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Table of Contents
Thoughts from the Desk 03
Overview 04
Special Topic: Drivers of Monetary Policy 06
Domestic Economy 16
Markets & Performance 24
Global Economy 31
Portfolio Management Strategy 36
2 SVB Asset Management | Quarterly Economic Report Q1 2015
Table of Contents
Central bankers were front and center during the quarter as policymakers continued to deal with growing deflationary trends and anemic economic growth.
Kicking off the year, the Bank of England unanimously approved keeping the overnight lending rate at 0.50 percent as inflationary readings near zero and signs of economic slowdown emerged. In a preemptive move against a full-scale quantitative easing program by the ECB, the Swiss National Bank unexpectedly removed its three-year policy of capping the 1.20 Swiss franc to the euro, which immediately caused the currency to sky rocket by 40 percent. The Bank of Japan (BOJ) and People’s Bank of China (PBOC) jumped back on the accommodative policy bandwagon by boosting liquidity in their respective regions. The BOJ retained its plan of increasing the monetary base by 80 trillion yen, while the PBOC slashed the reserve ratio by another 50 bps. As if dealing with Grexit wasn’t challenging enough, the ECB has committed to purchasing 1.1 trillion euro of sovereign debt in hope of reflating the economically troubled region.
The Federal Reserve is positioning itself for a rate liftoff in the third quarter and has set a path toward normalization of interest rates, despite the fact that “economic growth has moderated somewhat” in the second half of the quarter. By removing the term “patient” from its policy statement, the Fed could increase the overnight rate as early as June although concerns over slowing wage growth and a desire to see “further improvement in the labor market” should push the decision until at least Q3.
Policymaker posturing and broad-based cuts in forecasts for interest rates and economic growth sent U.S. interest rates lower by 30-50 bps in the first month of the quarter, although much of the pullback has been recovered due to continued improvements in private sector hiring. A combination of interest rate volatility and unseasonable increases in new bond issuances has produced positive and negative price returns in the various sectors of the bond market, but overall positive returns when incorporating coupon gains.
The first quarter is shaping up to meet our expectations of increased rate volatility and directional increase in rates. The “desk” will continue to monitor for investment opportunities and seek ways to deploy our clients’ capital in an efficient manner.
Ninh Chung, Head of Investment Strategy and Portfolio Management
Thoughts from the Desk
3 SVB Asset Management | Quarterly Economic Report Q1 2015
Thoughts from the Desk
Central bankers took the stage to combat deflationary pressures and anemic economic growth. Even the Swiss National Bank took preemptive steps ahead of a massive quantitative easing program by the ECB. (p. 7-8)
The removal of “patient” in the Federal Reserve’s policy statement does keep the door slightly open for a June rate hike although its downward forecast of interests rates and economic growth would suggest the first upward move to occur in September. (p. 9)
The Federal Reserve is positioned to begin interest rate liftoff in Q3 as improvements in labor markets and the desire to set a path towards normalization of interest rate policy emerges. (p. 10, 12)
Current economic conditions compared to the last tightening cycle in 2004 are much more favorable with the exception of an almost six-fold increase in the Fed’s balance sheet. (p. 11)
Unprecedented accommodative monetary policies have produced interest rate differentials favoring U.S. rates, thus appreciating the greenback against all major currencies. While the Fed considers this as “transitory” inflation remains well below its long-term target. (p. 13-14)
Special Topic: Drivers of Monetary Policy
Growth expectations for the year are balanced given headwinds from the stronger dollar and tailwinds from a stronger U.S. consumer. (p. 17)
Consumer performance looks to improve with higher confidence, lower energy prices, and large employment gains. (p. 18)
While there is no question the labor market has shown considerable strength, the Fed would like to see more improvement before removing policy accommodation. (p. 19-20)
The housing sector continues to report mixed results as severe weather impacted much of the country in the first quarter, while job gains provided some support. (p. 21)
Fed officials have stated they need to be “reasonably confident” that inflation will move to their 2 percent inflation objective before they raise interest rates. Currently, we are well below that. (p. 22-23)
Domestic Economy
Overview
4 SVB Asset Management | Quarterly Economic Report Q1 2015
Despite market volatility, there were positive inflows into equity and bond funds in the beginning of 2015 compared to last year. Money Market Mutual Fund assets increased in late 2014 and stabilized, as demand for high quality assets in the short end of the curve persists. (p. 25)
Short-term credit spreads have widened recently due to technical factors but continue to be near all-time lows. Spread performance will be volatile as markets await the Fed’s actions and react to global macro factors. (p. 26)
Regarding sector performance, income returns have consistently offset any negative price volatility. (p. 27)
The service sector has benefitted from solid consumer confidence, while financial services are aided by stronger balance sheets and stable performance. Healthcare credit performance should improve, while persistently low oil prices indicate the energy sector will trail. (p. 28-30)
Markets & Performance
Europe: The weakened euro from the ECB’s announced quantitative easing program should provide a boost to the economy by late 2015. (p. 32)
United Kingdom: A fear of falling prices is restraining the BOE from hiking interest rates prematurely. (p. 33)
China: The 2015 target growth rate has been lowered, while monetary and fiscal stimulus will be utilized to reach economic objectives. (p. 34)
Japan: The economy is beginning to reap benefits from a weakened yen, though inflation remains soft due, in part, to shaky consumption. (p. 35)
Global Economy
Overview
5 SVB Asset Management | Quarterly Economic Report Q1 2015
Drivers of Monetary Policy Central Bank Divergence
Sources: Federal Reserve, European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, Bloomberg and SVB Asset Management.
