SVB Asset Management Economic Book Q4 2013


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The SVB Asset Management Q4 2013 Economic Report provides an analysis of economic and market factors that impact global markets and business health. This edition takes a deeper dive into the future direction of the Federal Reserve, the beginning of tapering and the uncertainty of increasing fed fund rates.

Healthy economic readings in Q4 capped 2013 on a high note bolstered by improving labor conditions and strong general economic growth.
Additional highlights of the report include:
• Domestic Economy: Rise in Housing (pg 8-9) - The consumer continues to benefit from rising home values, equity prices and an improved labor market.
• Federal Reserve: The Beginning of Tapering (pg 19) - Tapering of Treasury and MBS purchases is not slamming on the breaks, but slowly removing its foot from the gas pedal.
• Markets/Performance: The Great Rotation (pg 22) – The risk of money flowing out of bonds and into equities could present itself in 2014.
• Global Economy: Europe (pg 32-33) – Sustaining low growth levels; current account surplus keeping euro firm.
• Regulatory: Debt Burden (pg 38) – The debt ceiling continues to be a concern.

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SVB Asset Management Economic Book Q4 2013

  1. 1. SVB Asset Management Q4 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 Regulation 37 SVB Asset Management | Quarterly Economic Report Q4 2013 2
  3. 3. Thoughts from our CIO Rounding the Corner In some future year when we look back on 2013, we'll realize it was the year the economy fully turned toward a growth trajectory. We can debate the causes, but there's no doubting the year brought consistency and breadth across the spectrum. Jobs, housing and consumption grew during the year and don't seem to be turning back. Of course, many challenges remain including the threat of higher interest rates, division in Washington and a lagging global economy. But the Fed and many private sector economists agree that better days lie ahead. As a result, the Fed has already begun to rein in stimulus by announcing a pull-back on monthly bond purchases that were designed to decrease long- term interest rates. Home builders are ramping up activity in the face of what is likely to be a year of rising interest rates. This is evidence they see solid demand in the new year despite higher costs for borrowers. And consumers drove activity through the third and fourth quarters, ignoring the government "shut-down" and its ancillary effects. Looking forward, the Fed will wind down "quantitative easing" in 2014, but will keep its target rate unchanged as inflation remains well below its target of two percent. A "thaw" in Washington will develop as Republicans will be much more agreeable on the debt ceiling and an Affordable Care Act overhang will keep Democrats from pushing a non-centrist agenda as well. Higher interest rates may temper growth in the housing sector, although a slowly improving jobs market and a rebound in new household formation will help potential homebuyers keep pace. Risk markets — both equities and high yield — look fully valued today. Price gains will be tempered by the true economic performance of the underlying issuers which have lagged in recent years. Previously, market price gains were driven by expectations of future corporate income and stability. In 2014, companies will have to show real economic improvement in order to drive outsized market performance. This means the "bubble" question will remain front and center for much of the year, but prices will remain stable with markets eking positive returns within the range of long-term expectations. No doubt, media and Gen-Xers will continue to be disappointed in the economy as we point to the boom years as our reference point. But continuing steady, positive growth is nothing to look down upon, and 2014 will fit the bill quite nicely. Joe Morgan, Chief Investment Officer SVB Asset Management | Quarterly Economic Report Q4 2013 3
