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Cetera Research The Outlook for 2014. Cetera Financial Corporation 200 N. Sepulveda Boulevard, Suite 1200 El Segundo, CA 90245 310.782.6880. Agenda. Where do we stand?. Economic Outlook for the Year Ahead. Investing in 2014. Where do we stand?.

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slide1

Cetera ResearchThe Outlook for 2014

Cetera Financial Corporation

200 N. Sepulveda Boulevard, Suite 1200

El Segundo, CA 90245 310.782.6880

agenda
Agenda

Where do we stand?

Economic Outlook for the Year Ahead

Investing in 2014

where do we stand
Where do we stand?
  • The global economy is recovering — slowly.
    • The U.S. economy has grown for 17 of the past 18 quarters.
    • Europe is coming out of recession, and Japan is no longer threatened by deflation.
    • The slide in the emerging markets’ growth appears over.
    • But: In no region is growth back to pre-recession rates.
  • Real GDP growth, % year-over-year
the recovery not great but getting better
The recovery: Not great but getting better
  • The U.S. economy is on track to grow about 2% in 2013 — below the 2.2% the consensus expected for this year.
  • Unemployment has edged down to 7.0% in November from a peak of 10% in 2009.
  • The consensus sees a pick-up in growth to an above-trend 2.6% in 2014.
2013 the difference a year makes
2013: The difference a year makes
  • Source: BEA, BLS, JP Morgan
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Where do we stand?

Economic Outlook for the Year Ahead

Investing in 2014

we believe the markets will focus on four key issues in 2014
We believe the markets will focus on four key issues in 2014:

Let’s take a look at each one in turn.

quantitative easing has led to an massive expansion of the fed s balance sheet
Quantitative easing has led to an massive expansion of the Fed’s balance sheet
  • With QE3, which began in September 2012, the Fed stepped up its bond buying to $85 billion per month.

Net Exports

$-.41

Government $2.5

Consumption $9.5

  • Source: Federal Reserve
the qe has boosted stocks and bonds
The QE has boosted stocks and bonds
  • The S&P 500 rose 30.5% during QE1, 10.2% during QE3, and another 23.9% (so far) during QE3.
  • Bond yields have declined (until June), and credit spreads have narrowed.
  • Source: S&P, Federal Reserve
  • The credit spread is the difference in yields on Moody’s Baa bond index and 30-year U.S. Treasuries
why isn t the fed normalizing monetary policy faster
Why isn’t the Fed normalizing monetary policy faster?
  • The Fed announced on December 18 that it would pare back its bond purchases from $85 billion to $75 billion a month. Why not taper off the purchases at a faster pace?
  • Inflation is below the Fed’s 2% target, raising concerns about deflation.

What is the Fed afraid of?

how will the market react to the end of qe
How will the market react to the end of QE?
  • The Dow rose 292 points on December 18 when the Fed announced it would begin tapering. It evidently likes the Fed’s confidence in the economy’s growth prospects more than it worries about the withdrawal of liquidity.
  • Although talk of tapering raised long-term interest rates, including mortgage rates, during the summer, bond yields barely budged on the Fed’s tapering announcement.
but liquidity is not the only market driver
But liquidity is not the only market driver
  • In the medium-term stock prices track earnings.
  • Earnings and profit margins have been growing since the recession and are now at an all time high.
  • Stock prices have caught up to earnings recently, but the consensus expects earnings to grow another 11% in 2014.
  • Source: S&P
tapering is not tightening
Tapering is not tightening
  • Even as it began tapering in December 2013, the Fed will still be buying tens of billions in bonds until it likely ends the program in 2014.
  • Fed officials have said they are not inclined to raise short-term rates until the unemployment rate falls below 6.5%.

Government $2.5

Investment $1.8

Consumption $9.5

  • The Fed funds futures market does not see
  • short-term rates rising until 2015.
  • Source: Bloomberg
where are the bond market vigilantes
Where are the bond market vigilantes?
  • Bond yields barely budged when the Fed announced it would begin tapering.
  • The rise in bond yields since tapering talk began in June does not reflect concerns about higher inflation. The TIPS market is pricing in only 2.2% inflation for the next ten years.
  • The FOMC has indicated it is concerned that inflation might be too low.

Government $2.5

what to expect of the new fed chairperson
What to expect of the new Fed Chairperson
  • In Congressional testimony Janet Yellen has promised continuity and a commitment to the Fed’s full employment and inflation mandates.
  • Once QE is over, Janet Yellen is likely to move away from quantitative targets in favor of “forward guidance.”
  • Is “forward guidance” a change in policy? No: It is not binding upon the Fed, which can always change its mind if circumstances change.

It will be up to Janet Yellen to wind down

the Fed’s balance sheet

stubbornly slow growth has raised the specter of secular stagnation
Stubbornly slow growth has raised the specter of secular stagnation
  • Four and a half years after the end of the recession, growth is still below potential.
  • Is the United States — and the rest of the developed world — in for a long period of tepid growth and deflation like Japan since 1989?
  • Source: CBO and Federal Reserve
is this time different
Is this time different?
  • Yes: In most postwar recoveries idle resources — especially labor — have been back to work much faster.
  • The unemployment rate even fell faster after the 1981-82 recession though it had reached a higher level (10.8%).
is this time different1
Is this time different?
  • No: Historically, recoveries from real estate bubbles, banking crises, and heavy debt burdens have taken years in many countries.*
  • Household debt burdens in the United States rose for decades, reaching a peak of 96% of GDP on the eve of the 2007-09 recession.
  • Since then households have been de-leveraging, rebuilding wealth, and increasing their savings — and not borrowing to spend.
  • *Carmen Reinhart and Kenneth Rogoff, This Time is Different, Princeton University Press, 2011.
  • Source: Federal Reserve
sources of stimulus or not
Sources of stimulus (or not)
  • Two sources of stimulus have been AWOL in the current recovery: government spending and business investment.
  • Contrary to the perceptions of many, government spending has been declining throughout the recovery.