United States United Kingdom Euro zone China Japan
Central Bank
Federal Reserve Bank of England European Central Bank People's Bank of China Bank of Japan
Benchmark Rate 0-0.25% 0.5% 0.05% 5.35% 0.1%
Current Policy Poised to raise interest rates when prices firm. U.S. has capacity for additional non-
inflationary growth.
Awaiting inflation to firm before raising interest rates. Rising sterling is
depressing prices despite strong economy.
Negative deposit rate. Initiated bond buying program, including
negative yield bonds.
Deposit & lending rates cut by 25 basis points. Reserve ratio cut by 50
basis points.
Maintained current
Quantitative & Qualitative program, including ¥80T (US
$665.7B) monetary base growth in 2015.
Inflation
Unemployment 5.5% 5.7% 11.2% 4.1% 3.6%
Analysis Labor market slack & muted
prices will likely delay rate hike until Q3 2015.
Disinflation worries delaying rate increase.
Further quantitative
easing unlikely in the near term, with the euro
currency weaker.
Additional easing ahead to combat falling inflation.
More easing ahead to support reaching its 2%
inflation target by year-end.
1.6%
0.0% 1.0% 2.0%
1.4%
0.0% 1.0% 2.0%
1.4%
0.0% 1.0% 2.0% 3.0%
0.6%
0.0% 1.0% 2.0%
0.1%
0.00% 1.00% 2.00%
Stable Stable
Easing Easing Easing
7 SVB Asset Management | Quarterly Economic Report Q1 2015
Drivers of Monetary Policy Central Bank Maneuvers
BOE UNAMINOUSLY HOLDS RATES AS U.K.
INFLATION NEARS ZERO
FOMC MAINTAINS ACCOMDATIVE POLICY
SNB UNEXPECTEDLY REMOVES SWISS
FRANC CAP AGAINST THE EURO
ECB ANNOUNCES €1.1T QE PROGRAM
PBOC CUTS RESERVE RATIO BY 50BPS
BOJ AFFIRMS PLAN TO EXPAND MONETARY
BASE BY ¥80T
FOMC DROPS "PATIENT" BUT LOWERS
ECONOMIC AND RATES FORECASTS
MARKET ANTICIPATES US RATE LIFTOFF IN Q3
1/1/15 2/1/15 3/1/15 4/1/15
8 SVB Asset Management | Quarterly Economic Report Q1 2015
Drivers of Monetary Policy Fed Rate Projections
9 SVB Asset Management | Quarterly Economic Report Q1 2015
Source: Federal Reserve as of March 20, 2015. Chart references median forecasted Fed rates at the end of each period.
0.625% 1.875% 3.125% 3.750%
Drivers of Monetary Policy Yellen’s Dashboard
10 SVB Asset Management | Quarterly Economic Report Q1 2015
The Federal Reserve has a dual mandate: to promote “maximum employment” and to keep prices stable. Below are the factors the Fed is considering to determine the best time to exit accommodative monetary policy.