  4. 4. Overview Domestic Economy   Economic growth is on firmer footing as evidenced by stronger gross domestic product numbers. (pg. 7) The consumer continues to benefit from rising home values, equity prices and an improved labor market. (pg. 8) The rise in household net worth has boosted spending and overall sentiment. (pg. 9) Employment has been improving, although at a slow pace. The unemployment rate dropped significantly in 2013; however, the reduction was due to multiple factors beyond simply additional jobs. (pg. 10) Inflation continues to run well below the Fed’s target measure of two percent. We believe the Fed will continue its accommodative monetary policy for a significant period. (pg. 14) Special Topic: The Fed   The Fed announced at the December FOMC meeting they will begin tapering of Treasury and MBS purchases to $75 billion from $85 billion. Notably, the Fed is not slamming the breaks, but slowly removing its foot from the gas pedal. (pg.19) Enhanced forward guidance was also announced saying the fed funds rate could remain unchanged “well past the time that the unemployment rate declines below 6.5 percent.” (pg. 20) A majority of Fed members do not see the fed funds rate being raised until 2015 and three members do not see it rising until 2016. (pg. 17) President Barack Obama officially nominated Janet Yellen to become the next chair of the Federal Reserve. (pg. 17) SVB Asset Management | Quarterly Economic Report Q4 2013 4
  5. 5. Overview Markets/Performance   The ‘Great Rotation’ did not materialize in 2013, but the risk of money flowing out of bonds and into equities could present itself in 2014. (pg. 22) Global Economy Regulatory   Europe: Sustaining low growth levels; current account surplus keeping Euro firm. (pg. 32-33)   Credit spreads have been tight and should continue to tighten with expectations of a U.S. economic recovery. (pg. 23) China: Yuan strengthened by exports, foreign direct investment; waft higher on strong current account. (pg. 34)   The Fed’s indecision on tapering in 2013 was the main driver of bond under/over performance. (pg. 24-26) Japan: BOJ stokes inflation and growth with QQE policy in short term; Yen lower on improving U.S. (pg. 35)   As rates begin to rise post-taper announcement, some companies will increase leverage to take advantage of cheaper financing. (pg. 24) U.S.: Dollar stabilizes amid tame inflation, macroeconomic strength, trimmed QE program. (pg.36)   Commodities are seeing a pop after the announcement of reduced government purchases with expectation of a decline, once again, as the dollar strengthens. (pg. 27)   Debt ceiling debate continues and is expected to heat up in late 1Q2014. More rhetoric is expected, but debt ceiling will continue to be raised. (pg. 38) Volcker Rule released in Dec 2013 but with many uncertainties and challenges. (pg. 39) Banks are trying to get ahead of regulations and are well prepared to meet the new requirements once they are implemented. There will be plenty of time to adjust to the new changes. (pg. 39) We expect further developments on the MMF reform in late Q1 2014. (pg. 40) SVB Asset Management | Quarterly Economic Report Q4 2013 5
  6. 6. SVB Asset Management Domestic Economy Domestic Economy
  7. 7. GDP Improvements On The Horizon GDP   The final Q3 GDP was revised higher to an annualized 4.1 percent from 3.6 percent. 10.0% 5.0%   The upward revision was due to an increase in the estimated growth in services such as healthcare and companies investing in software. 0.0%   Inventories contributed to a third of gains in Q3 GDP as corporate outlook for consumer demand brightened. -5.0% -10.0%   Stronger growth in the second to last quarter of the year support the Federal Reserve’s outlook that the U.S. economy is on a sustainable path. U.S. GDP Q-o-Q Trailing 4-Quarter Average GDP and Components   The fiscal drag in 2013 should dissipate in 2014. GDP Y-o-Y Growth 4Q Average – Long View 10.0% 5.0% 8.0% 3.0% 6.0% 1.0% 4.0% -1.0% 2.0% 0.0% -2.0% Government Inventories Bus Fixed Investment GDP Res Investment Net Exports 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 Q4 2013 7
  8. 8. Consumption Promising Signs Consumer Sentiment – University of Michigan   The consumer has benefited from improvements in the labor market, housing market and stock market. 120.0   Consumer sentiment hit a five- month high in December as it climbed to 82.5 ̶ a signal that Americans are likely to continue to spend in 2014. 100.0 80.0   Consumer purchases came in relatively strong, growing two percent in the third quarter. Consumers increased spending on services such as healthcare and recreation. Average 60.0 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 Q4 2013 8
