percentage Point Contribution to Real GDP Growth Real GDPTotal Fiscal Stimulus or Restraint
Changes in Real GDP
and Fiscal Changes as % of Prior Year Real GDP

17. SANDPOINTE 17
-200-10001002002014Winter198919941999200420092014
This Was The Coldest Winter In 25 Years, And Cut The Q1 Real GDP Growth Rate By ~1.5%
1st Quarter Deviation From 1985-2013 Average Temperature (“ Heating Degree Days” with Reverse Sign)
Unusually Mild Winter
Unusually Cold Winter

18. SANDPOINTE 18
The Q1 GDP Figures Show Huge Drags on Final Demand from the Harsh Winter, Plus Strangely Weak Initial Estimates of Inventory Accumulation and Net Exports
Contributions to GDP growth, percentage point annualized rates
-4-20246-20246 12Q112Q212Q312Q413Q113Q213Q313Q414Q114Q214Q314Q415Q115Q215Q315Q4 Real GDPInventoriesNet ExportsFinal sales to domestic purchasers Discretionary Consumer Spending
Source: Commerce Department
history forecast

19. SANDPOINTE 19
70
75
80
85
90
95
100
105
110
115
120%
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
14-Apr
14-May
Consumer Spending, Inflation-Adjusted
(Percent of 2012 Average Month)
Bicycles
Garments
Health Care
Furniture/furnishings
All Durable Goods
Restaurants
Major household
appliances
New Autos
New Light Trucks
Almost All Discretionary Markets Were Hurt By The Cold Weather Last
Winter, But Rebounded To Recovery Trend In March

20. SANDPOINTE 20
-30-20-10010202005200620072008200920102011201220132014Industrialproduction, manufacturingRealGDP,GoodsSector
The Officially Estimated Q1 GDP Drop Is Likely Exaggerated The Commerce Department’s Estimate Of Goods GDP Plunged In Q1, But The Federal Reserve’s Estimate Of Manufacturing Production Did Not
Real GDP in the goods sector and industrial production in manufacturing,
annualized real rate of growth, Q/Q, percent
Source: Commerce Department, Federal Reserve

21. SANDPOINTE 21
-6-5-4-3-2-101234567% -30-25-20-15-10-505101520253035% 200220032004200520062007200820092010201120122013201420152016 Real Consumer SpendingConsumer Sentiment (right scale: 5x) Household Net Worth (right scale: 5x) Disposable Income
Income, Consumer Finances, and Psychology Drive Spending in Systematic Patterns That Held True to Form Even Through the Great Recession
Source: Parthenon analysis; Bureau of Economic Analysis
Growth in Real Consumer Spending and Key Drivers, 2002-2016
Consumer Spending
Income
Net Worth
Psychology
Improving Wealth and Sentiment Offset the 2013 Tax Burden on Consumers, Setting the Stage for Strong Growth in Coming Years
Note that consumer spending growth is quite different from income growth when wealth is moving in the opposite direction

22. SANDPOINTE 22
050100150200250300350$400K 1965Q11967Q11969Q11971Q11973Q11975Q11977Q11979Q11981Q11983Q11985Q11987Q11989Q11991Q11993Q11995Q11997Q11999Q12001Q12003Q12005Q12007Q12009Q12011Q12013Q12015Q12017Q12019Q1Inflation-AdjustedNetWorthperAdult(Thousandsof$US) RealNetWorthperAdult(2012prices) 2.2%RealGrowthTrendfrom'72-'00Peaks2.0%RealGrowthTrendfrom'74-'91Troughs
99% Of The Maximum 2007-2009 Real Wealth Destruction Has Already Been Reversed with More Growth to Come
Source: Parthenon analysis; Federal Reserve
History Forecast
The Peak-to-Trough Loss Was an Exceptional 23% (’07Q1 to ’09Q1)

23. SANDPOINTE 23
0 5101520253035404550% RecordLowPrices 197119741977198019831986198919921995199820012004200720102013ShareofTypicalHouseholdIncome ExistingHousingNewHousing
Strong Home Demand Will Help GDP Directly and by Bolstering Furniture, Appliance and Vehicle Sales Though Home Prices Are Rising, Housing Remains At Historically Attractive Levels Of Affordability
020406080100120140160180200220240$260K Q42005Q42006Q42007Q42008Q42009Q42010Q42011Q42012Q42013 MedianNewHomeSalePriceMedianExistingHomeSalePrice
Source: U.S. Census Bureau; National Association of Realtors; BEA; Federal Reserve; Parthenon Analysis
New Home and Existing Home
Sale Prices ($K), 2005–2013
New and Existing Home Prices as
Share of Typical Household Income, 1996-2013
Carrying cost assumes 80% loan-to-value mortgage, at prevailing income levels and mortgage rates

24. SANDPOINTE 24
-0.50.00.51.01.52.02.53.0 196519701975198019851990199520002005201020152020AnnualChange(Millions) NetNewDwellingsAddedHousingStarts+Manuf.HomesAdultPopulationGrowth/1.8HouseholdGrowth
U.S. Housing Remains Weak, But Demographic Demand Necessitates A Long, Major Recovery
•
Almost 300,000 units are demolished per year (0.3%) and our household growth is 1.3 million, implying annual long-term demand for 1.6 million new units constructed
Source: Parthenon Analysis; Global Insight
Excess construction versus household formation
Inadequate construction versus household formation
History Forecast

25. SANDPOINTE 25
Monetary Policy is Particularly Important: In the Postwar Era, Recessions Are Nearly Perfectly Paired with Preceding Federal Funds Rate Increases
Source: Global Insight, BLS, IMF
Federal Reserve Rate Increases Always Precede Every Recession
-505101520-505101520 1959Q11962Q11965Q11968Q11971Q11974Q11977Q11980Q11983Q11986Q11989Q11992Q11995Q11998Q12001Q12004Q12007Q12010Q12013Q12016Q1 Unemployment RateFederal Funds Rate
The only rate increase not followed by a classic recession occurred in the mid-1990s