Pre-recession Level (2004-2007 Average)
Worst Level Since 2008 Current Level
Layoffs/Discharges Rate 1.4% 2.0% 1.2%
Job Openings Rate 3.0% 1.6% 3.4%
Nonfarm Payrolls (3-month average) 161.8K -826.0K 287.7K
Unemployment Rate 5.0% 10.0% 5.5%
Hires Rate 3.8% 2.8% 3.5%
Quits Rate 2.1% 1.3% 2.0%
U-6 Underemployment Rate 8.8% 17.2% 11.0%
Long-term Unemployed Share 19.1% 45.3% 31.1%
Labor Force Participation Rate 66.1% 62.7% 62.8%
Target Threshold Current Level
Inflation (Core PCE) 2.0% 2.5% 1.3%
Source: Bloomberg and SVB Asset Management. Data as of March 20,2015.
Drivers of Monetary Policy Now vs. Then
11 SVB Asset Management | Quarterly Economic Report Q1 2015
The last tightening cycle occurred from June 2004 – June 2006 in a “stair step” approach with 25 basis point increments. We examine how the economy looked then and compare it to how the economy is performing now.
Prior Tightening Cycle (2004) Current Level
Real GDP (Annual YoY) 3.8% 2.4%
Nonfarm Payrolls (12-month average) 127K 275K
Unemployment Rate 5.6% 5.5%
Labor Force Participation Rate 66.0% 62.8%
Average Hourly Earnings YoY 2.0% 1.6%
Inflation (Core PCE) 1.5% 1.3%
Size of Fed’s Balance Sheet $780 Billion $4.5 Trillion
Federal Reserve Money Supply M1 (YoY) 4.9% 9.9%
Source: Bloomberg and SVB Asset Management. Data as of March 20,2015.
Drivers of Monetary Policy Central Bank Projections
12 SVB Asset Management | Quarterly Economic Report Q1 2015
Source: Federal Reserve, European Central Bank, National People’s Congress of the People’s Republic of China, Bank of Japan. Federal Reserve ranges are central tendency measures that exclude the three highest and three lowest projections. Data as of March 20, 2015.
2014 2015 2016 2017 Longer Run Economic Projections, United States
Change in Real GDP 2.3 – 2.4 % 2.3 – 2.7 % 2.3 – 2.7 % 2.0 – 2.4 % 2.0 – 2.3 %
Unemployment Rate 5.8 % 5.0 – 5.2 % 4.9 – 5.1 % 4.8 – 5.1 % 5.0 – 5.2 %
PCE Inflation 1.2 – 1.3 % 0.6 – 0.8 % 1.7 – 1.9 % 1.9 – 2.0 % 2.0 %
Core PCE Inflation 1.5 – 1.6 % 1.3 – 1.4 % 1.5 – 1.9 % 1.8 – 2.0 %
Interest Rate Projections, United States
Federal Funds Target Rate (Median Projection) 0 – 0.250 % 0.625 % 1.875 % 3.125 % 3.750 %
Economic Projections, Euro Area
Change in Real GDP 0.9 % 1.5 % 1.9 % 2.1 %
CPI Inflation 0.4 % 0.0 % 1.5 % 1.8 %
Unemployment Rate 11.6 % 11.1 % 10.5 % 9.9 %
Economic Projections, China
Change in Real GDP 7.4 % 7.0 %
CPI Inflation 2.0 % 3.0 %
Unemployment Rate 4.1 % 4.5 %
Economic Projections, Japan
Change in Real GDP -0.03 % 2.1 % 1.6 %
CPI Inflation 2.7 % 1.0 % 2.2 %
Central Bank Economic Projections:
Drivers of Monetary Policy Strong Economy, Strong Dollar Gross Domestic Product
Source: Bloomberg and SVB Asset Management
-0.8 -0.5
0.2 1
1.4 2.4
2.5 2.6
2.8
-1 0 1 2 3
Japan Italy
France Netherlands
Germany US
Australia UK
Canada
% Year over Year Change; Year End 2014
Currency Performance versus U.S. Dollar
-14%
-11%
-11%
-9%
-8%
-16% -14% -12% -10% -8% -6% -4% -2% 0%
EUR
AUD
CAD
JPY
GBP
% Spot Return: 09/30/14 - 03/20/15
U.S. benefitted from swift Fed action & prompt fiscal stimulus that aided recovery
Expanding domestic activity provoking the end of extraordinary Fed policy
Leading The Pack
SVB Asset Management | Quarterly Economic Report Q1 2015
European stimulus late
Structural problems plague Japan
Oil price decline slowing Canada
Falling commodity prices harm Australia
U.K. recovery matches U.S.