  9. 9. Consumption Promising Signs 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 Billions $80.0 $60.0 $40.0 $20.0 $0.0   Personal incomes dipped into negative territory at the start of the fourth quarter due to a drop in farm revenue. This should be a temporary effect.   Savings rates as a percentage of disposable income have been hovering around 4.8 percent most of the year. Many Americans are still working to rebuild their balance sheets.   Household net worth continues to be on the rise due to higher home values and rising equity prices. The net worth of U.S. households and non-profit groups increased to $77.3 trillion, up over seven percent on a year-over-year basis. Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 9
  10. 10. Employment Superficially Better Full-Time Employment 500.0 0.0 5.0% -500.0 -1,000.0 -15.0% Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS) Long-Term Unemployment Thousands Thousands 125,000.0 25.0% 1,000.0 10,000.0 120,000.0 115,000.0 5,000.0 110,000.0 105,000.0 100,000.0 Thousands Employment Landscape 0.0 Full Time Employment (LHS) Part Time for Economic Reasons (RHS)   The unemployment rate (U-3) has dropped to seven percent. In 2013 the unemployment rate decreased by almost one percent. 50.0%   The underemployed rate (U-6) has also dropped, however, it remains relatively high compared to pre-recession figures. 40.0% 30.0%   The economy has been adding jobs at a decent pace, but the quality of jobs added has been weak with more part-time than full-time jobs being added. 20.0% 10.0% 0.0%   The number of long-term unemployed has come down since the peak, but remains elevated. 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 Q4 2013 10
  11. 11. Employment Superficially Better Fewer Workers Supporting Greater Population Participation Rate At Low 65.0% 5.0% 63.0% 66.0% 4.0% 61.0% 8.0% 68.0% 64.0% 3.0% 62.0% 2.0% 60.0% 1.0% 59.0% 3.0% 57.0% Labour Force Participation Rate (LHS) Unemployment Rate (LHS) Employment to Population Rate (RHS) Avg Hourly Earnings Growth (RHS) Hires and Quits Remain Depressed   Post financial crisis the U.S. economy continues to operate with fewer workers despite a growing population. 5.0%   The laborforce participation rate has been dropping for the last 13 years and is currently at a 35-year low. 4.0% 3.0%   Average hourly earnings have been relatively flat the last year. 2.0% 1.0%   Turnover, as measured by job hires and quits, is slowly trending upwards. Job Hire Rate Job Quit Rate Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 11
  12. 12. U.S. Housing Market Potential Slowdown Ahead 9.0 15.0 7.0 10.0 5.0 5.0 3.0 0.0 Total Sales (new & existing) Home Supply (months) Home Sales (Millions) Home Sales & Supply   Starts are most important when forecasting the industry’s effect on the overall economy. Unfortunately, housing starts remain at depressed levels.   Home prices reflect the same trend with double-digit, one-year increases, but levels remain below their prior peak.   Declining home affordability could hamper growth in 2014. Existing Home Supply Home Prices – Indexed to 100 2,500.0 350.0 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 Starts (Thousands)   Homes (single) sales have benefitted from last year’s pent-up demand and limited inventory. U.S. Population 240.0 190.0 140.0 90.0 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 Q4 2013 12
  13. 13. U.S. Housing Market Potential Slowdown Ahead 70.0% 68.0% 66.0% 64.0% Housing Affordability Composite Index Affordability Index Homeownership Rate 250.0 12.0% 200.0 10.0% 150.0 8.0% 100.0 6.0% 50.0 4.0% 0.0 2.0% 62.0% Housing Affordability 30 Year Fixed Mortgage Rates Home Foreclosures - % of Total Loans 5.0% 4.0% 3.0% 2.0% 1.0%   The drop in homeownership during the current downturn is a positive when considering what the future may bring.   Home affordability continues to be high, but a turn in interest rates ̶ and mortgage rates – have impacted this figure.   Foreclosures continue to drop and are approaching prerecession levels. 0.0% Source:, National Association of Realtors and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 13
  14. 14. Inflation Nowhere In Sight CPI Components 12-month Change Food & Bev. Housing Apparel less Footw ea Transportation Medical Care Recreation Educ. & Comm. Other 1.3% 2.1% -0.4% -2.4% 2.3% 0.4% 1.6% 1.6% Headline CPI 1.0% Energy Food -4.8% 1.3% Less: Core CPI Core PCE 3.6% 5.9% 3.4% 41.1% 6.7% Transportation 7.2% Food & Bev. Medical Care Educ. & Comm. 15.1% Recreation Apparel less footwear 17.0% 8.0% 6.0% 4.0% 2.0% 0.0% Core PCE 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% Other 1.7% Consumer Price Index % change from prior year Housing % change from prior year Component Distribution CPI 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 Q4 2013 14