Major sources of “autonomous” spending

Investment $1.8

Consumption $9.5

  • Source: BEA
business investment weaker than expected
Business investment: Weaker than expected
  • Surprisingly weak spending on plant and equipment has been one of the main reasons forecasts of faster growth have proven too optimistic.
  • U.S. corporations are holding $1.6 trillion in cash and cash-like instruments — up from $1.3 trillion in 2009. This adds up to a potential upside surprise in investment.
  • Source: BEA
a recovery in housing is one of the bright spots in the outlook for growth
A recovery in housing is one of the bright spots in the outlook for growth
  • The value of home equity has just this year regained parity with the value of household mortgage debt.
  • Source: Federal Reserve: Lombard Odier, Economist.com/graphicdetail
a competitive dollar is helping boost exports
A competitive dollar is helping boost exports
  • The U.S. dollar is down in real and nominal terms since 2000, though trendless since the end of the recession in mid-2009.
  • The low dollar will help keep exports up in the face of weak demand from abroad, especially Europe (the destination of 20% of U.S. exports).

The U.S. Dollar and Exports

  • Source: Federal Reserve, BEA
a year ago a widespread concern was that political paralysis would hurt stock market performance
A year ago a widespread concern was that political paralysis would hurt stock market performance
  • It was widely feared that 2013 might be the year of:
    • A fall off the “fiscal cliff” (even if short)
    • An across-the-board sequestration, and
    • Another government shutdown.
  • They all happened, yet…the stock market shrugged them off!
  • There was no repeat of the sharp sell-off that occurred in August 2011 when Congress and the Administration could not agree on the extension of the debt limit.
the federal budget deficit is shrinking and debt is stabilizing for now
The federal budget deficit is shrinking and debt is stabilizing — for now
  • The budget agreement passed by the House (and expected to be passed by the Senate) provides for a net reduction in the budget deficit through 2023.
  • The Congressional Budget Office projects that the budget deficit will fall to 2 percent of GDP by 2015, and debt held by the public will decline to 68% of GDP. But both will increase after those dates.
  • Source: OMB, Federal Reserve
the challenge for fiscal policy is for the years after 2020
The challenge for fiscal policy is for the years after 2020
  • The CBO projects that growing spending for social security and the government’s major health programs (Medicare, Medicaid, and subsidies provided through insurance exchanges) will begin to strain public finances within a few years.
  • Under the CBO’s baseline projection the budget deficit will begin to rise again by 2017 relative to GDP, taking the debt-to-GDP ratio to 71% of GDP by 2023 and 190% of GDP by 2038. Some unpleasant choices lie ahead.
growth has been weak abroad but is turning up in europe and japan
Growth has been weak abroad, but is turning up in Europe and Japan
  • After two years in a row of weaker-than-expected outcomes, GDP growth has surprised to the upside in the Eurozone and Japan this year.

IMF’s real GDP growth forecasts and actual growth

Eurozone

Japan

growth has also been weak in the emerging markets
Growth has also been weak in the emerging markets.
  • GDP growth has been weaker than IMF has forecasts for three years in a row. The consensus is looking for it to pick up in 2014.

IMF’s real GDP growth forecasts and actual growth

Emerging Markets

weak growth in the emerging markets explains the recent softness in commodity prices
Weak growth in the emerging markets explains the recent softness in commodity prices
  • Weak growth in China — the world’s largest importer of many commodities — is one of the main reasons commodity prices have fallen since 2010.

Commodity Prices

  • Source: Dept. of Energy, BLS
currency regimes within the european union
Currency regimes within the European Union…

Not all members of

the European Union

use the Euro.

  • Source: The Economist
are a pretty good guide to forecasted growth
…are a pretty good guide to forecasted growth

Countries outside of the

Eurozone — where monetary policy has generally been easier —are expected to grow fasterin 2014.

  • Source: The Economist
the outlook for global business is brighter according to surveyed executives
The outlook for global business is brighter, according to surveyed executives

3Q 2013 19

4Q 2012 -11

4Q 2011 -39

  • Source: The Economist/FT Survey of 1,500 business executives
summing it up for 2014
Summing it up for 2014

Likely to be gradual

Helps explain the slow growth

Public finances are improving (for now)

Are expected in all regions

Which adds up to

A gradually rising global GDP growth rate

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Where do we stand?

Economic Outlook for the Year Ahead

Investing in 2014

investing in a gradually improving global economy
Investing in a gradually improving global economy
  • Equity Allocation inline with Investment Objective
    • Domestically biased, internationally opportunistic
    • Slightly favor growth sectors
  • Prepare for Gradually Rising Interest Rates
    • Less interest rate sensitivity
    • High-grade corporate bonds
  • Increased Diversification
    • Commodities
    • Alternative and Flexible Strategies
disclosures
Disclosures
  • This information is compiled by Cetera Financial Group and is believed to be from reliable sources; however no representation is made as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment. Investment decisions should not be based on this material. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in an index. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security or use of investment strategy covered in this material may not be advisable or suitable.