Vulnerable Economies
13
Drivers of Monetary Policy Strength Prompts Restraint Currency Performance versus U.S. Dollar
Source: Bloomberg and SVB Asset Management
Currency Performance versus U.S. Dollar
Relatively high U.S. interest rates, combined with weakening currencies, attract U.S. dollar demand, keep lid on long term interest rates.
Rate hike could further increase overseas demand for U.S. dollar interest rate assets.
Stronger dollar hurting profitability of U.S. corporations with overseas operations.
Fatal Attraction
SVB Asset Management | Quarterly Economic Report Q1 2015
Devalued emerging market currencies risk capital flight, destabilizing global markets
Dollar pushing commodity prices lower
Commodity exporters hurt
Emerging Market Considerations
-33%
-24%
-12%
-12%
-11%
-6%
-35% -30% -25% -20% -15% -10% -5% 0%
Russia
Brazil
Malaysia
Turkey
Mexico
South Africa
% Spot Return: 09/30/14 - 03/20/15
-350 -300 -250 -200 -150 -100 -50 0
3M
McDonald's
Coca Cola
Du Pont
Oracle
$Millions * Latest Reported Quarter
14
Q2 2014 Q3 2014 Q4 2014 Q1 2015
Economics: U.S. economic data shows an improvement in the labor market, but the Q1 GDP print disappoints with a 2.1% contraction.
Monetary Policies: ECB announced negative rates on deposits.
Others: Treasury short covering on delayed Fed rate hike and further rate declines exacerbated by bond scarcity.
Economics: U.S. economic data showed a rebound in Q2 GDP to +4.6%. Data in the E.U. showed that growth in Germany is decelerating while Italy braced for a 3rd recession.
Monetary Policies: FOMC raised its end-of-year 2015 target level on Fed funds.
Geopolitical Events: Malaysian airline tragedy refueled tensions between Ukraine and Russia. Headlines centered around the Gaza strip, Iraq and ISIS.
Economics: U.S. data was generally all positive; however, IMF cut world growth estimates. Additionally, there was an affirmation of a Euro-area slowdown.
Monetary Policies: Fed QE program ended with market consensus showing a mid-2015 rate hike. The Fed will "be patient" with policy normalization.
Geopolitical Events: Headlines centered around ISIS and the Ebola outbreak.
Others: Oil prices plummet to at least a five-year low, Treasury short covering was prevalent, and Dodd-Frank rulings were set into motion to limit banks’ ability to be market-makers.
Economics: U.S. job growth continued to be robust, although muted wage growth, a strengthening dollar, and below-target inflation weighed on growth expectations.
Monetary Policies: Along with the ECB announcing its bond purchase program, central banks across the globe announced further easing measures. A Fed Funds rate liftoff is expected in September this year.
Drivers of Monetary Policy 12-Month Look Back
15 SVB Asset Management | Quarterly Economic Report Q1 2015
1 Year Treasury Bill: For majority of 2014, yields averaged 0.10%. In late 2014 and in 2015, yields touched 0.25-0.26%, and presently, we are at 0.22%. 2 Year Treasury Note: The volatility that we saw in Q4 2014 continued into the first quarter of 2015 and was driven by expectations for a mid-year rate hike combined with growth concerns abroad. The overall trend has been a gradual rise in interest rates with the current rate at 0.58%.
Source: Bloomberg and SVB Asset Management. Data as of March 20, 2015.
0.0
0.2
0.4
0.6
Perc
enta
ge
2 Year Treasury Yield 1 Year Treasury Yield
-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
10.0%
GDP Weathering the Storm GDP
GDP and Components GDP Growth Trailing 4-Quarter Average
With the second estimate of fourth quarter GDP rising at a +2.2 percent annualized rate, growth for the year of 2014 is on track for +2.4 percent.
Consumer spending was a strong component in the latest reading, rising the most in four years while a slowdown in exports attributed to the strengthening dollar weighed on growth.
Looking ahead to 2015, growth expectations are balanced given tailwinds from lower energy prices, an improving labor market and headwinds from the stronger dollar and slow wage growth.
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, on an annualized basis.