  15. 15. Inflation Nowhere In Sight Crude Oil – Spot & Futures $150.0 4.5% 4.0% Price per barrel Annual percentage change Wage Growth – Average Hourly Earnings 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   Inflationary measures have come down recently, with core PCE well below the Fed’s target of two percent. 5.5% 4.5%   The Fed has acknowledged that inflation has been running below its long-term objective and this could create issues for economic performance. 3.5% 2.5%   The Fed plans to monitor inflation developments carefully in search of evidence that inflation will move towards its target. 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 Q4 2013 15
  16. 16. SVB Asset Management Special Topic: The Federal Reserve Special Topic: The Federal Reserve
  17. 17. Federal Reserve A New Fed Regime In the fourth quarter, President Obama officially nominated Janet Yellen to become the next chairman of the Federal Reserve. Ben Bernanke’s eight year tenure as FOMC Chairman will end on January 31. Current Camp Voting (2013) Voting (2014) Permanent Board Members Ben Bernanke (Chair) Dove Yes No – term ends at the end of January Janet Yellen (Vice Chair) Dove Yes New Fed Chair Daniel Tarullo Dove Yes Yes Sarah Bloom Rakin Dove Yes No – leaving the board of governors Jeremy Stein Dove Yes Yes Ms. Yellen is currently the longest serving Fed official having started out in 1977 as an economist, then served as a Fed governor from 1994-1997. Followed by a position as president of the Federal Reserve Bank of San Francisco from 2004-2010 and then becoming the Federal Reserve’s Vice Chair in 2010. Jerome Powell Dove Yes No – term ends at the end of January William Dudley Dove Yes Yes With 18 Fed policymakers, each with divergent viewpoints, arriving to a policy consensus could be difficult. James Bullard Dove Yes No Esther George Hawk Yes No 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. Bank Presidents Eric Rosengren Dove Yes No Charles Evans Dove Yes No Sandra Pianalto Dove No No – announced retirement Dennis Lockhart Dove No No Narayana Kocherlakota Dove No Yes John Williams Dove No No Charles Plosser Hawk No Yes Jeffrey Lacker Hawk No No Richard Fisher Hawk No Yes SVB Asset Management | Quarterly Economic Report Q4 2013 17
  18. 18. Federal Reserve Is Q.E. Working? Billions Are Record Low Mortgage Rates Helping? $11.5 $11.0 $10.5 $10.0 $9.5 $9.0 6.0% 4.5% 3.0% 1.5% 0.0%   Mortgage rates are still at very low levels even though they have increased from the beginning of the year.   Although U.S. homeownership fell this year to the lowest levels since 1995, the Census Bureau recently released data showing homeownership increased in Q3.   The unemployment rate 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 with an increase in job growth coming from lowpaying sectors and many of the jobs being part-time positions. Mortgage Outstanding (LHS) 10 YR Treasury (RHS) U.S. Home Mortgage 30 Year Fixed National Average (RHS) Will the Wealth Effect be Sustainable? Low Participation Rate Impacts the Unemployment Rate $250.0 Thousands   The stock market has been the biggest benefactor of quantitative easing with the S&P 500 and Dow Jones Industrial average closing at all-time highs and NASDAQ reaching levels not seen in 13 years. 2,100 $230.0 1,600 $210.0 $190.0 68.0% 12.5% 66.5% 10.0% 1,100 $150.0 Home Prices (LHS) 5.0% 63.5% 600 $170.0 7.5% 65.0% 62.0% S&P 500 (RHS) 2.5% 0.0% Labour Force Participation Rate (LHS) Unemployment Rate (RHS) Source: National Association of Home Builders (NAHB),, S&P, and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 18
  19. 19. Federal Reserve Taper Finally Announced With the improved economic data in Q4 (lower unemployment rate, stronger GDP, improved retail sales) a taper was highly anticipated to be announced at either the December or January FOMC meeting. At the December FOMC meeting, the Federal Reserve announced it will begin tapering the monthly purchases of Treasuries and Mortgage-Backed Securities (MBS) beginning in January 2014. The Fed plans to scale back purchases of both asset classes by $5 billion bringing the total monthly purchases down to $75 billion from $85 billion ($40 billion Treasuries / $35 billion MBS). Recent Balance Sheet Trends $4.0 $3.5 Other Fed Reserve Assets Central Liquidity Swaps Other Aurora $3.0 Maiden Lane III Maiden Lane II $2.5 Trillions Markets continued to be fascinated with quantitative easing in Q4. Although a tapering announcement in September did not occur, the September FOMC meeting notes revealed members viewed a tapering as a “close call.” Maiden Lane I TALF $2.0 $1.5 $1.0 AIG Seasonal Credit Secondary Credit Primary Credit Other Loans Treasury Currency Outstanding Special Drawing $0.5 Gold Stock MBS $0.0 Federal Agency Debt Securities U.S. Treasury Securities Source: Federal Reserve and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 19
  20. 20. Federal Reserve Enhanced Guidance The FOMC has a dual mandate of max employment and price stability. The two key data points they focus on for these mandates are the unemployment rate and inflation. In 2012 the Fed announced for the first time in history explicit thresholds for unemployment and inflation in setting monetary policy. At the December FOMC meeting they added some “enhanced forward guidance” to these thresholds. The Fed said the fed funds rate could remain unchanged “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee’s two percent longer-run goal.” The future of tapering will be data dependent. If the economy continues to improve, the FOMC is projected to taper monthly purchases at a measured reduction and future reductions are not on a preset course. Fed Inflation, Employment Thresholds Worry Two of the Fed Presidents 12.0% 3.0% Core PCE Threshold 2.5% 2.0% U.S. Unemployment Target 6.5% 10.0% 8.0% 6.0% 4.0% 1.0% 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 Q4 2013 20
  21. 21. SVB Asset Management Markets & Performance Markets & Performance
  22. 22. Funds Flow Filling Up The Tank Equity Flows & Stock Performance   The trend of outflow from bond funds persisted through Q3 but began to reverse in Q4.   With the recent announcement to reduce government bond purchases expect net new flows into equity funds to decline.   Money market funds dipped in assets during the regulatory comment period and are bouncing back as investors await further developments. 20.0% $20.0 Millions   Flows into equity funds were strong despite a downturn in performance driven by mixed signals from the Fed and lackluster top line revenue growth. $40.0 10.0% $0.0 0.0% -$20.0 -10.0% -$40.0 -20.0% Net New Cash Flow (LHS) Net New Fund Flows Total Return on Equities (RHS) Money Market Fund Flows $40.0 $2.7 $2.6 Trillions Billions $0.0 -$40.0 $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 Q4 2013 22
  23. 23. Bond Sector Spreads Close to the Floor Spread Performance by Asset Class Investment grade bonds generated ~200bps in excess returns, mainly as a result of credit tightening of financial issuers. In the securitization market, investors could not get enough of consumer backed bonds. Performance of ABS was as steady as they come in terms of both price and income. 250 200 150 Spread (bps) Short-term risk-free rates sold off approximately 15bps in 2013 but experienced 30bps in higher rates for a six week duration. The negative price movement reversed until the FOMC tapering announcement in December. 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 Q4 2013 23
  24. 24. Yields No Carry Without Income 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Fed Funds Target Rate 2 Year Treasury Yield 3 Year Treasury Yield BofAML 1-3 year Governm ent/Credit Index Year 1994 1999 2004 2009 2010 2011 2012 2013 Price -5.486 -2.796 -2.662 0.329 0.077 -0.849 -0.739 -1.066 6.086 6.048 3.873 3.506 2.741 2.411 2.217 1.888 0.6 3.252 1.211 3.835 2.818 1.562 1.478 0.822 Incom e Total Source: Bloomberg, BoAML , and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 24
  25. 25. Bond Market It’s All About Income Despite higher rates and fear of Fed tapering, fixed income investors were rewarded for stepping further onto the risk curve in 2013. Negative price returns as a result of higher rates were more than offset by positive income returns from coupons with MBS being the exception. Regulatory challenges and negative headlines resulted in largest credit spreads in the banking and financial sectors. Bank fundamentals in turn made substantial and continued improvements especially high investment grade issuers. Credit spreads were essentially non-existent for industrial issuers as this sector reached all-time lows in credit spreads. 2.182 -1.30 Financial Services 1.546 -1.25 Media Healthcare 0.388 -1.06 -1.271 -3.15 -3.0 1.738 1.449 1.877 -1.0 Total Return % YTD 1.856 0.529 -1.21 MBS 4.296 0.668 -1.19 US Treasury 3.164 0.682 -3.61 ABS 3.736 0.97 -2.19 US Agency 3.037 2.937 0.972 -2.76 CMBS 3.998 1.08 -1.86 Consumer Cyclical 2.798 1.116 -1.92 Basic Industry 3.041 1.203 -2.80 Consumer Non-Cyclical 3.849 1.562 -1.48 Technology & Electronics 3.621 1.582 -2.27 Capital Goods 4.313 1.714 -1.91 Energy 3.746 1.788 -2.53 Telecommunications 3.04 1.915 -1.83 Services 3.542 1.919 -1.12 Insurance 3.486 2.057 -1.49 Automotive -5.0 Source: Bloomberg, BoAML and SVB Asset Management. YTD Sector Returns % Banking 1.0 Income Return % YTD 3.0 5.0 Price Return % YTD SVB Asset Management | Quarterly Economic Report Q4 2013 25