-3.0% -1.0% 1.0% 3.0% 5.0%
Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP
-10.0%
-5.0%
0.0%
5.0%
10.0%
U.S. GDP Q-o-Q Trailing 4-Quarter Average
17 SVB Asset Management | Quarterly Economic Report Q1 2015
Consumption Nearing Highs Consumer Sentiment – University of Michigan
Retail & Food Services Sales Personal Consumption – % Change
We continued to see consumer sentiment, as shown by the University of Michigan index, near cyclical highs in the first quarter. The average reading for the first quarter of 2015 is 94.9 vs. 89.8 for the fourth quarter of 2014. Retail sales showed a different story as the metric experienced three consecutive declines in the first quarter. The weather effect was to blame once again as much of the country experienced a record cold winter. Overall, consumer performance looks to improve with higher confidence, lower energy prices, and large employment gains.
Source: U.S. Bureau of Economic Analysis (BEA), Census.gov, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management.
40.0 50.0 60.0 70.0 80.0 90.0
100.0 110.0 120.0
Average
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0 $300.0 $350.0 $400.0 $450.0 $500.0
Vehi
cle
Sal
es (M
illio
ns)
Ret
ail &
Foo
d S
ervi
ces
Sal
es (B
illio
ns)
Ex Autos Vehicle Sales
-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
18 SVB Asset Management | Quarterly Economic Report Q1 2015
Employment Momentum Persists Employment Landscape Full-Time vs. Part-Time
The labor market has shown incredible performance with the last three months averaging 288,000 in job creation and the unemployment rate down to 5.5 percent. For the full year 2014, the economy created over 3 million jobs.
While there is no question the labor market has shown considerable strength, the Fed would like to see more improvement before removing policy accommodation.
Two main areas for concern are the persistently low labor force participation rate and the lack of wage growth.
Discouraged Workers Not in Labor Force
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.
-15.0%
-5.0%
5.0%
15.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
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
Thou
sand
s
Thou
sand
s
Full Time Employment (LHS) Part Time for Economic Reasons (RHS)
0.0 200.0 400.0 600.0 800.0
1000.0 1200.0 1400.0
Thou
sand
s
19 SVB Asset Management | Quarterly Economic Report Q1 2015
Employment Momentum Persists U.S. Labor Force Participation Rate Hires and Quits Remain Depressed
Average Hourly Earnings YoY With the Fed dropping the 6.5 percent threshold for the unemployment rate last year, it is now looking at a broader range of statistics including the labor force participation rate, the “quits” rate and wage growth.
At 62.8 percent, the labor force participation rate is the lowest in over 30 years and has been fluctuating between 62.7 – 62.9 percent for the past six months.
Wage growth continues to be soft with average hourly earnings rising between 2.0 – 2.2 percent on a year-over-year basis in recent months.
Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management.
0.0% 1.0% 2.0% 3.0% 4.0% 5.0%
Job Hire Rate Job Quit Rate
62.0%
63.0%
64.0%
65.0%
66.0%
67.0%
68.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
20 SVB Asset Management | Quarterly Economic Report Q1 2015
U.S. Housing Market Uneven Ground Home Sales & Supply
Housing Starts Home Prices – Indexed to 100
The housing sector continues to report mixed results as severe weather impacted much of the country in the first quarter while job gains accelerated. New home sales touched a seven-year high in February, existing home sales were constrained by a lack of inventory, and housing starts slumped in February by the most since 2011 on harsh weather conditions. Home prices are still on the rise, albeit at a slower, more sustainable pace than last year. The S&P/Case-Shiller 20-City Home Price index rose 4.5 percent on a year-over-year basis.
Sources: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.
0.0
5.0
10.0
15.0
3.0
5.0
7.0
9.0
Hom
e S
uppl
y (m
onth
s)
Hom
e S
ales
(Mill
ions
)
Total Sales (new & existing) Existing Home Supply
90
140
190
240
Case Schiller 20 City FHFA Purchase Median Home Price
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
Pop
ulat
ion
(Mill
ions
)
Hou
sing
Sta
rts
(Tho
usan
ds)
Housing Starts U.S. Population
21 SVB Asset Management | Quarterly Economic Report Q1 2015
Inflation Lackluster Growth Component Distribution Core PCE – % Change from Prior Year
Consumer Price Index – % Change from Prior Year Producer Price Index – % Change from Prior Year
Source: Census.gov and SVB Asset Management.
-5.0%
0.0%
5.0%
10.0%
15.0%
% c
hang
e fro
m p
rior y
ear
CPI Ex Food & Energy CPI
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
% c
hang
e fro
m p
rior y
ear
Core PCE Fed Target Monetary Policy Threshold
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
% c
hang
e fro
m p
rior y
ear
PPI Ex Food & Energy PPI
42.2%
15.3%
15.3%
7.7%
7.1%
5.8%
2.6% 3.4% Housing
Transportation
Food & Bev.