  26. 26. Investment Performance Where’s the Horsepower? Benchmark Performance Ticker 2013 2012 2011 2010 2009 2008 2007 3-Month Treasury Bill 3-Month Citi/Salomon CD 6-Month Treasury Bill 6-Month Cit/Salomon CD 1-yr Treasury Bill G0O1 SBMMCD3 G0O2 SBMMCD6 G0O3 0.073 0.204 0.180 0.272 0.277 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 1-3 yr Treasury 3-5 yr Treasury G1O2 G2O2 0.358 -0.913 0.434 1.577 1.554 6.229 2.348 5.695 0.785 -0.672 6.609 12.153 7.317 9.836 1-3 yr Corp/Govt 3-5 yr Corp/Govt B1A0 B2A0 0.705 -0.158 1.478 3.817 1.562 5.415 2.818 6.231 3.835 6.400 4.693 4.577 6.872 7.846 1-3 yr Agencies 3-5 yr Agencies G1P0 G2P0 .0.424 -0.531 0.847 2.588 1.536 5.290 2.338 4.900 2.189 3.223 7.034 8.971 6.735 8.261 1-3 yr Pre-refunded 3-7 yr Pre-refunded U1AF U2AF 0.807 0.952 0.520 1.539 1.800 4.951 0.923 2.087 3.189 5.345 5.875 7.992 4.710 5.390 ABS, Autos, Fixed Rate, (1.45yrs) R0U0 0.802 2.291 1.689 3.077 14.845 -0.682 5.723 Dow Jones Industrial Average S&P 500 NASD MSCI World Index CRB Index (Commodities) INDU SPX CCMP MXWO CRY 23.591 26.390 34.198 21.478 -5.837 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 Short Benchmarks Treasury Corporate/Govt (A Rated and Above) Agencies Municipals - Tax Exempt Auto Asset Backed Securities Other Indices Source: Bloomberg, BoAML, Morgan Stanley. SVB Asset Management | Quarterly Economic Report Q4 2013 26
  27. 27. Commodities U.S. Politics Driving Price Crude Futures – Per Barrel $120.0 $110.0 $100.0 $90.0 $80.0   Commodities were on the decline while the future of U.S. economic recovery took a stronger footing.   Oil prices were rising due to supply concerns then dipped on easing Eastern tension only to begin a rally once again after the Fed said it would reduce stimulus.   Iron ore prices have seen a recent rise driven by stock piling in Asian countries in preparation for winter and icy logistics.   The expected strengthening of the U.S. dollar will weaken commodity investments as the economy recovers post-taper. Gold Prices – An Ounce Iron Ore Futures – Per Ton $1,800.0 $160.0 $1,600.0 $140.0 $1,400.0 $120.0 $1,200.0 $100.0 Source: Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 27
  28. 28. Loan Market Fundamentals Credit Spreads Continue to Run Below 2009 Peak   Credit spreads have fallen since the 5.6 percent peak during the financial crisis in January 2009, but remain higher than the sub- two percent levels seen pre-crisis. 6.0%   Economy is expected to be on an upswing in 2014. As companies look to grow organically or via acquisition, 2014 will see a pick-up in M&A and LBO deals, though refinancing may still dominate as long as interest rates remain low. 2.0%   Secondary loan pricing have remained steady at above par levels indicating stability in the secondary loan market. January 2009 5.6% November 2013 2.7% 4.0% 0.0% 10 YR BBB Yield - 10 YR Treasury Yield Fundamentals Remain Steady 3-Month LIBOR Remains at Historic Lows 3 Month LIBOR LPC LCDX (Secondary Loan Price Index - Par = 100) 105.0 95.0 85.0 75.0 65.0 6.0% November 2013 0.28% 4.0% 2.0% 0.0% Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q4 2013 28
  29. 29. High Yield Market Fundamentals Net Assets ($ in Billions) High Yield Funds Dip Notably in June   Senior secured high yield bond issuance fell to $3 billion in November from $4 billion in October. So far this year, $53.7 billion of senior secured bonds have been issued, 19 percent less than in the same period last year.   Bond-for-loan takeout volume ($87.4 billion) has been the biggest use of bond proceeds so far in 2013. Bond-for-loan takeout volume amounted to $6.2 billion in November. Next is bond redemptions at $53.2 billion and M&A (excluding LBO) activity at $29.8 billion. LBO volume is at $17 billion.   According to the Bank of America Merrill Lynch HY Master II Index, corporate HY bond spreads are the tightest since October 2007, before the financial crisis. During the week of December 2, HY spreads declined to just 416bp over comparable Treasuries. $300.0 $200.0 $100.0 $0.0 Loan Funds HY Bond Funds High Yield Take-Outs of Bank Debt Issuance ($ in Billions) Thanksgiving week ended at a muted pace with only $1.4 billion priced over four deals. However, a total of $11.2 billion of HY bonds priced the week of December 2, bringing YTD volume to $316.6 billion, close to 2012’s record annual issuance volume of $326.7 billion.   $400.0 $60.0 $50.0 $40.0 $30.0 $20.0 $10.0 $0.0 Source: Thomson Reuters Loan Pricing Corp., Lipper FMI and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q4 2013 29
  30. 30. Overall Loan Market Overview Historical Syndicated Loan Volumes   Issuance ($ in Billions) The Federal Reserve has indicated that it will start tapering its historic bond buying in the new year's first month. This tapering, a few months earlier than widely expected, introduced more certainty to markets that have been highly focused on pinpointing the timing and degree of the Fed's retreat from unprecedented monetary stimulus.   $2,000.0 The primary market remains highly active. Following the busiest November on record with $71.3 billion in U.S. institutional issuance, over 60 percent of the institutional calendar is comprised of refinancing and re-pricing transactions, with Cumulus Media, Chrysler Group LLC, and American Airlines coming to market to reduce pricing on over $7 billion of debt.   Given the lack of new money deals, lenders have put money to work on opportunistic re-financings, re-pricings and dividend recap deals.   The core issues in 2014 will be refinancing and re-leveraging. Refinancing activity will remain strong amid record low rates and re-leveraging related activity to finance LBOs should continue to increase. $1,500.0 $1,000.0 $500.0 $0.0 Leverage I-Grade Other DXY USD Index 90 85 80 75 70 Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group SVB Asset Management | Quarterly Economic Report Q4 2013 30
  31. 31. SVB Asset Management Global Economy GlobalEconomy
  32. 32. Europe Ending Discontinuous Growth Euro Zone Expectation of Economic Growth 5.0% 100 50 0.0% 0 -5.0% -50 -100   Discontinuous growth is transitioning to steadier growth, albeit at marginal levels. Austerity phasedown, easing credit standards, and rising confidence levels support a continued recovery. -10.0% ZEW Expectation (LHS) Eurozone GDP Change (RHS) Euro Zone Unemployment Rate 12 10 8 6 4 2 0 Economist and investor sentiment reached a seven-year high in December, portending to better GDP ahead. Current situation sentiment remains highly negative, but is improving. While consumer sentiment increased throughout 2013, a stubbornly severe unemployment situation is inhibiting a more robust recovery. Euro zone services are trending upwards. New services business orders suggest the sector will begin to contribute positively in the near future. High unemployment aided a CPI reading of 0.7 percent in October, which stimulated deflation fears and incited the ECB to an unanticipated rate 25 basis point rate cut at its November meeting. Source: Eurostat, Zentrum fuer Europaeische Wirtschaftsforschung GmbH, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 32
  33. 33. Europe Euro and Pound Remain Firm GBP/USD 1.7 1.6 1.5 1.6 1.4 1.5 1.3 1.2 1.4 GBP Euro Zone Trade Balance '+& ! ' + + ' EUR EUR / USD Currency Performance   The GBP has been buoyed by accelerating macroeconomic improvements in the second half of 2013, while low inflation, relative political stability, and a persistent trade surplus have prevented the EUR from falling.   Economic growth quickened towards the end of 2013 in the UK, with PMI manufacturing and services indices reaching highs not seen since 2011. The BOE advanced its forecast to Q3 2015 for when the unemployment rate would hit its seven percent threshold.   Despite an unexpected rate cut by the ECB and a reduction by the Federal Reserve to its QE program, the EUR remained firm as the euro zone continues to run a positive current account. Consumption recovery will be slow enough to keep imports muted.   Anticipate the GBP and EUR to remain within the trading ranges of 2013, as the recent pace of economic activity in the UK steadies, and the Eurozone balances a low inflationary, low growth environment vis-à-vis faster U.S. growth. Downside is limited, as the Fed will not raise rates until at least 2015. Source: Eurostat, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 33
  34. 34. China Steadying Growth Chinese Renminbi   The Yuan touched a 20-year high in December, propelled by record export levels and increasing foreign investment. 6.4 CNY/USD   Though growth is structurally drifting lower, the PBOC has allowed the Yuan to appreciate at a steady pace, in part to control inflation and support macro policies to expand domestic consumption.   The Yuan is poised to waft higher in 2014, though government leaders may reduce 2014’s growth target to seven percent from 2013’s 7.5 percent target.