Medical Care
Educ. & Comm.
Recreation
Apparel less footwear
Other
CPI Components 12-month ChangeFood & Bev. 3.1%Housing 2.3%Apparel less Footw ea -2.4%Transportation -10.6%Medical Care 2.6%Recreation 0.0%Educ. & Comm. 0.4%Other 1.8%Headline CPI -0.1%Less:
Energy -19.6%Food 3.2%
Core CPI 1.6%
22 SVB Asset Management | Quarterly Economic Report Q1 2015
Inflation Lackluster Growth Wage Growth – Average Hourly Earnings NYMEX Crude Oil Generic Futures Contract
Univ. of Michigan Survey of Inflation Expectations Core PCE on a year-over-year basis remains below the Fed’s target of 2 percent and is currently at 1.3 percent.
Both core CPI and PPI have been very muted in recent months with both measures below 2 percent on a year-over-year basis.
Fed officials have stated they are monitoring this closely and need to be “reasonably confident” that prices will move to their 2 percent inflation objective before they raise interest rates.
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.
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Ann
ual p
erce
ntag
e ch
ange
$0.0 $20.0 $40.0 $60.0 $80.0
$100.0 $120.0 $140.0 $160.0
Pric
e pe
r bar
rel
1.5%
2.5%
3.5%
4.5%
5.5%
1 Year Ahead 5-10 Year Ahead 1 Year Ahead 5-10 Years Ahead
23 SVB Asset Management | Quarterly Economic Report Q1 2015
Fund Flows Positive Trends
Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management.
Equity Flows & Stock Performance
Net New Fund Flows Money Market Fund Flows
Both equity and bond funds have benefitted from positive fund flows in beginning of the year after some volatility in 2014.
Stock returns have fluctuated within a band for the past two years. Much of the movements in 2015 will depend on future interest rates, the health of the global economy, any geopolitical risks and volatility in energy prices.
Money market fund assets have picked up and stabilized as investors shift towards safer assets given the uncertainty about the future of the global economy.
$2.4
$2.5
$2.5
$2.6
$2.6
$2.7
$2.7
Trill
ions
MMF AUM
-$70.0
-$50.0
-$30.0
-$10.0
$10.0
$30.0
Bill
ions
Total Equity Total Bond
25 SVB Asset Management | Quarterly Economic Report Q1 2015
Bond Sector Spreads Near Term Volatility
Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management.
Spread Performance by Asset Class
Dovish comments from the March FOMC meeting sparked a rally in U.S. equity and Treasury markets. Meanwhile short-term credit spreads widened as new issue markets hit record highs in bond issuance.
Over the past year, credit spread performance has been mixed and is expected to be volatile in the near term as markets anticipate the Fed’s decision on interest rates and react to global macro factors: global economic slowdown, strengthening dollar and low inflation.
0
200
400
600
800
2008 2009 2010 2011 2012 2013 2014 2015
Spre
ad (b
ps)
0
10
20
30
40
50
60
70
80
90
Mar-14 Jun-14 Sep-14 Dec-14 Mar-15
Spre
ad (b
ps)
Inv. Grade Corporates U.S. Agency MBS ABS
26 SVB Asset Management | Quarterly Economic Report Q1 2015
Market Returns Income Returns Dominate
Source: Bloomberg, BoAML and SVB Asset Management.
27 SVB Asset Management | Quarterly Economic Report Q1 2015
Sector Heat Map Law of Diminishing Returns
Source: Bloomberg, BoAML and SVB Asset Management.
28 SVB Asset Management | Quarterly Economic Report Q1 2015
Performance YTD Returns and Credit Outlook
Best Performing Sector YTD based on Total Return Weakest Performing Sector YTD based on Total Return Financial Services Services With the regulatory headlights on its rival banking sector, the financial
services sector was the best performing sector of 1Q2015. The anticipation of higher interest rates, which would boost income,
combined with relatively less regulatory scrutiny, will allow financial services to strengthen their market positions and take advantage of opportunities when they arise. Creditwise, the financial services sector has recovered from the
2007-2008 uncertainties with a stronger balance sheet and stabilizing performance.