  35. 35. #( #'+ #' #+ 6.2 6.1 6 GDP 2 Exports 6.3 '(2 '2 .2 ,2 *2 (2 2 Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 34
  36. 36. Asia Inflation Desired and Despised India Industrial Production Lacks Growth ' , / . * -
  37. 37. '' - +
  38. 38. . 2 Declining – Yen Continues, Rupee Moderates (2 '+2 '2 +2 2 +2 '2 2 Japan Nationwide Consumer Price Index Rises )2 (2 '2 2 '2 (2 )2   Japan: The Bank of Japan (BOJ) affirmed its commitment to the ‘Quantitative-Qualitative Easing’ (QQE) program at its December meeting, which is scheduled to double the BOJ’s balance sheet by the end of 2014. A slow decline in the Yen should persist, as the BOJ may add a time commitment for the program, while the FED reduces balance sheet growth.   India: The Reserve Bank of India (RBI) refrained from increasing interest rates at its December meeting, after hiking the repo rate 25 bps each time during its previous two meetings. Rupee volatility may decline in the nearterm if inflation eases, but soft economic growth will prevent any substantial appreciation. Source: Japan Ministry of Internal Affairs and Communications, India Central Statistical Organisation, Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 35
  39. 39. The U.S. Dollar Stability Ahead U.S. Treasury Curve   The Federal Reserve’s modest reduction in the pace of its bond purchase program will be supportive of the USD, as it will slow the expansion of the Fed’s balance sheet at a pace that will not hinder macroeconomic growth. *2 (2 2 ( (') (') (+ () DXY USD Index .* .( . (.   Longer term interest rates trended higher while short and medium-term rates remain anchored due to the Fed’s commitment not to raise interest rates immediately after the unemployment rate reaches 6.5 percent.   Inflation remains benign and below the Fed’s preference of two percent. A stronger housing market may buoy inflation but will be offset by softer energy prices.   The federal funds rate is expected to remain unchanged until the second half of 2015, which will prevent any substantial appreciation in the USD. -. -, -* -( Source: Bloomberg and SVB Asset Management. SVB Asset Management | Quarterly Economic Report Q4 2013 36
  40. 40. SVB Asset Management Regulatory Regulatory
  41. 41. U.S. Debt Grapevine Ahead 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. Continued payments from Fannie and Freddie together with the sequester and other tax measures have eased pressures on the debt ceiling. We expect another heated discussion about the debt ceiling in late Q1 2014 or early Q2 2014 when the Treasury exhausts its extraordinary measures. $16.0 $14.0 $12.0 Trillions After much debate in October, the debt ceiling is currently suspended until February 7, 2014. $18.0 $10.0 $8.0 $6.0 $4.0 $2.0 $0.0 Outstanding Treasury Securities Democrat Republican US Statutory Debt Limit Source: Bloomberg, SVB Asset Management SVB Asset Management | Quarterly Economic Report Q4 2013 38
  42. 42. Volcker Rule Tightening the Reins Details   Prohibits banks from engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account.   Prohibits banks from owning and sponsoring hedge funds and private equity funds.   Five Main Exemptions:   Government obligations including selected agencies, municipal securities and FDIC obligations. Foreign sovereign debt allowed under certain conditions.   Clearly identified hedging activities.   Market making activities.   Underwriting.   Foreign bank transactions that occur and are held outside of U.S. Challenges   953 pages, with much of the details yet to be determined by regulators.   Determination of “reasonably expected near-term demands of customer” for underwriting and market making related activities.   Unintended consequence of creating a “safer” banking environment.   Limit participation in private equity funds which have been spurring technological and biomedical developments.   Additional compliance and reporting requirements, leading to additional costs to the banks which would be passed on to their customers.   Final Rule is effective April 1, 2014 but banks are allowed conformance period up to July 21, 2015. Source: SVB Asset Management SVB Asset Management | Quarterly Economic Report Q4 2013 39
  43. 43. Regulatory Environment Decisions, Decisions As of June 2013, two additional SEC proposals have been put forward, requiring public comments from the industry. After a 90-day comment period and review of the comments, the SEC will vote to implement either one or a combination of the two proposals described briefly to the right. Regulatory action is subject to an implementation period estimated to span one to two years subsequent to the second vote. Source: SVB Asset Management. Potential Reform Proposals by the SEC as of June 2013 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 2 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   Expect further actions from SEC in late Q1 2014 SVB Asset Management | Quarterly Economic Report Q4 2013 40
  44. 44. European Money Markets The EU Speed bump 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 Q4 2013 41
  45. 45. 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 Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman SVB Asset Management | Quarterly Economic Report Q4 2013 42
  46. 46. 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, SVBFind 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-14-13207 Rev. 01-08-2014 SVB Asset Management | Quarterly Economic Report Q4 2013 43
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