Positive consumer sentiment will continue to benefit travel services, including air transport, rental cars and hotels. Solid housing market and household formations are helping related
industries, including home improvement retail stores and home services (cable/internet, waste services, maintenance). Credit performance has reached a crescendo and is expected to remain
stable, with a downward skew related to the potential for companies to reach too far to propel growth.
Source: Bloomberg, BoAML and SVB Asset Management.
-0.25%
0.00%
0.25%
0.50%
0.75%
1.00%
Financial Services
Price Return % YTD Income Return % YTD Total Return % YTD Excess Return % YTD
-0.5%
-0.3%
0.0%
0.3%
0.5%
0.8%
1.0%
Services
Price Return % YTD Income Return % YTD Total Return % YTD Excess Return % YTD
29 SVB Asset Management | Quarterly Economic Report Q1 2015
Performance YTD Returns vs. Credit Outlook
Source: Bloomberg, BoAML and SVB Asset Management.
30 SVB Asset Management | Quarterly Economic Report Q1 2015
Europe Revving Up Euro zone Export to Non Euro zone Countries
Source: Eurostat, European Central Bank, European Commission, Bloomberg and SVB Asset Management.
Euro Area Current Account Euro zone Consumer Confidence
In March, the European Central Bank (ECB) initiated a quantitative easing program of purchasing €60 billion per month of government bonds. The pace of purchases is planned to run through at least September 2016. The ECB’s actions have significantly weakened the euro, which will provide a growth boost from exports. Sustainable growth is dependent on revitalizing domestic consumption, which may occur in the latter half of 2015. Meanwhile, the euro is susceptible to gains due to an unrelenting current account surplus.
-10
0
10
20
30
40
€ B
illio
ns
-35 -30 -25 -20 -15 -10 -5 0
> In
crea
se C
onfid
ence
100 110 120 130 140 150 160 170
€ B
illio
n
32 SVB Asset Management | Quarterly Economic Report Q1 2015
United Kingdom Solid Growth, Soft Prices Unemployment Rate – United Kingdom
Source: UK Office for National Statistics, Markit, Bloomberg and SVB Asset Management.
Consumer Price Index – United Kingdom Euro/Sterling Exchange Rate
Employment conditions remain solid, pointing to higher wages and consumer demand over the medium term. A strengthening British sterling and lower oil prices helped steer inflation to zero for the first time since 1989. The exchange rate’s impact on inflation contributed to the Bank of England’s decision to refrain from raising interest rates. National elections on May 7 present potential political risk, as current Prime Minister David Cameron is indicating support for a European Union referendum if the Conservatives prevail.
0.0 1.0 2.0 3.0 4.0 5.0 6.0
% C
hang
e Ye
ar o
ver Y
ear
0.7 0.7 0.7 0.8 0.8 0.8 0.8 0.8 0.9
Eur
o/B
ritis
h P
ound
5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5
% U
nem
ploy
men
t Rat
e
33 SVB Asset Management | Quarterly Economic Report Q1 2015
China Prevention Measures China Real Estate Climate
Source: National Bureau of Statistics of China, Bloomberg and SVB Asset Management.
China Producer Price Index China Manufacturing PMI
Premier Li Keqiang announced a 7 percent growth target for 2015, along with a goal to set consumer inflation around 3 percent. The government sounded caution on the health of the property market and falling inflation. China plans more fiscal stimulus. The People’s Bank of China (PBOC) cut interest rates by 25 basis points in March 2015, and reduced the reserve ratio requirement by 50 basis points in February 2015. We expect more easing this year to prevent pricing and growth shortfalls.
92 94 96 98
100 102 104 106 108
> P
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ve S
entim
ent
48
49
50
51
52
>50
= G
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th
-10
-5
0
5
% C
hang
e, Y
ear o
ver Y
ear
34 SVB Asset Management | Quarterly Economic Report Q1 2015
Japan Nervously Monitoring Japan Gross Domestic Product
Source: Bank of Japan, Ministry of Finance Japan, Bloomberg and SVB Asset Management.
Japan Merchandise Trade Export Volume
Japan Industrial Production The Bank of Japan (BOJ) took no action at its February 2015 meeting, noting upside to industrial production exports while acknowledging weaker private consumption. The yen has held its recent decline, which is providing a boost to exporters. The BOJ expects the economy to improve moderately through 2015, though a continuation of soft domestic consumption skews growth to the downside. With lower gasoline prices not providing any large boost to consumer consumption, the BOJ may need to take further action in late 2015.
-10 -8 -6 -4 -2 0 2 4 6
% C
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-4 -3 -2 -1 0 1 2 3 4
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-15 -10 -5 0 5
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35 SVB Asset Management | Quarterly Economic Report Q1 2015
Portfolio Strategy Duration Positioning
Short duration benchmark
(3, 6, 9 month)
Intermediate duration
benchmark (1 yr)
Long duration benchmark
(2+ yrs)
Duration Targets
Sector Overweights
Financial corporate bonds, commercial paper, MMFs
Financial & industrial corporate bonds, commercial paper, credit card ABS, bullet agencies, on-the-run Treasuries
Financials & industrial corporate bonds, credit card & auto ABS, bullet & callable agencies, on-the-run Treasuries
Sector Underweights
Treasuries, agencies, industrials
Short Treasuries and short agencies
Short Treasuries and short agencies
In the first quarter of 2015 the focus continues to be on the FOMC and anticipating when they will begin to raise the Fed Funds Rate which has been anchored at 0-0.25 percent since 2008. The statements and projections made by the FOMC at the January and March meetings were perceived by market participants as an indication that initial liftoff will occur later than market participants projected, which was mid-2015. The September FOMC meeting is the current market consensus of a potential initial rate hike.
In Q1, spread products outperformed Treasuries & agencies. In short duration sectors, credit outperformed with industrials and utilities slightly outperforming financials. Auto and credit card ABS performed similarly.
Source: SVB Asset Management
-30% Neutral +30% -30% +30% Neutral +30% Neutral -30%
Portfolio Strategy Outlook
37 SVB Asset Management | Quarterly Economic Report Q1 2015
Treasuries & Agencies Corporate Bonds: Finance Sector
Corporate Bonds: Industrial Sector ABS
We continue to anticipate a gradual rise of rates into year end.
On-the-run 2-year and 3-year Treasuries offer great total return range trades.
Bullet & Callable agencies offer attractive yield pick-up over comparable Treasuries.
We prefer 2-year Callable Agencies that are trading at a slight discount dollar price.
End of first quarter 2015 approximate yields:
2-yr Treasury: ~0.57% 2-yr Bullet Agency: ~0.65% 2-yr Callable Agency: ~0.75%
Banks and brokers offer the best value as the industry is incentivized to build capital to meet regulatory requirements. Additionally, earnings continue to be strong.
Over $145 billion in corporate bonds were issued in Q1 2015, of which approximately 30 percent were from the finance sector.
Due to their attractive spread/yields and larger supply inventory base compared to industrials, we favor overweighting financials.
End of first quarter 2015 spreads/yields: 2-yr A/A2 Finance: ~+50 / ~1.08 % 2-yr A-/A3 Finance: ~+80 / ~1.37 %
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 first quarter 2015 spreads/yields: 2-yr A/A2 Industrials: ~+25 / ~0.87 % 2-yr A-/A3 Industrials: ~+48 / ~1.03 %
Strong fundamentals in the Auto and Credit Card ABS sectors.
Very stable spreads.
Active new issue and secondary markets.
We favor Prime Automobile and Prime Credit Card ABS with 1- to 2-year durations. We like the soft-bullet maturity structure of Credit Card ABS as it offers the ability to receive scheduled principal back similar to a corporate bond.
End of first quarter 2015 spreads/yields: 2-yr AAA/Aaa Auto & Credit Card ABS Spread: Swaps ~+20 / ~1.03%
Portfolio Strategy Sector Overview
Source: SVB Asset Management and Bloomberg Yields to date as of March 25, 2015 Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
38 SVB Asset Management | Quarterly Economic Report Q1 2015
Our Team
Portfolio Managers
Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected]
President, SVB Asset Management
Lauri Moss [email protected]
Head of Investment Strategy and Portfolio Management
Ninh Chung [email protected]
Head of Credit Research
Melina Hadiwono, CFA [email protected]
Credit and Risk
Sook Kuan Loh, CFA [email protected] Tim Lee, CFA [email protected] Kyle Balough [email protected]
Silicon Valley Bank Partners
Maria Menard Priyanka Raju Girish Mallya
39 SVB Asset Management | Quarterly Economic Report Q1 2015
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.
© 2015 Silicon Valley Bank. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, and non-bank affiliate of Silicon Valley Bank and members of SVB Financial Group.
Products offered by SVB Asset Management::
Are Not insured by the FDIC or any other federal government agency
Are Not Deposits of or guaranteed by a Bank
May lose value
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